FIN 401 Study Guide - Midterm Guide: Share Repurchase, Operating Lease, Capital Structure
FIN 401
RYERSON UNIVERSITY
Mid-Term Exam - Alan Kaplan – Version A - Solution
Time allowed: 2 hours
Aids allowed: Closed book except for an 8’1/2” by 11’ note sheet
Answer all multiple choice questions on the scan sheet.
All multiple choice questions are worth 1 mark each. There are 30 multiple choice questions
1. Which version of the exam do you have? This is a free mark. Take it.
a) A
b) B
2. Please fill in the blank. The use of personal borrowing to change the overall amount of
financial leverage to which the individual is exposed is called ____________?
a) Financial Risk
b) Homemade Dividends
c) Business Risk
d) Homemade Leverage
e) Indirect Bankruptcy Costs
3. Please fill in the blank. The theory that the value of the firm is independent of its capital
structure is called ___________?
a) M&M Proposition I
b) The Static Theory of Capital Structure
c) M&M Proposition II
d) M&M Proposition III
e) The Dynamic Theory of Capital Structure
Please use the following information to answer the next TWO questions.
XYZ Corporation has no debt outstanding and a total market value of $125,000. Earnings before
interest and taxes, EBIT, are projected to be $24,000 if economic conditions are normal. If there
is strong expansion in the economy, then EBIT will be 25 percent higher. If there is recession,
then EBIT will be 50 percent lower. XYZ Corporation is considering a $45,000 debt issue with
an 8 percent interest rate. The proceeds will be used to repurchase shares of stock. There are
currently 26,000 shares outstanding. The company has a market-to-book ratio of 1.0. There are
no taxes.
4. What will be the ROI for the remaining shareholders if the firm encounters a recession and if
the firm goes through with the $45,000 debt issue and stock repurchase?
a) 9.6%
b) 10.5%
c) 11.4%
d) 12.3%
e) None of the above
ROI = (EBIT – Int) / (total shareholder investment)
= (($24K*.5) – ($45K*.08)) / ((80K/125K) *$125,000))
= $8.4K / $80K = .105
5. What is the breakeven point in EBIT (i.e., the Indifference Point) for this firm?
a) $25,000
b) $15,000
c) $20,000
d) $10,000
e) None of the above
EBITall equity / # of sharesall equity = (EBITpart debt – Interest) / # of sharespart debt
# of shares all equity = 26K, Interest = $3.6K, # of shares part debt = 16.64K
Indifference EBIT = $10K
6. X-cell Inc. expects an EBIT of $6,000 every year forever. X-cell Inc. currently has no debt,
and its cost of equity is 15 percent. The firm can borrow $10,000 at 12 percent and buy back
shares. If the corporate tax is 38 percent, what is the value of the Levered firm (i.e., the firm after
it borrows the funds)?
a) $14,200
b) $17,600
c) $21,200
d) $28,600
e) None of the above
Value of the unlevered firm = (EBIT*(1-t))/ Ru = ($6K*(1-.38)) /.15 = $24.8K + $3.8K = $28.6K
Value of the levered firm = Vu + (t*D) = $24.8K + ($10K*.38) = $28.6K
7. What is the “Pie”?
a) The value of the debt in a levered firm
b) The value of the equity in a levered firm
c) The value of the assets in a firm
d) The value of the assets less the value of the equity in an unlevered firm
e) The value of the assets less the value of both of the equity and the debt in a levered firm
8. Which of the following is an attribute of a financial lease, in comparison to an operating
lease?
a) The payments made are usually NOT sufficient to cover fully the lessor’s cost of
purchasing the asset and pay the lessor a return on investment.
b) The lessor is frequently required to maintain the asset.
c) The lessee is usually able to cancel the lease contract before the expiration date without a
significant penalty.
d) The lessee is usually responsible for insurance, maintenance, and taxes.
9. Which of the following is/are a good reason for leasing?
I) Lower transactions costs
II) ROA and ROI can be higher if you lease instead of buying
a) I) only
b) II) only
c) Both I) and II)
d) Neither I) nor II)
Please use the following information to answer the next FOUR questions.
Tollways Corp. is going to acquire a new Tolling machine for $25,000. The firm has not decided
whether to lease the machine or purchase it outright. Tollways can secure a $25,000 loan from
the bank, with an annual interest rate of 8% paid at the end of each year, and with the principal to
be repaid in full at the end of the three years. The firm can lease the machine for $7,900 per year
over three years. At the end of that time, the machine will have a salvage value of $2,500. The
leasing contract will give Tollways the right to purchase the machine at the end of the three year
lease for $5,000. The CCA rate for this machine is 40%, and Tollway’s corporate tax rate is 0%
(it is a non-profit organization).
10. What is the NAL?
a) $1,984.58
b) $2,656.35
c) $4,330.81
d) $5,125.43
e) None of the above
NAL = +IC – PVATLP – PVSal
NAL = +25K - $20,359.07 – 1,984.58 = $2,656.35
11. What is the PV of the CCA tax benefit?
a) $1,259.32
b) $3,591.40
c) $5,449.53
d) $7,125.86
e) None of the above
Since the corporate tax rate is 0, there is no CCA tax benefit
12. What is the annual lease payment that will make Tollways indifferent to whether it leases or
buys the machine?
a) $8,930.75
b) $6,328.52
c) $7,742.15
d) $8,073.11
e) None of the above
NAL = 0 = $25,000 – PVATLP - $1,984.58
PVATLP = $23,015.42, N=3, r = .08
PMT = $8,930.75
Document Summary
Mid-term exam - alan kaplan version a - solution. Aids allowed: closed book except for an 8"1/2 by 11" note sheet. Answer all multiple choice questions on the scan sheet. All multiple choice questions are worth 1 mark each. Take it: a, b, please fill in the blank. The use of personal borrowing to change the overall amount of financial leverage to which the individual is exposed is called ____________: financial risk, homemade dividends, business risk, homemade leverage, indirect bankruptcy costs, please fill in the blank. The theory that the value of the firm is independent of its capital structure is called ___________: m&m proposition i, the static theory of capital structure, m&m proposition ii, m&m proposition iii, the dynamic theory of capital structure. Xyz corporation has no debt outstanding and a total market value of ,000. Earnings before interest and taxes, ebit, are projected to be ,000 if economic conditions are normal.
