SCHULICH SCHOOL OF BUSINESS FINE6100 Corporate Finance Fall 2010 Final Exam Prof. A. Marshall NAME: I.D.

. # : NUMBER OF PAGES: Cover & Instruction pages Exam, including spare page LENGTH OF EXAMINATION: EXAMINATION AIDS ALLOWED: INSTRUCTIONS: 1 2 3 4 5 6 7 8 9 10 11 12 Cheating on an examination will result in an F grade in the course concerned and possible suspension from the University. All notes, except your formula sheet, briefcases, and books must be deposited at the front of the room unless you are writing an open book examination. Count the pages to be certain that there are no pages missing. Do not begin this examination until you are instructed to do so. You are not allowed to use your own paper for rough work. If you need scrap paper, use the back side of each page. No notes or books are permitted, other than your formula sheet. No marks will be given for unsupported answers. Assume a 365-day year throughout this exam. No questions will be answered during the exam. Answers must be written (or printed) neatly and legibly in the space provided. DO NOT REMOVE ANY PAGES OR THE STAPLE FROM THIS EXAM. There will be a penalty of 10 marks for the removing the staple and for each page missing. When you are finished, you must submit this examination booklet as well as the multiple choice and formula sheet package. If either is removed from the room, you will be assigned a mark of zero (0) and face disciplinary proceedings under the Regulations on Academic Honesty. 16 pages total 2 pages (unnumbered) 14 pages 3 hours 1 8 x 11 double-sided formula sheet Calculator

FINE6100 Corporate Finance

Fall 2010

ADDITIONAL INSTRUCTIONS

1. 2. 3. 4. 5. 6.

Please place your I.D. card on the right-hand side of the desk. If you must leave the room for personal reasons, please raise your hand and a proctor will escort you. Budget your time carefully. You are to stop writing immediately upon being told that the exam is over. Make sure you submit the examination, upon completion. The suggested times below are guidelines only. They provide a time budget that will use 2.5 hours of the allotted time.

DO NOT WRITE IN THE TABLE BELOW Question 1 Question 2 Question 3 Question 4 Question 5 Question 6 Question 7 Question 8 TOTAL 12 marks 6 marks 6 marks 13 marks 7 marks 20 marks 16 marks 20 marks 100 marks 18.0 min. 12.0 min. 12.0 min. 19.5 min. 10.5 min. 30.0 min. 24.0 min. 30.0 min. 150.0 min.

Final Examination

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FINE6100 Corporate Finance Question 1 (12 marks)

Fall 2010

York Brothers Inc (YoBro), an all equity-financed firm, is considering a change in its capital structure that would entail issuing $500,000 in debt at an interest rate of 12% and then repurchasing some of its shares with the debt issue proceeds at the current market price per share of $25. The firm has 50,000 common shares outstanding, the beta of its common stock is 1.5, its tax rate is 40% and its EBIT (earnings before interest and taxes) equals $375,000. Assume that the EBIT and the debt are perpetuities and that there is no possibility of debt default. Required: Determine what will happen to the following variables if the firm were to adopt the change in capital structure: (a) Total market value of the firm. (2 marks)

(b)

Total market value of equity. (2 marks)

(c)

Market price per share. (2 marks)

Final Examination

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FINE6100 Corporate Finance Question 1 (Continued) (d) WACC (weighted average cost of capital). (2 marks)

Fall 2010

(e)

Cost of equity capital. (2 marks)

(f)

Beta of the common stock. (2 marks)

Final Examination

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FINE6100 Corporate Finance Question 2 (6 Marks)

Fall 2010

Roberts Industries has 10 million shares of common stock outstanding at a current market price of $30.00 per share. The firm plans to raise $50 million through a rights offering with the subscription price set at $20 per share. Required: (a) How many rights are required to purchase one share? (2 marks)

(b)

What is the expected value of the embedded right on the day before the ex-rights date, assuming that the shares still trade for $30.00? (2 marks)

(c)

If the share price is $28.60 on the ex-rights date, what is the value of a right? (2 marks)

Final Examination

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FINE6100 Corporate Finance Question 3 (6 marks)

Fall 2010

York Professional Services (YoProf) follows a residual dividend policy, has a debtequity ratio of 1:3 and expects to spend $4 million in the coming year on capital projects. Required: (a) If the firm earns $2.5 million in the coming year, what will be the total dividends paid and how much new external equity will the firm need to raise?

(b)

If the firm earns $5 million in the coming year, what will be the total dividends paid and how much new external equity will the firm need to raise?

Final Examination

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FINE6100 Corporate Finance Question 4 (13 Marks)

Fall 2010

Golden Slumbers Mattress Company (GSMC, statements on page 1) is forecasting sales to increase by 6% in 2011 to $58.4 million. (A multiplicative factor of 320/300 will give you the exact growth factor.) The firms capacity is sufficient for sales of up to $60 million and the firms fixed expenses are expected to remain fixed to that same level. The owners, Jacob Golden and Jaime Slumbers, have indicated that they plan to withdraw $7.5 million in dividends in 2011, after drawing $5 million in 2009 and $6 million is 2010. Interest is 8% of long term debt, but the rate earned on marketable securities is so low at this time that it is being forecast at 0%. The marketable securities can only be bought and sold in multiples of $1 million. The target is to maintain the cash balance between $2 million and $3 million, and adjusting the marketable securities balance or drawing on their unused line of credit, as necessary. Depreciation, which is included in Fixed Expenses on the Income Statement, is 20% of the preceding years Net Fixed Assets value. Required: (a) Using the percentage of sales method, forecast GSMCs working capital needs for 2011. For your convenience, if needed, you are provided the entire set of financial statements are provided, but only the working capital items will be marked. Place your forecast values in the boxes on the next page. (10 marks) Which of the following are appropriate types of securities for the marketable securities portfolio mentioned above? (3 marks) Security Bankers Acceptances 20 Year Government of Canada Bond Bank of Nova Scotia Common Stock Province of Ontario Treasury Bills Google Inc. Commercial Paper Indicate Yes/No

