Download Practice Questions of Corporate Finance and more Exercises Corporate Finance in PDF only on Docsity!
CORPORATE FINANCE
FINAL EXAM: FALL 1992
- You have been asked to analyze the capital structure of DASA Inc, and make recommendations on a future course of action. DASA Inc. has 40 million shares outstanding, selling at $20 per share and a debt-equity ratio (in market value terms) of 0.25. The beta of the stock is 1.15, and the firm currently has a AA rating, with a corresponding market interest rate of 10%. The firm's income statement is as follows: EBIT $150 million Interest Exp. $ 20 million Taxable Inc. $130 million Taxes $ 52 million Net Income $ 78 million The current riskfree rate is 8% and the market risk premium is 5.5%. a. What is the firm's current weighted average cost of capital? (1 point) b. The firm is proposing borrowing an additional $200 million in debt and repurchasing stock. If it does so its rating will decline to A, with a market interest rate of 11%. What will the Weighted average cost of capital be if they make this move? (1 point) c. What will the new stock price be if they borrow $200 million and repurchase stock (assuming rational investors)? (1 point) d. Now assume that the firm has another option to raise its debt/equity ratio (instead of borrowing money and repurchasing stock). It has considerable capital expenditures planned for the next year ($150 million). The company also pays $1 in dividends per share currently (Current Stock Price=$20). If the company finances all its capital expenditures with debt and doubles its dividend yield from the current level for the next year, what would you expect the debt/equity ratio to be at the end of the next year. (3 points)
2a. RYBR Inc., an all-equity firm, has net income of $100 million currently and expects this number to grow at 10% a year for the next three years. The firm's working capital increased by $10 million this year and is expected to increase by the same dollar amount each of the next three years. The depreciation is $50 million and is expected to grow 8% a year for the next three years. Finally, the firm plans to invest $60 million in capital expenditure for each of the next three years. The firm pays 60% of its earnings as dividends each year. RYBR has a cash balance currently of $50. Assuming that the cash does not earn any interest, how much would you expect to have as a cash balance at the end of the third year? (2 points) b. Assume that RYBR had financed 20% of its reinvestment needs with debt, estimate the cash balance at the end of the third year. ( 2 points) c. Now assume that stockholders in RYBR are primarily corporations. They are exempt from ordinary taxes on 85% of the dividends that they receive (Ordinary tax rate=30%), and pay capital gains on price appreciation at a 20% rate. If RYBR pays a dividend of $2 per share, how much would you expect the stock price change to be on the ex-dividend date? (2 points)
- LOB Inc. is a firm with the following characteristics: Year 1 2 3 After year 3 Growth rate in EPS 20% 16% 12% 6% ROC 20% 20% 16% 12% D/E 0% 10% 25% 50% i NA 8% 8% 8% Beta 1.40 1.25 1.15 1. The firm has EPS currently of $2.00. The tax rate is 40%. The current riskfree rate is 6.5%. The tax rate is 40%. (The market risk premium is 5.5%) a. What would you project the EPS and DPS to be for the next three years? (2 points) b. What is the terminal price (at the end of the third year)? (2 points) c. What is your best estimate for the DDM Value per share? (2 points)
Roy Rogers 1.35 70% (The comparable firms all have the same tax rate as Boston Turkey). You can assume that the market risk premium is 5.5%. As general information, you have also collected data on interest coverage ratios, ratings and interest rate spreads, and they are summarized below: Rating Interest Cov. Ratio gt. and Cov. Ratio lt. Spread over T-bond AAA 9.65 ∞ 0.30% AA 6.85 9.35 0.70% A+ 5.65 6.849999 1.00% A 4.49 5.649999 1.25% A- 3.29 4.4899999 1.50% BBB 2.76 3.2899999 2.00% BB 2.17 2.7599999 2.50% B+ 1.87 2.1699999 3.00% B 1.57 1.8699999 4.00% B- 1.27 1.5699999 5.00% CCC 0.87 1.2699999 6.00% CC 0.67 0.8699999 7.50% C 0.25 0.6699999 9.00% D - 100000 0.2499999 12.00% The treasury bill rate is 3.00% and the treasury bond rate is 6.25%. a. What is the current cost of equity? b. What is your best estimate of the current after-tax cost of debt? (The company is not rated currently) c. What is the current cost of capital?
