Business Finance Class

BUS 330 BUSINESS FINancE

Part I MULTIPLE CHOICE QUESTIONS

( ) 1.  Based on the following information, make an estimate of the stock's beta: Month 1 = Stock +1.1%, Market +1.5%; Month 2 = Stock +1.4%, Market +2.4%; Month 3 = Stock -2.1%, Market -2.9%.  A. Beta is greater than 1.0. B. Beta is less than 1.0. C. Beta equals 1.0. D. There is no consistent pattern of returns.

( ) 2.  If a firm has 4 times as much equity as debt in its capital structure, then the firm has:  A. 20.0% debt. B. 40.0% equity. C. 50.0% debt. D. 75.0% equity.

E. 80.0% debt

( ) 3.  If the value of an unlevered firm is $4,000,000, then the value of the same firm with debt financed is:  A. $3,000,000 B. $3,500,000 C. $4,000,000 D. $5,000,000

( ) 4. What is the weighted-average cost of capital for a firm with the following sources of funds and corresponding required rates of return: $15 million common stock at 15%, $5 million preferred stock at 9%, and $10 million debt at 6%. All amounts are listed at market values and the firm's tax rate is 35%. 

A. 9.0% B. 10.3%

C. 12.1% D. 13.5% E. 14.4%

( ) 5.  Which of the following is NOT a cost to the firm of increasing debt financing:  A. Investors will demand a higher interest rate on debt. B. The risk to common stockholders increases. C. Stockholders will demand a higher return. D. The cost of common equity will decrease.

( ) 6.  A decrease in a firm's financial leverage will:  A. Increase the operating risk of the firm. B. Decrease the value of the firm in a non-MM world. C. Decrease the WACC.

D. Reduce the variability in earnings per share.

( ) 7.  What is the after-tax cost of debt for a firm in the 30% tax bracket that pays 12% on its debt?  A. 5.25%

B. 8.40% C. 9.75% D. 12.17% E. 20.25%

Part II Problem Solving Questions

1. Discuss the trade-off theory of capital structure, including the determination of an optimal debt level. 

2. ABC Inc. recently is doing the following financing: (1) The firm's non-callable bonds mature in 20 years, have an 6.00% annual coupon, a par value of $1,000, and a market price of $1,050.00. (2) The company’s tax rate is 40%. (3) The risk-free rate is 5%, the market return is 12%, and the stock’s beta is 1.20. (4) The target capital structure consists of half debt and half equity. The firm uses the CAPM to estimate the cost of common stock, and it does not expect to issue any new shares. What is its WACC?

3. The company has the following free cash flows for the next 4 years FCF1=-100, FCF2=-55, FCF3=-40, FCF4=150, after year 4, the growth rate of the FCF will be 10%, and the WACC=15%, then what the firm value should be?

4. Tri Co. has the following cost of debt structure :

wd	0%	20%	30%	40%	50%
rd	0.0%	9.0%	10.0%	11.0%	12.0%

The market risk premium is 4.5%, the risk free rate is 5%, beta of unleveraged firm is 1.20, Hamada’s equation b= bU [1 + (1 - T)(wd/we)]

Please use the above information to answer following questions:

a) If the firm uses 50% debt, what is the cost of equity of the firm, based on CAPM model?

b) What is WACC of the firm?

c) If the firm has infinite FCF1=35 million and grow at 5% forever, what is the firm’s value?