(b)

Final Examination

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FINE6100 Corporate Finance Government of Ireland Treasury Bills

Fall 2010

Final Examination

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FINE6100 Corporate Finance Question 4(Continued)

2009 Sales COGS Gross Margin Fixed Expenses EBIT Interest Profit Before Tax Taxes Net Income Assets Cash Marketable Securities Accounts Receivable Inventory Prepaid Expenses Current Assets Fixed Assets Less: Acc. Depreciation Net Fixed Assets Total Assets Liabilities & Equity Accounts Payable & Accruals Line of Credit Long Term Debt Common Shares Retained Earnings Total Liabilities & Equity Dividends Change in Retained Earnings 2,555 7,665 4,088 2,044 16,352 24,000 7,200 16,800 33,152 2,484 3,000 8,760 4,818 2,190 21,252 24,000 10,560 13,440 34,692 24,000 51,100 20,440 30,660 21,400 9,260 1,200 8,060 2,418 5,642 2010 54,750 21,900 32,850 21,400 11,450 1,200 10,250 3,075 7,175 2011 58,400

Fall 2010

21,400

2,044 15,000 3,000 13,108 33,152 5,000 642

2,409 15,000 3,000 14,283 34,692 6,000 1,175 7,500 15,000 3,000

Final Examination

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FINE6100 Corporate Finance Question 5(7 Marks)

Fall 2010

Express all answers in this question in percentages and to two decimal places, i.e., 9.78% (a) What is the EAR cost of a 6% (APR) one-month loan compounded monthly with an 8% compensating balance? (2 marks)

(b)

What is the effective annual rate of interest of not taking the discount on a trade account with terms of 3/15, net 45 assuming payment on the due date? (2 marks)

(c)

Its Sunday night and you just lost all you money for the week at the casino and you decide to go to the Money Shop which charges 2.9% of the face value of a cheque which will be post-dated 5 days. What is the EAR? (3 marks)

Final Examination

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FINE6100 Corporate Finance Question 6(20 Marks)

Fall 2010

A firm with an unlevered beta of 1.0 is considering a project that will cost $25 million, and produce perpetual EBIT of $4.4 million. The firms tax rate is 25%, the risk free rate is 4% and the market risk premium (MRP) is 8%. The firm plans to have a debt ratio (D/V) of 1/3 which corresponds to a Debt-Equity Ratio of 0.5 and the debt issued would be risk free, so the pre-tax cost of debt will be 4%. Required: (a) What is the levered cost of equity? (3 marks)

(b)

What is the weighted average cost of capital? (3 marks)

(c)

Should the project be accepted according to the NPV Approach based on the WACC? (4 marks)

Final Examination

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FINE6100 Corporate Finance Question 6(Continued) (d)

Fall 2010

Use either the APV or FTE approach to determine if the project should be accepted. (10 marks) (Hint: doing the NPV based on the WACC first makes it easier to do either of these approaches.)

Final Examination

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FINE6100 Corporate Finance Question 7 (16 Marks)

Fall 2010

BQS Corporation is considering acquiring Bhullar Investments. BQS has 10,000,000 common shares outstanding and a stock price of $25 per share, while Bhullar has 3,000,000 shares outstanding at a stock price of $10 per share. Both corporations have no debt in their capital structures and being in the same industry, the beta for both firms is 1.2. (The risk free rate is 4% and the market risk premium is 7.5%.) Synergistic benefits associated with the acquisition are estimated to be $2,000,000 in annual net after-tax savings for the next 10 years. BQS intends to pay Bhullar stockholders a premium of 25% above the prevailing market price of Bhullar shares. Required: (a) If the acquisition is proposed as an exchange of shares, should BQS proceed with the acquisition? Should Bhullar shareholders accept the offer? (6 marks)

Final Examination

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FINE6100 Corporate Finance Question 7 (Continued) (b)

Fall 2010

If the acquisition is proposed as a cash offer, should BQS proceed with the acquisition? Should Bhullar shareholders accept the offer? (4 marks)

(c)

If the acquisition is proposed as a hybrid offer of $7.50 cash and 1/5th of a BQS share for every Bhullar share, should BQS proceed with the acquisition? Should Bhullar shareholders accept the offer? (6 marks)

Final Examination

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FINE6100 Corporate Finance Question 8(20 Marks)

Fall 2010

For each of the following terms, explain how they are similar and different (2 marks each) (a) Stock Dividend Stock Split

(b)

Special Cash Dividend

Share Repurchase

(c)

Underwriting Securities

Underwriting Insurance

(d)

Direct Method

vs.

Indirect Method

of Cash Flow Forecasting

Final Examination

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FINE6100 Corporate Finance Question 8(Continued) (e) Aggressive vs Conservative

Fall 2010

Working Capital Policy

(f)

Short Cash Cycle

High Levels of Cash and Equivalents

(g)

Factoring Receivables

Pledging Receivables

(h)

Tender Offer

Proxy Battle

Final Examination

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FINE6100 Corporate Finance SPARE PAGE

Fall 2010

Final Examination

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