As part of your analysis, you are examining whether Boston Turkey should borrow $500, and buy back stock. If it does so, its rating will drop to A-. d. If it does so, what will the new cost of equity be? e. How much will the stock price change if it borrows $500,000 and buys back stock?
- Boston Turkey was so impressed with your grasp of capital structure basics that they have come back to you for some advice on dividend policy. To save you the trouble of having to refer back to page 1, the latest financial statements are reproduced on this page. Income Statement Revenues $ 1,000,
- Expenses $ 400,
- Depreciation $ 100, EBIT $ 500,
- Interest Expense $ 100, Taxable Income $ 400,
- Tax $ 160, Net Income $ 240, Balance Sheet Assets Liabilities Property, Plant & Equipment $ 1,500,000 Accounts Payable $ 500, Land & Buildings $ 500,000 Long Term Debt $ 1,000, Current Assets$ 1,000,000 Equity (100,000 shares) $ 1,500, Total $ 3,000,000 Total $ 3,000, Boston Turkey expects its revenues to grow 10% next year, and its expenses to remain at 40% of revenues. The depreciation and interest expenses will remain unchanged at $100,000 next year. The working capital, as a percentage of revenue, will remain unchanged next year. The managers of Boston Turkey claim to have several projects available to choose from next year, where they plan to invest the funds from operations, and suggest that the firm really should not be paying dividends. The projects have the following characteristics -- Project Equity Investment Expected Annual CF to Equity Beta
(The comparable firms all have a tax rate of 40%) [ This is the same information you were given in problem 1. You can use the beta estimated from that section in this problem.] a. Assuming that these numbers are sustainable for the next three years, what is the expected growth rate in earnings per share for this period? b. The growth rate after year 3 is expected to be 6% forever. What will the price per share be at the end of year 3? c. What is the value per share using the dividend discount model?
Corporate Finance: Final Exam - Fall 1994
- Jackson-Presley Inc. is a small company in the business of producing and selling musical CDs and cassettes and it is also involved in promoting concerts. The company last two reported income statements indicate that the company has done very well in the last two years – Last Year Current Year Revenues $ 100 million $150 million
- Cost of Goods Sold $ 40 million $ 60 million
- Depreciation & Amortization $ 10 million $ 13 million Earnings before interest and taxes $ 50 million $ 85 million Interest Expenses $ 0 $ 5 million Taxable Income $ 50 million $ 80 million Taxes $ 20 million $ 32 million Net Income $ 30 million $ 48 million The company's current balance sheet also provides an indication of the company's health: Assets Liabilities Property, Plant & Equipment $ 100 million Current Liabilties $ 20 million Land and Buildings $ 50 million Debt $ 60 million Current Assets $ 50 million Equity $120 million Total $ 200 million Total $200 million Jackson-Presley's stock has been listed on the NASDAQ for the last two years and is trading at twice the book value (of equity). There are 12 million shares outstanding. Jackson-Presley derives 75% of its total market value from its record/CD business and 25% from the concert business. While the price data on the company is insufficient to estimate a beta, the betas of comparable firms in these businesses is as follows – Comparable Firms Business Average Beta Average D/E Ratio Record/CD Business 1.15 50.00% General Information The current treasury bond rate is 8.00%. All the questions in this exam relate to the company described in problem 1. You can use information across problems.
- The equity is trading in the market at two times the book value. The debt is composed of ten-year bonds, and is rated A (Typical A rated bonds are yielding 10% currently in the market).
- Assume that Jackson-Presley intends to maintain its working capital at the same percentage of revenues for the next year, as it has this year.
