“THE TEXTBOOK USED FOR THIS ASSIGNMENT IS

ROSS, JAFFE AND
WESTERFIELD, CORPORATE FINANCE,
9TH EDITION

THIS IS A
GRADUATE LEVEL COURSE

PLEASE READ ALL
DIRECTIONS CAREFULLY. I HAVE REPEATED
THE DIRECTION ON EACH PAGE.

THE ASSIGNMENT
CONSISTS OF
EIGHT
(8) MULTIPLE CHOICE
TWO
(2) SHORT ANSWER
SIX
(6) WORKED PROBLEMS

Finance Assignment 55
Spring 2013

Remember to show any assumptions that you
used.

All payments occur at the end of the period
unless stated otherwise.

Interest is compounded annually unless stated
otherwise. Face value of all bonds is
$1000.

Use
12 point type.
PLACE MULTIPLE CHOICE
ANSWERS ONSHEET 1OF ANEXCEL SPREADSHEET.

MUST ADD EXPLANATIONS TO EXPLAIN YOUR ANSWER TOEACH MULTIPLE CHOICE QUESTION.(1-8)

1. The degree to which two
variables move together

A) Variance
B)
Covariance
C)
Return

2. What is an advantage of the
adjusted present value (APV) method?

A) Easier to apply
when the firm does not maintain a consistent debt-equity ratio
B)
Ignores market imperfections and so stresses
the value of the asset
C)
Useful for firms with extensive leverage.

PAGE 2 of 10
SEE NEXT PAGE

3. In a perfect world with no corporate
taxes, firm value is maximized by

A) All equity
financing
B)
All debt financing
C)
A weighted average of debt and equity
financing
D) Capital
structure is irrelevant in this case

4.
All else equal, firms with
____ will tend to use more debt.

A) Lots of
intangible assets
B)
Many growth opportunities
C)
Low operating leverage
D) Very cyclical
revenues

5. Which portfolio has the best diversification?

A) A set of 10
stocks selected from 3 industries
B)
A set of 50 stocks randomly selected by
throwing darts
C)
A set of 50 stocks plus 25 corporate,
municipal and Treasury bonds.

6.
The beta for Starbucks
is .90 on Yahoo (.yahoo.com/””>www.yahoo.com). It is 1.22 on Reuters (.reuters.com/””>www.reuters.com). Why can
the numbers be different?

A) Different measurement period.
B) Different return intervals.
C) Different choice of the market
portfolio.
D) All are reasons they can differ.

7.
In an imperfect world,
the firm should select the capital structure that

Maximizes shareholder value
Minimizes corporate taxes
Maximizes firm growth

Minimizes financial distress

8.
Using debt impacts the
business risk of the assets.

True
False

PAGE 3 of 10
SEE NEXT PAGE

All payments occur at the end of the period
unless stated otherwise.

Interest is compounded annually unless stated
otherwise. Face value of all bonds is $1000.

Use
12 point type.
PLACE SHORT ANSWER
QUESTIONS ONSHEET 2OF ANEXCEL SPREADSHEET.

MUST ADD EXPLANATIONS TO EXPLAIN YOUR ANSWER TOEACH SHORT ANSWER QUESTION.(1-2)

Short Answer:You should be able to answer these in
2 to 3 sentences.

1.
A firm has an asset beta
of 1 and a company cost of capital of 15%.
A new project comes along with a beta of .2 and an expected return (IRR)
of 10%. Putting the projects beta into
the CAPM gives the project a return of 5% based on project risk. Should the firm accept or reject the project?
Explain.

2. Regression provides both a beta (used in the CAPM)
and an alpha. There is an interest in
chasing alpha. What is alpha? Why
would investors chase alpha? HINT: Putting
alpha risk investment into any search engine will give you additional
information. Be sure to put the information in your own
words.

PAGE 4 of 10
SEE NEXT PAGE

Remember
to show any assumptions that you used.

