Corporate Finance Ii Reviewer

Final Exam Practice Problems

1. Firm ABC’s only outstanding debt is $100,000 worth of coupon bond (market value). Its yield to maturity is 8%. Given that its tax rate is 40%, what is its effective cost of debt?

Effective cost of debt = cost of debt * (1-tax rate) =8%*(1-40%)=4.8%

2. Firm ABC has a stock currently traded at $20. The next year’s dividend will be $0.20. The dividend growth rate is forecasted to be 6% forever. Risk-free rate is 3%, and market risk premium is 4%. Assume that Constant Dividend Growth Model and CAPM give you the same estimate of the cost of capital for equity, what is the beta of its stock?

By the Constant Dividend Growth Model:

Cost of Equity = D/P+g = 0.2/20+6%=7%

By CAPM, cost of equity = R(f)+ beta * market risk premium = 3% + beta* 4%,

Set this to be equal to 7%, solve for beta: beta=1

3. Firm ABC has a cost of equity of 8%, a cost of debt of 5%. It stock is traded at $10/share, and has 10 million shares outstanding. Its debt value is $20 million. Tax rate is 40%. What is its after-tax WACC?

Equity Value = 10*10=$100 million, Debt Value=$20 million

So, equity weight = 100/120=83.3%, debt weight=20/120=16.7%

After-tax WACC= equity weight * cost of equity + debt weight * effective cost of debt

=83.3%*8%+16.7%*5%*(1-40%) = 7.2%

4. Suppose you are the founder of a private company ABC. Initially you raised $500,000 from an angel investor from the first-round financing. As a result, both you and the angel investor hold 100,000 shares. Now in the second-found financing, you plan to raise another $1,000,000 from a venture capitalist. The venture capitalist will hold also 100,000 shares. What is your ownership before and after the second-round financing?

Before the second-round financing, ownership = 100,000/200,000=50%

After the second-round financing, ownership = 100,000/300,000=33%

5. What is the difference between a “firm commitment IPO” and an “auction IPO”?

Refer to the book...