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Corporate Finance

1. Canadian-based mining company El Dorado Gold (EGO) suspended its dividend in March 2016 as a result of declining gold prices and delays in obtaining permits for its mines in Greece. Suppose you expect EGO to resume paying annual dividends in two years time, with a dividend of $0.75 per share, growing by 2.8% per year. If EGO’s equity cost of capital is 9.1%, what is the value of a share of EGO today?

The value of a share of EGO today is $____________ (Round to the nearest cent.)

2. Heavy Metal Corporation is expected to generate the following free cash flows over the next five years:

Year	1	2	3	4	5
FCF ($ million)	53.053.0	68.068.0	78.078.0	75.075.0	82.082.0

After that, the free cash flows are expected to grow at the industry average of 4.0% per year. Using the discounted free cash flow model and a weighted average cost of capital of

14.0 %.

a. Estimate the enterprise value of Heavy Metal. (Round to two decimal places.)

b. If Heavy Metal has no excess cash, debt of $300 million, and 40 million shares outstanding, estimate its share price. (Round to two decimal places.)

3. Given the data from the following table: (Question 3 data file Excel attachment) What if the period from 1990 to 2014 had been “normal”?

a. Calculate the arithmetic average return on the S&P 500 from 1926 to 1989. (Round to two decimal places.)

b. Replace the actual returns from 1990 to 2014 with the average return from (a). How much would $100 invested in the S&P 500 at the end of 1925 have grown to by the end of 2014? (Hint: Use the actual returns from 1926 to 1989 and then continue the growth at the assumed rate.) . (Round to the nearest dollar.)

c. Do the same for small stocks.

a. Calculate the arithmetic average return on the S&P 500 from 1926 to 1989.

The arithmetic average return of the S&P 500 from 1926 to 1989 is

nothing%.

b. Replace the actual returns from 1990 to 2014 with the average return from (a). How much would $100 invested in the S&P 500 at the end of 1925 have grown to by the end of 2014? (Hint: Use the actual returns from 1926 to 1989 and then continue the growth at the assumed rate.)

$100 invested in the S&P 500 at the end of 1925 would have grown to $

nothing

c. Do the same for small stocks. The arithmetic average return of the small stocks from 1926 to 1989 is

_______________ (Round to two decimal places.)

4. Aluminum maker Alcoa has a beta of about 0.64, whereas Hormel Foods has a beta of 0.87. If the expected excess return of the market portfolio is 5%, which of these firms has a higher equity cost of capital, and how much higher is it?

5. You need to estimate the equity cost of capital for XYZ Corp. You have the following data available regarding past returns:

Risk-free Return Market Return XYZ Return

2011 2% 7% 10%

2012 1% -31% -49%

a. What was XYZ’s average historical return?

b. Compute the market’s and XYZ’s excess returns for each year.

The market’s excess return for 2011 was _____________ (Round to the nearest integer.)

The market’s excess return for 2012 was _____________ (Round to the nearest integer.)

XYZ’s excess return for 2011 was ___________________ (Round to the nearest integer.)

XYZ’s excess return for 2012 was ___________________ (Round to the nearest integer.)

Estimate XYZ’s beta.

XYZ’s beta is ________________________ (Round to two decimal places.)

c. Estimate XYZ’s historical alpha.

XYZ’s historical alpha was ____________________ (Round to one decimal place.)

d. Suppose the current risk-free rate is 4%, and you expect the market’s return to be 10%. Use the CAPM to estimate an expected return for XYZ Corp.’s stock.

The expected return for XYZ Corp.’s stock was _________________ (Round to two decimal places.)

e. Would you base your estimate of XYZ’s equity cost of capital on your answer in part (a) or in part (d)? (Select the best choice below.)

A. Part (a) because the average past returns provides a better estimate of expected returns.

B. Part (d) because the average past returns provides a better estimate of expected returns.

C. Part (d) because the CAPM provides a better estimate of expected returns.

D. Part (a) because the CAPM provides a better estimate of expected returns.

6. In mid-2012, Ralston Purina had AA-rated, 10-year bonds outstanding with a yield to maturity of 1.83%

a. What is the highest expected return these bonds could have? (Round to two decimal places.)

b. At the time, similar maturity Treasuries had a yield of 0.83%. Could these bonds actually have an expected return equal to your answer in part (a)? (Select the best choice below.)

