The document appears to be a midterm exam for a financial management course, as it contains 15 multiple choice and short answer questions about topics like banking regulations, costs and benefits of going public, market efficiency, types of securities issued, the role of financial intermediaries, capital structure patterns, leverage, the Modigliani-Miller proposition, bankruptcy costs, covenants, project finance loans, capital leases, and sinking funds. It also includes 10 problems calculating values related to IPOs, returns, required rates of return, debt-to-equity ratios, and the impact of leverage on firm value.
The document appears to be a midterm exam for a financial management course, as it contains 15 multiple choice and short answer questions about topics like banking regulations, costs and benefits of going public, market efficiency, types of securities issued, the role of financial intermediaries, capital structure patterns, leverage, the Modigliani-Miller proposition, bankruptcy costs, covenants, project finance loans, capital leases, and sinking funds. It also includes 10 problems calculating values related to IPOs, returns, required rates of return, debt-to-equity ratios, and the impact of leverage on firm value.
The document appears to be a midterm exam for a financial management course, as it contains 15 multiple choice and short answer questions about topics like banking regulations, costs and benefits of going public, market efficiency, types of securities issued, the role of financial intermediaries, capital structure patterns, leverage, the Modigliani-Miller proposition, bankruptcy costs, covenants, project finance loans, capital leases, and sinking funds. It also includes 10 problems calculating values related to IPOs, returns, required rates of return, debt-to-equity ratios, and the impact of leverage on firm value.
The document appears to be a midterm exam for a financial management course, as it contains 15 multiple choice and short answer questions about topics like banking regulations, costs and benefits of going public, market efficiency, types of securities issued, the role of financial intermediaries, capital structure patterns, leverage, the Modigliani-Miller proposition, bankruptcy costs, covenants, project finance loans, capital leases, and sinking funds. It also includes 10 problems calculating values related to IPOs, returns, required rates of return, debt-to-equity ratios, and the impact of leverage on firm value.
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FM 2- FINANCIAL MANAGEMENT 2 MIDTERM EXAMINATION
Name: Year: Date:
Answer the following
1. Discuss the U.S banking system regulations that have had a major effect on the development of the U.S financial system. In what ways has the U.S. system been positively and negatively affected by these regulations? 2. What do you think are the most important costs and benefits of becoming a publicly traded firm? If you were asked to advise an entrepreneur whether to take his or her firm public, what are the key questions you would ask before making your recommendation? 3. Are the significantly positive short - run returns and the significantly negative long - run returns, earned by IPO shareholders, compatible with market efficiency? If not, why not? 4. What are the general trends regarding public security issuance by U.S. corporations? Specifically, which security type is most often sold to the public? What is the split between initial and seasoned equity offerings? 5. Define the term “financial intermediary.” What role do financial intermediaries play in U.S. corporation finance? How does this compare with the role of non-U.S. financial intermediaries? 6. What industrial and national capital structure patterns are exhibited globally? What factors seem to be driving these patterns? 7. Why is the use of long term debt financing referred to as using financial leverage? 8. What is the basic conclusion of the original Modigliani and Miller Proposition I? 9. What is the fundamental principle of financial leverage? 10. In what way did M&M change their conclusion, regarding capital structure choice, with the additional assumption of corporate taxes? In this context, what composes the difference in value between levered and unlevered firms? 11. Differentiate between direct and indirect costs of bankruptcy. Which of the two is generally more significant? 12. What purpose do covenants serve in a debt agreement? What factors should a manager consider when negotiating covenants? 13. What is a project finance loan? What role does a vehicle company play in the typical project finance deal? 14. What elements must be included in a lease in order for it to be considered a financial (capital) lease? 15. How do sinking funds reduce default risk?
Problems
1. West Coast manufacturing Company (WCMC) is executing an initial public offering with the following characteristics. The company will sell 10 million shares at an offer price of P$25 per share, the underwriter will charge a 7 percent underwriting fee, and the shares are expected to sell for $32 per share by the end of the first-day’s trading. Assuming this IPO is executed as expected, answer the following:
a. Calculate the initial return earned by investors who are allocated shares in the IPO. b. How much will WCMC receive from this offering? c. What is the total cost (underwriting fee and under pricing) of this to WCMC?
