微信客服：xiaoxionga100
微信客服：ITCS521
finm2415代写-FINM2415
时间：2022-11-15
FINM2415 - Final Exam Semester 2 2021
This exam has 50 marks in total and carries 50% of the total mark of this course. There are
six (6) questions. Answer all questions
Question 1 5 marks
A. You are evaluating an energy drink project of your firm that lasts for three years. You
initially forecast marketing and support costs at $2 million per year and revenue at $10 million
per year. The project pays a 30% tax rate on its pre-tax income and its cost of capital is 20%.
You are now analysing a situation that competitors can run their big promotion programs
during these years. The marketing division proposes one solution to the situation by
increasing its marketing and support costs by 50% of the originally forecasted level and
simultaneously lowering the forecasted revenue by 10% of the originally forecasted level.
What is the change in the level of the net present value (NPV) of the proposed energy drink
project as the result of the solution proposed by the marketing division?
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
B. A small firm introduces its start-up project where it will sell a new product. The life of the
project is 3 years. The project requires an initial investment in equipment of $1,000 and has the
cost of capital of 10%. The firm expects to sell 50 units each year over life of the project and
each unit of the new product will generate a net cash flow of $20. However, if the firm’s
competitors introduce a similar product in the second year of the project, the firm would have
an option to abandon the project in that year and sell the equipment for a net cash flow of $200.
(i) Without the option to abandon, what is the net present value (NPV) of the start-up
project?
(ii) Assume that the net cash flow per unit of the new product remains $20 for the whole
life of the project, and the sale in the first year of the project remains 50 units.
Assume also that if the firm’s competitors introduce a similar product in the second
year of the project, the expected sale of the firm’s new product for each year during
the remaining life of the project will be revised and set equal to the sale of the
second year. At what level of unit sale in the second year would it make sense for
the firm to abandon the project?
2
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Question 2 5 marks
A. Wildcat is an oil and gas exploration company that is operating two active oil fields with
a current market value of $200 million each. Wildcat has debt with its current market value
of $500 million. A large oil company has offered Wildcat a speculative project in exchange
for one of their active oil fields. With this speculative project, there is a 10% chance that
Wildcat will discover a major new oil field that would offer a cash flow with the net present
value of $1200 million, a 15% chance that Wildcat will discover a productive oil field that
would offer a cash flow with the net present value of $600 million, and a 75% chance that
Wildcat will not discover oil at all.
(i) What is the expected payoff to debt holders if Wildcat accepts the offer?
(ii) What is the expected payoff to equity holders if Wildcat accepts the offer?
(iii) Briefly explain whether or not equity holders would like to accept this offer?
3
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
B. Plump, Inc. has a $20 million loan due at the end of the year and its assets will have a
market value of only $15 million when the loan comes due. At the end of the year, Plump
will have $2 million in cash and consider two possible alternative uses for this cash. One
possibility is to pay the $2 million out to shareholders in the form of a special dividend. The
second possibility is to invest the $2 million in a project that offers a net present value of $4
million at that time.
(i) Under each of the two alternatives, which one would equity holders prefer? Which
one would debt holders prefer?
(ii) What is the economic terminology that describes the situation as in (i) and explain
whether the situation in (i) is consistent with the shareholder theory or the
stakeholder theory?
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
4
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Question 3 10 marks
Rose, Inc. is currently valuing a new project that has the average risk of its investment projects.
The project requires upfront R&D and marketing expenses of $5 million and a $28 million
investment in equipment. The equipment will be obsolete in 4 years and will be depreciated
using the straight-line method over that period. For each year over the next 4 years, the project
offers annual sales of $100 million, has annual manufacturing costs of $30 million, and annual
operating expenses of $10 million. Further, the project requires no net working capital in year
0, and $2.0 million in net working capital in each year from year 1 to year 3 and no net working
capital in year 4. Beyond year 4, the project’s free cash flows are expected to grow at an annual
rate of 2%.
