CORPORATION FINANCE I
CORPORATION FINANCE I FIN 3322
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This 7 page Study Guide was uploaded by Micah Klocko on Thursday October 22, 2015. The Study Guide belongs to FIN 3322 at Texas Tech University taught by George Cashman in Fall. Since its upload, it has received 65 views. For similar materials see /class/226366/fin-3322-texas-tech-university in Finance at Texas Tech University.
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Date Created: 10/22/15
Finance 3322 Exa 2 stu y guide Exam Date Monday November 5 2007 1 Exam time 155 7 325 71 hour and 30 minutes 2 I plan to be in the classroom 5 minutes early or around 150 Everyone should plan to be seated by 155 so that you have the full 1 hour and 30 minutes The exam will be dif cult and hard to nish Study hard Work quickly 3 Special of ce hours Thursday 11107 2 pm 7 5 pm Friday 11207 2 pm 7 5 pm Monday 11507 9 am 712 noon 4 Review sessions Wednesday 103107 7 am 7 8 am BA 57 Wednesday 103107 5 pm 7 6 pm BA 57 5 Coverage Chapters 6 beginning with the topic Evaluating two mutually exclusive projects with unequal lives Chapter 7 Chapter 8 and Chapter 9 problem set 2 6 Exam format Everyone starts with 8 points Multiple choice 18 questions worth 4 points per question 72 points total similar to quiz questions Problems 3 questions answer M 2 of 3 worth 10 points each 20 points total 7 Practice exam 7 there is no practice exam for the second midterm 8 Grading of multiple choice questions same as quiz grading 7 can give more than one answer for reduced credit 9 Grading of problem questions Assum the correct answer is 100000 Full credit plus one bonus point 99999 100001 within 001 of100000 Full credit 99500 99998 or 100002 100500 within 2 Of100000 Minus 20 if you are more than 2 away from the correct answer but your formulas are correc Minus an additional 20 minimum for each mistake in your formulas Therefore if your answer is more than 2 away from the correct answer and if you make only one mistake in a formula this will result in a 40 minimum reduction in score answer minus 100 Incorrect answer no work minus 100 Incorrect answer can t understand your work minus 100 Let me repeat an important point 7 if you get an answer wrong and you don t show your work you will get no credit for your answer A problem question can have more than one part However there are not a speci c number of points allocated to each part Rather each problem is graded on a 10point scale For example ifa problem had two parts part A and part B it is possible to have 10 points deducted for an error in part B even if you get part A completely correct 10 What can you bring to the exam This is a closed book closed note exam but you can bring Calculator and calculator manual and time value of money tables Crib sheets two sheets of paper 85 x 11 for formulas and notes etc Pencils pens erasers 11 Study hints Start putting together your crib sheets as soon as possible Study the practice problems next pages and in the chapter notes and the problem set Come by and ask me questions 12 Possible problem questions A EAC computation and PV of project cash ows similar to problem set 2 problem 1 Practice problem Using a 10 05 real discount rate what is the net present value of the follow1ng perpetual cash ow stream Note the project s cash ow pattern 100 50 60 70 80 is given in real dollars and it repeats itself every four years in perpetuity EAC 32264598 PVofperpetuity first example 322646 PVofperpetuity second example 266650 Cash ows 7 rst example 0 1 2 3 4 5 I6 7 I8 IAndsoonI 100 50 60 70 80 50 60 70 80 100 100 Cash ows 7 second example 0 l 2 3 4 5 6 7 8 9 10 And so on 0 0 100 50 60 70 80 50 60 70 80 100 100 Cost of using excess capacity similar to the last problem we discussed in the chapter 6 notes and problem set 2 problem 2 Practice problem Your rm is considering a project Project X that will use the excess capacity of an existing machine Problem assumptions 1 2 3 WSP Fquot Q 1 1 8 Project X t 0 initial investment cash ow l25000 Incremental cash ows from acceptance of Project X 5100 each year in perpetuity starting at t 1 These incremental cash ows do not consider the cash ow effects from the existing or new machines described below Operation maintenance costs of the old machine under normal usage ie Project X is rejected 8000 cash ow per year The old machine should continue working for 6 years under normal usage Operation maintenance costs of the old machine under high usage ie Project X is accepted l2000 cash ow per year The old machine should continue working for 4 years under high usage Cost ofnew machine 32000 cash ow at either time 6 or time 4 Operation maintenance costs of new machine 7500 cash ow per year Life of new machine 8 years Assume that the new machine is replaced every 8 years in perpetuity with the same cash ows All cash ows are real cash ows Real discount rate 3 uestions