FIN4801
EXAM
PACK
2023
, lOMoARcPSD|24668432
SOLUTIONS
Practice questions
Multiple Choice
1. XYZ has $25,000 of debt outstanding and a book value of equity of $25,000. The company has
10,000 shares outstanding and a stock price of $10. If the unlevered beta is 0.75 and the marginal
tax rate is 20%, what is XYZ's levered beta?
a. 0.75
b. 0.8
c. 0.85
D. 0.9
Market value of equity = 10,000 x $10 = $100,000; β L = 0.75[1+(1-0.2)($25,000/$100,000)]
2. The Collection Co. has a current beta of 1.6. The market risk premium is 7 percent and the risk-
free rate of return is 3 percent. By how much will the cost of equity increase if the company
expands their operations such that their company beta rises to 1.9?
a. 0.30 percent
b. 0.90 percent
c. 1.50 percent
D. 2.10 percent
e. 2.70 percent
Current cost of equity = 3+1.6(7) = 14.2%
New cost of equity = 3+1.9(7) = 16.3%
Change in cost of equity = 16.3 – 14.2 = 2.1
3. Blue Ribbon, Inc. wants to have a weighted average cost of capital of 10 percent. The firm has an
aftertax cost of debt of 4 percent and a cost of equity of 12 percent. What debt-equity ratio is
needed for the firm to achieve their targeted weighted average cost of capital?
a. .25
B. .33
c. .50
d. .67
e. .75
.10 = [W e .12] + [(1 W e) .04)
.10 = .12W e + .04 .04W e
.06 = .08W e
W e =.75
Wd = 1 We = 1 .75 = .25
Debt-equity ratio = .25 / .75 = .33
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SOLUTIONS
4. If a firm uses its WACC as the discount rate for all of the projects it undertakes then the firm will
tend to:
I. reject some positive net present value projects.
II. accept some negative net present value projects.
III. favor high risk projects over low risk projects.
IV. maintain its current level of risk.
a. I and III only
b. III and IV only
C. I, II, and III only
d. I, II, and IV only
e. I, II, III, and IV
5. Wayne's of New York specializes in clothing for female executives living and working in the
financial district of New York City. Allen's of PA. specializes in clothing for women who live
and work in the rural areas of Western Pennsylvania. Both firms are currently considering
expanding their clothing line to encompass working women in the rural upstate region of New
York state. Wayne's currently has a cost of capital of 11 percent while Allen's cost of capital is 9
percent. The expansion project has a projected net present value of $36,900 at a 9 percent
discount rate and a net present value of $13,200 at an 11 percent discount rate. Which firm or
firms should expand into rural New York state?
a. Wayne's only
b. Allen's only
C. both Wayne's and Allen's
d. neither Wayne's nor Allen's
e. cannot be determined from the information provided
6. You are considering a project that will generate sales of $89,000, costs of $56,000, and annual
depreciation of $26,000. What is the value of the operating cash flow if the tax rate is 34
percent?
a. $28,380
b. $30,620
C. $47,780
d. $59,000
OCF = [($89,000 − $56,000) × (1 − .34)] + 26,000 = $47,780
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SOLUTIONS
7. If a firm is operating with the optimal amount of debt, then the:
a. financial distress costs must equal the present value of the tax shield on debt.
B. value of the levered firm will exceed the value of the firm if it were unlevered.
c. value of the firm is equal to V U +T C D.
d. value of the firm is equal to V L +T C D.
e. debt-equity ratio is equal to 1.0.
8. The basic lesson of M&M Theory is that the value of a firm is dependent upon the:
a. capital structure of the firm.
B. total cash flows of the firm.
c. percentage of a firm to which the bondholders have a claim.
d. tax claim placed on the firm by the government.
e. size of the stockholders' claims on the firm.
9. Lester's Meat Market is currently an all equity firm that has 24,000 shares of stock outstanding at
a market price of $25 a share. The firm has decided to leverage its operations by issuing $200,000
of debt at an interest rate of 8 percent. This new debt will be used to repurchase shares of the
outstanding stock. The restructuring is expected to increase the earnings per share. What is the
minimum level of earnings before interest and taxes that the firm is expecting? Ignore taxes.
A. $48,000
b. $52,400
c. $57,620
d. $60,200
e. $61,340
EBIT / 24,000 = [EBIT - ($200,000 .08)] / [24,000 - ($200,000 / $25)]
16,000EBIT = 24,000EBIT - $384,000,000
EBIT = $48,000
10. Denver Dry Goods has expected earnings before interest and taxes of $14,600, an unlevered cost
of capital of 15 percent, and a tax rate of 35 percent. The company also has $3,500 of debt that
carries a 6 percent coupon. The debt is selling at par value. What is the value of this firm?