A. No, if the bonds are risk-free, the expected return equals the risk-free rate, and if they are not risk-free the expected return is less than the yield.

B. Yes, if the bonds are risky enough, that is if the probability of default is high enough.

C. Yes, the yield to maturity is the maximum expected return you can expect.

D. Yes, because the reasons given in both A. and B. are true.

c. If you believe Ralston Purina’s bonds have 1.4% chance of default per year, and that expected loss rate in the event of default is 52%, what is your estimate of the expected return for these bonds?

7. Your firm is planning to invest in an automated packaging plant. Harburtin Industries is an all-equity firm that specializes in this business. Suppose Harburtin’s equity beta is 0.87, the risk-free rate is 3%, and the market risk premium is 5%.

a. If your firm’s project is all-equity financed, estimate its cost of capital.

After computing the project’s cost of capital you decided to look for other comparables to reduce estimation error in your cost of capital estimate. You find a second firm, Thurbinar Design, which is also engaged in a similar line of business. Thurbinar has a stock price of $23 per share, with 15 million shares outstanding. It also has $111 million in outstanding debt, with a yield on the debt of 4.4%. Thurbinar’s equity beta is 1.00. The project’s cost of capital is ______________ (Round to two decimal places.)

b. Assume Thurbinar’s debt has a beta of zero. Estimate Thurbinar’s unlevered beta. Use the unlevered beta and the CAPM to estimate Thurbinar’s unlevered cost of capital. (Round to two decimal places.)

c. Estimate Thurbinar’s equity cost of capital using the CAPM. Then assume its debt cost of capital equals its yield and using these results, estimate Thurbinar’s unlevered cost of capital. (Round to two decimal places.)

d. Explain the difference between your estimate in part (b) and part (c). (Select the best choice below.)

A. In the first case, we assumed the debt had a beta of zero so we assumed the cost of debt was the riskless rate, while in the second case we assumed the cost of debt was the yield on debt.

B. The answers are actually the same; any difference is just due to rounding errors.

C. The answers differ because we are using approximations rather than formulas that hold exactly.

D. We should have gotten the same answer, the problem is the numbers in the problem are not consistent.

e. You decide to average your results in part (b) and part (c), and then average this result with your estimate from part (a). What is your estimate for the cost of capital of your firm’s project?

The average unlevered cost of capital from part (b) and part (c) is _______________ (Round to two decimal places.)

The average unlevered cost of capital from part (b) and part (c) with part (a) is _______________

(Round to two decimal places.)

FIN571 Multiple Choice Questions

1.

The primary goal of financial management is to:

minimize operational costs and maximize firm efficiency.

maximize current dividends per share of the existing stock.

maximize the current value per share of the existing stock.

avoid financial distress.

maintain steady growth in both sales and net earnings.

2

Financial managers should primarily strive to:

maximize current dividends even if doing so adds financial distress costs to the firm.

minimize costs while increasing current dividends.

maximize the current value per share of existing stock.

maximize current market share in every market in which the firm participates.

maximize the current profits of the firm.

3.

If a firm is currently profitable, then:

its reported sales exceed its costs.

its cash flows are known with certainty.

its current cash inflows must exceed its current cash outflows.

it will always have sufficient cash to pay its bills in a timely manner.

the timing of the cash flows on proposed projects is irrelevant.

4. The owners of a limited liability company generally prefer:

having liability exposure similar to that of a general partner.

having liability exposure similar to that of a sole proprietor.

being taxed like a corporation.

being taxed personally on all business income.

being taxed like a corporation with liability like a partnership.

5.

First City Bank pays 6 percent simple interest on its savings account balances, whereas Second City Bank pays 6 percent interest compounded annually.

If you made a $69,000 deposit in each bank, how much more money would you earn from your Second City Bank account at the end of 10 years? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Difference in accounts

$

6.

a.	Compute the future value of $2,000 compounded annually for 10 years at 6 percent. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Future value

$

b.	Compute the future value of $2,000 compounded annually for 10 years at 11 percent. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Future value

$

c.	Compute the future value of $2,000 compounded annually for 15 years at 6 percent. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Future value

$

7.

What is the future value of $3,052 invested for 9 years at 5.00 percent compounded annually?

