1

ADM 3350 A
Fall 2011
CORPORATE FINANCE
MIDTERM EXAMINATION October 19th, 2011
Professor: Kaouthar LAJILI, PhD., CGA Duration: 1 hour and 30 minutes

Part I 20
Part II 30
TOTAL 50
NAME: __________________________________________
STUDENT #: ________________________
Statement of Academic Integrity
The School of Management does not condone academic fraud, an act ! a student that ma! result in
a false academic e"aluation of that student or of another student# $ithout limiting the generalit! of
this definition, academic fraud occurs %hen a student commits an! of the follo%ing offences&
'lagiarism or cheating of an! (ind, use of oo(s, notes, mathematical tales, dictionaries or other
stud! aid unless an e)'licit %ritten note to the contrar! a''ears on the e)am, to ha"e in his*her
'ossession cameras, radios +radios %ith head sets,, ta'e recorders, 'agers, cell 'hones, or an! other
communication de"ice %hich has not een 're"iousl! authori-ed in %riting#
Statement to be signed by the student:
I ha"e read the te)t on academic integrit! and I 'ledge not to ha"e committed or attem'ted to
commit academic fraud in this e)amination#
Signed&......................................
/ote& an e)amination co'! or oo(let %ithout that signed statement %ill not e graded and %ill
recei"e a final e)am grade of -ero#
INSTRUCTIONS
Please answer all questions.
No notes, texts, etc.
alculators, but not com!uters, are !ermitted.
"se three decimals for all calculated results.
Please hand in the entire questionnaire.
No exam boo# needed.
2
PA$% I: &ulti!le hoice 'uestions
(20 points total)
Please circle the correct answer
1# In a %orld of no cor'orate ta)es if the use of le"erage does not change the "alue of the le"ered
firm relati"e to the unle"ered firm this is (no%n as&
A, the conser"ation of energ! 'rinci'le#
0, MM Pro'osition I that le"erage is in"ariant to mar(et "alue#
1, MM Pro'osition II that the cost of e2uit! is al%a!s constant#
3, MM Pro'osition I that the mar(et "alue of the firm is in"ariant to the ca'ital structure#
4, MM Pro'osition III that there is no ris( associated %ith le"erage in a no ta) %orld#
2# The /P5 formula for ris(! 'ro6ects e"aluates .......... using the ........... #
A, ris(less discount rate, e)'ected incremental cashflo%s#
0, certain cashflo%s, ris(less discount rate#
1, ris(less discount rate, e)'ected incremental cashflo%s#
3, certain cashflo%s, ris(! discount rate#
4, e)'ected incremental cashflo%s, ris(! discount rate#


3# If the use of su''lier financing decreases and is re'laced ! cash financing for the same le"el of
usiness acti"it!, the cash c!cle %ill&
A, increase ecause da!s in 'a!ales decrease#
0, sta! the same ecause the change is onl! on the o'erating c!cle#
1, decrease ecause da!s in 'a!ales decrease#
3, sta! the same ecause usiness acti"it! does not change#
4, sta! the same ecause cash is used for 'a!ment#

