The University of Melbourne
Department of Finance
Practice Test, Final Exam
FNCE20005 CORPORATE FINANCIAL DECISION MAKING
Semester TWO, 2021
Exam Duration: Three (3) Hours writing time
15 minutes reading time
30 minutes upload time (Section B – Gradescope only)


Instruction to Candidates

1. This is an OPEN BOOK examination.

2. No formulae sheet provided.

3. The exam must be submitted within the relevant deadlines for each section.

4. Late submissions will attract a 10% penalty of the total maximum mark for the exam for each
30 minutes immediately after the submission deadline (e.g., an exam submitted two minutes
after the deadline will lose 8 marks of an exam worth 80%). Submissions made or attempted
1 hour after the submission deadline will not be marked. Students who were prevented from
submitting due to technical difficulties will need to apply for technical consideration with
supporting documentation.

5. This examination contains TWO SECTIONS for a total of 100 marks.
Marks Total
Questions
Required Submission
Method
Section A –
Multiple Choice
Questions
60 20 Attempt ALL questions Canvas
Quiz
Section B –
Short Answer Questions
40 10 Attempt ALL questions Gradescope
Total 100 30 Attempt ALL questions

6. For Section A, you will need to attempt the questions in Canvas Quiz.
a. The Quiz saves your answers as you go, but once you press “Submit” at the
conclusion, it cannot be reopened. Do not submit until you are certain that you do not
need to go back to change your responses.

7. For section B, you will need to upload answers to Gradescope.
a. The answers must be handwritten unless otherwise stated. If you submit typed
answers for questions that ask for handwritten answers, you will receive zero marks.
b. You can use a tablet and stylus to write your answers. However, you are responsible
for any related tech issues.
c. Start each question on a NEW PAGE and include question number and student
number on the top of each answer.
d. Please note that when uploading answers to Gradescope, you need to assign specific
pages to each of the question.

8. Please scan your answers using a scanner or a mobile device. Detailed instructions about
scanning on mobile devices are available via https://lms.unimelb.edu.au/students/student-
guides/gradescope-converting-images-to-pdf. All answers submitted MUST BE LEGIBLE,
illegible (unreadable) answers will be awarded ZERO marks.

9. The Exam Support tool in CANVAS will be available from 3:00 PM AEST on November
11th to 3:45 PM AEST on November 11th, subject coordinators and the tutor-in-charge will
be there assisting in resolving issues related to exam contents. Please make sure that the issue
is clearly stated.

10. Once the Exam Support tool is closed (i.e., at 3:45 PM AEST), students are advised to
contact 13MELB. Inside Australia: 13MELB (13 6352) (13 6352 - Option 1 - Exams; from
Outside Australia: +61 3 9035 5511) if they have queries on exam content.

11. For any issues other than exam content (including those arising during the first 45 minutes of
the exam), students are also recommended to contact 13MELB (13 6352 - Option 1 - Exams;
from Outside Australia: +61 3 9035 5511)

12. Collusion between students is absolutely forbidden and will result in very serious
consequences.

This paper CAN NOT be lodged with the Baillieu Library AT ANY TIME.












Section B. Short Answer Questions
 This section consists of 10 questions. Attempt ALL questions.
 All answers must be handwritten unless otherwise stated, and uploaded to Gradescope.
 In order to get marks, you need to show your detailed workings along with the final
answers.




Question 21.

Pinder Co. currently has 100 million shares outstanding, which are trading at $12 per share.
Additionally, it has issued three tranches of stock options to its management to enhance
managerial incentives and reduce agency costs. The first tranche consists of 1.25 million (call)
options with an exercise price of $9. The second tranche consists of 1 million options with an
exercise price of $10. The third tranche consists of 2.25 million options with an exercise price of
$15. Pinder Co accounts for these stock options using the treasury stock method. Pinder Co has
also issued $100 million in convertible bonds with a conversion price of $20. Pinder Co accounts
for this convertible bond using the if-converted method. What is the fully diluted number of
shares outstanding for Pinder Co? (Show all your work. Answer must be handwritten)


Solution
100 + 1.25 + 1 – (1.25*9 + 1*10)/12 + 100/20 = 105.4792 million shares.



