$4,450.57

$1,923.52

$4,720.69

$4,734.65

$4,748.62

8.

Six months ago, you purchased 1,200 shares of ABC stock for $21.20 a share and have received total dividend payments of $.60 a share. Today, you sold all of your shares for $22.20 a share. What is your total dollar return on this investment?

$1,440

$720

$3,840

$1,200

$1,920

9.

The excess return you earn by moving from a relatively risk-free investment to a risky investment is called the:

inflation premium.

geometric average return.

time premium.

risk premium.

arithmetic average return.

10.

Which one of the following accounts is included in stockholders’ equity?

intangible assets

plant and equipment

accumulated retained earnings

deferred taxes

long-term debt

11.

Shelton, Inc., has sales of $391,000, costs of $179,000, depreciation expense of $44,000, interest expense of $25,000, and a tax rate of 40 percent. (Do not round intermediate calculations.)

What is the net income for the firm?

Net income

$

Suppose the company paid out $34,000 in cash dividends. What is the addition to retained earnings?

Addition to retained earnings

$

12

Net working capital is defined as:

current assets plus fixed assets.

current assets minus current liabilities.

current assets plus stockholders’ equity.

fixed assets minus long-term liabilities.

total assets minus total liabilities.

13

Which one of these equations is an accurate expression of the balance sheet?

Stockholders’ equity ≡ Assets + Liabilities

Stockholders’ equity ≡ Assets −Liabilities

Liabilities ≡ Stockholders’ equity −Assets

Assets ≡ Stockholders’ equity −Liabilities

Assets ≡ Liabilities −Stockholders’ equity

14

Galaxy United, Inc. 2009 Income Statement ($ in millions)
Net sales	$8,450
Less: Cost of goods sold	7,220
Less: Depreciation	410
Earnings before interest and taxes	820
Less: Interest paid	83
Taxable Income	737
Less: Taxes	258
Net income	$ 479

Galaxy United, Inc. 2008 and 2009 Balance Sheets ($ in millions)
	2008	2009		2008	2009
Cash	$ 110	$ 150	Accounts payable	$1,100	$1,130
Accounts rec.	940	780	Long-term debt	1,000	1,332
Inventory	1,490	1,510	Common stock	$3,110	$2,910
Sub-total	$2,540	$2,440	Retained earnings	520	698
Net fixed assets	3,190	3,630
Total assets	$5,730	$6,070	Total liab. & equity	$5,730	$6,070

What is the days’ sales in receivables? (use 2009 values)

41.0

33.7

24.9

47.5

80.4

15

A firm has sales of $1,360, net income of $227, net fixed assets of $469, and current assets of $329. The firm has $95 in inventory. What is the common-size statement value of inventory?

41.5 percent

11.9 percent

20.3 percent

7.0 percent

28.9 percent

16.

The Purple Martin has annual sales of $4,800, total debt of $1,360, total equity of $2,200, and a profit margin of 5 percent. What is the return on assets?

10.91 percent

6.74 percent

17.65 percent

8.72 percent

5.00 percent

17.

Al’s Sport Store has sales of $2,740, costs of goods sold of $2,100, inventory of $533, and accounts receivable of $444. How many days, on average, does it take the firm to sell its inventory assuming that all sales are on credit?

71.0

92.6

140.0

130.0

91.4

18

Jessica’s Boutique has cash of $47, accounts receivable of $70, accounts payable of $190, and inventory of $160. What is the value of the quick ratio?

2.07

1.46

.37

.62

.84

19.

One of the primary weaknesses of many financial planning models is that they:

ignore the size, risk, and timing of cash flows.

are iterative in nature.

ignore the goals and objectives of senior management.

rely too much on financial relationships and too little on accounting relationships.

ignore cash payouts to stockholders.

20

If a firm bases its growth projection on the rate of sustainable growth, shows positive net income, and has a dividend payout ratio of 30 percent, then the:

number of common shares outstanding will increase at the same rate of growth.

debt-equity ratio will remain constant while retained earnings increase.

debt-equity ratio will have to increase.

fixed assets will have to increase at the same rate, even if the firm is currently operating at only 78 percent of capacity.

fixed assets, the debt-equity ratio, and number of common shares outstanding will all increase.

