Unit 1
1. XYZ Limited has no debt financing and has a value of $55 million and EBIT of $24.5 million. The firm is planning to change its capital structure by issuing $25 million in debt, and repurchasing $15 million of common stock. The firm is estimated to pay 8 percent on interest expense.
a) According to the MM view of corporate taxes, what is the value of the levered firm in millions of dollars if the company's tax rate is 20 percent?
b) What is XYX's cost of equity before the change in capital structure?
c) What will be cost of equity of XYZ under the new capital structure?
Note *8 % is the cost of debt
d) What will be the new firm's WACC?
2. Firm U is an all equity firm and has a market value of $600,000 and EBIT of $200,000. Firm L is identical in all respects to Firm U, but Firm L has $200,000 market value of debt outstanding and $400,000 worth of stock. Firm L pays total annual interest of $16,000 on his debt and has a tax rate of 40 percent. Both firms satisfy the MM assumptions.
a. What is the value of firm L according to MM's proposition 1 with corporate taxes?
b. Tropical is the holder of $30,000 worth of L's stock. What rate of return can he expect, assuming a dividend payout of 100%.
c. Using homemade leverage, show how Tropical could generate exactly the same cash flows and rate of return by investing in Firm U.
Unit 2
3. You have invested 700 shares in Maxwell's Company Limited. For the next three years you will receive dividends of $4.50 per share in year one, $5.75 per share in year two and a liquidating dividend of $45.00 in year three. Assume Maxwell Ltd has a required rate of return is 10 percent and dividend is an annuity.
a) What is the price of Maxwell's stock today?
b) You wish to maintain an equal dividend cash flow through the three year period, how would you accomplish this using the concept of homemade dividend.
4. Whitmore Corporation's expected net income for next year is $2.5 million. The company target and current structures are 40 percent debt and 60 percent common equity. The optimal capital budget for next year is $1.75million.
a) What is the expected payout ratio if Whitmore Corporation uses the residual distribution model to determine next year's distribution and makes all distributions in the form of dividends?
b) Explain why the residual theory of dividends leads Miller and Modigliani to theorize the irrelevance of dividends.
c) Evaluate the following statement. "When a firm repurchases its own shares, the price rises due to the decrease in the supply of shares outstanding"
d) Assuming perfect capital markets, a company announced a $4 dividend, if the last price cum-dividend is $55, what should its first ex-dividend price be?
Unit 3
5. a) The following data has been compiled from various sources on the web. Use the data to check if the IRP holds. Show all workings
S0 = €0.786/US$ F90=€0.864/US$
IUS = 0.025% per quarter
IEurozone = 0.54% per quarter
b) Show how the uncovered interest rate parity is used to derive the International Fisher Effect.
c) Differentiate between absolute and relative PPP.
6. Respond to the following sentences based on your readings on International Financial Management. (One term may be used more than once)
a) If an investor notices a discrepancy in the exchange rates of two countries and acted upon it, he would be engaging in.
b) One element in the communications network for foreign transactions has the acronym.
c) Suppose the spot exchange rate is 2 US dollars per British pound. The forward exchange rate is 1.9 dollars per pound. The pound is selling at a.
d) Interest rate parity is ensured by.
e) Investing in a financial instrument other than one's home currency and locking in the proceeds through the forward rate is called.
f) The spot lira/dollar exchange rate is 833 lira/$. The 3-month forward rate is 863 lira/$. The lira has a forward on the dollar.
g) states that difference between the forward and spot exchange rates is related to the interest rate differential between the currencies.
Units 4
7. A stock sells for $125. A call option on the stock has an exercise price of $110 and expires in 3 months. If the interest rate is 0.15 and the standard deviation of the stock's return is 0.30.
a) Calculate the call using the Black-Scholes model. Show all workings.
b) What would be the price of a put with an exercise price of $140 and the same time until expiration? Show all workings.
c) You are a financial manager and you have bonds worth $3,000,000 in your portfolio which have a 7 percent coupon rate and will be maturing in 10 years from now. What type of risk exposure do you face on these bonds? Suppose a futures contract on these bonds is available with a standard contract size of US$300,000 per contract. How will you hedge your exposure? If the market interest rates change to 9 percent, what will be your position?
Unit 6
8. Complete the following sentences using the most appropriate term(s) from your readings on Mergers and acquisitions. (Some sentences would require two word phrases)
a) A(n) results when firms X and Y combine assets to form a firm Z. (consolidation)
b) A(n) results when firm X exchanges some of its shares for some shares of Y, whereby X becomes the parent company and Y the subsidiary. (acquisition)
c) A combination that involves two firms in a customer-supplier relationship is called a combination. (vertical)
d) A combination of firms having little or no similarity in economic relationship is known as combinations (conglomerate)
e) A formal proposal to purchase a given number of shares of a firm's stock at a specified price is a (n) . (tender offer)
f) A(n) is a form of divestiture in which an operating unit becomes an independent company.
g) is a dubious motive for merging. (growth/diversification)
h) A firm in a merger transaction that attempts to merge or take over another company is called a . (target company)
i) In defending against a hostile takeover, the strategy that involves the target firm creating securities that give their holders certain rights that become effective when a takeover is attempted is called the strategy. (poison pill)
j) Determination of the "price" is actually the determination of a(n) in mergers involving the exchange of shares of common stock. (exchange ratio)
9. Company A has decided to acquire Company B. Market information about the two firms are summarized below:
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Company A
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Company B
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Earnings
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USD6 million
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USD 7 million
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Shares Outstanding
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4 million
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3 million
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EPS
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USD1.50
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USD2.33
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P/E Ratio
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5.0
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1.72
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Market price per share
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USD7.50
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USD4.00
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a) What is the weighted average price per earnings of the combined firm AB?
b) What is the maximum number of shares firm A will be willing to offer to shareholders of firm B and the minimum number if shares acceptable to firm B?