Faculty of Economics and Business
Academic Year 2016-2017
Exam:
Financiering
6012B0217Y
Date and time of the exam: 22 November, 12:00 - 14:00, World Fashion Center Oosthal
Duration of the exam: 1 ½ hour
Identification:
You have to identify yourself using your certificate of registration (UvA-identification card) and a valid proof
of identity (passport, ID card) with a good resembling photograph. If you cannot identify yourself, access to
the exam may be denied.
If you are not correctly registered via SIS for the course component, your exam will not be marked and
registered.
Please write your name and student number on every sheet of paper you hand in.
Warning against fraud/cheating:
Students who are caught at any form of fraud/cheating will be punished.
Make sure that your mobile phone is switched off and put away in your briefcase/bag. This also applies for
other audio equipment, headphones, digital watches (e.g. I-watches) and other electronic devices. Your
briefcase/bag must be closed and placed on the floor beside your table.
During the exam you are not allowed to go to the toilet (unless, by way of exception, this is approved for by
the invigilation supervisor).
Tools allowed: pencil, pen, eraser, non-programmable calculator, dictionary.
Exam results and exam inspection:
The examiner determines the result of a written exam within 10 working days after the examination date.
The results of this exam will be published within 13 working days following the date of the exam by the
Student Administration Economics and Business via SIS.
It is possible to inspect the exam. The day and time will be announced on blackboard. You are allowed to
make copies of the assessed work and the elaborations/solutions, at cost price.
Specific information on this exam: 18 multiple choice questions equally weighted with correction
for guessing
Version code 1
Please fill in the version code on your answer sheet before you start.
On the answer sheet, Answer A corresponds with 1, B with 2, C with 3 and D with 4
MC Questions, so please use mc form for your answer!
Question 1
Your firm is planning to invest in a new plant. Mokal is an all equity firm that specializes in
this business. Suppose Mokal’s equity beta is 0.66, the risk-free rate is 4%, and the market
risk premium is 8%. If your firm's project is all equity financed, then your estimate of your
cost of capital is closest to:
A) 9.00%
B) 9.25%
C) 9.50%
D) 9.75%
Question 2
Assume stocks A and B have standard deviations of respectively 15% and 19%. Which of
the following claims is TRUE?
A) If the expected return of stock B is lower than stock A, nobody will invest in stock B.
B) Since B is more risky than A, B will have a higher expected return.
C) We do not have enough information to understand which stock has a higher expected
return.
D) Since B is more risky than A, B will have a lower expected return.
Question 3
There are two public-listed companies, X and Y. The equity betas for X and Y are 0.8 and
1.2, respectively. The market portfolio return is 8% and the risk-free rate is 3%. Assume that
CAPM holds. Which of the following portfolios has the same beta as the market portfolio
beta?
A) Invest 33% in the stock of X and 67% in the stock of Y.
B) Invest 50% in the stock of X and 50% in the stock of Y.
C) Lend 40% at the risk free rate and invest 60% in Y.
D) Borrow 10% at the risk free rate and invest 110% in X.
Question 4
Which of the following statements is FALSE?
A) We should be suspicious of beta estimates that are extreme relative to industry norms.
B) When using historical data, there is always the possibility of estimation error.
C) Evidence suggests that betas tend to revert toward zero over time.
D) Beta corresponds to the slope of the best-fitting line in the plot of the security’s excess
returns versus the market excess return.