2. Suppose you purchase shares of a company that recently executed in IPO at the post- offering market price of $32 per share, and you hold the shares for one year. You then sell your shares for $35 per share. The company does not pay dividends, and you are not subject to capital gains taxation. During this year, the return on the overall stock market was II percent. What net return did you earn on your share investment? Assess this return compared with the overall market return. 3. Norman Internet Service Company (NISC) is interested in selling common stock to raise capital for capacity expansion. The firm has consulted First Tulsa Company, a large underwriting firm, which believes that the stock can be sold for $50 per share. The underwriter’s investigation found that is administrative costs will be 2.5 percent of the sale price, and its selling cost will be 2.0 percent of the sale price. If the underwriter requires a profit, equal to 1 percent of the sale price, how much in dollars, with the spread have to be to cover the underwriter’s costs and profit? 4. The Norman Company needs to raise $50 million of new equity capital. Its common stock is currently selling for $50 per share. The investment bankers require an underwriting spread of 3 percent of the offering price. The company’s legal, accounting, and printing expenses, associated with the seasoned offering, are estimated to be $750, 000. How many new shares must the company sell to net $50 million? 5. SMG Corporation sol 20 million shares of common stock in a seasoned offering. The market price of the company’s shares, immediately before the offering, was $14.75. The shares were offered to the public at $14.50, and the underwriting spread was 4 percent. The company’s expenses associated with the offering were $7.5 million. How much new cash did the company receive? 6. As Chief Financial of the Campus Supply Corporation (CSC), you are considering a recapitalization plan that would convert CSC from its current all-equity capital structure to one including substantial finance leverage. CSC now has 250, 000 shares of common stock outstanding, which are selling for $60.00 each, and the recapitalization proposal is to issue $7, 500, 000 worth of long-term debt at an interest rate of 6.0 percent and use the proceeds to repurchase 125, 000 shares of common stock worth $7, 500, 000. USC’s earnings next year will depend on the state of the economy. If there is normal growth, EBIT will be $2, 000, 000; EBIT will be $1, 000, 000 if there is a recession and EBIT will be $3, 000, 000 if there is an economic boom. You believe that each economic outcome is equally likely. Assume there are no market frictions such as corporate or personal income taxes.
a. Calculate the number of shares outstanding, the per-share price and the debt - to- equity ratio for CSC if the proposed recapitalization is adopted. b. Calculate the expected earnings per share (EPS) and return on equity for CSC shareholders under all three economic outcomes (recession, normal growth and boom), for both the current all-equity capitalization and the proposed mixed debt/equity capital structure. c. Calculate the break - even level of EBIT where earnings per share for CSC stockholders are the same under the current and proposed capital structures. d. At what level of EBIT will CSC shareholders earn zero EPS under the current and the proposed capital structure?
7. An unlevered company operates in perfect markets and has a net operating income (EBIT) of $250, 000. Assume that the required return on assets for firms in this industry is 12.5 percent. The firm issues $1 million worth of debt, with a required return of 5 percent, and uses the proceeds to repurchase outstanding stock.
a. What is the market value and required return of this firm’s stock before the repurchases transaction? b. What is the market value and required return of this firm’s remaining stock after the repurchase transaction?
8. Assume that the capital markets are perfect. A firm finances its operations with $50 million in stock, with a required return of 15 percent, and $40 million in bonds, with a required return of 9 percent. Assume that the firm could issue $ 10 million worth equity, what would happen to the firm’s WACC? What would happen to the required return on the company’s stock?
9. A firm operates in perfect capital markets. The required return on its outstanding debt is 6 percent, the required return on its shares is 14 percent, and its WACC is 10 percent. What is the firm’s debt - to - equity ratio? 10. Assume that two firms, U and L, are identical, in all respects, except that Firm U is debt free, and Firm L has a capital structure that is 50 percent debt and 50 percent equity, by market value. Further suppose that the assumptions of the Modigliani and Miller capital structure irrelevance proposition hold (no taxes or transactions costs, no bankruptcy costs, etc.) and that each firm will have net operating income (EBIT) of $800, 000. If the required return on assets, r, for these firm is 12.5 percent, and risk-free debt yields 5 percent, calculate the following values for both Firm U and Firm L: (1) total firm value, (2) market value of debt and equity, and (3) required return on equity.
