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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 supplierâ€™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 Companyâ€™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 firmâ€™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. Reillyâ€™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 Reillyâ€™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 truckâ€™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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