All
payments occur at the end of the period unless stated otherwise.

Interest is compounded annually unless stated
otherwise. Face value of all bonds is $1000.

Use
12 point type.
PLACE PROBLEM#1 on SHEET
3OF ANEXCEL SPREADSHEET.
MUST ADD EXPLANATIONS TO EXPLAIN YOUR ANSWER TOEACH QUESTION(1 through 6) See Below
Worked Problems 1 of 6

You invest 30% in Ham
and 70% in Cheese.

Time

Ham

Cheese

1

-.04

.11

2

.15

.41

3

.21

-.13

4

.18

.39

Find the return and variance on the portfolio. You must calculate: expected return for both
firms; standard deviation or variance (assume it is a population (n
observations)) for both firms; correlation or covariance between Ham and Cheese.

PAGE 5 of 10
SEE NEXT PAGE

Remember
to show any assumptions that you used.

All
payments occur at the end of the period unless stated otherwise.

Interest is compounded annually unless stated
otherwise. Face value of all bonds is $1000.

Use
12 point type.
PLACE PROBLEM#2 onSHEET
4OF ANEXCEL SPREADSHEET.
MUST
ADD EXPLANATIONS TO EXPLAIN YOUR ANSWER
TOEACH QUESTION(1 through 6) See Below

Worked Problems 2 of 6

Suppose stock returns
can be explained by the following three factor model:
Ri = RF + 1F1
+ 2F2 3F3
Assume
there is no firm-specific risk. The
information for each stock is presented here:

1

2

3

Stock A

1.45

.80

.05

Stock B

.73

1.25

-.20

The
risk premiums for the factors are 5.3 percent, 3.9 percent, and 4.2 percent,
respectively. If you create a portfolio with 60 percent invested in stock A
and the remainder in stock B, and the risk-free rate is 2 percent, what is the
expected return of your portfolio?

PAGE 6 of 10
SEE NEXT PAGE

Remember
to show any assumptions that you used.

All
payments occur at the end of the period unless stated otherwise.

Interest is compounded annually unless stated
otherwise. Face value of all bonds is $1000.

Use
12 point type.
PLACE PROBLEM#3 onSHEET
5OF ANEXCEL SPREADSHEET.
MUST
ADD EXPLANATIONS TO EXPLAIN YOUR ANSWER
TOEACH QUESTION(1 through 6) See Below

Worked Problems 3 of 6

Ember is considering an investment of $40 million in plant and
machinery. This is expected to produce
free cash flows of $13 million in year 1, $14 million in year 2, $15 million in
year 3, and 25 million in
year 4. The tax rate is
35%. You dont know the target capital
structure, but you do have the following information:

Bonds: There are 37,000
bonds with a 5.5% coupon outstanding.
The coupons are paid annually.
The bonds have a 1000 face value and 8 years to maturity. They sell for 96.7% of par.

Retained Earnings (Internal Equity): There
are 950,000 shares outstanding with a price of $55 per share. The beta on the stock is 1.25. The risk-free rate is 2% and the market risk
premium is 6%.
a) Calculate the weighted average cost of
capital. Hint: To get the weights, you
will need to solve for the market value of the debt and equity.
b) Calculate the net present value (NPV)
with the WACC.
c) Should they invest? Why or why not?

PAGE 7 of 10 SEE NEXT PAGE
All
payments occur at the end of the period unless stated otherwise.

Interest is compounded annually unless stated
otherwise. Face value of all bonds is $1000.

Use
12 point type.
PLACE PROBLEM#4 onSHEET
6OF ANEXCEL SPREADSHEET.
MUST
ADD EXPLANATIONS TO EXPLAIN YOUR ANSWER
TOEACH QUESTION(1 through 6) See Below
Worked Problems 4 of 6

This is an M&M world with corporate
taxes. Sci-fi is originally all equity
financed (unlevered). All earnings are
paid out as dividends, and the growth rate is zero. The firm decides to issue $8,000,000 in debt
at 6% and to use the proceeds to repurchase stock. The capital structure change is permanent (so
debt is perpetual). Fill in all of the
missing information in the table below.