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Question 5
Consider the following information regarding corporate bonds:
Rating
Average Default Rate
Recession Default Rate
Average Beta
AAA
0.0%
0.0%
0.05
AA
0.1%
1.0%
0.05
A
0.2%
3.0%
0.05
BBB
0.5%
3.0%
0.10
BB
B
CCC
2.2% 5.5% 12.2%
8.0% 16.0% 48.0%
0.17 0.26 0.31
Rearden Metal has a bond issue outstanding with ten years to maturity, a yield to maturity of
8.6%, and a B rating. The corresponding risk-free rate is 3% and the market risk premium is
6%. Assuming a normal economy, the expected return on Rearden Metal's debt is closest to:
A) 8.6%
B) 3%
C) 4.6%
D) 6.0%
Question 6
Consider the following information regarding corporate bonds:
Rating
Average Default Rate
Recession Default Rate
Average Beta
AAA
0.0%
0.0%
0.05
AA
0.1%
1.0%
0.05
A
0.2%
3.0%
0.05
BBB
0.5%
3.0%
0.10
BB
2.2%
8.0%
0.17
B
CCC
5.5% 12.2%
16.0% 48.0%
0.26
0.31
Galt Industries has a market capitalization of $50 billion, $30 billion in BBB rated debt. If
Galt's equity beta is 1.15, then Galt's underlying asset beta is closest to:
A) 0.75
B) 0.83
C) 0.92
D) 1.15
Question 7
In a world where taxes exist but no other capital market imperfections, the following is
TRUE:
A) The WACC after taxes is independent of the capital structure.
B) There is no advantage from debt financing
C) The value of an unlevered firm is larger than that of an leveraged firm
D) The value of a leveraged firm is larger than that of an unlevered firm.
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Question 8
Peanut industries has €800 million in debt outstanding with an interest rate of 12%. It is
contractually determined that Peanut has to repay €160 million of the balance at the end of
each year. Suppose that the marginal corporate tax rate is 35%. Assume that the risk of the
interest tax shields is higher than the risk of the loan and therefore that the appropriate
discount rate to calculate the present value of the tax shield is 15%. The present value of the
interest tax shield in € million is:
A) 72.4
B) 73.8
C) 78.1
D) 92.3
Question 9
Which of the following statements is FALSE?
A) The levered equity return equals the unlevered return, plus an additional return due to
leverage.
B) By holding a portfolio of the firm’s equity and its debt, we can replicate the cash flows
from holding its levered equity.
C) The cost of capital of levered equity is equal to the cost of capital of unlevered equity
plus a premium that is proportional to the market value debt-equity ratio.
D) If a firm is unlevered, all of the free cash flows generated by its assets are available to be
paid out to its equity holders.
Question 10
Suppose that Taggart Transcontinental currently has no debt and has an equity cost of
capital of 10%. Taggart considers borrowing funds at a cost of 6% and using these funds to
repurchase existing shares of stock. Assume perfect capital markets. If Taggart borrows
until they achieved a debt -to-value ratio of 20%, then Taggart's levered cost of equity would
be closest to:
A) 8.0%
B) 9.2%
C) 10.0%
D) 11.0%
Question 11
Flagstaff Enterprises expects to have a free cash flow at the end of the year of $8 million,
and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has
an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate
tax bracket.
If Flagstaff currently maintains a 0.5 debt to equity ratio, then the value of Flagstaff as a
levered firm is closest to:
A) $114 million
B) $100 million
C) $111 million
D) $140 million
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Question 12
Which of the following statements is FALSE?
A) An important consequence of leverage is the risk of costly bankruptcy.
B) Financial distress is a decline in the value of a firm's assets that can occur even before the
firm is in default.
C) Whether default occurs depends on the free cash flows, not on the relative values of the
firm's assets and liabilities.
D) Modigliani and Miller's results continue to hold in a perfect market even when debt is
risky and the firm may default.
Question 13
Consider a firm with a corporate income tax rate of 35% that can choose its permanent debt
level according to the table below where the chosen debt level influences the costs of
financial distress.
Debt $10 Debt $20 Debt $30 Debt $40 Debt $50
Probability of
0%
2%
5%
10%
15%
financial distress
Present Value of
$100
$110
$120
$130
$140
costs when
financial distress
occurs
What is the optimal capital structure for this firm according to the trade-off theory?
A) $10
B) $20
C) $30
D) $40
Question 14
Which of the following statements is FALSE?
A) The most important insight regarding capital structure goes back to Modigliani and
Miller: With perfect capital markets, a firm's security choice alters the risk of the firm’s
equity, but it does not change the firm value or the amount it can raise from outside
investors.
B) When agency costs are significant, short-term debt may be the most attractive form of
external financing.