Rose currently has 10 million outstanding shares with its stock price of $30 per share, $220
million in debt, $20 million in excess cash, the cost of debt of 5%, and the cost of equity of
10%, and the corporate tax rate of 40%. The firm plans to maintain a constant (net) debt-equity
ratio for the foreseeable future, including any financing related to this new project.
(i) Calculate the enterprise value of the project using free cash flows (WACC) method
(ii) If the firm still maintains a constant (net) debt-to-equity ratio after taking this project,
how much new debt must the firm borrow? By how much does the market value of
the firm’s equity increase?
(iii) Calculate the unlevered value of the project using the adjusted present value (APV)
method
(iv) Calculate the present value of all interest tax shields of the project
(v) Calculate the net present value (that is, equity value) of the project using the flow
to equity method
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
5
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
6
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
7
Question 4 10 marks
A. Wyatt Oil has assets with a market value of $600 million, $70 million of which are excess
cash. It has debt of $250 million, and 20 million shares outstanding. The board of directors
of Wyatt Oil has just announced that it will use the excess cash to pay a special cash dividend.
Suppose that all capital gains are taxed at a 15% rate, and that cash dividends are taxed at a
25% rate. Assume that there are no other market imperfections except taxes.
(i) If Wyatt Oil’s shareholders could not make any profits by selling their shares
either just before or just after the ex-dividend date, what would be the share price
just after the ex-dividend date?
(ii) An investor purchased 1,000 shares of Wyatt Oil several days before the dividend
announcement date at the price of $12 per share. If the investor firmly predicts
that the ex-dividend price is $15 per share and takes some transactions to benefit
from the investor’s prediction, what is the net profit (that is, the net income after
all taxes) of this investor?
(iii) Suppose that Wyatt Oil makes a surprise announcement that it would use the
excess cash to conduct a share repurchase rather than pay a special cash dividend,
what is the net tax savings for a shareholder who sells 1,000 shares of Wyatt Oil
following this announcement?
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
8
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
B. You are an Australian citizen who pays your income tax at the rate of 30%. The corporate
tax rate is 40%. You own 5,000 shares of Commonwealth Bank and receive a cash dividend
of 60 cents per share. This dividend is fully franked, that is, Commonwealth Bank has paid a
full amount of corporate taxes on this dividend payment.
(i) What is the amount of tax credit, that is, the franking credit, you receive?
(ii) How much additional personal tax (beyond the tax already paid on your behalf at the
corporate level) will you have to pay on this dividend?
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
9
Question 5 10 marks
A. Ocean Gas is a private firm and has 10 million shares outstanding. The company has
planned for its initial public offering (IPO). The IPO price has been set at $30 per share, and
the underwriting spread is 7%. The IPO is a big success. The number of shares sold in the
primary offering is 8 million shares and the number of shares sold in the secondary offering
is 6 million shares. The share price rises to $50 on the first day of trading.
(i) How much did Ocean Gas raise through this IPO?
(ii) Explain whether there is any underpricing situation in this IPO.
(iii) Assume that the post-IPO value of Ocean Gas is its fair market value. Suppose
Ocean Gas could have issued shares directly to investors at their fair market
value, in a perfect market with no underwriting spread and no underpricing.
Assuming that Ocean Gas could raise the same amount of funds that it would
have with the investment banker handling the underwriting, what is the share
price in this case? How many new shares would Ocean Gas issue?
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
B. Luther Industries currently has 100 million outstanding shares at a price of $25 per share.
The company wants to raise money and has announced a rights issue. Every existing
shareholder will be sent one right per share of stock that he or she owns. The company plans
to require 20 rights to purchase one share at a price of $20 per share.
(i) How much money will the company raise?
(ii) What will the share price be after the rights issue?
(iii) Assume that the company aims to raise an exact amount of $150 million
through this rights issue and it is willing to offer the existing shareholders
to purchase one new share at $15 per share. How many rights should the
company require to purchase one new share at this $15 per share?
