final exam accounting probs – Fairweather Corporation purchases merchandise on terms of 2/15

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Question 1.1.

Fairweather Corporation purchases merchandise on terms of
2/15, net 40, and its gross purchases (i.e., purchases before taking off the
discount) are $800,000 per year. What is
the maximum dollar amount of costly trade credit the firm could get, assuming it
abides by the supplier’s credit terms?
(Assume a 365-day year.)

(Points : 15)

$53,699

$56,384

$59,203

$62,163

$65,271

Question 2.2.

A U.S. based importer, Zarb Inc., makes a purchase of
crystal glassware from a firm in Switzerland for 39,960 Swiss francs, or
$24,000, at the spot rate of 1.665 francs per dollar. The terms of the purchase are net 90 days,
and the U.S. firm wants to cover this trade payable with a forward market hedge
to eliminate its exchange rate risk.
Suppose the firm completes a forward hedge at the 90-day forward rate of
1.682 francs. If the spot rate in 90
days is actually 1.638 francs, how much will the U.S. firm have saved or lost
in U.S. dollars by hedging its exchange rate exposure?

(Points : 15)

-$396

-$243

$0

$243

$638

Question 3.3.

Suppose 90-day investments in Britain have a 6% annualized
return and a 1.5% quarterly (90-day) return.
In the U.S., 90-day investments of similar risk have a 4% annualized
return and a 1% quarterly (90-day) return.
In the 90-day forward market, 1 British pound equals $1.65. If interest rate parity holds, what is the
spot exchange rate?

(Points : 15)

1 pound =
$1.8000

1 pound =
$1.6582

1 pound =
$1.0000

1 pound =
$0.8500

1 pound =
$0.6031

Question 4.4.

Preissle Company’s stock sells for $42 per share. The company wants to sell some 20-year,
annual interest, $1,000 par value bonds.
Each bond would have 75 warrants attached to it, each exercisable into
one share of stock at an exercise price of $47.
The firm’s straight bonds yield 10%.
Each warrant is expected to have a market value of $2.00 given that the
stock sells for $42. What coupon
interest rate must the company set on the bonds in order to sell the
bonds-with-warrants at par?

(Points : 15)

7.83%

8.24%

8.65%

9.08%

9.54%

Question 5.5.

Mikkleson Mining is considering issuing a 10-year
convertible bond that would be priced at its $1,000 par value. The bonds would have an 8.00% annual coupon,
and each bond could be converted into 20 shares of common stock. The required rate of return on an otherwise
similar nonconvertible bond is 10.00%.
The stock currently sells for $40.00 a share, has an expected dividend
in the coming year of $2.00, and has an expected constant growth rate of
5.00%. What is the estimated floor price
of the convertible at the end of Year 3?

(Points : 15)

$794.01

$835.81

$879.80

$926.10

$972.41

Question 6.6.

Potter & Lopez Inc. just sold a bond with 50 warrants
attached. The bonds have a 20-year maturity and an annual coupon of 12%, and
they were issued at their $1,000 par value. The current yield on similar
straight bonds is 15%. What is the implied value of each warrant?

(Points : 15)

$3.76

$3.94

$4.14

$4.35

$4.56

Question 7.7. Arthouse Inc., a national artist supply chain,
is considering purchasing a smaller chain, Craftworks Inc. Arthouse’s analysts project that the merger
will result in incremental free flows and interest tax savings with a combined
present value of $72.52 million, and they have determined that the appropriate
discount rate for valuing Craftworks is 16%.
Craftworks has 4 million shares outstanding and no debt. Craftwork’s current price is $16.25. What is the maximum price per share that
Arthouse should offer? (Points : 15)

$16.25

$16.97

$17.42

$18.13

$19.00

Question 8.8. Kelly Tubes is considering a merger with
Reilly Tires. Reilly’s market-determined
beta is 0.9, and the firm currently is financed with 20% debt, at an interest
rate of 8%, and its tax rate is 25%. If
Kelly acquires Reilly, it will increase the debt to 60%, at an interest rate of
9%, and the tax rate will increase to 35%.
The risk-free rate is 6% and the market risk premium is 4%. What will Reilly’s required rate of return on
equity be after it is acquired? (Points : 15)

7.4%

8.9%

9.3%

9.6%

9.7%

Question 9.9.

