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(2)Questions for midterm exam
Financial management (National Chung Cheng University)
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BBA
Fall 2019
Corporate Finance Midterm
1. There are two questions in this part. Please describe in your words as much as
you can.
a. Discuss the difference between book values and market values on the
balance sheet and explain the best method for determining the value of a
firm to its stockholders. (3 points)
b. Why is cash flow management important? (2 points)
2. Rita corporation’s accountants prepared the following financial statements for
year-end 2019.
a. Explain the change in cash during 2019.
b. Determine the change in net working capital in 2019.
c. Determine the cash flow generated by the firm’s assets during 2019.
RITA CORPORATION
Income Statement 2019
Revenue
$987
Expenses
534
Depreciation
120
Net Income
$333
Dividends
$313
RITA CORPORATION
Balance Sheet December 31
Assets
2018
Cash
2019
$50
$83
Other current assets
$160
$172
Net fixed assets
$350
$405
Total assets
$560
$660
Liabilities and Equity
2018
2019
Accounts payable
$150
$155
Long-term debt
$110
$185
Stockholders’ equity
$300
$320
Total liabilities and equity
$560
$660
3. Delta Kloudy, CFO of Amazing Inc., has created the firm’s pro forma balance sheet
for the next fiscal year. Sales are projected to grow by 8 percent to $310 million.
Current assets, fixed assets and short-term debt are 15%, 75%, and 20% of sales
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respectively. Amazing Inc. pays out 35% of its net income in dividends. The firm
currently has $120 million of long-term debt and $60 million in common stock
par value. The profit margin is 7%.
a. Construct the current balance sheet for the firm using the projected sales
figure.
b. Based on Mr. Kloudy’s sales growth forecast, how much does Amazing Inc.
need in external funds for the upcoming fiscal year?
c. Construct the firm’s pro forma balance sheet for the next fiscal year and
confirm the external funds needed that you calculated in part (b).
4.
Mr. Kelvin is planning to save for retirement over the next 25 years. To do this,
his personal financial advisor give him 2 options
Option 1: To invest his money $1,200 per month in a stock account, the return
of the stock account is expected to be 11 percent per year
Option 2 : To buy a retirement fund. For this fund, the payout at maturity is
$1,900,000 and the following annual payment as: $38,000 , $44,000 , $50,000 ,
$56000 , $62,000 , $68,000.
After 6 years, no more payments are made and the relevant rate is 11% for
the first
six years and 8.5% for all subsequent years. Is this fund worth buying?
Although Mr. Kelvin select option 1 or 2 after retirement, he will put his
money into an saving account with an annual return of 6 percent. If Mr. assume a 25
year withdrawal period after retirement, which options that he can have maximum
withdraw each month?
5.
Mr. John is going to ask for a loan to buy his new apartment. Two banks offer 25year, $400,000 mortgages at 5.5 percent and charge a $3,000 loan application
fee.
However, the application fee charged by Bank A is refundable if the loan
application is denied, whereas that charged by Bank B is not.
The current disclosure law requires that any fees that will be refunded if the
applicant is rejected be included in calculating the APR, but this is not required with
nonrefundable fees (because refundable fees are part of the loan rather than a fee).
5.1 In case of the loan application has been accepted, Mr.John’s
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lOMoARcPSD|18722858
BBA
Fall 2019
affordability is $2,500 per month. Does he afford the house loan?
5.2 What are the EARs on these two loans? And What are the APRs?
6.
You just received an offer to transfer your $20,000 balance from your current
credit card,
which charges an annual rate of 19.2%, to a new credit card charging a rate of
9.6%
If you plan your monthly payments of $400 with the new card ,
How much faster could you pay the loan off ?
7.
CCU is trying to choose between the following two mutually exclusive design
projects:
Year
Project 1
Project 2
0
-$54,000
-$24,800
1
25,300
12,400
2
25,300
12,400
3
25,300
12,400
a.
b.
8.
If the required return is 10 percent and the company applies the profitability
index decision rule, which project should the firm accept?
If the company applies the NPV decision rule, which project should it take?
Consider the following cash flows of two mutually exclusive projects for CCU.
Assume the discount rate for both projects is 10 percent.
Year
Project 1
Project 2
0
-$1,000,000
-$620,000
1
750,000
340,000
2
600,000
520,000
3
625,000
365,000
a.
b.
c.
Based on the payback period, which project should be taken?
Based on the NPV, which project should be taken?
Based on the IRR, which project should be taken?
9.
Consider two mutually exclusive new product launch projects that Mike is
considering. Assume the discount rate for both products is 15 percent.
Project A:Product A will take an initial investment of $680,000 at Year 0.
For each of the next 5 years (Years 1-5), sales will generate a consistent
cash flow of $200,000 per year.
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Introduction of new product at Year 6 will terminate further cash flow from
this project.
Project B: Product B will take an initial investment of $520,000 at Year 0.
Cash flow at Year 1 is $115,000. In each subsequent year, cash flow will
grow at 12 percent per year.
Introduction of new product at Year 6 will terminate further cash flow from
this project.