21

Marcie’s Mercantile wants to maintain its current dividend policy, which is a payout ratio of 35 percent. The firm does not want to increase its equity financing but is willing to maintain its current debt-equity ratio. Given these requirements, the maximum rate at which Marcie’s can grow is equal to:

65 percent of the sustainable rate of growth.

65 percent of the internal rate of growth.

35 percent of the internal rate of growth.

the internal rate of growth.

the sustainable rate of growth.

22

f the Hunter Corp. has an ROE of 11 and a payout ratio of 19 percent, what is its sustainable growth rate? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Sustainable growth rate

%

23

24. The operating cycle can be decreased by:

increasing the accounts payable turnover rate.

discontinuing the discount given for early payment of an accounts receivable.

paying accounts payable faster.

collecting accounts receivable faster.

decreasing the inventory turnover rate.

25

The length of time between the payment for inventory and the collection of cash from receivables is called the:

inventory period.

operating cycle.

accounts receivable period.

cash cycle.

accounts payable period.

26.

Consider the following financial statement information for the Rivers Corporation:

Item	Beginning				Ending
Inventory	$	11,000				$	12,000
Accounts receivable		6,000					6,300
Accounts payable		8,200					8,600
Net sales			$	90,000
Cost of goods sold				70,000

Calculate the operating and cash cycles. (Use 365 days a year. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)


Operating cycle	days
Cash cycle	days

27.

Here are the most recent balance sheets for Country Kettles, Inc. Excluding accumulated depreciation, determine whether each item is a source or a use of cash, and the amount. (Do not round intermediate calculations and round your answers to the nearest whole number, e.g., 32. Input all amounts as positive values):

COUNTRY KETTLES, INC. Balance Sheet December 31, 2016
	2015		2016
Assets
Cash	$	31,400		$	30,590
Accounts receivable		70,900			74,080
Inventories		61,800			64,125
Property, plant, and equipment		157,000			167,800
Less: Accumulated depreciation		(46,720	)		(50,900	)

Total assets	$	274,380		$	285,695

Liabilities and Equity
Accounts payable	$	45,900		$	48,090
Accrued expenses		7,280			6,420
Long-term debt		26,600			29,500
Common stock		26,000			31,000
Accumulated retained earnings		168,600			170,685

Total liabilities and equity	$	274,380		$	285,695

Item	Source/Use		Amount
Cash		$
Accounts receivable		$
Inventories		$
Property, plant, and equipment		$
Accounts payable		$
Accrued expenses		$
Long-term debt		$
Common stock		$
Accumulated retained earnings		$

28.

The rate at which a stock’s price is expected to appreciate (or depreciate) is called the _____ yield.

earnings

dividend

current

total

capital gains

29.

Last year, a bond yielded a nominal return of 7.37 percent while inflation averaged 3.26 percent. What was the real rate of return?

3.86%

3.2 7%

3.98%

3.71%

3.42%

30.

A corporate bond is currently quoted at 101.633. What is the market price of a bond with a $1,000 face value?

$1,102.77

$1,000.28

$1,002.77

$1,276.70

$1,016.33

31.

Stu wants to earn a real return of 3.4 percent on any bond he acquires. The inflation rate is 2.8 percent. He has determined that a particular bond he is considering should have an interest rate risk premium of .27 percent, a liquidity premium of .08 percent, and a taxability premium of 1.69 percent. What nominal rate of return is Stu demanding from this particular bond?

7.38%

8.74%

8.24%

8.40%

7.19%

32.

Miller Manufacturing has a target debt–equity ratio of .50. Its cost of equity is 15 percent, and its cost of debt is 6 percent. If the tax rate is 34 percent, what is the company’s WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

WACC

%

33.

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33.

Filer Manufacturing has 9.2 million shares of common stock outstanding. The current share price is $62, and the book value per share is $4. The company also has two bond issues outstanding. The first bond issue has a face value of $71.8 million and a coupon rate of 7.9 percent and sells for 107.4 percent of par. The second issue has a face value of $61.8 million and a coupon rate of 8.4 percent and sells for 110.7 percent of par. The first issue matures in 8 years, the second in 27 years.

Suppose the company’s stock has a beta of 1.2. The risk-free rate is 4 percent, and the market risk premium is 7.9 percent. Assume that the overall cost of debt is the weighted average implied by the two outstanding debt issues. Both bonds make semiannual payments. The tax rate is 35 percent. What is the company’s WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

WACC

34.

