T HE U NIVERSITY O F N EW S OUTH WALES Australian School Of Business School Of Banking And Finance FINS1613: Business Finance Semester 1 2012

Practice Questions for the Final Hints for Select Numerical Questions

4. The correct approach is to nd a combination of two of the bonds that gives the same cash ows in years 1 and 2 as the third bond. If the cash ows are the same, then the price of the two bond bundle must equal the price of the third bond. The approach below combines bonds B and C to have the same cash ows in years 1 and 2 as Bond A. Focus on matching Bond As year 1 cash ows to start. Determine the fractional ownership of Bond B required to produce $23 in Year 1. Call this fractional ownership X. What are the cash ows from your holding in Bond B in Year 2? Determine how much additional cash ows would be required to get Bond As year 2 cash payment of $123. What fractional holding of Bond C is required to produce the cash ow computed above? Call this ownership in Bond C Y . Now that youve matched cash ows, determine the price of Bond C using the Law of One Price implication that P riceA = X P riceB +Y P riceC. A way to test your knowledge of this approach is to see if you can combine bonds A and C to produce the same cash ows as Bond B. The price for Bond C you get with this approach should be the same. 8. Incremental cash ows of the pogo stick project must be compared to what the rm will do without that project. Without the project, the rm will still dismantle the monorail stations and build retail space. 9. You will need to compute the taxes on the capital gain on this sale. This is based on the book value of the pogo sticks after 3 years and the companys marginal tax rate. Marginal tax rates are based on total rm taxable income.

11. This is an application of pricing using the yield curve. Draw a timeline of the cash ows from the bond. Then discount each cash ow at the discount rate appropriate for when the cash ow is received. For example, a cash ow received in one year is discounted at 3.0%, while a cash ow received in two years is discounted at 4.5%. 17. For any debt level, the net impact on rm value is the difference between the tax benets of debt and the present value of nancial distress. The present value of the tax benet is equal to the corporate tax rate multiplied the debt value. So, for example, the net impact on rm value for $200mil in debt is 200 0.3 35 = $35mil. 19. The problem indicates that there are no taxes or market imperfections. This means that the overall cost of capital does not change with leverage, so for all debt levels the cost of capital is 10%. Given the 8% cost of debt and the new debt level 60%, solve for the cost of equity.