10
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Question 6: 10 Marks
The following information is used for Parts A, B, and C.
Rearden Metal has earnings per share of $2. It has 10 million shares outstanding and is trading
at $20 per share. Rearden Metal is planning to acquire Associated Steel, which has earnings
per share of $1.25, 4 million shares outstanding, and a price per share of $15. Both companies
have no debt in their capital structure.
A. Rearden Metal estimates that there are no expected synergies from the takeover.
Rearden Metal will pay for Associated Steel by issuing new shares. If Rearden offers
an exchange ratio such that, at the post-announcement share prices for both firms, the
offer represents a 20% premium to buy Associated Steel.
(i) What is the price per share of the combined corporation after the takeover?
(ii) What is the price per share of Associated Steel immediately after the
announcement?
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
11
B. Assuming that Rearden Metal seeks an independent valuation from an external financial
analyst. The analyst estimates that Rearden Metal will increase its revenue with a net
cash flow of $500,000 per annum in perpetuity after acquiring Associated Steel. The
cost of capital of Rearden Metal is 20% per annum. Rearden Metal will pay for
Associated Steel by issuing new shares.
(i) If the exchange ratio is 0.5, what is the earning per share (EPS) of the combined
firm after the takeover?
(ii) If Rearden would like to achieve an EPS of $2 in the combined firm after the
takeover, what is the exchange ratio?
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
C. Assuming that Rearden Metal seeks an independent valuation from an external financial
analyst. The analyst estimates that Rearden Metal will increase its revenue with a net
cash flow of $500,000 per annum in perpetuity after acquiring Associated Steel. The
cost of capital of Rearden Metal is 20% per annum. Rearden Metal will pay for
Associated Steel by cash payment and the offer price is $70 million.
(i) What is the stock price of Rearden Metal and what is the stock price of
Associated Steel after the announcement of the takeover? Explain why there is
an increase or a decrease in stock prices each of these two firms after the
announcement of the takeover?
(ii) What is the net present value (NPV) of this takeover to Associated Steel and
what is the net present value (NPV) of this takeover to Rearden Metal?
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
12
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
This exam has 50 marks in total and carries 50% of the total mark of this course. There are
six (6) questions. Answer all questions
Question 1 5 marks
A. You are evaluating an energy drink project of your firm that lasts for three years. You
initially forecast marketing and support costs at $2 million per year and revenue at $10 million
per year. The project pays a 30% tax rate on its pre-tax income and its cost of capital is 20%.
You are now analysing a situation that competitors can run their big promotion programs
during these years. The marketing division proposes one solution to the situation by
increasing its marketing and support costs by 50% of the originally forecasted level and
simultaneously lowering the forecasted revenue by 10% of the originally forecasted level.
What is the change in the level of the net present value (NPV) of the proposed energy drink
project as the result of the solution proposed by the marketing division?
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
B. A small firm introduces its start-up project where it will sell a new product. The life of the
project is 3 years. The project requires an initial investment in equipment of $1,000 and has the
cost of capital of 10%. The firm expects to sell 50 units each year over life of the project and
each unit of the new product will generate a net cash flow of $20. However, if the firm’s
competitors introduce a similar product in the second year of the project, the firm would have
an option to abandon the project in that year and sell the equipment for a net cash flow of $200.
(i) Without the option to abandon, what is the net present value (NPV) of the start-up
project?
(ii) Assume that the net cash flow per unit of the new product remains $20 for the whole
life of the project, and the sale in the first year of the project remains 50 units.
Assume also that if the firm’s competitors introduce a similar product in the second
year of the project, the expected sale of the firm’s new product for each year during
the remaining life of the project will be revised and set equal to the sale of the
second year. At what level of unit sale in the second year would it make sense for
the firm to abandon the project?