Unlevered

Levered

EBIT

7,500,000

7,500,000

INTEREST

EBT

Taxes (40%)

Net Income

#Shares

1,000,000

EPS

Unlevered return

10%

10%

Return on Equity rS

Price

Firm Value (V)

WACC

PAGE 8 of 10 SEE NEXT PAGE
All
payments occur at the end of the period unless stated otherwise.

Interest is compounded annually unless stated
otherwise. Face value of all bonds is $1000.

Use
12 point type.
PLACE PROBLEM#5 onSHEET
7OF ANEXCEL SPREADSHEET.
MUST
ADD EXPLANATIONS TO EXPLAIN YOUR ANSWER
TOEACH QUESTION(1 through 6) See Below

Worked Problems 5 of 6

The firm wants to diversify with a new product line. The project
requires an initial investment of $8,000,000 and will provide $2,750,000 in
after-tax unlevered cash flows at the end of each year for 7 years. The project’s unlevered cost of capital is
12%. The firms target debt-equity ratio
is 1.50. Debt (bonds) of $6,000,000 will
be issued. Assume the debt has a 7-year life, a yield of 5% and a coupon of
5%. The tax rate is 40%.
a.
Find the value of the project using APV (adjusted present value). You will need to estimate the unlevered cost
of capital.
b.
Find the value of the project using FTE (flow to equity).

PAGE 9 of 10 SEE NEXT PAGE

All
payments occur at the end of the period unless stated otherwise.

Interest is compounded annually unless stated
otherwise. Face value of all bonds is $1000.

Use
12 point type.
PLACE PROBLEM#6 onSHEET
8OF ANEXCEL SPREADSHEET.
MUST
ADD EXPLANATIONS TO EXPLAIN YOUR ANSWER
TOEACH QUESTION(1 through 6) See Below

Worked Problems 6 of 6

Brain Drain is about to launch a new
product. Depending on the success of the
new product, there are three possible outcomes for value next year: $210 million, $150 million or $60
million. These outcomes are all equally
likely, and this risk is diversifiable.
Suppose the risk-free interest rate is 5%. (Ignore all other market imperfections, such
as taxes.). Brain Drain has $120 million
in debt due next year.
a. What is Brains total value with
leverage?
b. Now suppose that in the event of
default, 30% of the value of Brains assets will be lost to bankruptcy costs. What is Brains total value with leverage and
distress costs?

