Final Exam Practice Questions

1. The common stock of Chelsea, Inc. has a beta of 1.14, a market price of $38.90, and an
expected dividend of $0.90 next year. The market risk premium is 6% and the risk-free
rate of return is 3%. What is the cost of equity for Chelsea, Inc.?
Using CAPM: rE = 3%+6%*1.14 = 9.84%
- Dividend growth model cannot be used as the growth rate is not given

2. Blofeld Corporation has 9.2 million shares of common stock outstanding, 360,000
shares of 5% $100 par value preferred stock outstanding, and 157,000 7.50%
semi-annual bonds outstanding, par value $1,000 each. The common stock currently
sells for $40 per share and has a beta of 1.60, the preferred stock currently sells for $96
per share, and the bonds have 15 years to maturity and sell for 111% of par. The market
risk premium is 8.0%, T-bills are yielding 5%, and Blofeld’s tax is 40%. The WACC of the
company is: Answer = 12.28%

3. Henry, Co. needs $22.5 million to finance its latest venture which will be funded by
issuing new shares of common stock at $50 a share. The indirect costs of the issue are
$185,000, the direct costs are $925,000, and the underwriting spread is 7.5%. How many
shares of stock must Henry, Co. issue to fully fund their venture?
Total funds needed to be raised = 22,500,000+185,000+925000 = 23,610,000 Funds
raised from issuing each share after the underwriting spread = 50*(1-7.5%) = 46.25
Number of shares to be issued to raise the required fund = 23,610,000/46.25 = 510,486
4. Szoltan, Inc. is proposing a rights offering. Presently there are 200,000 shares
outstanding at $60 each. There will be 40,000 new shares offered at $50 each. What is
the value of a right?

Number of rights required to buy one share, N = 200,000/40,000 = 5 M = 60

S = 50 Value of right = (60 – 50)/(5+1) = 1.67

5. With firm commitment underwriting, the issuing firm:

Knows up-front the amount of money they will receive from the stock offering.

6. Fich & Co. expects its EBIT to be $66,000 every year forever. The firm can borrow at 8
percent. Fich & Co. currently has no debt, and its cost of equity is 14 percent. What will
the value be if the company borrows $140,000 and uses the proceeds to repurchase
shares? Tax rate is 35%.
Value of unlevered firm, Vu = 66,000*(1-35%)/14% = 306,428.57 Value of the levered firm,
VL = 306,428.57 + 140,000*35% = 355,428.57

7. An investor owns 500 shares of stock in a firm with a debt/equity ratio = 1.0. The investor
prefers an all-equity firm. If the stock price is $2 per share, what should the investor do?
Answer: Sell 250 shares and lend $500
As D/E is 1, the firm currently has 50% Debt and 50% equity financing
- In order to de-lever the shareholder needs to sell 50% of their shares and lend the
proceeds
- They need to sell 500 x 50% = 250 shares for 250 x $2 = $500 and lend it

8. Fergi, Inc. is financed 100% with equity. The firm has 100,000 shares of stock
outstanding with a market price of $5 per share. Total earnings for the most recent year
are $50,000. The firm has cash of $25,000 in excess of what is necessary to fund its
positive NPV projects. What will be the firm's price/earnings ratio after the repurchase if
the firm uses the $25,000 excess cash to buy back stock at $5 per share?
Number of shares after buyback = 100,000 – 25,000/5 = 95,000 New EPS after the
repurchase = 50,000/95,000 = 0.5263 New P/E ratio = 5/0.5263 = 9.5

9. Fiester & Miester has 75,000 shares of stock outstanding at a market price of $87 a
share. The company has just announced a 5-for-3 stock split. There will be _______
shares of stock outstanding after the split trading at ____ per share.
Number of shares after the stock split = 75000*5/3 = 125,000
Price of shares after the split = $87*3/5 = $52.20

10. Apples 'R' Us, a national chain of fruit stands, has an inventory period of 65 days, an
accounts payable period of 30 days, and an accounts receivable period of 24 days. The
CFO wants to implement a discount plan in order to reduce the receivables period to 18
days. What will happen to the firm's operating cycle?
Old operating cycle = Inventory period + A/R period = 65 + 24 = 89 days
New operating cycle = 65 + 18 = 83 days
11. Which of the following issues is NOT considered a part of short-term finance?
- How much credit should be extended to customers?
- How much should the firm borrow short-term?
- What is a reasonable level of cash for the firm to maintain?
- How much of the firm's current income should be paid out as dividends?
- Should the firm issue commercial paper or obtain a bank loan?