Question 22.

Pinder LLC is planning on a leveraged buyout of Value Co. To finance the buyout, Pinder
approaches two banks for conditions on their term loans. Bank A offers Pinder LLC a $4 billion
term loan with a Libor floor of 1% and a spread of 5%. However, the conditions of the loan
prevents Pinder LLC from borrowing additional funds by issuing senior notes. Bank B offers
Pinder LLC a $2 billion term loan with a Libor floor of 1.25% and a spread of 4.50%. The loan
from Bank B does not prevent Pinder LLC from borrowing additional funds by issuing senior
notes. Which option gives Pinder LLC a higher IRR on its investment? Assume that all other
conditions of the buyout are identical to the assumptions in the lecture.

(For this question, the answer does not need to be handwritten. You only need to copy paste the
relevant sensitivity tables containing the entry and exit multiples at 8.0x EBITDA after making
the necessary changes to the template. Make sure the assumptions in the lecture are correctly
inputted in the template – the IRR prior to making changes should be 19.7%.)


Solution
IRR with loan from Bank A



IRR with loan from Bank B


The term loan from Bank A gives a higher IRR






22.9% 7.0x 7.5x 8.0x 8.5x 9.0x
7.0x 30.7% 33.6% 36.3% 38.9% 41.2%
Entry 7.5x 23.2% 26.0% 28.6% 31.0% 33.2%
Multiple 8.0x 17.8% 20.4% 22.9% 25.2% 27.3%
8.5x 13.5% 16.1% 18.4% 20.6% 22.7%
9.0x 10.0% 12.5% 14.8% 16.9% 18.9%
IRR - Assuming Exit in 2017E
Exit Multiple
18.9% 7.0x 7.5x 8.0x 8.5x 9.0x
7.0x 23.3% 25.8% 28.1% 30.3% 32.3%
Entry 7.5x 18.4% 20.8% 23.0% 25.1% 27.0%
Multiple 8.0x 14.4% 16.8% 18.9% 20.9% 22.8%
8.5x 11.2% 13.4% 15.5% 17.4% 19.3%
9.0x 8.4% 10.6% 12.6% 14.5% 16.3%
IRR - Assuming Exit in 2017E
Exit Multiple
Question 23.

Briefly explain why the discounted cash flow (DCF) method allows the analyst to directly assess
the effects of operational improvements and other synergistic efficiencies. (Answer must be
handwritten)



Solution
In a DCF set-up, the analyst can easily modify input variables such as growth (from year to
year), reduction in costs, increase in operational efficiency (margins) etc. and compute the
change in value of the target in the future.































Question 24.

Tasty Pies is expanding its business and wants to open a new facility to make frozen pies, which
requires a new automated pie maker. One such pie maker can be purchased for $300,000.
Alternatively, it can be leased for $52,000 per year for seven years and lease rentals need to be
paid annually in advance. The management informs you that the new pie maker can be fully
depreciated to zero using the straight-line method over four years and that its scrap/residual value
is expected to be $5,000 at the end of the lease. Tasty Pies has estimated that the appropriate
after-tax opportunity cost of capital of the expansion is 19% per annum, and the net present value
of the expansion is expected to $10,000.

Tasty Pies pays tax at the rate of 30% and it can borrow funds at a before-tax rate of 11% per
annum. All cash-flows have been quoted on a before-tax basis. Would you recommend that
Tasty Pies buy or lease the pie maker? What is the incremental wealth associated with your
decision? (Show all your work. Answer must be handwritten)

Solution

Answer:







Question 25.

You are an analyst employed to evaluate a financial lease relating to a piece of machinery. You
are provided with the following information:

Purchase price of machinery $200,000
Useful life of machinery 5 years
Corporate tax rate 30%
Net operating cash flows (before tax)
produced by the machine at the end of each
year
$70,000
Required rate of return from the machine
itself (after tax)
17% p.a.
Cost of debt capital used to purchase the
machine (before tax)
9% p.a.