C) Of all the different possible market imperfections that drive capital structure, the most
clear-cut, and possibly the most significant, are taxes.
D) Too much debt can motivate equity holders to take less risk and refuse new outside
financing.
Question 15
If managed effectively, ABC Inc. will have assets next year with either a market value of
$200, $300 million, or $400 million. Each outcome is equally likely. Managers, however,
may decide to engage in empire building that reduces ABC’s market value by $10 million.
Managers will engage in empire building unless that behavior increases the likelihood of
bankruptcy. Assume the firm has $250 in debt maturing in 1 year. For simplicity, ignore
discounting.
What are the agency costs of leverage due to empire building for this firm closest to?
A) $0 million
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B) $5 million
C) $10 million
D) $15 million
Question 16
Suppose that AXY Inc. is a pharma company that would like to produce a drug to cure
cancer. Currently, the drug is in the test phase. For the continuation of the project, AXY
needs to raise funds either through debt or equity issuance. Assume that there is no tax, cost
of financial distress or debt agency benefits. Which of the following is TRUE in a world of
asymmetric information?
A) If neither the management of AXY nor the market knows the test results, it would be
better for AXY management to issue equity rather than debt.
B) If neither the management of AXY nor the market knows the test results, it would be
better for AXY management to issue debt rather than equity.
C) If the management of AXY knows the test result is successful but the market does not
know, it would be better for AXY management to issue equity rather than debt.
D) If the management of AXY knows the test result is successful but the market does not
know about it, it would be better for AXY management to issue debt rather than equity.
Question 17
According to the agency theory of capital structure, debt overhang arises when a firm is
highly levered and:
A) Shareholders decide not to finance new positive NPV investments, because they are too
risky for shareholders.
B) Shareholders decide not to finance new positive NPV investments because most of the
profits will go to debtholders.
C) Debtholders do not want to invest in the firm and want to withdraw their credit.
D) Shareholders decide to finance negative NPV investments to benefit from taking low risk
investments.
Question 18
A Pharmaceutical company discovered a new drug against Obesity. In order to test this and
bring it to the market, the firm needs to raise capital to fund the investment: 350 million
Euros. Currently the firm is all equity financed and there are 10 million shares outstanding.
In funding the investment it has the opportunity to fund both with debt or equity.
There are potential side effects of this drug. These side effects will affect the value of both
the project as well as the current assets of the firm in the following way:
(All is on the basis of market values and in millions of euros).
Current assets
Present value
free cash flows project
Net present Value
With side effects
1200
Without side effects Average
1600
1400
500
150
850
500
675
325
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Assume that there is asymmetric information and that the firm knows whether there are side
effects or not (and the market knows that the firm is better informed). You may ignore
further market imperfections. The firm decides to fund the project with equity. What will be
the price at which shares will be issued?
A) 172.5
B) 210
C) 135
D) 205
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Formula Sheet Finance Exam
NPV
T
NPV = 
t =1
Perpetuity
Growing perpetuity
FCFt
− Initial cos t
(1 + r )t
PV0 =
Cash Flow
r
PV0 =
CF1
r−g
1

1
PV0 = CF ×  −

t
 r r (1 + r ) 
Annuity
Expected return of a
portfolio
E [ RP ] =  i xi E [ Ri ], where xi =
value of investment i
total value of portfolio
Variance and standard
deviation of a stock
CAPM
E(Ri ) = ri = rf + βiMkt (E(RMkt ) − rf )
Beta
βiMkt ≡
Unlevered beta without
taxes
SD(Ri ) × Corr (Ri ,RMkt )
Cov(Ri ,RMkt )
=
SD(RMkt )
Var (RMkt )
βA = βU =
E
D
βE +
βD
E+D
E+D
Pre-tax WACC:
rU = rA = pre − tax rwacc =
Levered return on equity
rE = rU +
D
(rU − rD )
E
After-tax WACC
after − tax rwacc =
Debt capacity
E
D
rE +
rD
E + D
E + D
E
D
D
rE +
(1 − τ c ) rD = rU − τ c rD
E + D
E + D
V
Dt = d × Vt L
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