Company A can issue floating-rate debt at LIBOR + 1%, and it
can issue fixed rate debt at 9%. Company
B can issue floating-rate debt at LIBOR + 1.5%, and it can issue fixed-rate
debt at 9.4%. Suppose A issues
floating-rate debt and B issues fixed-rate debt, after which they engage in the
following swap: A will make a fixed 7.95%
payment to B, and B will make a floating-rate payment equal to LIBOR to A. What are the resulting net payments of A and
B?

(Points : 15)

A pays a
fixed rate of 9%, B pays LIBOR + 1.5%.

A pays a
fixed rate of 8.95%, B pays LIBOR + 1.45%.

A pays LIBOR
plus 1%, B pays a fixed rate of 9.4%.

A pays a
fixed rate of 7.95%, B pays LIBOR.

None of the above answers is correct.

Question 10.10. Suppose the December CBOT Treasury bond
futures contract has a quoted price of 80-07.
If annual interest rates go up by 1.00 percentage point, what is the
gain or loss on the futures contract?
(Assume a $1,000 par value, and round to the nearest whole dollar.)
(Points : 15)

-$78.00

-$82.00

-$86.00

-$90.00

-$95.00

Question 11.11.

Arnold Inc. purchases merchandise on terms of 2/10 net 30,
and it always pays on the 30th day. The
CFO calculates that the average amount of costly trade credit carried is
$375,000. What is the firm’s average
accounts payable balance? Assume a
365-day year.

(Points : 30)

Question 12.12.

Delamont Trucking Company (DTC) is evaluating a potential
lease for a truck with a 4-year life that costs $40,000 and falls into the
MACRS 3-year class. If the firm borrows
and buys the truck, the loan rate would be 10%, and the loan would be amortized
over the truck’s 4-year life, so the interest expense for taxes would decline
over time. The loan payments would be
made at the end of each year. The truck
will be used for 4 years, at the end of which time it will be sold at an
estimated residual value of $10,000. If
DTC buys the truck, it would purchase a maintenance contract that costs $1,000
per year, payable at the end of each year.
The lease terms, which include maintenance, call for a $10,000 lease
payment (4 payments total) at the beginning of each year. DTC’s tax rate is 40%. Should the firm lease or buy? Show all computations. (Note:
MACRS rates for Years 1 to 4 are 0.33, 0.45, 0.15, and 0.07.)

(Points : 30)


Question 13.13.

McGovern Enterprises is interested in issuing bonds with
warrants attached. The bonds will have a 30-year maturity and annual interest
payments. Each bond will come with 20 warrants that give the holder the right
to purchase one share of stock per warrant. The investment bankers estimate
that each warrant will have a value of $10.00. A similar straight-debt issue would
require a 10% coupon. What coupon rate should be set on the bonds-with-warrants
so that the package would sell for $1,000?

(Points : 30)

Question 14.14.

Palmer Company has $5,000,000 of bonds outstanding. Each bond has a maturity value of $1,000, an
annual coupon of 12.0%, and 15 years left to maturity. The bonds can be called at any time with a
premium of $50 per bond. If the bonds
are called, the company must pay flotation costs of $10 per new refunding
bond. Ignore tax considerations–assume
that the firm’s tax rate is zero.

The company’s decision of whether to call the bonds depends
critically on the current interest rate on newly issued bonds. What is the breakeven interest rate, the rate
below which it would be profitable to call in the bonds?

(Points : 30)

Question 15.15.

Raymond Supply, a national hardware chain, is considering
purchasing a smaller chain, South Georgia Parts (SGP). Brau’s analysts project that the merger will
result in the following incremental free cash flows, tax shields, and horizon
values:

Year
1 2 3
4

Free cash flow
$1 $3 $3
$7

Unlevered horizon value 75

Tax shield
1 1 2
3

Horizon value of tax shield 32

Assume that all
cash flows occur at the end of the year.
SGP is currently financed with 30% debt at a rate of 10%. The acquisition would be made immediately,
and if it is undertaken, SGP would retain its current $15 million of debt and
issue enough new debt to continue at the 30% target level. The interest rate would remain the same. SGP’s pre-merger beta is 2.0, and its
post-merger tax rate would be 34%. The
risk-free rate is 8% and the market risk premium is 4%. What is the value of SGP to Brau?

(Points : 30)

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