- Also assume that the following is the listing of the major investment opportunities that Jackson-Presley has for the next year. Project Total Investment IRR on project (using CF to Equity) Beta (Levered) A $ 15 million 16% 1. B $ 30 million 15% 1. C $ 25 million 12.5% 1. D $ 20 million 11.5% 0. a. If revenues, net income and depreciation are all expected to grow 20% next year, and the firm maintains its existing debt financing mix (in market value terms), how much can the firm afford to pay out as dividends after meeting working capital and capital budgeting needs? ( 5 points) b. The company's current cash balance is $10 million. What will happen to this cash balance if Jackson-Presley maintains its payout ratio at 25% next year? (1 point)
- The managers at Jackson-Presley also believe that they are significantly undervalued, and want you to estimate how much the equity in the firm is truly worth. They provide you with the following additional information –
- They believe that they can maintain 'high growth' for the next five years.
- The beta calculated, using comparable firms, in problem 1b, is a good estimate of the beta for the next five years.
- The dividend payout ratio will be maintained at 25% for the high-growth period.
- The current (from the current income statement and balance sheet) return on capital, debt equity ratio and interest rate will be maintained for the high growth period. (The book value of equity at the beginning of the year was $ 100 million but the book value of debt is unchanged…)
- There are 12 million shares outstanding.
- After the high-growth period, the earnings growth rate is expected to drop to 6%, and the firm's return on capital will also drop to 15%. The debt equity ratio and interest rate are expected to remain unchanged. The beta is expected to be 1.00 in the stable growth period. a. Estimate the expected growth rate in the high growth period. ( 2 points) b. Estimate the expected dividends in the high growth period. (1 point) c. Estimate the expected payout ratio in the stable growth phase. (2 points) d. Estimate the terminal price (at the end of the high-growth period) (2 points) e. Estimate the value today from the dividend discount model. (1 point)
- Jackson-Presley is now planning a major restructuring involving the following actions
- A division, producing records and cassettes, will be sold for $ 50 million. That division is currently earning $ 5 million before interest and taxes. As mentioned in problem 1, comparable firms in this business have an average beta of 1.15 and an average debt/equity ratio of 50%.
- The cash from the sale of the divisions will be used to buy back stock.
- The dividend payout ratio will be reduced to 15%. a. Estimate the new growth rate in earnings, after the restructuring, using fundamentals. (4 points) b. Estimate the new cost of equity for Jackson-Presley after the restructuring. (4 points)
Company Beta D/E Ratio Alberto Culver 0.85 10% Avon Products 1.3 40% Gillette 1.25 25% Helen of Troy 0.95 15% Helene Curtis 0.85 20% All these firms face a marginal tax rate of 40%.
- The debt on the balance sheet has two components. The first is traded bonds, with ten years to expiration and a coupon rate of 7%; there are 50,000 bonds outstanding, trading at $ 850 apiece (the face value is $ 1000). The second is $50 million in bank debt, which also has a ten year maturity, and carries an interest rate of 6%. a. Estimate the cost of equity for SDL Inc. (2 points) b. Estimate the market value of debt and the after-tax cost of debtfor SDL Inc. c. Estimate the cost of capital for this firm. (1 point) d. Assume that you have regressed SDL’s firm value over the last 8 quarters against long term rates, GNP growth and the DM (SDL’s overseas sales are primarily in Europe) and have arrived at the following results – Change in firm value = 0.11 - 1.50 (Change in Long Term Interest Rate) Change in firm value = 0.18 + 0.50 (GNP Growth) Change in firm Value = 0.15 - 0.26 (US $ /DM Currency Rate) Does SDL’s current debt mix (ten-year $ debt) fit its needs? If so, why? If not, why not? How would you change the debt mix to fit their firm characteristics? (2 points) e. Assume that this firm decides to do an acquisition of XLNT Inc, a specialty retailer, who sells primarily cosmetics. XLNT has an estimated market value of equity of $ 150 million, a beta of 1.25 and no debt outstanding. The acquisition will be financed entirely with debt, which will result in the rating for SDL dropping to BBB; typical BBB rated bonds currently carry an interest rate of 9.5%. Estimate SDL’s cost of capital after this acquisition. (4 points)
- VRF Inc. is a well-established firm that manufactures automobile components, and has a long and venerable history. It has come to you for advice on dividend policy, and it
provides you with the following information for 1994 (which is its most recent year of financial data)–
- In 1994, it had revenues of $1,000 million and made a net income of $ 150 million; it had a book value of equity of $ 1.5 billion.