2
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Question 2 5 marks
A. Wildcat is an oil and gas exploration company that is operating two active oil fields with
a current market value of $200 million each. Wildcat has debt with its current market value
of $500 million. A large oil company has offered Wildcat a speculative project in exchange
for one of their active oil fields. With this speculative project, there is a 10% chance that
Wildcat will discover a major new oil field that would offer a cash flow with the net present
value of $1200 million, a 15% chance that Wildcat will discover a productive oil field that
would offer a cash flow with the net present value of $600 million, and a 75% chance that
Wildcat will not discover oil at all.
(i) What is the expected payoff to debt holders if Wildcat accepts the offer?
(ii) What is the expected payoff to equity holders if Wildcat accepts the offer?
(iii) Briefly explain whether or not equity holders would like to accept this offer?
3
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
B. Plump, Inc. has a $20 million loan due at the end of the year and its assets will have a
market value of only $15 million when the loan comes due. At the end of the year, Plump
will have $2 million in cash and consider two possible alternative uses for this cash. One
possibility is to pay the $2 million out to shareholders in the form of a special dividend. The
second possibility is to invest the $2 million in a project that offers a net present value of $4
million at that time.
(i) Under each of the two alternatives, which one would equity holders prefer? Which
one would debt holders prefer?
(ii) What is the economic terminology that describes the situation as in (i) and explain
whether the situation in (i) is consistent with the shareholder theory or the
stakeholder theory?
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
4
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Question 3 10 marks
Rose, Inc. is currently valuing a new project that has the average risk of its investment projects.
The project requires upfront R&D and marketing expenses of $5 million and a $28 million
investment in equipment. The equipment will be obsolete in 4 years and will be depreciated
using the straight-line method over that period. For each year over the next 4 years, the project
offers annual sales of $100 million, has annual manufacturing costs of $30 million, and annual
operating expenses of $10 million. Further, the project requires no net working capital in year
0, and $2.0 million in net working capital in each year from year 1 to year 3 and no net working
capital in year 4. Beyond year 4, the project’s free cash flows are expected to grow at an annual
rate of 2%.
Rose currently has 10 million outstanding shares with its stock price of $30 per share, $220
million in debt, $20 million in excess cash, the cost of debt of 5%, and the cost of equity of
10%, and the corporate tax rate of 40%. The firm plans to maintain a constant (net) debt-equity
ratio for the foreseeable future, including any financing related to this new project.
(i) Calculate the enterprise value of the project using free cash flows (WACC) method
(ii) If the firm still maintains a constant (net) debt-to-equity ratio after taking this project,
how much new debt must the firm borrow? By how much does the market value of
the firm’s equity increase?
(iii) Calculate the unlevered value of the project using the adjusted present value (APV)
method
(iv) Calculate the present value of all interest tax shields of the project
(v) Calculate the net present value (that is, equity value) of the project using the flow
to equity method
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
5
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
6
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
7
Question 4 10 marks
A. Wyatt Oil has assets with a market value of $600 million, $70 million of which are excess
cash. It has debt of $250 million, and 20 million shares outstanding. The board of directors
of Wyatt Oil has just announced that it will use the excess cash to pay a special cash dividend.
Suppose that all capital gains are taxed at a 15% rate, and that cash dividends are taxed at a
25% rate. Assume that there are no other market imperfections except taxes.
(i) If Wyatt Oil’s shareholders could not make any profits by selling their shares
either just before or just after the ex-dividend date, what would be the share price
just after the ex-dividend date?
(ii) An investor purchased 1,000 shares of Wyatt Oil several days before the dividend
announcement date at the price of $12 per share. If the investor firmly predicts
that the ex-dividend price is $15 per share and takes some transactions to benefit
from the investor’s prediction, what is the net profit (that is, the net income after
all taxes) of this investor?
(iii) Suppose that Wyatt Oil makes a surprise announcement that it would use the
excess cash to conduct a share repurchase rather than pay a special cash dividend,
what is the net tax savings for a shareholder who sells 1,000 shares of Wyatt Oil
following this announcement?