lniti ly ignore the cost of using the excess capacity of the existing machine Using the 3 real discount rate the initial investment ofl25000 and the expected cash ows of5100 per year in perpetuity starting in one year what is the NPV ofthe project 125 000 5100 003 4500000 What is the present value of operating maintaining the old machine for the next six years under normal usage ie project rejected 43337 5316 t is the present value of operating maintaining the old machine for the next four years under high usage ie project accepted 446051808 What is the equivalent annual cash ow EAC for the new replacement machine 12 058 604442 What is the present value of buying and operating maintaining the new machine ass every eight years therea er ie normal usage for the old machine project rejected 336 629 7126 What is the present value of buying and operating maintaining the new ma 39 every eight years therea er ie high usage for the old machine project accepted 357 1304621 A er considering the costs of using the excess capacity of the old machine what is the NPV of Project X 2323160 see below Sum of the present values assuming acceptance ofProjectX 45000 44605I808 357I30462I 356 7356429 Sum ofthe present values assuming rejection ofProjectX 4333753I6 336629 7126 3799672442 The NPVofProjectX including costs 356 73564297 3799672442 2323160 Should you accept the project Yes NPV ofproject equal to 2323160 ispositive uming purchase at time 6 and clune assuming purchase at time 4 and ofusing excess capacity is equal to the di erence in the above twoPVs C Calculation of beta NPV and other variables with information similar to Chapter 7 notes similar to problem set 2 problem 3 Practice problem Time one cash ows from a 100 investment in the riskfree asset the market and Project XYZ are as follows Use this information to calculate the variables given below Additional information Riskfree rate 5 market risk premium 84 0 Initial investment 100000000 Covariance ofproject XYZ s cash ows with the market returns 1792000 Variance ofthe market s returns 4590400 0 Standard deviation ofthe market s returns 21 425219 Variance ofthe project s returns based on the PV 0741815 0 Standard deviation ofthe project s returns based on the PV 8612869 0 Correlation coef cient between the market s returns and the project s returns based on the PV 0959414 Using the above information what is the Expected time one cash ow 103 000000 Expected return based on the initial investment 3 000000 Present value ofthe project s time one cash ow 1012I8277 NPV 12I8277 Beta 0 385681 CAPM discount rate 1760277 Assume the WACC for this rm is 10 Where would this project locate on the SML WACC graph The projeetplots above the SML line and below the WACC line Note 7 the problem question on the exam would provide the additional information listed above However expect to have some multiple choice questions in which you are asked to calculate some of these variables eg covariance standard deviation correlation etc U Calculating the effects of a capital structure change and the acceptance of a project on the expanded market value balance sheet Practice Problem Fill in the missing values on the following expanded market value balance sheet Assume nancial markets are perfect ef cient and in equilibrium ie the assumptions we have been using in Chapter 9 and use the CAPM Solutions in parentheses The rm described above is planning to issue 5000000 ofdebt Debt 4 that has a beta of03 and a required and expected return of 752 The rm will use the money to repurchase 5000000 of stock and therefore have 50000000 of equity after the transaction What is the beta of the equity and required return for the equity after the change in capital structure Equity beta 234 equity required return 24656 P1 711 Q Calculation of the yieldtomaturity on a Treasury Bond Practice problem Using the following information what is the annual yield to maturity for the following 20year Treasury Bond 5234 Price 11021 Annual coupon rate 610 Face amount 100 Semiannual compounding Calculation of the discount rate for shortterm mediumterm and longterm projects Practice problem Using the following information and the CAPM what discount rate would you use for a twentyyear project 166 Project beta 15 Market risk premium 84 Onemonth Treasury Bill yieldtomaturity from today s Wall Street Journal 5 Twentyyear Treasury Bond yieldtomaturity om today s Wall Street Journal 6 Longterm maturity risk premium average historical difference in yields since 1926 between 20year Treasury Bonds and onemonth Treasury Bills as calculated by Ibbotson and Associates 20 Using the discount rate calculated above what is the NPV of the following 20year project 49484 Time 0 initial investment cash ow 5000 Time 1 7 time 19 cash ows 900 per year Time 20 cash ow 7900 Be able to graphically draw a regression line through sample data to estimate the equity beta for a rm Use this equity