Year
Product A
Product B
0
-$680,000
-$520,000
1
200,000
115,000
2
200,000
128,800
3
200,000
144,256
4
200,000
161,567
5
200,000
180,955
Please fill in the following table:
Product A
Product B
Which to Accept
Payback
IRR
PI
NPV
10. Your firm is contemplating the purchase of a new $540,000 computer-based
order entry system. The system will be depreciated straight-line to zero over the
project’s 5-year life. It will be worth $55,000 at the end of that time. You will
safe $180,000 before taxes per year in order processing costs, and you will be
able to reduce working capital by $67,000 (this is a one-time reduction). If the
tax rate is 20 percent, what is the IRR for this project?
11. CCU is considering a new project that complements its existing business. The
machine required for the project costs $4.35 million. The marketing department
predicts that sales related to the project will be $2.32 million per year for the
next four years, after which the market will cease to exist. The machine will be
depreciated to zero over its 4-year economic life using the straight-line method.
Cost of goods sold and operating expenses related to the project are predicted
to be 23.5 percent of sales. The company also needs to add net working capital
of $165,000 immediately. The additional net working capital will be recovered in
full at the end of the project’s life. The corporate tax rate is 25 percent and the
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BBA
Fall 2019
required return for the project 14 percent. Should the company proceed with
the project?
12. CCU has decided to sell a new line of golf clubs. The clubs will sell for $930 per
set and have a variable cost of $440 per set. The company has spent $145,000
for a marketing study that determined the company will sell 48,000 sets per
year for seven years. The marketing study also determined that the company
will lose sales of 9,000 sets of its high-priced clubs. The high-priced clubs sell at
$1,550 and have variable costs of $600. The company also will increase sales of
its cheap clubs by 11,500 sets. The cheap clubs sell for $470 and have variable
costs of $200 per set. The fixed costs each year will be $9.2 million. The
company also has spent $1.2 million on research and development for the new
clubs. The plant and equipment required will cost $28.7 million and will be
depreciated on a straight-line basis to a zero-salvage value. The new clubs also
will require an increase in net working capital of $2.6 million that will be
returned at the end of the project. The tax rate is 23 percent and the cost of
capital is 14 percent. Calculate the payback period, the NPV, and the IRR.
13. Mike comes to you with a sure-fire way to make some quick money and help
pay off your student loans. His idea is to sell T-shirts with his face and CCU BA on
them. “All we have to do is buy a used silk screen press for $6,400 and we are in
business!” he said. Assume there are no fixed costs and you depreciate the
$6,400 in the first period. The tax rate is 18 percent.
a. What is the accounting-breakeven point if each shirt costs $2.8 to make and you
can sell them for $16 a piece?
Now assume one year has passed and you have sold 5,500 shirts. You find out that
CCU BA have copyrighted the CCU BA title and are requiring you to pay $24,000 to
continue operations. You expect this craze will last for another three years and that
your discount rate is 12 percent.
b. What is the break-even point for your enterprise now?
14. CCU is considering a new product launch. The firm expects to have an annual
operating cash flow of $9.1 million for the next 10 years. The discount rate for
this project is 13 percent. The initial investment is $42.3 million. Assume that
the project has no salvage value at the end of its economic life.
a. What is the NPV of the new product?
b. After the first year, the project can be dismantled and sold for $26 million. If the
estimates of remaining cash flows are revised based on the first years’
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Fall 2019
experience, at what level of expected cash flows does it make sense to abandon
the project?
15. TSMC has a 5 percent coupon bond outstanding. MediaTek has a 9 percent bond
outstanding. Both bonds have 15 years to maturity, make semiannual payments,
and have a YTM of 8 percent. If interest rates suddenly rise by 2 percent, what is
the percentage change in the price of these bonds? What if interest rates
suddenly fall by 2 percent instead? What does this problem tell you about the
interest rate risk of lower coupon bonds?
16. CCU has 7.3 percent coupon bonds on the market with 11 years to maturity. The
bonds make semiannual payments and currently well for 103 percent of par.
What is the current yield on the bond? The YTM? The effective annual yield?
17. The YTM on a board is the interest rate you earn on your investment if interest
rates don’t change. If you actually sell the bond before it matures, your realized
return is known as the holding period yield (HPY).
a. Suppose that today you buy a bond with an annual coupon of 5.2 percent
for $850. The bond has 10 years to maturity. What rate of return do you
expect to earn on your investment?
b. Two years from now, the YTM on your bond has declined by 1 percent and
you decide to sell. What price will your bond sell for? What is the HPY on
your investment?
18. CCU just paid a dividend of $3.02 per share. The company will increase its
dividend by 20 percent next year and will then reduce its dividend growth rate
by 5 percent points per year until it reaches the industry average of 5 percent
dividend growth, after which the company will keep a constant growth rate
forever. If the required return on the company’s stock is 13 percent, what will a
share of stock sell for today?
19. CCU is expected to pay the following dividends over the next four years: $8, $6,
$4.75, $2.25. Afterwards, the company pledges to maintain a constant 4 percent
growth rate in dividends forever. If the required return in the stock is 10
percent, what is the current share price?
20. Suppose you know that a company’s stock currently sells for $75 per share and
the required return on the stock is 9.8 percent. You also know that the total
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lOMoARcPSD|18722858
BBA
Fall 2019
return on the stock is evenly divided between a capital gains yield and a
dividend yield. If it’s the company’s policy to maintain a constant growth rate in
the dividends, what is the current dividend per share?
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