Finance Homework

For each of the following 11 questions determine if the statement is true or false. If the statement is false, provide a complete explanation as to what makes the statement is false.

1. President Trump has signaled the intention to lower corporate tax rates. The direct impact of this action should be an increase in optimal leverage for the average firm.

2. A relatively small decrease in WACC (i.e., 1%) typically results in a large increase in firm value.

3. The market value of a firm's assets which could be used as collateral for their debt suddenly increases. As a result, the firm's optimal leverage ratio decreases.

4. The cost of equity, cost of debt, and the weighted average cost of capital each will increase when leverage increases.

5. Firms A and B produce identical products and have operations that are the same except firm A pays its employees based on production levels while firm B pays its employees a fixed annual amount. Firm A has a higher optimal leverage ratio.

6. A firm would always use covenants in their debt contracts to lower their weighted average cost of capital despite the costs covenants might impose on the firm.

7. Firms can credibly signal future expected profitability by increasing leverage.

8. Firms with more potential for agency problems have a higher optimal leverage ratio.

9. Tesla would make an ideal target for an LBO buyout by a private equity firm.

10. Being acquired by a venture capital firm is a clear sign that a company will be successful.

11. The average IPO firm has positive abnormal returns on the day of the IPO and negative abnormal performance over the next year.

Use the following information to answer questions 12-15. The Gap, Inc. (GPS) paid four quarterly dividends of $0.26 in 2016. In 2011, GPS paid four quarterly dividends of $0.12. GPS currently sells in the market for $25.03.

12. What is the annual growth rate in dividends for GPS from 2011 to 2015?

13. Estimate the required rated of return on equity for GPS using the constant growth model.

14. Re-estimate the required rate of return on equity for GPS using any realistic long-term growth rate (as opposed to the growth rate calculated in 12).

15. Now, assume that GPS will grow at the rate calculated in 12 for 3 years. From the fourth year on indefinitely, GPS will grow at a 3% rate. Estimate the required return on equity for GPS using the variable growth rate technique.

Use the following information for questions 16-19: TBF, Inc. 1,000,000 zero-coupon bonds outstanding with 5 years to maturity. These bonds have a $1,000 par value and sell in the market for $842.57. TBF also has 50,000,000 shares of common equity outstanding that trade in the market for $45.40/share. TBF has a beta of 1.42. The risk-free rate is 0.9% and the return on the S&P 500 is expected to be 7%. TBF has a tax rate of 24%.

16. What is TBF's weight in debt and weight in equity?

17. What is TBF's cost of debt?

18. What is TBF's cost of equity?

19. What is TBF's weighted average cost of capital (WACC)?

20. Jeanne Co. has annual fixed costs of $200,000 and variable costs of $2/unit for a product that sells for $12 unit. How many units does Jeanne need to sell to break even?

21. DDX, Inc. has annual fixed costs of $70,000 and variable costs of $7/unit for a product that sells for $12 unit. How many units does DDX need to sell to break even?

22. All else equal, what can you infer about the optimal leverage ratio for Jeanne and DDX based on their production processes?

23. Fill in the table based on the bids in this IPO dutch auction if the company plans to sell 200K shares:

24. Snap, Inc. went through its initial public offering (IPO). The IPO price was $17. Snap is currently trading at $25.70. If the risk free rate is 0.1% and S&P 500 earned 0.5% over this same period, what would Snap's beta have to be to imply that this return is completely explain by risk (under the CAPM)? Is this realistic?

25. On explanation for the underpricing in Snap's IPO is monopsony power by investment banks. Explain what that means.