12. Your firm has an average receipt size of $125. A bank has approached you concerning a
lockbox service that will decrease your total collection time by two days. You typically
receive 6,400 cheques per day. The daily interest rate is .016 percent. The bank charges
a lockbox fee of $175 per day. Your firm should accept the lockbox agreement because
its NPV is:
PV of benefits from lockbox = 6400*125*2 = $1,600,000
PV of costs of lockbox = 175/0.016% = $1,093,750
NPV of lockbox = $1,600,000 - 1,093,750 = $506,250

13. Han, Inc. and Solo Co. are all-equity firms. Han has 2,400 shares outstanding at a market
price of $24 a share. Solo has 4,000 shares outstanding at a price of $17 a share. Solo is
acquiring Han for $63,000 in cash. The incremental value of the acquisition is $5,500.
What is the net present value of acquiring Han to Solo?
Value of Han to Solo, VB* = 2400*24 + 5500 = $63,100
Cost of acquisition = $63,100
NPV of the acquisition = VB* - Cash cost of acquisition = $100

14. A tender offer in a merger and acquisition bid can best be defined as:
A public offer by one firm to directly buy the shares from another.

15. A consolidation is the combining of firms such that: A new firm is created and both the
acquired and the acquiring firms cease to exist.

16. Wheatley Corp. is acquiring Romney Company. Both firms have no debt. Wheatley
believes the acquisition will increase its total after-tax annual cash flows by $1.9 million,
indefinitely. The current market value of Romney is $41 million, and that of Wheatley is
$79 million. The appropriate discount rate for the incremental cash flows is 10 percent.
Wheatley has offered 40 percent of the combined firm’s stock to Romney’s
shareholders. What is Wheatley’s cost of acquisition?
Value of the merged firm = 41 m + 79 m + 1.9 m/10% = $139 m
Merged firm = cost of acquisition = 139*40% = $55.6 m

17. Which one of the following statements is correct concerning acquisitions?

If the acquisition is done on an all cash basis the shareholders of the target firm are
excluded from any losses resulting from an unsuccessful merger

18. In the financial world, the term poison pill refers to: A tactic to make unfriendly takeover
attempts unappealing.
19. MG Inc is a multi-divisional firm that uses its WACC as the discount rate for all proposed
projects. Each division is in a separate line of business and each presents risks unique
to those lines. Given this, a division within the firm will tend to: prefer higher risk
projects over lower risk projects.

20. Both firms are 100% equity-financed. Firm A can acquire firm B for $82,500 in the form
of either cash or stock. The synergy value of the deal is $12,500. Firm A has 10,000
shares while firm B has 7,500 shares outstanding. Firm A shares are trading for $25 and
B’s shares are trading for $10 in the market. What will the price per share be of the
post-merger firm if payment is made in stock?
Value of merged firm = 10000*$25 + 7500*$10 + 12,500 = $337,500
Number of shares outstanding after paying B with shares = 10,000+82,500/25 = 13,300
Share price of merged firm = $337,500/13,300 = $25.38

21. When Firm A acquired Firm B, no incremental value was created but earnings per share
increased. If the financial markets are astute, the price-earnings ratio of Firm A should
_________ and the stock price of Firm A should __________. decrease; remain constant

22. Which of the following is NOT a source of acquisition gains from cost reduction?
- Unused debt capacity
- Economies of scale
- Complementary resources
- Economies of vertical integration
- Enhanced operating efficiencies

23. Shinnit Bicycles makes reproduction cruisers. The firm primarily uses steel to make the
bikes with only a small amount of plastic. The cost of producing each bike is highly
sensitive to steel prices and relatively insensitive to the price of plastic. The slope of the
firm's risk profile with regard to ________ will, therefore, be ______ its risk profile with
regard to __________. plastic; flatter than; steel

24. Which one of the following obligates the seller to buy an asset for a specified price but
only if the contract is exercised? Put option

25. You sell one futures contract for 112,000 pounds of sugar with a settlement price of
20.87 cents per pound. If the price is 19.63 cents per pound at the contract expiration,
what is your payoff?
Short position wins as the price of the underlying asset goes down in the market
Payoff from the short futures on sugar = 112,000*(20.87 – 19.63) = 138,880 c.

26. What do we mean when we say a contract is a zero sum game?

One party to the contract can make money only at the expense of the other

27. Gains and losses on futures contracts are realized: On a daily basis through
marking-to-market.
28. Which one of the following statements concerning forward contracts is true? The seller
of a forward contract on corn profits when the price of corn falls.

29. ABC Company and XYZ Company need to raise funds to pay for capital improvements at
their manufacturing plants. ABC Company can borrow funds either at 8% fixed or LIBOR
+ 1% floating rate. XYZ Company can borrow funds either at a 9.5% percent fixed rate or
at LIBOR + 0.5% floating rate. Company ABC prefers floating but has issued fixed rate
bonds. Company XYZ prefers fixed loans but have borrowed at floating rate. You can
bring these two companies together in an interest rate swap where:
Answer: Net payment for ABC will be LIBOR and for XYZ will be 9% while you make 0.5%
as a swap dealer

30. The common stock of Pallmall, Inc. is currently priced at $52.50 a share. One year from
now, the stock price is expected to be either $54 or $60 a share. The risk-free rate of
return is 4 percent. What is the value of one call option on Pallmall stock with an
exercise price of $55? Answer: $0.48