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
8
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
B. You are an Australian citizen who pays your income tax at the rate of 30%. The corporate
tax rate is 40%. You own 5,000 shares of Commonwealth Bank and receive a cash dividend
of 60 cents per share. This dividend is fully franked, that is, Commonwealth Bank has paid a
full amount of corporate taxes on this dividend payment.
(i) What is the amount of tax credit, that is, the franking credit, you receive?
(ii) How much additional personal tax (beyond the tax already paid on your behalf at the
corporate level) will you have to pay on this dividend?
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
9
Question 5 10 marks
A. Ocean Gas is a private firm and has 10 million shares outstanding. The company has
planned for its initial public offering (IPO). The IPO price has been set at $30 per share, and
the underwriting spread is 7%. The IPO is a big success. The number of shares sold in the
primary offering is 8 million shares and the number of shares sold in the secondary offering
is 6 million shares. The share price rises to $50 on the first day of trading.
(i) How much did Ocean Gas raise through this IPO?
(ii) Explain whether there is any underpricing situation in this IPO.
(iii) Assume that the post-IPO value of Ocean Gas is its fair market value. Suppose
Ocean Gas could have issued shares directly to investors at their fair market
value, in a perfect market with no underwriting spread and no underpricing.
Assuming that Ocean Gas could raise the same amount of funds that it would
have with the investment banker handling the underwriting, what is the share
price in this case? How many new shares would Ocean Gas issue?
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
B. Luther Industries currently has 100 million outstanding shares at a price of $25 per share.
The company wants to raise money and has announced a rights issue. Every existing
shareholder will be sent one right per share of stock that he or she owns. The company plans
to require 20 rights to purchase one share at a price of $20 per share.
(i) How much money will the company raise?
(ii) What will the share price be after the rights issue?
(iii) Assume that the company aims to raise an exact amount of $150 million
through this rights issue and it is willing to offer the existing shareholders
to purchase one new share at $15 per share. How many rights should the
company require to purchase one new share at this $15 per share?
10
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Question 6: 10 Marks
The following information is used for Parts A, B, and C.
Rearden Metal has earnings per share of $2. It has 10 million shares outstanding and is trading
at $20 per share. Rearden Metal is planning to acquire Associated Steel, which has earnings
per share of $1.25, 4 million shares outstanding, and a price per share of $15. Both companies
have no debt in their capital structure.
A. Rearden Metal estimates that there are no expected synergies from the takeover.
Rearden Metal will pay for Associated Steel by issuing new shares. If Rearden offers
an exchange ratio such that, at the post-announcement share prices for both firms, the
offer represents a 20% premium to buy Associated Steel.
(i) What is the price per share of the combined corporation after the takeover?
(ii) What is the price per share of Associated Steel immediately after the
announcement?
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
11
B. Assuming that Rearden Metal seeks an independent valuation from an external financial
analyst. The analyst estimates that Rearden Metal will increase its revenue with a net
cash flow of $500,000 per annum in perpetuity after acquiring Associated Steel. The
cost of capital of Rearden Metal is 20% per annum. Rearden Metal will pay for
Associated Steel by issuing new shares.
(i) If the exchange ratio is 0.5, what is the earning per share (EPS) of the combined
firm after the takeover?
(ii) If Rearden would like to achieve an EPS of $2 in the combined firm after the
takeover, what is the exchange ratio?
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
C. Assuming that Rearden Metal seeks an independent valuation from an external financial
analyst. The analyst estimates that Rearden Metal will increase its revenue with a net
cash flow of $500,000 per annum in perpetuity after acquiring Associated Steel. The
cost of capital of Rearden Metal is 20% per annum. Rearden Metal will pay for
Associated Steel by cash payment and the offer price is $70 million.
(i) What is the stock price of Rearden Metal and what is the stock price of
Associated Steel after the announcement of the takeover? Explain why there is
an increase or a decrease in stock prices each of these two firms after the
announcement of the takeover?
(ii) What is the net present value (NPV) of this takeover to Associated Steel and
what is the net present value (NPV) of this takeover to Rearden Metal?
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
12
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
