Fi 414 Practice Exam

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Exam #1- Finance 414 – Spring 2011

Name:_________________________________

Student PID Number ____________________

You have 1 hour and 20 minutes to complete this exam. Section I has 32 multiple choice questions worth 2.5 points each for a total of 80 points. Section II has 2 long problems worth 10 points each. Plan your time accordingly. Read each question carefully and show all of your work clearly on the long problems as partial credit will be given. If you run out of space use the back of the page to complete your answer. Good Luck!

Section 1- Multiple Choice- Circle the single best answer to each question

1. If an investor purchases shares in an unlevered firm and borrows on their own account to purchase some of these shares, the investor is pursuing the ______________ strategy. (a) milking the property

(b) homemade leverage
(c) excessive risk taking
(d) Enron

2. Which of the following are true according to the Modigliani and Miller theory in a world with no taxes and no financial distress costs. a) Total firm value is independent of capital structure
b) A firm’s weighted-average-cost-of-capital is independent of capital structure c) The expected return on a firm’s stock is independent of capital structure d) a and b
e) b and c
f) a and b and c

3. Which of the following are true according to the Modigliani and Miller theory in a world with corporate taxes but no financial distress costs or personal taxes.
(a) Firm value increases with the amount a firm borrows
(b) A firm’s weighted-average-cost-of-capital increases with the amount a firm borrows (c) The expected return on a firm’s stock is independent of capital structure (d) a and b
(e) b and c
(f) a and b and c

4. The expected return on a firm’s stock is 20% and currently the firm has no debt. The firm is contemplating changing its debt-equity ratio to 1 There are no corporate or personal taxes and the risk-free interest rate is 10%. Under the new capital structure rWACC will equal ________. a) 15.0%

b) 16.0%
c) 19.0%
d) 20.0%
e) 30.0%

5. The expected return on a firm’s stock is 20% and currently the firm has no debt. The firm is contemplating changing its debt-equity ratio to 1. The corporate tax rate is 50% and there are no personal taxes or financial distress costs. The risk-free interest rate is 10% and the firm’s borrowing cost is also 10%. Under the new capital structure rWACC will equal ________. (a) 15.0%

(b) 16.0%
(c) 19.0%
(d) 20.0%
(e) 30.0%

6. A firm currently has $20 million in stock outstanding and $80 million in bonds outstanding. The corporate tax rate is 40% and there are no personal taxes and no financial distress costs. If a firm announces it is selling $10 million in bonds and using the proceeds to repurchase shares, what will be the total value of the firm’s stock immediately after the announcement of the transaction (but before the transaction is complete)? (a) $10.0 million

(b) $14.0 million
(c) $20.0 million
(d) $24.0 million
(e) $26.0 million
(f) $30.0 million

7. A firm currently has $20,000 in debt outstanding and $80,000 in equity outstanding. The interest rate on the outstanding debt is 10% and the corporate tax rate is 40%. If the firm sells $20,000 in stock and uses the proceeds to repurchase all of the outstanding debt, by how much will the firm’s income tax bill in the following year change? a) no change

b) tax bill will increase by $400
c) tax bill will decrease by $400
d) tax bill will increase by $800
e) tax bill will decrease by $800
f) tax bill will increase by $4,000
g) tax bill will decrease by $4,000

8. A firm currently has 10,000 shares selling for $10 a share. The firm currently has no debt. The corporate tax rate is 50% and there are no personal taxes or financial distress costs. If the firm announces it is issuing $10,000 in bonds and using the proceeds to repurchase shares, what will the...
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