PAGE 10 of 10

THE END
THE TEXTBOOK
USED FOR THIS ASSIGNMENT IS ROSS, JAFFE AND
WESTERFIELD, CORPORATE FINANCE, 9TH EDITIONTHIS IS A
GRADUATE LEVEL COURSEPLEASE READ ALL
DIRECTIONS CAREFULLY. I HAVE REPEATED
THE DIRECTION ON EACH PAGE. THE ASSIGNMENT
CONSISTS OF EIGHT
(8) MULTIPLE CHOICETWO
(2) SHORT ANSWERSIX
(6) WORKED PROBLEMSFinance Assignment 55Spring 2013 Use
12 point type. PLACE MULTIPLE CHOICE
ANSWERS ONSHEET 1OF ANEXCEL SPREADSHEET.
MUST ADD EXPLANATIONS TO EXPLAIN YOUR ANSWER TOEACH MULTIPLE CHOICE QUESTION.(1-8)1. The degree to which two
variables move togetherA) VarianceB)
CovarianceC)
Return2. What is an advantage of the
adjusted present value (APV) method?A) Easier to apply
when the firm does not maintain a consistent debt-equity ratioB)
Ignores market imperfections and so stresses
the value of the asset C)
Useful for firms with extensive leverage.PAGE 2 of 10
SEE NEXT PAGE3. In a perfect world with no corporate
taxes, firm value is maximized by A) All equity
financingB)
All debt financing C)
A weighted average of debt and equity
financing D) Capital
structure is irrelevant in this case4.
All else equal, firms with
____ will tend to use more debt.A) Lots of
intangible assets B)
Many growth opportunities C)
Low operating leverage D) Very cyclical
revenues5. Which portfolio has the best diversification?A) A set of 10
stocks selected from 3 industriesB)
A set of 50 stocks randomly selected by
throwing darts C)
A set of 50 stocks plus 25 corporate,
municipal and Treasury bonds. 6.
The beta for Starbucks
is .90 on Yahoo (.yahoo.com/””>www.yahoo.com). It is 1.22 on Reuters (.reuters.com/””>www.reuters.com). Why can
the numbers be different? A) Different measurement period. B) Different return intervals. C) Different choice of the market
portfolio. D) All are reasons they can differ. 7.
In an imperfect world,
the firm should select the capital structure that 8.
Using debt impacts the
business risk of the assets. PAGE 3 of 10
SEE NEXT PAGEUse
12 point type. PLACE SHORT ANSWER
QUESTIONS ONSHEET 2OF ANEXCEL SPREADSHEET.
MUST ADD EXPLANATIONS TO EXPLAIN YOUR ANSWER TOEACH SHORT ANSWER QUESTION.(1-2)Short Answer:You should be able to answer these in
2 to 3 sentences. 1.
A firm has an asset beta
of 1 and a company cost of capital of 15%.
A new project comes along with a beta of .2 and an expected return (IRR)
of 10%. Putting the projects beta into
the CAPM gives the project a return of 5% based on project risk. Should the firm accept or reject the project?
Explain. 2. Regression provides both a beta (used in the CAPM)
and an alpha. There is an interest in
chasing alpha. What is alpha? Why
would investors chase alpha? HINT: Putting
alpha risk investment into any search engine will give you additional
information. Be sure to put the information in your own
words. PAGE 4 of 10
SEE NEXT PAGERemember
to show any assumptions that you used.All
payments occur at the end of the period unless stated otherwise. Use
12 point type. PLACE PROBLEM#1 on SHEET
3OF ANEXCEL SPREADSHEET. MUST ADD EXPLANATIONS TO EXPLAIN YOUR ANSWER TOEACH QUESTION(1 through 6) See BelowWorked Problems 1 of 6You invest 30% in Ham
and 70% in Cheese. TimeHamCheese 1-.04.112.15.413.21-.134.18.39Find the return and variance on the portfolio. You must calculate: expected return for both
firms; standard deviation or variance (assume it is a population (n
observations)) for both firms; correlation or covariance between Ham and Cheese.PAGE 5 of 10
SEE NEXT PAGERemember
to show any assumptions that you used. All
payments occur at the end of the period unless stated otherwise. Use
12 point type. PLACE PROBLEM#2 onSHEET
4OF ANEXCEL SPREADSHEET. MUST
ADD EXPLANATIONS TO EXPLAIN YOUR ANSWERTOEACH QUESTION(1 through 6) See BelowWorked Problems 2 of 6Suppose stock returns
can be explained by the following three factor model: Ri = RF + 1F1
+ 2F2 3F3Assume
there is no firm-specific risk. The
information for each stock is presented here:123Stock A1.45.80.05Stock B.731.25-.20The
risk premiums for the factors are 5.3 percent, 3.9 percent, and 4.2 percent,