When estimating the cost of equity using the DDM, which one of these is most apt to add error to this estimate?

beta

next year’s dividend

firm’s tax rate

dividend growth rate

current stock price

35

A firm’s WACC can be correctly used to discount the expected cash flows of a new project when that project:

will be financed solely with new debt and internal equity.

will be financed solely with internal equity.

has the same level of risk as the firm’s current operations.

will be financed with the same proportions of debt and equity as those currently used by the overall firm.

will be managed by the firm’s current managers.

36.

The weighted average cost of capital for a firm is the:

discount rate which the firm should apply to all of the projects it undertakes.

rate the firm should expect to pay on its next bond issue.

maximum rate which the firm should require on any projects it undertakes.

overall rate which the firm must earn on its existing assets to maintain its value.

rate of return that the firm’s preferred stockholders should expect to earn over the long term.

37.

Jamestown Ltd. currently produces boat sails and is considering expanding its operations to include awnings. The expansion would require the use of land the firm purchased three years ago at a cost of $142,000 that is currently valued at $137,500. The expansion could use some equipment that is currently sitting idle if $6,700 of modifications were made to it. The equipment originally cost $139,500 six years ago, has a current book value of $24,700, and a current market value of $39,000. Other capital purchases costing $780,000 will also be required. What is the amount of the initial cash flow for this expansion project?

$962,300

$963,200

$953,400

$948,900

$927,800

38

An independent investment is acceptable if the profitability index (PI) of the investment is:

less than one.

less than the internal rate of return.

greater than the internal rate of return.

greater than a pre-specified rate of return.

greater than one.

39.

Samson’s purchased a lot four years ago at a cost of $398,000. At that time, the firm spent $289,000 to build a small retail outlet on the site. The most recent appraisal on the property placed a value of $629,000 on the property and building. Samson’s now wants to tear down the original structure and build a new strip mall on the site at an estimated cost of $2.3 million. What amount should be used as the initial cash flow for new project?

$2,987,000

$2,929,000

$2,058,000

$2,300,000

$2,242,000

40

Foamsoft sells customized boat shoes. Currently, it sells 16,850 pairs of shoes annually at an average price of $79 a pair. It is considering adding a lower-priced line of shoes which sell for $49 a pair. Foamsoft estimates it can sell 5,000 pairs of the lower-priced shoes but will sell 1,250 less pairs of the higher-priced shoes by doing so. What is the estimated value of the erosion cost that should be charged to the lower-priced shoe project?

$146,250

$98,750

$138,750

$52,000

$123,240

41

Marshall’s purchased a corner lot five years ago at a cost of $498,000 and then spent $63,500 on grading and drainage so the lot could be used for storing outdoor inventory. The lot was recently appraised at $610,000. The company now wants to build a new retail store on the site. The building cost is estimated at $1.1 million. What amount should be used as the initial cash flow for this building project?

$1,710,000

$1,498,000

$1,208,635

$1,661,500

$1,100,000

42.

What is the net present value of a project with an initial cost of $36,900 and cash inflows of $13,400, $21,600, and $10,000 for Years 1 to 3, respectively? The discount rate is 13 percent.

$204.36

$797.22

−$1,195.12

−$1,350.49

−$287.22

43.

A project costing $6,200 initially should produce cash inflows of $2,860 a year for three years. After the three years, the project will be shut down and will be sold at the end of Year 4 for an estimated net cash amount of $3,300. What is the net present value of this project if the required rate of return is 11.3 percent?

$3,011.40

$1,980.02

$2,903.19

$935.56

$2,474.76

44.

Flatte Restaurant is considering the purchase of a $10,400 soufflé maker. The soufflé maker has an economic life of five years and will be fully depreciated by the straight-line method. The machine will produce 2,200 soufflés per year, with each costing $2.60 to make and priced at $5.45. Assume that the discount rate is 16 percent and the tax rate is 34 percent.

What is the NPV of the project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

NPV

$

Should the company make the purchase?

YesNo

45.

What is the net present value of a project that has an initial cash outflow of $7,670 and cash inflows of $1,280 in Year 1, $6,980 in Year 3, and $2,750 in Year 4? The discount rate is 12.5 percent.

$68.20

$371.02

$86.87

$249.65