The following questions should be answered either True or False. Further, to receive full credit, your answer should be briefly explained. (3 points each)
1. An increase in interest rates will cause the current resale value of a long term bond to increase more than that of a short term bond.
2. In the CAPM, Beta can best be described as the relative volatility of a security as compared to the total stock market with a Beta of 1 indicating that the stock is equally as volatile as the markets are as a whole.
3. Most companies will use the lowest interest rate of their long term debt as the discount rate (hurdle rate) for doing the NPV calculations on capital projects.
4. The Present Value (PV) of $10,000 received 3 years from now assuming an interest rate of 4.5% would be $11,411.66.
5. If two capital projects are mutually exclusive you should always select the one with the highest IRR and ignore the NPV of each project.
6. One of the major advantages of funding the company with debt financing is the tax effects realized because the interest charges are a tax deduction.
7. When it comes to paying dividends, a large mature slow-growing company is much more likely to pay out a dividend than is a new fast-growing start up company.
8. If you were to graph the WACC you would find that increasing the amount of debt will lower the WACC to a point and then it will start to rise again as debt increases further. This results in a U shaped curve on the graph.
9. A company that is underleveraged (too little debt) can be considered a more attractive take over target simply because of this fact.
10. The Pay Back Method is preferred by many companies because it is relatively easy to use and incorporates Time Value of Money concepts.
This next set of problems will require you to do some math. Each problem is worth 5 points. For maximum credit you should show your work.
22. The warrants of Integra Life Sciences allow the holder to buy a share of stock at $11.75 and are selling for $2.85. The stock price is currently $8.50. What price must the stock go to for the warrant purchaser to at least be assured of breaking even?
23. The Redford Investment Company bought 100 Cinema Corp. warrants one year ago and would like to exercise them today. The warrants were purchased at $24 each, and they expire when trading ends today (assume there is no speculative premium left.) Cinema Corp. common stock is selling today for $50 per share. The exercise price is $30 and each warrant entitles the holder to purchase two shares of stock, each at the exercise price.
a. If the warrants are exercised today, what would the Redford Investment Company’s dollar profit or loss be?
b. What is the Redford Investment Company’s percentage rate of return?
24. The Clark Corporation desires to expand. It is considering a cash purchase of Kent Enterprises for $3 million. Kent has a $700,000 tax loss carry-forward that could be used immediately by the Clark Corporation, which is paying taxes at the rate of 30 percent. Kent will provide $420,000 per year in cash flow (aftertax income plus depreciation) for the next 20 years. If the Clark Corporation has a cost of capital of 13 percent, should the merger be undertaken?