The company accountant tells you the asset will be fully depreciated over its useful life and will
have zero residual value. You are also told that the machine is integral to a project that
management has already decided the company will proceed with.

What is the maximum lease payment that the company should be willing to pay? (Show all your
work. Answer must be handwritten)

Solution




Question 26.

You are an analyst for a financial services firm that was engaged one month ago to conduct
sensitivity analysis on a new project for a client. Fortunately, the client is an alum of the
University of Melbourne and has asked that the approach taught in Corporate Financial Decision
Making be used. The project involves a contract with a high quality and low risk customer who
has guaranteed that they will pay $60 per unit of the product to your client at the end of each of
each of the eight years of the project’s life. The only uncertainty your client faces is how many
units their customer will purchase (as determined by the quality of your item relative to
competitors) and the variable cost per unit your client faces in producing the product – with most
of that variable cost being taken up by the cost of labour. You collect the following information.


Variable Pessimistic estimate Expected Optimistic estimate
Sales volume
demanded p.a.
40,000 60,000 80,000
Variable cost per unit $55 $40 $35

You also know that the project will require an initial investment of $500,000 at the
commencement of the project and then another investment of $500,000 six months into the
project. The required rate of return from the project is 13% p.a.

Utilising the principles discussed during class, provide a ranking of the variables from most to
least important. (Show all your work. Answer must be handwritten)

Solution












Question 27.

Coleman Ltd is a transport company that has been asked to assess an opportunity to provide
services to a mining company, Aztec Ltd, that extracts copper in Western Australia. The 10-year
contract provides that the cash flows paid to Coleman Ltd at the end of each of the 10 years of
the contract are a function of the international price for copper during only the first year of the
contract. Specifically, if the average price of copper in the first year is greater than a benchmark
price, then the contract allows for Coleman Ltd to be paid a net cash flow of $1,000,000 per
annum over the life of the contract. If the average price of copper in the first year of the contract
is less than the benchmark price, then Coleman Ltd enjoys a net cash flow of only $250,000 per
annum over the life of the contract.

You estimate that there is a 60% chance that the price of copper will exceed the benchmark rate
in the first year of the contract. You also estimate that Coleman Ltd will have to invest $2
million initially to purchase the specialized transport equipment necessary to service the contract.

As a final point, Coleman Ltd insist that they should have the right to walk away from the
contract at the end of the first year if the price of copper is below the benchmark rate. In that
case, you estimate that they would be able to sell their transport equipment for $1.5 million.

The required rate of return for the project is 12% per annum.

What is the value, today, of the option to walk away from the contract? (Show all your work.
Answer must be handwritten)



Solution









Question 28.

Diacono Ltd, is the largest listed shoe manufacturing company in Australia and is considering
launching a bid for Midgley Ltd, it’s chief competitor. You are engaged by Diacono Ltd to
consider the merits of the proposed deal and collect the following pre-bid information regarding
the two companies.

Diacono Ltd Midgley Ltd
Share price $20 $25
Number of shares on issue 30 million 12 million

You also estimate that if the deal was to go through then the following events would be expected
to occur:
 There would be one-off integration costs of $2 million at the end of each of the first two
years post-acquisition associated with bringing the two businesses together
 The ability to sell extra shoes to each other’s customers would increase net sales revenues
(after tax) by $5 million per annum (at year end) for the next 7 years
 The elimination of identical roles across the two organisations would reduce net costs
(after tax) by $3 million per annum over the next 4 years

What takeover premium (measured as a percentage of current share price) would Diacono Ltd
have to offer Midgley Ltd shareholders in order to split the gain equally between the two
shareholder groups? (Show all your work. Answer must be handwritten)

Solution













Question 29.