7# If the 1APM is used to estimate the cost of e2uit! ca'ital the e)'ected e)cess mar(et return is
e2ual to&
A, the return on the stoc( minus the ris(8free rate#
0, the difference et%een the return on the mar(et and the ris(8free rate#
1, the eta times the mar(et ris( 'remium#
3, the eta times the ris(8free rate#
4, the mar(et rate of return#
5# In an 4PS840I gra'hical relationshi', the det ra! and e2uit! cross# At this 'oint the e2uit! and
det are&
A, e2ui"alent %ith res'ect to 4PS ut ao"e and elo% this 'oint e2uit! is al%a!s su'erior#
0, at rea(e"en in 4PS ut ao"e this 'oint det increases 4PS "ia le"erage and decreases 4PS
elo% this 'oint#
1, e2ual ut a%a! from rea(e"en e2uit! is etter as fe%er shares are outstanding#
3, at rea(e"en and MM Pro'osition II states that det is the etter choice#
4, at rea(e"en and det is the etter choice elo% rea(e"en ecause small 'a!ments can e
made#
9# $hat is its cost of e2uit! if there are no ta)es or other im'erfections: The firm has a det8to8
e2uit! ratio of #90# Its cost of det is ;<# Its o"erall cost of ca'ital is 12<#
A, 1;<
0, 17#7<
1, 10<#
3, 13#5<
=# A firm has a det8to8e2uit! ratio of 1# Its cost of e2uit! is 19<, and its cost of det is ;<# If there
are no ta)es or other im'erfections, %hat %ould e its cost of e2uit! if the det8to8e2uit! ratio
%ere 0:
A, ;<#
0, 10<#
1, 12<#
3, 17<#
4, 19<#
;# 0r!an in"ested in 0r!co, Inc# stoc( %hen the firm %as financed solel! %ith e2uit!# The firm is
no% utili-ing det in its ca'ital structure# To unle"er his 'osition, 0r!an needs to&
A, orro% some mone! and 'urchase additional shares of 0r!co stoc(#
3
0, maintain his current 'osition as the det of the firm did not affect his 'ersonal le"erage
'osition#
1, sell some shares of 0r!co stoc( and hold the 'roceeds in cash#
3, sell some shares of 0r!co stoc( and loan it out such that he creates a 'ersonal det8e2uit!
ratio e2ual to that of the firm#
4, create a 'ersonal det8e2uit! ratio that is e2ual to e)actl! 50< of the det8e2uit! ratio of the
firm#
># A firm has -ero det in its ca'ital structure# Its o"erall cost of ca'ital is ><# The firm is
considering a ne% ca'ital structure %ith 70< det# The interest rate on the det %ould e 7<#
Assuming that the cor'orate ta) rate is 37<, its cost of e2uit! ca'ital %ith the ne% ca'ital
structure %ould e:
A, 10#32<#
0, 11#2<#
1, 11#0<#
3, 13#>5<#
10# 1ash c!cle e2uals&
A, in"entor! 'eriod 'lus accounts recei"ale 'eriod#
0, change in net %or(ing ca'ital 'eriod#
1, o'erating c!cle 'lus accounts 'a!ale 'eriod#
3, o'erating c!cle 'lus in"entor! 'eriod#
4, none of the ao"e#
11# Selling goods and ser"ices on credit is&
A, an in"estment in a customer#
0, necessar! ecause customers cannot 'a! for the goods#
1, a decision inde'endent of customers#
3, 'ermissile if !our an( lends the mone!#
4, none of the ao"e#
12# The cost of ca'ital for a firm, r
$A11
, in a -ero ta) en"ironment is&
A, e2ual to the e)'ected 40IT di"ided ! mar(et "alue of the unle"ered firm#
0, e2ual to r
o
the rate of return for that usiness ris( class#
1, e2ual to the o"erall rate of return re2uired on the le"ered firm#
3, all of the ao"e#
4, none of the ao"e#
13. $hich of the follo%ing statements is not true:
A, /et %or(ing ca'ital is the difference et%een short8term assets and short term liailities#
0, Short8term financing deals %ith the management of short8term liailities and short8term
assets#
1, Short8term financing is concerned %ith determining reasonale amounts of cash to hold, %hich
customers should get credit and others related issues#
3, /et %or(ing ca'ital does not utili-e the conce't of 'resent "alue since all flo%s are short8term#

