Information for online Test · To be held on Wednesday 13 May. · The 50-minute test is to be held online and is an open book test starting at 3.10pm – finishing 4pm. Please try the practice test to...

The 50-minute test is to be held online and is an open book test starting at 3.10 pm – finishing at 4 pm on Wednesday 13 May.CORPFIN_3500 Corporate Finance Theory



Information for online Test · To be held on Wednesday 13 May. · The 50-minute test is to be held online and is an open book test starting at 3.10pm – finishing 4pm. Please try the practice test to ensure all is working. · The test has three questions covering topics 4-6, including readings. · It counts for 25% of your total marks and is not redeemable. · Formulae will not be provided as it is open book. · There are no tutorials during the week of the test. Tutorial 7 on Topic 7 will be held in the week after the test. · Sample questions are below. ADELAIDE UNIVERSITY CORPORATE FINANCE THEORY Mid-Semester Test Time: 50 mins Answer all three questions and show any workings. Non-programmable calculators are permitted. Question one Engineering One Limited will either purchase or lease a new $756,000 fabricator. If purchased, the fabricator will be depreciated on a straight-line basis over seven years. Engineering One Limited can lease the fabricator for $130,000 per year for seven years payable at the beginning of the period. Engineering One Limited has a tax rate of 35% and has a borrowing rate of 7% pre-tax. Required: a. What are the cash flow consequences of leasing the fabricator? b. What are the cash flow consequences of buying the fabricator? c. What are the incremental cash flows of leasing versus buying the fabricator? d. Briefly discuss what would be the balance sheet consequences if this were classified as an operating lease? As a finance lease? 8 marks Answer: Time 0 1 2 3 4 5 6 7 a. Lease -84500 -84500 -84500 -84500 -84500 -84500 -84500 b. Buy -756000 Dep tax shield 37800 37800 37800 37800 37800 37800 37800 c. Lease - buy 671500 122300 122300 122300 122300 122300 122300 37800 At 4.55% -116978 -111887 -107017 -102360 -97905.3 -93644.5 -27683.7 14025 Depreciation tax shield = 35% × 756,000/7 = $37,800 After-tax lease payment = 130,000 × (1 – 35%) = $84,500 After-tax borrowing rate = 7% × (1 – 35%) = 4.55% d. If operating then lessee only need report rental expense, if financing then both assets and liabilities are increased by the amount of the pv(lease payments). Question two On average, issuers of convertible bonds experience around a -1 to -2 % stock market response when announcing a convertible issue. The empirical literature finds that small, high growth firms tend to be issuers of convertible bonds. With reference to the literature, can we reconcile the two empirical findings? Briefly explain. 5 marks Answer: Pecking order – must include information asymmetry and sensitivity to new information. Small high growth firms are unable to issue debt due to cost, equity is too undervalued hence convertible debt only option. Question three Global Utilities Company (GUC) follows a policy of paying out 60 per cent of its net income as cash dividends to its shareholders each year. The company plans to do so again this year, during which GUC earned $50 million in net profits after tax. If the company has 25 million shares outstanding and pays dividends quarterly, what is the company’s nominal dividend payment per share each quarter? Assuming that GUC’s stock price is $42 per share immediately before ex-dividend date, what is the expected price of GUC stock on the ex-dividend date if there are no personal taxes on dividend income received? 7 marks Answer 60% x $50 million = $30 million $30 million/ 4= $7.5 million in dividend quarterly $7,500,000/25,000,000 shares = $0.3 The expected price ex-dividend will be $42 - $0.3 = $41.70