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CORPORATE FINANCE COURSE

University LUISS Guido Carli, Rome Academic year 2014-2015


FINAL EXAM
15 December 2014 Version A

Student ID: _____________


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You have 100 minutes to answer all the questions. Each question gets a maximum score of 5 points. Pass
is 18 points or above, max is 30 points. As this is a closed-book exam you are not allowed to look at the
textbook and/or at your own notes. You are allowed to keep on the desk just a pen, a calculator and the
exam sheets (the one for the questions and the ones for the answers). Use of mobile phones (or any
other device which can storage notes or connect to Internet) is strictly forbidden. Good luck!
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Question 1
You have just won a big lottery prize. You and your family will receive each year a payment of $20,000,
forever. You are going to receive the first payment today. However, you have a strong preference for
receiving all the money immediately and you decide to sell your prize to a friend. How much should your
friend pay in order to acquire from you the right to receive all the perpetual cash flows? (Assume the
annual interest rate is 15%).
PV of perpetuity due = 20,000/0.15 + 20,000 = 153,333
Question 2
The beta of a stock is 1.5; the standard deviation of returns on the market portfolio is 40%. The
correlation coefficient between returns on the market and returns on the stock is 0.8.
a) Calculate the standard deviation of the returns on the stock;
1.5 = (0.8 * stock )/40%; stock =75%
b) calculate the required return on the stock, given that the risk-free rate is 5% and the market
return is 10%
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re = 5% + 1.5 * (10%-5%) = 12.5%


c) assume that the firm that issued the shares gets 70% of its funding from risk-free debt and that
the corporate taxation rate is 30%: what discount rate would you use to find the net present
value of the future cash flows of the firm? (taking into account the benefits of tax shields)
After-tax WACC = (1-0.3) * 5% * 0.7 + 12.5% * 0.3 = 6.2%

In the two following questions, please indicate the correct answer(s). Please note that more than one
answer could be correct.
Question 3
A firm is financed entirely by common stock which offers a 10% expected return. If the company
repurchases 50% of the common stock and substitutes an equal value of debt offering a 5% return, what
is the expected return on the common stock after refinancing? (Ignore taxes)
a)
b)
c)
d)

13%
12.5%
15%
more information is needed

re = 10% + 1 * (10%-5%) = 15%

Question 4
Efficient portfolios (Markowitz) can be obtained by:
a)
b)
c)
d)

investing in portfolios offering the highest expected return for any given level of risk
combining more stocks, but only if the correlation coefficient between their returns is negative
combining more stocks whose returns are not perfectly correlated
investing in portfolios with the lowest Sharpe ratio

Question 5
Please discuss the adjustments needed to calculate cash flow starting from accounting income,
explaining why such adjustments are necessary.
Question 6
Please discuss Modigliani-Miller Proposition I on capital structure. Then discuss how the value of a firm
changes if taxation and costs of financial distress are taken into account; please also provide a graphical
representation.
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