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CORPORATE FINANCE EXAM QUESTIONS AND ANSWERS #10
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CORPORATE FINANCE EXAM QUESTIONS AND ANSWERS #1010-1: The Heuser Company's currently outstanding bonds have 10% coupon and a 12%
YTM. Heuser believes it could issue new bonds at par that would provide a similar yield
to maturity. If its marginal tax rate is 35%, what is Heuser's after-tax cost of debt? -
correct answer Rd(1-T) = 0.12 (0.65) = .0780 or 7.8%
10-6b: The future earnings, dividends, and common stock price of Carpetto
Technologies Inc. Are expected to grow 7% per year. Carpetto's common stock
currently sells for $23 per share; its last dividend was $2; and it will pay a $2.14
dividend at the end of the current year.
If the firm's beta is 1.6, the risk-free rate is 9% and the average return on the market is
13%, what will be the firm's cost of common equity using the CAPM approach? - correct
answer Re = Rrf + (Rm-Rrf)B
= 9% + (13%-9%)1.6
=15.4%
10-9: Cost of common equity is 16%, its before-tax cost of debt is 13%, and its marginal
tax rate is 40%. Assume that the firm's long-term debt sells at par value. The firm's total
debt, which is the sum of the company's short-term debt and long-term debt, equals
$1,152. The firm has 576 shares of common stock outstanding that sell for $4.00 per
share. Calculate the WACC using market-value weights?
Assets:
Cash $130
Accounts Receivable $240
Inventories $360
Plant and Equip. $2160
Total assets $2890
Liabilities&Equity:
Acct payable $10
ST debt $52
LT debt $1,100
Common Equity 1728
Total $2890 - correct answer BV total debt = ST debt + LT debt = MV
Total debt = $1,152
P0 = $4.00
Shares = 576
T = 40%
WACC = wdrd(1-T) +were
=0.3333(0.13)(0.6) + 0.6667(0.16)
, =0.0260 + 0.1067 = 13.27%
Ch.10: J. Peterman Company's raw beta is 2.5 (adjust it). The YTM of their bonds is
9%. The 10-year T-note is yielding 4%. The firm's tax rate is 21% and the equity risk
premium is 5%. Based on the market value of their securities, the firm currently has
60% of common equity and 40% of interest-bearing debt and they feel that this is the
optimal capital structure. What is the firm's WACC? - correct answer Adjusted Beta
= .67(2.5) + (.33)(1) = 2.01
Rd = 9%
Re = 4% + 5(2.01) = 14.05%
WACC = (0.4)[9%(1-.21)] + (0.6)14.05%
=2.844 + 8.43
=11.27%
Thomas Brothers are expected to pay a $0.50 per share dividend at the end of the year.
The dividend is expected to grow at a constant rate of 7% a year. The required rate of
return on the stock is 15%. What is the stock's current value per share? - correct answer
D1 = $0.50
G = 7%
Re = 15%
Pstock = 0.50/(0.15-0.07)
=$6.25
Investors require a 15% rate of return on Levine Company's stock. What is its value if
the previous dividend was D0=$2 and investors expect dividends to grow at a constant
annual rate of 1. -5% 2. 0% 3. 5%, or 4. 10% - correct answer Pstock =
$2(1-0.05)/(0.15+0.05) = $9.50
Pstock = $2(1_0.00)/(0.15-0.00) - $13.33
Pstock = $2(1+0.05)/(0.15-0.05) = $21.00
Pstock= $2(1+0.10)/(0.15-0.10) = $44.00
Is it reasonable to think that a constant growth stock could have g> Rs? - correct
answer No. It is not reasonable for a firm to grow indefinitely at a rate higher than its
required return. Such a stock, in theory, would become so large that it would eventually
overtake the whole economy
12-1: Operating cash flows rather than accounting income are listed in table 12.1. Why
do we focus on cash flows as opposed to net income in capital budgeting? - correct
answer Only cash can be spent or reinvested, and since accounting profits do not
represent cash, they are of less fundamental importance than cash flows for investment
analysis. Recall that in the stock valuation chapter we focused on dividends, which
represent cash flows, rather than on earnings per share
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