17# The o'timal credit amount is determined !&
A, the 'oint %hich minimi-es the total credit cost cur"e#
0, the 'oint %hich ma)imi-es the carr!ing costs associated %ith granting credit#
1, the 'oint %hich ma)imi-es o''ortunit! costs associated %ith granting credit#
3, the 'oint %here the additional net cash flo% from ne% customers %ill not co"er the carr!ing
costs of the in"estment in recei"ales#
4, oth a and d#
15. If the a"erage accounts recei"ale that a firm holds decreases %ithout an! decrease in credit sales,
the o'erating c!cle %ill&
A, sta! the same ecause of no sales change#
0, sta! the same ecause cash collections are sooner and it %ill affect the cash c!cle onl!#
1, decrease ecause da!s sales outstanding decreases#
3, sta! the same ecause accounts recei"ale are not in the o'erating c!cle#
4, ha"e an un(no%n effect#
7
19# $hich of the follo%ing statements aout the current ratio is accurate:
A, ?se of oo( "alues in calculation of this ratio is unacce'tale ecause the mar(et "alues of
these assets and liailities tend to de"iate from oo( "alues#
0, This ratio is calculated ! di"iding current liailities ! current assets#
1, It %ill al%a!s e greater than the 2uic( ratio in com'anies that carr! in"entor!#
3, This ratio is intended to indicate the long run li2uidit! 'osition of the firm#
4, The higher the current ratio, the higher the le"el of cash in a firm#
1=# The o'timal ca'ital structure is the mi)ture of det and e2uit! %hich&
I# Ma)imi-es the "alue of the firm#
II# Minimi-es the firm@s %eighted a"erage cost of ca'ital#
III# Ma)imi-es the mar(et 'rice of the firm@s onds#
A, I onl!
0, III onl!
1, I and II onl!
3, I and III onl!
4, I, II, and III
1;# Airms that use maturit! hedging as a guide to financing 'olic!&
A, tr! to hedge %ith futures contracts#
0, hold e)cess cash alances to reduce ris(#
1, %ill finance long term assets %ith long term financing#
3, rel! on go"ernment 'olic! to (ee' interest rates lo%#
1># 3elta P3A 3istriutors has an in"estment in accounts recei"ale of B2,=50,000# 3ail! credit sales
are B11;,2;0# If 30< of 3elta@s credit customers recei"e a discount ! 'a!ing %ithin 10 da!s, %hat
is the net 'eriod that 3elta maintains:
A, 10 da!s#
0, 23 da!s#
1, 3; da!s#
3, 75 da!s#
4, There is not enough information to tell#
Ans%er& 4
20# $hich of the follo%ing is not true concerning considerations in setting a credit 'olic!:
A, A firm that su''lies a 'erishale 'roduct %ill tend to offer restricti"e credit terms#
0, A firm %hose customers are in a high8ris( usiness %ill tend to offer restricti"e credit terms#
1, Lengthening the credit 'eriod effecti"el! reduces the 'rice 'aid ! the customer#
3, Small accounts, associated %ith firms that find it difficult to ac2uire a line of credit, tend to
recei"e longer credit 'eriods#
5
PA$% II Problems (%otal )* !oints+
N,%-: Solve problem (1) below and choose two more problems from the following
three ((2) (3) and (4)) and solve (total 3 problems)
Problem . a!ital Structure with %axes +10 'oints,
The $estla(e 1om'an! e)'ects 'er'etual earnings efore interest and ta)es +40IT, of B9
million 'er !ear# The firmCs after8ta)D all8e2uit! discount rate r0 is 17<# The
$estla(e 1om'an! is su6ect to a cor'orate ta) rate of 35<# The 'reta) cost of
the firmCs det ca'ital is 11< 'er annum, and the firm has B> million of det in its
ca'ital structure#
A+ $hat is $estla(e 1om'an!Cs "alue: (/.0 !oints+
1+ $hat is $estla(e 1om'an!Cs cost of e2uit! +rs,: ().0 !oints+
+ $hat is $estla(e 1om'an!Cs %eighted a"erage cost of ca'ital +r$A11,: (2
!oints+
Answer (if necessary, you may use the bac# of the !age+
9
Problem / redit &anagement +10 'oints,
A01 Inc# o'erates a mail8order to!s usiness# Management is considering dro''ing its
'olic! of no credit# The credit 'olic! under consideration ! A01 Inc# is as follo%s&
No credit redit
8888888888888888888888888888888888888888888888888888888888888888
Price 'er unit B=0 B;0
1ost 'er unit B50 B97
Euantit! sold 7,000 9,000
Proailit!
of 'a!ment 100< ;5<
1redit 'eriod 0 1
3iscount rate 0 3<
8888888888888888888888888888888888888888888888888888888888888888
A+ Should A01 Inc# offer credit to its customers: (3.0 !oints+
1+ $hat must the 'roailit! of 'a!ment e efore A01 Inc# %ould ado't the
credit 'olic!: ().0 !oints+
Answer (if necessary, you may use the bac# of the !age+
=
Problem ) Short4term 5inance (.* !oints+
1anadian Lights has 'ro6ected the follo%ing sales for the coming !ear&
E1 E2 E3 E7
Sales B;30 B=75 B>05 B>;0
Sales in the !ear follo%ing this one are 'ro6ected to e 15< greater in each 2uarter#
A+ 1alculate 'a!ments to su''liers assuming that 1anadian Lights 'laces
orders during each 2uarter e2ual to 30< of 'ro6ected sales for the ne)t
2uarter# Assume that the com'an! 'a!s immediatel!# $hat is the
'a!ales 'eriod in this case: () !oints+
1+ Fe%or( +A, ao"e assuming a >08da! 'a!ales 'eriod () !oints+
+ Fe%or( +A, ao"e assuming a 908da! 'a!ales 'eriod (2 !oints+
Answer (if necessary, you may use the bac# of the !age+
;
Problem 2 1asic a!ital Structure +10 'oints,
Al'ha 1or'# and 0eta 1or'# are identical in e"er! %a! e)ce't their ca'ital structures#
Al'ha 1or'oration, an all8 e2uit! firm, has 10,000 shares of stoc( outstanding, currentl!
%orth B 20 'er share# 0eta 1or'oration uses le"erage in its ca'ital structure# The mar(et
"alue of 0etaCs det is B 50,000, and its cost of det is 12 'ercent# 4ach firm is e)'ected
to ha"e earnings efore interest of B 55,000 in 'er'etuit!# /either firm 'a!s ta)es#
Assume that e"er! in"estor can orro% at 12 'ercent 'er !ear#
A+ $hat is the "alue of Al'ha 1or'oration: $hat is the "alue of 0eta
1or'oration: $hat is the mar(et "alue of 0eta 1or'orationCs e2uit!: ()
!oints+
1+ Go% much %ill it cost to 'urchase 20 'ercent of each firmCs e2uit!: (/
!oints+
+ Assuming each firm meets its earnings estimates, %hat %ill e the dollar
return to each 'osition in +0, o"er the ne)t !ear: (/ !oints+
6+ 1onstruct an in"estment strateg! in %hich an in"estor 'urchases 20
'ercent of Al'haCs e2uit! and re'licates oth the cost and dollar return of
'urchasing 20 'ercent of 0etaCs e2uit!# () !oints+
Answer (if necessary, you may use the bac# of the !age+
>
&idterm -xam 5ormula Sheet (A6& ))0*+
.#
R D P g
E
= +
1 0
/#
[ ]
R R R R
E f E M f
= +
)# ( ) ( ) ( ) WACC E V R D V R T
E D C
= + 1
2#
( )
[ ]
( ) [ ]
Yield
Coupon FV ice Matuit!
FV ice
=
+
+
Pr *
Pr * 2

