Download Corporate Finance Re-exam Financial Management

School of Business, Economics and Law
Industrial and Financial Management & Logistics
Anonymous exam No
Written Examination
Financial Management
2013-08-21
Please, keep your number till the results are published.
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Written Examination in
Corporate Finance
Re-exam Financial Management
21st of August 2013, 9 - 14, V30
The written examinations consist of 7 questions 40 points
The following grades are given:
Fail = 0 - 24 points
Pass = 25 points (cases included)
High Pass = 37 points (cases included)
The examination can be answered in Swedish!
Non-programmed Calculator, distributed formulas and a dictionary (not a
specialized Dictionary of Business or Economics) are allowed to be used
during the examination!
Good Luck!
……………………………………………………………………………………………………………………………………………………………
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School of Business, Economics and Law
Industrial and Financial Management & Logistics
Anonymous exam No
Written Examination
Financial Management
2013-08-21
Please, keep your number till the results are published.
Question1 (5 points)
Explain the difference between the economic definition of profit and the accounting definition profit.
Also, explain why it is appropriate for managers to use economic definition of profit.
School of Business, Economics and Law
Industrial and Financial Management & Logistics
Anonymous exam No
Written Examination
Financial Management
2013-08-21
Please, keep your number till the results are published.
Question 2. (5 points)
a) Calculate the effective tax advantage of debt for an investor that pay taxes in a region with the
following tax rates:
Corporate tax rate = 35%; Average personal tax rate on equity income = 34 %; Average personal tax
rate on interest income = 28%.
b) Explain the clientele effect for optimal capital structure
School of Business, Economics and Law
Industrial and Financial Management & Logistics
Anonymous exam No
Written Examination
Financial Management
2013-08-21
Please, keep your number till the results are published.
Question 3. (5 points)
Consider the following income statement for Kirchler Inc. (all figures in $ Millions):
Year
Total Sales
Cost of goods sold
Selling, general &
admin expenses
Depreciation
Operating Income
Other Income
EBIT
Interest expense
Earnings before tax
Taxes (35%)
Net Income
2006
60,553
45,565
11,688
2005
56,434
42,140
12,191
2004
53,791
39,637
11,575
1,265
2,035
0
2,035
510
1,525
534
991
1,256
847
0
847
557
290
102
189
1,209
1,370
0
1,370
604
766
268
498
a) Calculate the total amount available to payout to all investors in Kirchler Inc. in year 2006.
b) Calculate the income that would be available to equity holders in year 2006 if Kirchler was not
levered (all equity financed)
c) Explain the difference between your answers in question a) and b)
School of Business, Economics and Law
Industrial and Financial Management & Logistics
Anonymous exam No
Written Examination
Financial Management
2013-08-21
Please, keep your number till the results are published.
Question 4. 12p
a) Suppose there are only two possible future states of the world. In state 1 the stock price rises by
50%. In state 2, the stock price drops by 25%. The current stock price S(0) = $50. If a call option has
an exercise price of $50 and the risk-free rate (r) for the period is 5%: (i) Calculate the call option
hedge ratios; (ii) Use the binomial option pricing model to value the call option.
b) Suppose the stock price is 40 and we need to price a call option with a strike of 45 maturing in 4
months. The stock is not expected to pay dividends. The continuously-compounded riskfree rate is
3%/year, the mean return on the stock is 7%/year, and the standard deviation of the stock return is
40%/year. (i)What is the Black-Scholes call price?; (ii) What is the Black-Scholes price for the
European put with the same strike and maturity?; (iii) Since the put option is worth more alive than if
exercised now, can we conclude that an American version of the put is worth the same as the
European put? Motivate your answer.
c) You are trying to decide whether to make an investment in automobile industry in the city of
Tolyatti in southern Russia. This city is known as mono-city, where a single industry or factory
accounts for most of the local economy and therefore you fear social instability. This implies that you
may need a flexible model to make now or later decisions rather than now or never decisions. Hence,
ROA comes in handy.
You have calculated that the static NPV is $520m, the risk free rate is 4%, the volatility is 30%, time to
maturity of this business project is 5 years. You also want to revise your decision twice so your time
step is 2 years (2 step tree). You have the following three real option strategies available. What is the
chooser option value of this project when;
i) the gain from contracting 20% of your capacity is $140m for the first 2,5 years and then the gain
from contracting 18% of your capacity is $135m between 2,5 and 5 years.
ii) the cost of 20% expansion is $190m for the first 2,5 years and then the cost of 22% expansion is
$195m between 2,5 and 5 years.
School of Business, Economics and Law
Industrial and Financial Management & Logistics
Anonymous exam No
Written Examination
Financial Management
2013-08-21
Please, keep your number till the results are published.
Question 5. 3p
a) The risk-free rate is a completely certain return. (i) Which conditions are needed for complete
certainty? (ii) Which risk-free rate should be used (to discount cash flows) to get to the theoretically
correct risk-free rate of return? Motivate your answers.
b) List and explain the major puzzles related to individual investor trading.
School of Business, Economics and Law
Industrial and Financial Management & Logistics
Anonymous exam No
Written Examination
Financial Management
2013-08-21
Please, keep your number till the results are published.
Question 6. 4p
Suppose that Pasabahce, a glass manufacturer, would experience a direct loss of $500 million in the
event of a major earthquake that disrupted its operations. The probability of such an earthquake is
2% per year, with a beta of -0.6.
a) If the risk-free interest rate is 5% and the expected return on the market is 11%, what is the
actuarially fair insurance premium required to cover Pasabahce’s loss?
b) Suppose the insurance company raises the premium by an additional 15% over the amount
calculated in part (a) to cover its administrative and overhead costs. What amount of financial
distress or issuance costs would Pasabahce have to suffer if it were not insured to justify purchasing
the insurance?
School of Business, Economics and Law
Industrial and Financial Management & Logistics
Anonymous exam No
Written Examination
Financial Management
2013-08-21
Please, keep your number till the results are published.
Question 7. 6p
Variance and covariance matrix for the four stocks is given below:
Covariance A
B
C
D
A
0.001144 0.000115 0.000027 0.000135
B
0.000115 0.000411 0.000033 0.000118
C
0.000027 0.000033 0.001412
D
0.000135 0.000118
0.00013
0.00013 0.004862
You place 20% on A, 35% on B, 30% on C, and 15% of your capital on D. Assume that you borrow 30%
more at a 3% interest rate and invest in this portfolio, calculate the standard deviation of your new
portfolio.
School of Business, Economics and Law
Industrial and Financial Management & Logistics
Anonymous exam No
Written Examination
Financial Management
2013-08-21
Please, keep your number till the results are published.
Extra answer sheet Question…………………..