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Applied Fin. Mgmt Professor Paul Gilson Final Exam for FNCE4209 Spring 2021 Instructions ? You must submit this take-home exam by the date of the actual final exam OR a date I agree to in the cover email with which I send this exam. Obviously email solutions. NO SPREADSHEETS – as in of course you can use spreadsheets to calculate answers, BUT I don’t want spreadsheets submitted as I don’t want to play scavenger hunt the answer on a confusing spreadsheet. As a suggestion, an image capture of a table in a spreadsheet, is more than adequate in most cases! ? There are 6 pages in this exam. Please take a moment to ensure that you have all of the pages. You may take 3 hours to take this exam. I think this is more than adequate to take this exam. You may choose the three-hour period you use to take this exam. IT MUST BE CONTIGUOUS – one block of three hours – you may NOT as an example, take one-hour Monday evening, then two Tuesday morning. NOT ALLOWED. ? The exam is open book and open notes and of course open computer. ? The exam consists of 20 problems, some with multiple parts. The total points available are 75. Show workings to receive partial credit. As an example, you could use a formula in Word, or you could include a capture of the spreadsheet you used. ? If any question is ambiguous, use your best judgment given the other information in the question as to what interpretation of the ambiguous information is most appropriate. ? Cheating of any sort will not be tolerated and will result in a failure of the quiz or assignment and potential failure of the course. You may not communicate with anybody inside or outside the classroom – this quiz must be entirely your work. I take this very seriously; DO NOT presume that as the exam is “take-home” that you may discuss with others – YOU MAY NOT. I consider the same rules to apply AS IF you were in an exam room. You may believe my expectations are “quaint” or “old fashioned”, but I expect that students who sign below act ethically and have a code of honor. If you sign below and that is not true… then you have far bigger worries than an undergraduate exam! Finally, as this is virtual, I will accept your email containing your solutions act as your “Print your name” and “Signature”. Print your name Read the following statement and sign on the line below: “I have neither given nor received unauthorized help on this quiz.” Signature Page 1 Applied Fin. Mgmt 1. Professor Paul Gilson Multiple Choice: What is the primary purpose of a cash discount offered to customers? (1 point) a. b. c. d. e. 2. Means of offsetting the interest charges on an account receivable Customer compensation for an out-of-stock item Inducement to pay promptly Customer compensation for faulty goods or services Incentive to purchase a specialty item Multiple Choice: Which one of the following is a system for managing demand-dependent inventories that minimizes the amount of inventory on hand? (1 point) a. b. c. d. e. 3. Inventory flow log Materials requirements planning Just-in-time inventory system Kanban Keiretsu Multiple Choice: Which one of the following is generally considered to be the best form of analysis if you have to select a single method to analyze a variety of investment opportunities? (1 point) a. b. c. d. e. 4. Profitability index Internal rate of return Net present value Modified internal rate of return Payback period Multiple Choice: Both Projects A and B are acceptable as independent projects. However, the selection of either one of these projects eliminates the option of selecting the other project. Which one of the following terms best describes the relationship between Project A and Project B? (1 point) a. b. c. d. e. 5. Conventional Mutually exclusive Unconventional Periodic None of the above Multiple Choice: A cost that should be ignored when evaluating a project because that cost has already been incurred and cannot be recouped is referred to as which type of cost? (1 point) a. b. c. d. e. 2021s Fixed Variable Opportunity Sunk Side effect Page 2 Applied Fin. Mgmt Professor Paul Gilson 6. True or False: Depreciation never plays any role in cash flow estimation for project evaluation purposes as depreciation is an accounting adjustment and has no cash flow implications. (1 point) 7. True or False: A car dealer likes to keep an extra $500K of cash in liquid bank accounts. At the end of the car year – some manufacturers offer special deals BUT ONLY if the dealer is ready to pay cash (these deals cannot be done on credit terms). Our car dealer keeps the $500K easily accessible just for those purposes. We would describe the reason for holding this cash as precautionary. (1 point) 8. Circle the correct response (or type your choice if you email your responses in the virtual world): A particular industry has been drastically deregulated. This has led to intense competition with all companies in the industry facing greater uncertainty about future cash flows. All things being equal managers of these companies will increase / decrease the levels of debt in the capital structure of these companies? (1 point) 9. Circle the correct response (or type your choice if you email your responses in the virtual world): All things being equal, if corporate taxes in the US increase, the levels of debt in the capital structure of corporations will likely increase / decrease? (1 point) 10. Fill in the blank (or type your choice if you email your responses in the virtual world): As part of the development of a fuel-cell portable charging unit. The company has an existing line of long-term bleed generators, and if the new product is launched, likely sales of the existing business will decline. This type on incremental cash flow is best described as _________________________________________? (1 point) 11. Fill in the blank (or type your choice if you email your responses in the virtual world): Belize Pool sales operates two types of retail stores – franchise and company owned. When Belize negotiates to franchise a store in a large valuable market, they always negotiate a clause that allows them to buy and convert the franchise store into a company owned. In the language of real options, this is best described as _________________________________________ type of real option? (1 point) 12. Fill in the blank (or type