0" [ ]
( ) ( ) [ ]
R
# # $ P
# $ $ # # $ P# %PV

+ + + =
@
@
, @ + , +
3" APR & peiodic ate' ()*+ (net peiod , discount peiod)
7. EAR & +1 - (peiodic ate)) to t.e po/e 0(()*+ (net peiod1discount peiod)2 8 1
SGOFT8T4FM SOL54/1H FATIOS
1urrent ratio I 1urrent assets J 1urrent liailities
Euic( ratio I +1urrent assets 8 In"entor!, J 1urrent liailities
A1TI5ITH FATIOS
Total asset turno"er I Total o'erating re"enues J A"erage total assets
Fecei"ales turno"er I Total o'erating re"enues J A"erage recei"ales
A"erage collection 'eriod I 3a!s in 'eriod J Fecei"ales turno"er
In"entor! turno"er I 1ost of goods sold J A"erage in"entor!
3a!s in in"entor! I 3a!s in 'eriod J In"entor! turno"er
AI/A/1IAL L454FAK4 FATIOS
3et ratio I Total det J Total assets
3et8e2uit! ratio I Total det J Total e2uit!
42uit! multi'lier I Total assets J Total e2uit!
Interest co"erage I 4arnings efore interest and ta)es J Interest
PFOAITA0ILITH FATIOS
/et 'rofit margin I /et income J Total o'erating re"enue
Kross 'rofit margin I 4arnings efore interest and ta)es J Total o'erating re"enues
/et return on assets I /et Income J A"erage Total Assets
Kross return on assets I 4arnings efore interest and ta)es J A"erage total assets
/etLKrossM Feturn on assets +FOA, I /etLKrossM Profit margin ) Asset Turno"er
Feturn on e2uit! +FO4, I /et income J A"erage stoc(holders@ e2uit!
Pa!out ratio I 1ash di"idends J /et Income
Fetention ratio I Fetained earnings J /et Income I 1 N Pa!out ratio
MAFO4T 5AL?4 FATIOS
Price8to8earnings +P*4, ratio I Mar(et 'rice 'er share J 4arnings 'er share
3i"idend !ield I 3i"idend 'er share J Mar(et 'rice 'er share
Mar(et8to8oo( +M*5, ratio I Mar(et 'rice 'er share J 0oo( "alue 'er share
Toin@s E ratio I +Mar(et "alue of det P e2uit!, J Fe'lacement "alue of total assets

r
r, P +1
1
8 1
A I n, r, P5+A, I Annuit! an of
n
PV