Prof. Dr.

Alexander Klos
QBER - Institut fr quantitative betriebsund volkswirtschaftliche Forschung
Final Exam

Corporate Finance
Winter 2012/2013
19-Feb-2013

All answers must be written either completely in English or completely in German.

Please make your handwriting legible.
You may only use a non-programmable calculator and an English dictionary.
Answer the following questions briefly but precisely. If necessary, explain your
calculations and define symbols not mentioned in the text. If there are any missing
specifications, please make appropriate economic assumptions.
Please provide your answers in the bluebook only. Answers provided on the exam
sheet will not be considered.
Allotted time to answer the questions is 60 minutes.
The exam text comprises 10 pages (including the cover sheet).
Good luck!

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Grade

Prof. Dr. Alexander Klos

-1-

Problem 1: Financial Leverage and Firm Value

(4 points)

In a world with no taxes, no information asymmetries, no transaction costs, and no costs of

financial distress, is the following statement true, false, or uncertain? If a firm issues
equity to repurchase some of its debt, the share price of the firms equity will rise because
the shares are less risky. Explain briefly.

Problem 2: Shareholders Incentives

(4 points)

Do you agree or disagree with the following statement? A firms shareholders will never
want the firm to invest in projects with negative net present values. Why?

-2-

Problem 3: Capital Structure

(6 points)

Indell stock has a current market capitalization of $120 million and a beta of 1.50. Indell
currently has risk-free debt as well. The firm decides to change its capital structure by
issuing $30 million in additional risk-free debt, and then using this $30 million plus another
$10 million in cash to repurchase stock. With perfect capital markets, what will the beta of
Indell stock be after this transaction?

Problem 4: Market Timing

(8 points)

Electronic Gaming Incorporated (EGI) is a firm with no debt and its 20 million shares are
currently trading for $16 per share. Based on the prospects for EGI's new hand held video
game, management feels the true value of the firm is $20 per share. Management believes
that the share price will reflect this higher value after the video game is released next fall.
EGI has already announced plans to raise $100 million from investors to build a new
factory.
a.) Assume that EGI decides to raise the $100 million through the issuance of new
shares prior to the release of the new video game. Calculate EGI's share price
following the release of the new video game.

(4 points)

-3-

b.) Assume that EGI decides to wait until after the release of the new video game
before they raise the $100 million through the issuance of new shares. Calculate
EGI's share price following the release of the new video game.
(4 points)

-4-

Problem 5: Payout Policy

(13 points)

a.) Consider an all-equity company that pays out all its earnings as dividends. The
company has 100 shares outstanding and its annual earnings amount to 200 (i.e.
growth rate of annual earnings is zero). The companys equity cost of capital is
equal to 8%. There are no corporate taxes and no capital gain taxes. Dividends are
taxed at 25%. Suppose the company has 100 in excess cash and the companys
management decides to pay out a special dividend in the amount of the excess
cash. Compare the cum- and the ex-dividend share price!
(5 points)

b.) Explain the main stylized facts underlying Lintners model of payout choices!
(5 points)

-5-

c.) Give a short explanation of the dividend-capture theory and its motivation!
(3 points)

-6-

Problem 6: Mergers & Acquisitions

a.) Name four reasons why a horizontal merger might be value-enhancing!

(13 points)
(4 points)

b.) How does a toehold help to overcome the free rider problem in mergers and
acquisitions?

(2 points)

-7-

c.) Consider an all-equity company trading at 10 per share. The company has
currently 1,000 shares outstanding. Furthermore, the company has adopted a
poison pill which is triggered whenever some investor reaches an ownership
threshold of 20% in the companys shares. In this case, all other owners of the
companys shares get the right to buy one new share for every old share they own
at a price of 5. Assume that a corporate raider acquires a toehold of 20% in the
company. What happens to the companys share price?
(4 points)

d.) Why might a companys management decide to adopt a poison pill?

(3 points)

-8-

Problem 7: Equity Offerings and Dilution

(6 points)

The Newton Company has 10,000 shares of equity that each sell for $40. Suppose the
company issues 5,000 new shares at the following prices: $40, $20, and $10. What is the
effect of each of the alternative offering prices on the existing price per share?

-9-

Problem 8: WACC

(6 points)

National Electric (NEC) is considering a 50 million project in its power systems division.
Tom Edison, the company's chief financial officer, has evaluated the project and
determined that the project's unlevered cash flows will be 3.5 million per year in
perpetuity. NEC's pre-tax cost of debt is 7.2%, and its cost of equity is 10.9%. The
company's target debt-to-firm-value ratio is 80%. The project has the same risk as NEC's
existing businesses, and it will support the same amount of debt. NEC is in the 34% tax
bracket. Should NEC accept the project?