your choice if you email your responses in the virtual world): A company is faced with a real problem. Because of bad decisions two years back, the company owes its banks a considerable amount of money. The firm has the opportunity to invest in a positive NPV project, but unfortunately, any value created will go straight to the banks. This type of influence of debt on the actions of shareholders and the passing up of good investments is called the _________________________________________? (1 point) 2021s Page 3 Applied Fin. Mgmt 13. Professor Paul Gilson A company is considering the development of a new infrastructure hub. There are two possibilities – the company can choose between the two; or select neither – but there is no point in doing both; the company does not need two hubs – one is sufficient to transport weapons with negative entropy into the future/past. The rail hub takes a lower initial investment but yields lower future after-tax cash inflows. The table below shows the cash flows of both projects in $Ms: 14. 2021s $Ms Initial Investment Year 1 Year 2 Year 3 Year 4 Year 5 Rail hub 125 40 40 40 40 40 Port hub 435 130 130 130 130 130 a. If the risk-adjusted discount rate for projects of this risk is 11.0% (stealing high-grade plutonium tends to be very correlated with the market), what is the NPV of each project? (4 points) b. What is the IRR of each project? (2 points) c. If the company can reinvest future cash flows earning a 12.0% return, what is the MIRR of each project? (4 points) d. What is the profitability index of each project? (2 points) e. What investment decision should the company make and why? (5 points) A large international import/export business has prepared a strategic plan for the coming year. The company has four possible capital projects it COULD invest in next year. These projects are independent. The company’s analyst has developed the following project evaluation data (she is a really good analyst, so the estimates can be relied on as properly created): Initial Investment $Ms NPV $Ms PI IRR Project 1 $700 $300 1.43 15.0% Project 2 $750 $250 1.30 15.5% Project 3 $350 $160 1.46 16.0% Project 4 $500 $250 1.50 18.0% a. If the company has no capital constraints, in which projects should the company invest and why? (2 points) b. If the projects are not scalable, and the company only has $1.5B to invest next year, in which projects should the company invest and why? (4 points) c. If the projects ARE scalable, and the company only has $1.5B to invest next year, in which projects should the company invest and why? (4 points) Page 4 Applied Fin. Mgmt 15. Professor Paul Gilson CarCare International is a manages a chain of car cleaning franchisees. The company is looking to open a new company-owned concept – the car cleaning multi-store. The following data relates to a perspective store: Initial Investment $5.5M Life 10 years Expected cars cleaned per year 130,000 Price charged per car on average $15.00 Variable costs (percentage of revenue) 28.0% Fixed costs per year (excludes depreciation) $250K Depreciation expense per year $300K Tax rate 18.0% In addition to the above details, there is no significant investment in net working capital, no other depreciation than that given above, and there is no salvage value at the end of the ten years of operations. a. What is the forecast net profit per year, forecast after-tax operating cash flow per year, and If the appropriate discount rate for this type of project is 12.0%, what is the estimated NPV of this project? (5 points) b. How many cars does the store need to clean per year in order to break-even on a profit basis and on an after-tax cash flow basis? (3 points) c. How many cars does the store need to clean per year in order to break-even on an NPV basis? (2 points) 16. Ankles Inc., writes 3 checks a day for an average amount of $5,400 each. These checks generally clear the bank 4 days after they are written. In addition, the firm generally receives and deposits checks amounting to $18,700 each day. All deposits are available on the next day. What is the firm's net float? (3 points) 17. Jen’s Batting Cages purchased $3,300 worth of goods. The terms of the sale were 1/7, net 21. What is the effective annual rate of interest for the credit period for this sale? (3 points) 18. Vesper Crafts is a small public company with a market cap currently of $2.2B. The company has no debt and pays taxes at 20%. If the company issues $1.2B of perpetual debt, using the proceeds to buy back stock, what is the best estimate of the market cap after the recapitalization? (3 points) 2021s Page 5 Applied Fin. Mgmt 19. Professor Paul Gilson Ballyhoo Inc., was taken private through an LBO transaction many years ago. The company is now carrying a considerable amount of debt in the form of a zero-coupon bond with a face value of $2.5B which needs to be repaid in two years. The estimated market value of the Ballyhoo underlying business is $2.0B, and the volatility of the underlying business is 30.0%. Using a risk-free rate of 1.5%: 20. a. What is the equity worth in this business? (5 points) b. What if the value of the debt? (3 points) c. What is the debt-to-equity ratio of the firm? (2 points) d. What is the yield to maturity of the debt? (3 points) Frank is looking to find investors to open an Arbys in Argentina. Frank needs $2.0M to open the business and intends to invest $1.5M of his own money and convince a group of friends to supply the other $500K. Normally, Frank would give up 25% of the business to raise the $500K, with the remaining 75% owned by Frank for his $1.5M investment. Frank knows his friends really can’t afford to lose $500K, so he offers to sweeten the deal in the following way: Instead of receiving 25% they will instead receive 20% of the business BUT in 3 years IF THEY WANT, the other investors can get their $500K back no questions asked. Thus, if in three years the idea has failed, Frank is willing to write his friends a check for $500K to give them back the money they originally invested Suppose the market value of the underlying business today is $2.0M, and the volatility of returns of this type of business can be measured at 40% per year, are the smaller investors better taking the 25% stake for $500K or the new deal of 20% for $500K with the “get your money back” choice? Assume a risk-free rate of 1.5%.