beta and market values for the debt and equity and an estimate of the debt beta to estimate the discount rate for a project Practice prob1em Assume that the market value of a rm s debt is 540 The current stock price is 360 per share and there are 100 shares outstanding The debt beta is 02 What is the estimated equity beta from the following graph Approximately 2 On the test make sure you draw the regression line on the graph and try to estimate the beta as accurately as possible Using the estimated equity beta and the methods discussed in Chapter 9 what is the discount rate for a project that has the same risk as this rm Use the CAPM a risk free rate of 5 and a market risk premium of 84 Assume the nancial markets are perfect ef cient and in equilibrium I2 728 Stock ret Finance 3322 Exam 3 study guide Fall 2007 1 Exam date and time Wednesday December 12 2007 530 7 730 p m be in class 5 minutes early 2 Exam format All multiple choice 34 questions worth 3 points each 34 x 3 102 p01nts 3 The exam should be as dif cult as the rst two exams and take just a little longer to nish than the rst two exams However you have 2 hours to nish the exam instead of 15 hours 4 Coverage Chapters 10 11 12 13 17 18 and problem set 3 We will probably only get through about half of chapter 18 I will point out the stopping point on the last day of class 5 Grading of multiple choice questions similar to the other exams 7 you can give more than one answer for reduced credit 6 There is no practice exam for the third exam 7 What can you bring to the exam Calculator calculator manual time value of money tables crib sheets two sheets of paper 85 x 11 for formulas and notes no restriction on content pencils pens and erasers 8 Review sessions Friday December 7 2007 700 7 800 am tentatively BA 57 Friday December 7 2007 400 7 500 pm tentatively BA 57 9 Office hours during Final Exam Week Monday December 10 2007 900 71100 am 200 7 400 pm Tuesday December 11 2007 900 71100 am 200 7 400 pm Wednesday December 12 2007 900 71100 am 200 7400 pm 10 Study hints Start putting together your crib sheet as soon as possible 0 Study the practice problems included with this study guide and in the chapter notes and the problem sets 0 Come by and ask me questions 0 Check for typos on the class web site the morning before the exam ll Expect to see multiple choice questions based on the following problems In addition to the following problems there are additional multiple choice questions covering other topics A Perform a sensitivity analysis for sales price by filling in the following table answers in italics A project involves purchasing a product for resale to the public The time zero initial investment 000 Sales price 1500 20 chance 1400 50 chance or 1300 30 chance Unit sales 1100 20 chance 1000 50 chance or 850 30 chance Variable cost per unit 10 The beta of the time one expected cash ow 00 the riskfree rate is 5 and the market risk premium is 84 Use the CAPM 95quot5P N w 4 Sales Price Sensitivity Analysis B Determination of the breakeven point for a project similar to the rst problem in problem set 3 Practice problem Based on the information provided below and a 10 discount rate the NPV for the following one year project is equal to 1318182 Expected sales price per unit 1792 Expected variable cost per unit 1200 Expected units sold 100000 Expected xed costs 440000 Expected time one cash ow 1792 1200 100000 440000 152000 Time zero cash ow initial investment 125000 NPV 152000 ll 125000 1318182 What is the breakeven point for yariable cost per unit 12145 C Calculation of the accounting and economic ROI and related calculations for a project similar to the second problem in problem set 3 U Practice problem A threeyear project requires a 6000 investment in depreciable property at time zero The property will be depreciated straight line for accounting purposes over three years no salvage value Therefore the accounting depreciation is 2000 a year The following is accounting net income for the threeyear project 0 1 2 3 IRevenue 4000 I 3000 I 2750 Denrer iatinn 2000 2000 I 2000 INetIncome 2000 I 1000 750 What is the accounting ROI in years 1 2 and 3 0 1 2 3 Accounting R01 3333 2500 3750 Practice problem Using the following cash ow information and a 10 discount rate what is the expected economic investment expected economic depreciation expected economic income and expected economic R01 per year for years 1 2 and 3 0 l 2 3 Expected cash ow 2500 500 1000 1500 0 I 2 3 Exp Econ Invst 240796 2148 76 136364 000 Exp Econ Depr 25920 78512 136364 Exp Econ Income 24080 21488 136 36 Exp Econ R01 10 10 10 Calculation of the effects of a capital structure change on the expected return required return beta and current market value of a rm s stoc Practice Problem ABC Inc is currently highly levered and as a consequence has very highrisk equity The president wants you to put together an analysis of how the rm will be