respectively. If you create a portfolio with 60 percent invested in stock A
and the remainder in stock B, and the risk-free rate is 2 percent, what is the
expected return of your portfolio?PAGE 6 of 10
SEE NEXT PAGERemember
to show any assumptions that you used.All
payments occur at the end of the period unless stated otherwise. Use
12 point type. PLACE PROBLEM#3 onSHEET
5OF ANEXCEL SPREADSHEET. MUST
ADD EXPLANATIONS TO EXPLAIN YOUR ANSWERTOEACH QUESTION(1 through 6) See BelowWorked Problems 3 of 6Ember is considering an investment of $40 million in plant and
machinery. This is expected to produce
free cash flows of $13 million in year 1, $14 million in year 2, $15 million in
year 3, and 25 million inyear 4. The tax rate is
35%. You dont know the target capital
structure, but you do have the following information:
Bonds: There are 37,000
bonds with a 5.5% coupon outstanding.
The coupons are paid annually.
The bonds have a 1000 face value and 8 years to maturity. They sell for 96.7% of par.
Retained Earnings (Internal Equity): There
are 950,000 shares outstanding with a price of $55 per share. The beta on the stock is 1.25. The risk-free rate is 2% and the market risk
premium is 6%. a) Calculate the weighted average cost of
capital. Hint: To get the weights, you
will need to solve for the market value of the debt and equity. b) Calculate the net present value (NPV)
with the WACC. c) Should they invest? Why or why not? PAGE 7 of 10 SEE NEXT PAGEAll
payments occur at the end of the period unless stated otherwise. Use
12 point type. PLACE PROBLEM#4 onSHEET
6OF ANEXCEL SPREADSHEET. MUST
ADD EXPLANATIONS TO EXPLAIN YOUR ANSWERTOEACH QUESTION(1 through 6) See BelowWorked Problems 4 of 6This is an M&M world with corporate
taxes. Sci-fi is originally all equity
financed (unlevered). All earnings are
paid out as dividends, and the growth rate is zero. The firm decides to issue $8,000,000 in debt
at 6% and to use the proceeds to repurchase stock. The capital structure change is permanent (so
debt is perpetual). Fill in all of the
missing information in the table below.UnleveredLeveredEBIT7,500,0007,500,000INTERESTEBTTaxes (40%)Net Income#Shares1,000,000EPSUnlevered return10%10%Return on Equity rSPriceFirm Value (V)WACCPAGE 8 of 10 SEE NEXT PAGEAll
payments occur at the end of the period unless stated otherwise. Use
12 point type. PLACE PROBLEM#5 onSHEET
7OF ANEXCEL SPREADSHEET. MUST
ADD EXPLANATIONS TO EXPLAIN YOUR ANSWERTOEACH QUESTION(1 through 6) See BelowWorked Problems 5 of 6The firm wants to diversify with a new product line. The project
requires an initial investment of $8,000,000 and will provide $2,750,000 in
after-tax unlevered cash flows at the end of each year for 7 years. The project’s unlevered cost of capital is
12%. The firms target debt-equity ratio
is 1.50. Debt (bonds) of $6,000,000 will
be issued. Assume the debt has a 7-year life, a yield of 5% and a coupon of
5%. The tax rate is 40%. a.
Find the value of the project using APV (adjusted present value). You will need to estimate the unlevered cost
of capital. b.
Find the value of the project using FTE (flow to equity). PAGE 9 of 10 SEE NEXT PAGEAll
payments occur at the end of the period unless stated otherwise. Use
12 point type. PLACE PROBLEM#6 onSHEET
8OF ANEXCEL SPREADSHEET. MUST
ADD EXPLANATIONS TO EXPLAIN YOUR ANSWERTOEACH QUESTION(1 through 6) See BelowWorked Problems 6 of 6Brain Drain is about to launch a new
product. Depending on the success of the
new product, there are three possible outcomes for value next year: $210 million, $150 million or $60
million. These outcomes are all equally
likely, and this risk is diversifiable.
Suppose the risk-free interest rate is 5%. (Ignore all other market imperfections, such
as taxes.). Brain Drain has $120 million
in debt due next year. a. What is Brains total value with
leverage? b. Now suppose that in the event of
default, 30% of the value of Brains assets will be lost to bankruptcy costs. What is Brains total value with leverage and
distress costs? PAGE 10 of 10THE END”