a. $63,267
b. $64,184
C. $64,492
d. $65,211
e. $66,267
V U = [$14,600 (1 - .35)] / .15 = $63,266.67;
V L = $63,266.67 + (.35 $3,500) = $64,491.67 = $64,492
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EXAM
PACK
2023
, lOMoARcPSD|24668432
SOLUTIONS
Practice questions
Multiple Choice
1. XYZ has $25,000 of debt outstanding and a book value of equity of $25,000. The company has
10,000 shares outstanding and a stock price of $10. If the unlevered beta is 0.75 and the marginal
tax rate is 20%, what is XYZ's levered beta?
a. 0.75
b. 0.8
c. 0.85
D. 0.9
Market value of equity = 10,000 x $10 = $100,000; β L = 0.75[1+(1-0.2)($25,000/$100,000)]
2. The Collection Co. has a current beta of 1.6. The market risk premium is 7 percent and the risk-
free rate of return is 3 percent. By how much will the cost of equity increase if the company
expands their operations such that their company beta rises to 1.9?
a. 0.30 percent
b. 0.90 percent
c. 1.50 percent
D. 2.10 percent
e. 2.70 percent
Current cost of equity = 3+1.6(7) = 14.2%
New cost of equity = 3+1.9(7) = 16.3%
Change in cost of equity = 16.3 – 14.2 = 2.1
3. Blue Ribbon, Inc. wants to have a weighted average cost of capital of 10 percent. The firm has an
aftertax cost of debt of 4 percent and a cost of equity of 12 percent. What debt-equity ratio is
needed for the firm to achieve their targeted weighted average cost of capital?
a. .25
B. .33
c. .50
d. .67
e. .75
.10 = [W e .12] + [(1 W e) .04)
.10 = .12W e + .04 .04W e
.06 = .08W e
W e =.75
Wd = 1 We = 1 .75 = .25
Debt-equity ratio = .25 / .75 = .33
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SOLUTIONS
4. If a firm uses its WACC as the discount rate for all of the projects it undertakes then the firm will
tend to:
I. reject some positive net present value projects.
II. accept some negative net present value projects.
III. favor high risk projects over low risk projects.
IV. maintain its current level of risk.
a. I and III only
b. III and IV only
C. I, II, and III only
d. I, II, and IV only
e. I, II, III, and IV
5. Wayne's of New York specializes in clothing for female executives living and working in the
financial district of New York City. Allen's of PA. specializes in clothing for women who live
and work in the rural areas of Western Pennsylvania. Both firms are currently considering
expanding their clothing line to encompass working women in the rural upstate region of New
York state. Wayne's currently has a cost of capital of 11 percent while Allen's cost of capital is 9
percent. The expansion project has a projected net present value of $36,900 at a 9 percent
discount rate and a net present value of $13,200 at an 11 percent discount rate. Which firm or
firms should expand into rural New York state?
a. Wayne's only
b. Allen's only
C. both Wayne's and Allen's
d. neither Wayne's nor Allen's
e. cannot be determined from the information provided
6. You are considering a project that will generate sales of $89,000, costs of $56,000, and annual
depreciation of $26,000. What is the value of the operating cash flow if the tax rate is 34
percent?
a. $28,380
b. $30,620
C. $47,780
d. $59,000
OCF = [($89,000 − $56,000) × (1 − .34)] + 26,000 = $47,780
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, lOMoARcPSD|24668432
SOLUTIONS
7. If a firm is operating with the optimal amount of debt, then the:
a. financial distress costs must equal the present value of the tax shield on debt.
B. value of the levered firm will exceed the value of the firm if it were unlevered.
c. value of the firm is equal to V U +T C D.
d. value of the firm is equal to V L +T C D.
e. debt-equity ratio is equal to 1.0.
8. The basic lesson of M&M Theory is that the value of a firm is dependent upon the:
a. capital structure of the firm.
B. total cash flows of the firm.
c. percentage of a firm to which the bondholders have a claim.
d. tax claim placed on the firm by the government.
e. size of the stockholders' claims on the firm.
9. Lester's Meat Market is currently an all equity firm that has 24,000 shares of stock outstanding at
a market price of $25 a share. The firm has decided to leverage its operations by issuing $200,000
of debt at an interest rate of 8 percent. This new debt will be used to repurchase shares of the
outstanding stock. The restructuring is expected to increase the earnings per share. What is the
minimum level of earnings before interest and taxes that the firm is expecting? Ignore taxes.
A. $48,000
b. $52,400
c. $57,620
d. $60,200
e. $61,340
EBIT / 24,000 = [EBIT - ($200,000 .08)] / [24,000 - ($200,000 / $25)]
16,000EBIT = 24,000EBIT - $384,000,000
EBIT = $48,000
10. Denver Dry Goods has expected earnings before interest and taxes of $14,600, an unlevered cost
of capital of 15 percent, and a tax rate of 35 percent. The company also has $3,500 of debt that
carries a 6 percent coupon. The debt is selling at par value. What is the value of this firm?
a. $63,267
b. $64,184
C. $64,492
d. $65,211
e. $66,267
V U = [$14,600 (1 - .35)] / .15 = $63,266.67;
V L = $63,266.67 + (.35 $3,500) = $64,491.67 = $64,492
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