31. Which of the following is true regarding convertible bonds?

The floor price of a convertible bond is the greater of the straight bond value and the
conversion value

32. The maximum value of a call option is equal to: The price of the underlying stock.
33. Roomla stock is currently priced at $42.27 a share. The six-month puts on Roomla
shares are priced at $0.80 and have a $42.50 strike price. Fred owns 1,000 shares of
Roomla stock and wants to sell it for the best possible returns now. Fred should:
Answer: Sell the shares directly at the market price

If sold right now, Fred will get $42.27 per share

If Fred uses put options to sell shares, he will get = 42.5 – 0.8 = $41.70 per share
He is better off (higher return) selling the shares in the market for $42.27 now

34. Employee stock options are designed to: Align employee goals with shareholder goals

35. A firm has a zero-coupon bond issue outstanding with a face value of $12 million, a
current market value of $8 million, and a maturity date of 5 years. The risk-free rate of
return is 4%. The equity in this firm is a:
Answer: Call option with a strike price of $12 million.
- Using the concept of equity as a call option when the firm is levered

36. You own a put option contract on Peloton Brothers stock with an exercise price of
$37.50. What is the intrinsic value of your investment if Peloton stock is currently selling
for $32.90 a share? $460
Put option is in the money as the strike price is higher than the underlying asset’s price
in the market
The intrinsic value of the option = (37.5-32.9)*100 = $460

37. A new 30-year callable, convertible bond has a 3.2 percent coupon, payable annually,
and its face value is $1,000. The conversion price is $58 and the stock currently sells for
$39. Comparable nonconvertible bonds are priced to yield 4.9 percent. What is the
minimum value of the bond in the market?
Conversion ratio = 1000/58 = 17.24 Conversion value = 17.24*39 = 672.41
Based on information provided about the bond, the straight bond value will be $735.66
[YOU WILL NOT BE REQUIRED TO CALCULATE THIS VALUE IN YOUR TEST – THE
QUESTION WILL PROVIDE INFORMATION ABOUT THE STRAIGHT BOND VALUE]
The floor/minimum value of the bond will be the higher of straight bond value and
conversion value, which is $735.66

38. A rights offering in which an underwriting syndicate agrees to purchase the

unsubscribed portion of an issue is called a _____ underwriting. Stand-by
39. Several rumors concerning Setla stock are causing the market price of the stock to be
quite volatile. Given this situation, you decide to buy both a one-month European $10
put and a one-month European $10 call on this stock. The call premium is $0.35 and the
put premium is $1.60. What will your net profit or loss be on these option positions if the
stock price is $7 on the day the options expire? Ignore taxes. $105

The call option ends up out of the money and will have a zero payoff
The put option is in the money and will have a payoff of (10-7)*100 = $300
Total premium paid on the options = (0.35+1.6)*100 = $195 Net profit from the two
options = $300 – 1995 = $105

40. Dortmund Tech is currently an all equity firm that has 320,000 shares of stock
outstanding with a market price of $21 a share. The current cost of equity is 15.4
percent and the tax rate is 34 percent. In a capital restructuring decision, the firm is
considering adding $1.2 million of debt with a coupon rate of 8 percent to its capital
structure. The debt will be sold at par value. What will be the levered value of equity?
VU = 320000*21 = $6.72 m VL = 6.72 m + 1.2 m *0.34 = $7.128m
Value of levered equity = VL – Debt = 7.128 m – 1.2 m = $5.928m

41. Principal, Inc. is acquiring Secondary Companies for $29,000 in cash. Principal has
2,500 shares of stock outstanding at a market price of $30 a share. Secondary has 1,600
shares of stock outstanding at a market price of $15 a share. Neither firm has any debt.
The net present value of the acquisition is $4,500. What is the price per share of
Principal after the acquisition?
Value of Principal after merger = V Principal + NPV of merger = 2500*30 + 4500 =
$79,500
Price of share after merger = 79,500/2,500 = $31.80

42. Costs that decrease as a firm acquires additional current assets are called _____ costs.
Shortage

43. An increase in which of the following will increase the value of a call?
➔ I. time to expiration
➔ II. underlying stock price
➔ III. risk-free rate of return
➔ IV. price volatility of the underlying stock
I, II, III and IV

44. Oil processor and canola farmer are the two parties in a futures contract. Suppose that
three days after taking out 100 futures contracts the price of December canola
increases from $610 to $640 a tonne. The ______ will make a $3,000 payment to the
______ for marking to market. Farmer; Processor
45. On May 1, your firm had a beginning cash balance of $175. Your sales for April were $430
and your May sales were $480. During May, you had cash expenses of $110 and payments
on your accounts payable of $290. Your accounts receivable period is 30 days. What is
your firm's beginning cash balance on June 1?

May cash disbursements = 110 + 290 = 400 May cash receipts = April sales (as the
receivables period is 30 days) = $430 Beginning cash balance of June = Ending cash
balance of May = Beginning cash balance of May + Cash collection in May – Cash
disbursement in May = 175 + 430 – 400 = $205