Fish Pies Inc. (FPI) has recently announced its intention to acquire Hamburgers ‘R Us (HRU).
FPI has identified potential annual gains from the acquisition of $250,000 per annum forever,
with the first cash flow occurring exactly four years after the acquisition. If the acquisition were
to proceed, FPI will however incur re-organization and integration costs of $300,000 per annum
at the end of the first two years after the acquisition. Information about the two companies’
relevant share prices and shares outstanding is provided below:

Fish Pies Inc. Hamburgers ‘R Us
Share price $2.70 $5.50
Number of shares outstanding 15,000,000 1,200,000

FPI has also decided to make a cash bid for all outstanding shares of HRU and offers $6.40 per
share to HRU shareholders. The appropriate opportunity cost of capital is 12% per annum.-

The chairman of FPI’s board has been meeting with board members from HRU to discuss the
proposed acquisition. After a couple of meetings, he makes the following statement:

“I have had very friendly and cordial meetings with HRU. We have jointly determined that after
accounting for all re-organization costs etc. the present value of total gains to be generated is
$6,500,000. Given the co-operation offered by HRU, I have now decided not to proceed with a
cash offer but to make a share offer instead.

I need the answers to these TWO questions:
i. What is the maximum exchange ratio that can be offered to HRU?
ii. If we split the gains as 70% and 30% between FPI and HRU respectively, what is the
appropriate stock exchange ratio to complete the acquisition under this arrangement?”

Assuming the bid were to proceed immediately, conduct all relevant analysis to provide the
answer to the Chairman’s questions. (Show all your work. Answer must be handwritten)


Solution
Part i)
Maximum net cost = $6.5 = b (40.5+6.6+6.5) - 6.6
=>b=0.244403
Initially there were 15m shares in FPI.
After the bid, there will be 15m+X shares where X = the number of shares issued to HRU
shareholders
X / [15m + X] = 0.244403 => X = 4.851852m
There were 1.2 million HRU shares, therefore the exchange ratio is 4.04321 FPI shares for 1
HRU share.
Part ii)
The gain of $6.5m is split 70/30 between FPI and HRU
FPI = $4.55m; HRU = $1.95m
Net cost to FPI = 1.95 = b (40.5 + 6.6 + 6.5) – 6.6
=> b=0.159515
Initially there were 15,000,000 shares in FPI.
After the bid, there will be 15m + X shares where X = the number of shares issued to HRU
shareholders.
X / [15m + X] = 0.159515 => X = 2.846838m
There were 1.2 million HRU shares, therefore the exchange ratio is 2.372365 FPI shares for 1
HRU share.































Question 30.

ABC Inc is a publicly listed company in Australia and pays corporate tax rate at a rate of 30%.
The company conducted its first off-market share buyback on April 15, 2015 and the
shareholders were invited to tender their shares between $3.40 and $4.20. ABC’s volume
weighted average price over the five days before the announcement was $3.98 and over the
period from the announcement to the close of the buyback the market index decreased by 0.8%.
ABC announced the buyback price to be $3.40 with capital component of $0.95 and the rest will
be treated a fully franked dividend. The buyback was conducted under tax determination TD
2004/22.

John Major, who is a resident Australian investor, bought 200 shares in ABC at $1.25 per share
on July 15, 2014 and sold all his shares in the buyback. You need to answer the following
questions with regards to the buyback:
(a) What was the per share capital gain or loss under the buyback for John Major?
(b) Assume that John’s personal tax rate is 20%. What were the total after-tax proceeds that he
received after selling all his shares in the buyback?

Solution
a). Deemed consideration: 3.98(1-0.008) = 3.94816
Dividend component = 3.4 – 0.95 = 2.45
Deemed capital component = 3.94816 – 2.45 = 1.49816
Capital gain = 1.49816 – 1.25 = 0.24816
b). After tax proceeds from dividend = 2.45 + 0.3 (2.45/0.7) – 0.2 (2.45/0.7) = 2.80
After tax proceeds from cap gain/loss = 0.95 - 0.2 (0.24816) = 0.900368 per share.
After tax proceeds = 2.8 + 0.900368 = $3.700368 per share
Total after-tax proceeds = $740.07 for 200 shares.