- It had capital expenditures of $ 175 million in 1994, and depreciation of $ 100 million.
- The working capital increased from $80 million in 1993 to $100 million in 1994.
- The firm did not have debt outstanding at any time during the year.
- The firm’s cash balance increased by $ 25 million from 1993 to 1994, after the payment of dividends for the period. a. How much did the company pay out as dividends during 1994? (4 points) b. Assume now that you are trying to estimate how much it should pay out as dividends during 1995, and that you are given the following additional information –
- The revenues and earnings are expected to grow 10% from 1994 levels.
- The working capital is expected to remain at the same percent of revenues as in 1994.
- The depreciation is expected to grow at the same rate as earnings, but the firm has broken out its expected capital expenditures by division for 1995– Division Cap Ex Needs Return on Equity Beta A $ 75 million 13% 1. B $ 50 million 16% 2. C $ 65 million 12% 0. D $ 60 million 15% 1. The long term bond rate is 6%, and the beta of the stock is 1.05. The market risk premium is 5.5%.
- The firm also plans to raise 20% of its net capital expenditure and working capital needs from debt. Should it make all its scheduled capital expenditures? Assuming that you can reevaluate these capital expenditures, how much cash does the firm have available to return to stockholders in 1995? (5 points)
Corporate Finance: Final Exam - Spring 1996
Aswath Damodaran
- You have been hired by Samson Corporation, a mid-size company which manufactures luggage to assess their capital structure. You have been provided with the most recent income statement and balance sheet for the company – Income Statement Revenues $ 100 million
- Cost of Goods Sold $ 60 million (Includes depreciation of $ 10 million) = EBIT $ 40 million
- Interest Expenses $ 6 million = Taxable Income $ 34 million
- Taxes $ 13.6 million = Net Income $ 20.4 million Balance Sheet Assets Liabilities Fixed Assets $ 100 million Current Liabilities $ 20 million Current Assets $ 40 million Debt $ 60 million Equity $ 60 million The company had 10 million shares outstanding trading at $24 per share. Nearly 40% of the outstanding stock is held by the founding family. You are also provided with the following additional information –
- A regression of returns on the stock against a market index over the last 5 years yields a beta of 0.90, but Samson had no debt for the first four out of the five years. Its debt ratio in the fifth year was similar to its current debt ratio.
- The debt is 10-year bank debt; however, based on its interest coverage ratio the firm would be rated AA and carry a market interest rate of 10%. The treasury bond rate is 8% and the market risk premium is 5.5%. a. Estimate the current cost of equity for Samson Corporation. ( 2 points) b. Estimate the current weighted average cost of capital for Samson Corporation ( 2 points). This exam is worth 30 points. Please answer all questions.
c. Assume now that Samson Corporation plans to double its debt ratio. The bond rating is expected to drop to BBB, with a market interest rate of 11.5%. Estimate the new cost of capital. ( 2 points) d. If Samson does decide to double its debt capacity immediately by buying back stock, estimate the dollar debt it would need to borrow. ( 1 point) e. If Samson decides to double its debt ratio over the next 3 years, and plans to use the new debt to finance new projects, estimate the total dollar debt that the firm will have to issue over the next 3 years. (Samson pays no dividends) ( 3 points) f. Based upon the most recent financial data, would you suggest that Samson take projects with the debt or return cash to stockholders. Explain. (You can assume that the book value of equity was $ 40 million at the beginning of the year, while the book value of debt was $ 60 million) (1 point)
- You have been asked by Jupiter Corporation, a toy manufacturer, for advice on dividend policy. Jupiter Corporation had net income of $ 150 million in 1995 and reported depreciation of $ 20 million. Its balance sheets for 1994 and 1995 are provided below (in millions): Assets Liabilities 1994 1995 1995 1995 Net Fixed Assets $750 $ 800 Current Liabilities $50 $ Current Assets Debt $ 200 $ 215 Cash $ 50 $ 100 Equity $ 650 $ 720 Non-cash Current Assets $100 $ 120 a. Estimate how much Jupiter paid out as dividends during 1995.( 2 points) b. Estimate how much capital expenditure Jupiter Corporation had in 1995. ( 1 point) c. Now assume that you have been given the following information on next year’s projections for Jupiter Corporation.
