Mock Exam of Corporate Finance Subject

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e TCH321 – CORPORATE FINANCE MOCK EXAM Time: 1 hour 30 minutes The exam lasts 1 hour and 30 minutes and consists of 5 questions. Approved calculators are permitted. You are not allowed to use Excel. This is a closed book exam. You are NOT permitted to access any other material in either written or electronic form. All numerical answers should be reported to TWO decimal places. To ensure the accuracy of your answer, you should perform all intermediate calculations to at least THREE decimal places. Choose FIVE questions. DO show your working. Question 1. (20 marks) Suppose that you have the following information about a company Credit rating Beta Tax expense Pre-tax income Preferred dividend rate Preferred stock par value Preferred stock price Preferred stock outstanding Common stock price Common stock par value Common stock outstanding Expected next common stock dividend Long term bond yield-to-maturity Enterprise value Market risk premium 30 year Treasury bond yield-to-maturity AA 0.95 14,325,000 113,895,000 5.25% $100.00 $101.25 13,000,000 $53.29 $25.00 50,000,000 $1.95 7.55% 4,945,795,000 6.00% 4.75%


a. What is the estimated cost of common equity for the company? [4 marks]  

b. What is the estimated after-tax cost of debt for the company? [4 marks]


c. What is the estimated cost of preferred equity for the company? [4 marks]


d. What is the estimated WACC of the company? [4 marks]


e. What is the implied long run growth rate of the company’s dividends? [4 marks]


Question 2. (20 marks) Your company is considering buying a new factory. The initial cost of the factory is $500,000, but there is an annual maintenance charge of $15,000. The factory will be depreciated over 25 years on a straight line basis (i.e. the depreciation rate each year). Your company plans to sell the factory in 3 years for $400,000. Use of the factory requires an increase in net working capital of $40,000. The 2   

factory would increase net operating revenues by $200,000. The company’s marginal tax rate is 40 percent. Assume that all cash flows occur at the end of the respective year. a. What is the total year 0 cash flow? [4 marks]


b. What are the net operating cash flows in years 1, 2 and 3? [4 marks]  



c. What is the terminal year cash flow? [4 marks]


d. If the project’s cost of capital is 10 percent, what is the NPV of the project? [4 marks]


e. What is the payback period of the project? [4 marks]



Question 3. (20 marks) Consider two stocks, A and B, with the following expected returns and betas E(R) A B 9.55% 10.98% Beta 0.80 1.10

The risk free rate is 5.75% a. Assuming that Stock A is priced according to the CAPM, What is the market risk premium? [4 marks]  

b. What is the equilibrium expected return of Stock B? [4 marks]  

c. Consider Stock C, which has a beta of 0.90. Suppose that you have forecast a return of 8.00% for Stock C. Is Stock C is overpriced, underpriced or fairly priced? [4 marks]  

d. Suppose that you construct an arbitrage portfolio to exploit any mispricing that you might have found in Stocks A, B and C. What would the weights of this portfolio be? [4 marks]


e. Suppose that the risk free rate rises by 1%. What is the equilibrium expected return of Stock A? [4 marks]   4   

Question 4. (20 marks) Consider two stocks, A and B, with the following expected returns and standard deviations. E(R) A B 8.00% 12.00% Std. Dev. 20.00% 30.00%

The correlation coefficient between the returns of A and B is 0.3. Short selling is allowed. a. Consider a portfolio, P, that comprises 45% invested in stock A and 55% invested in stock B. What is the expected return, standard deviation and coefficient of variation of P? [4 marks]  

b. Plot A and B in expected return-standard deviation space and draw (approximately) the feasible set for P. On this diagram, mark the minimum variance portfolio and the efficient set. [4 marks]...
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