affected by a reduction in the amount of debt Currently ABC Inc has riskfree perpetual debt with a market value of 40 million The beta of this debt is 0 and its interest rate is 5 Your analysis will include calculations based on the current debt level as well as a reduction of debt down to 30 million Some other facts The existing assets of ABC Inc which have a beta of 10 produce one of three possible annual cash ows each year in perpetuity 25 probability of a 2000000 cash ow pessimistic outcome for the year 0 45 probability of a 3000000 cash ow middle outcome for the year 0 30 probability of a 3383333333 cash ow optimistic outcome for the year All cash ows from the rm s assets a er payment of interest on the debt are paid to the rm s stockholders as a dividend ABC Inc will issue equity to pay down the debt level Thus to reduce the debt level to 30 million ABC Inc will issue 10 million of equity to the public The riskfree interest rate is 5 and the market risk premium is 84 Use the CAPM Also use the Chapter 17 perfect capital market assumptions in your analysis Assume the market is ef cient and in equilibrium Base Case Analysis 40 million of debt 0 What is the expected cash ow from the rm s assets 12 000 000 o What are the interest payments to debt in the three states pessimistic middle and optimistic 2 million 2 million 2 million 0 What are the dividend payments to equity in the three states pessimistic middle and optimistic 0 1000000 and 31 83333333 What is the expected dividend for the rm39s stock based on the dividends listed in the previous question 10 0 million What is the CAPM required return for the rm s assets 5 1 84 134 What is the market value ofthe rm s assets 12 000 000 0134 89552239 What is the market value ofthe rm s stock 89 552239 40000000 49552239 What is the expected return for the rm s stock 10000 000 49552239 20180723 What is the beta of the rm s stock 18072289 What is the required return for the rm s stock 5 1807228984 20180723 P1 711 o What is the market value ofthe rm39s stock 10 000 000 020180723 49552239 Explore the effects of the 30 million debt level on the solutions to the 11 questions given above 40 million ofdebt Assets Debt Equity 25 2 000 000 2 000 000 0 45 3 000 000 2 000 000 1 000 000 30 33 833 333 2 000 000 31 833 333 Exp Cashlow 12 000 000 2 000 000 10 000 000 Market Value 89 552239 40 000 000 49 552 239 Beta 1 0000 00000 18072289 Required Return 1340 500 20180723 ExpectRetum 1340 500 20180723 30 million ofdebt Assets Debt Equity 25 2 000 000 1500 000 500 000 45 3 000 000 1500 000 1 500 000 30 33 833 333 1 500 000 32 333 333 Exp Cash flow 12000000 1500 000 10 500 000 Market Value 89 552239 30 000 000 59552239 Beta 1 0000 00000 1503 7594 Required Return 1340 5 00 17 631579 ExpectRetum 13 40 500 17 631579 Determination of how an investor can structure the purchase of an unlevered rm s stock and make it have the same expected return and risk as the stock of a levered rm and vice versa Practice Problem Assume that Firm U an all equity corporation has the exact same assets as ABC Inc described above Firm U manages its assets the same way that ABC Inc manages its assets Assume you have 50 to invest How can you structure your investment in Firm U stock to make it look like ABC Inc stock Assume that ABC Inc has 40 million of debt as originally assumed Use the Chapter 17 perfect capital market assumptions and assume the market is ef cient and in equilibrium Borrow 4036I4 and buy 90 3614 ofstoek ofFirm U How can you structure your investment in ABC Inc stock to make it look like Firm U stock Buy 27 23 ofABC Inc stock andmake a 22 3 riskfreeperpetual debt investment Calculation of rm cash ows and the value of a rm a er taking into account the tax bene ts of debt nancing Practice Problem Refer back to the previous two problems Assume there is a corporate income tax all corporations are in the 34 tax bracket and there is a tax deduction for interest payments Besides this one change in assumption use all of the other Chapter 17 assumptions Assume the market is ef cient and in equilibrium Also assume that the expected taxable income for Firm U is 12 million a year same as expected asset cash ow before taxes and the expected taxable income for ABC Inc is 10 million a year same as expected asset cash ow minus interest on 40 million of debt but before taxes Use the discount rates calculated above A What is the expected cash ow for Firm US assets a er payment of income tax 7920 000 B Using the 134 required rate of return for Firm US assets and stock What is the market value of Firm US stock 7920000 0134 59 104478 C What is the expected cash ow for ABC Inc a er payment of income tax 8 600 000 2 000 000 to owners of debt and 6 600 000 to the owners ofequity D What is the market value ofABC Inc 59 104478 40000 000 034 72 704 478 E What is the market value ofABC Inc s equity 32 704478
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