- Net Income, depreciation and non-cash working capital are expected to increase 10% from 1995 levels.
- The firm has four projects that it is considering for next year Project EBIT Investment Beta
Corporate Finance: Final Exam - Spring 1997
This exam is worth 25% and you have 2 hours.
- Solo Corporation, a manufacturer of surf boards, has asked for your advice on whether to invest $ 40 million in a new line of beach products:
- The investment will yield earnings before interest and taxes of $ 10 million a year, and any depreciation on the project will be invested back into the project as capital maintenance expenditure. There will be no working capital investments.
- The project is expected to have an infinite life.
- The company has a beta of 1.2, but this project is expected to have a beta of 1.5.The firm will maintain its existing financing mix of 60% equity and 40% debt. The cost of borrowing is 10%.
- The tax rate for the company, including California State taxes, is 40%. The ten-year bond rate is 7%. Calculate the NPV of this project. ( 3 points)
- VRC Inc., a privately-owned business in several business lines, wants to estimate a cost of equity for itself as a business. The company provides you with the following information on the businesses it operates in, the operating income it has in each business and the betas of comparable firms in each business line Business Line Operating Income Comparable Firms Beta D/E Ratio Technology $ 50 million 1.60 10% Auto Parts $ 40 million 1.20 30% Financial Services $ 60 million 1.15 100% Assuming that the tax rate for all firms is 40%, that the operating income is proportional to divisional value and that VRC has a debt to capital ratio of 40%, estimate the equity beta for VRC. ( 4 points)
- SynerMedia Inc., a entertainment and media corporation, with 50 million shares trading at $ 40 per share, and no debt, announces that it will borrow $ 500 million and buy back $ 500 million worth of stock. The stock price immediately jumps to $ 44 per
share. If the beta before the stock buy back was 0.80, estimate the interest rate paid on the new debt. (The T.Bond rate is 7% and the company has a tax rate of 40%) ( 5 points) 4a. DelCash Inc., a discount retailer, has declared and paid a dividend of $ 500 million this year. You notice, looking over their financial statements, that they have net income of $ 2 billion for this year, and that the cash balance for the firm increased by $ 250 million. If the non-cash working capital was unchanged over the year, and the firm finances 30% of its net capital expenditures from debt, estimate the net capital expenditures that DelCash had during the year. ( 2 points) 4b. On the ex-dividend day, the stock price of Del Cash dropped by $ 1.80. If the typical stockholder in Del Cash paid 40% on dividend income and 20% on capital gains taxes, estimate the number of shares outstanding in the firm. ( 2 points)
- PlayMania, a company that manufactures play equipment for children, has called you in as a value consultant.
- The company has made and expects to continue to make a return on equity of 15% on its projects, and the beta of the stock is 1.
- It pays out 60% of its earnings as dividends, and the firm views itself as stable.
- The company has earnings per share of $ 2.00 in the current year.
- The T.Bond rate is 7% a. Estimate the equity value per share of this company. ( 2 points) b. The company is planning to increase capital expenditures and lower its payout ratio to 50%. In doing so, it will also be taking projects with lower returns, resulting in a return on equity to 14%. Assuming that it can sustain this payout ratio and return on equity forever, estimate the value of equity per share. ( 3 points)
- Answer the following true or false questions on valuation ( 1 points each)
- Increasing the debt ratio of a firm will increase the value of the firm. TRUE FALSE
- The FCFE value per share for a firm will always be greater than the dividend discount model. TRUE FALSE
