Information for online Test
· To be held on Wednesday 13 May.
· The 50-minute test is to be held online and is an open book test starting at 3.10pm – finishing 4pm. Please try the practice test to ensure all is working.
· The test has three questions covering topics 4-6, including readings.
· It counts for 25% of your total marks and is not redeemable.
· Formulae will not be provided as it is open book.
· There are no tutorials during the week of the test. Tutorial 7 on Topic 7 will be held in the week after the test.
· Sample questions are below.
ADELAIDE UNIVERSITY
CORPORATE FINANCE THEORY
Mid-Semester Test
Time: 50 mins
Answer all three questions and show any workings.
Non-programmable calculators are permitted.
Question one
Engineering One Limited will either purchase or lease a new $756,000 fa
icator. If purchased, the fa
icator will be depreciated on a straight-line basis over seven years. Engineering One Limited can lease the fa
icator for $130,000 per year for seven years payable at the beginning of the period. Engineering One Limited has a tax rate of 35% and has a bo
owing rate of 7% pre-tax.
Required:
a. What are the cash flow consequences of leasing the fa
icator?
. What are the cash flow consequences of buying the fa
icator?
c. What are the incremental cash flows of leasing versus buying the fa
icator?
d. Briefly discuss what would be the balance sheet consequences if this were classified as an operating lease? As a finance lease?
8 marks
Answer:
Time
0
1
2
3
4
5
6
7
a. Lease
-84500
-84500
-84500
-84500
-84500
-84500
-84500
b. Buy
-756000
Dep tax shield
37800
37800
37800
37800
37800
37800
37800
c. Lease - buy
671500
122300
122300
122300
122300
122300
122300
37800
At 4.55%
-116978
-111887
-107017
-102360
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
14025
Depreciation tax shield = 35% × 756,000/7 = $37,800
After-tax lease payment = 130,000 × (1 – 35%) = $84,500
After-tax bo
owing rate = 7% × (1 – 35%) = 4.55%
d. If operating then lessee only need report rental expense, if financing then both assets and liabilities are increased by the amount of the pv(lease payments).
Question two
On average, issuers of convertible bonds experience around a -1 to -2 % stock market response when announcing a convertible issue. The empirical literature finds that small, high growth firms tend to be issuers of convertible bonds. With reference to the literature, can we reconcile the two empirical findings? Briefly explain.
5 marks
Answer:
Pecking order – must include information asymmetry and sensitivity to new information. Small high growth firms are unable to issue debt due to cost, equity is too undervalued hence convertible debt only option.
Question three
Global Utilities Company (GUC) follows a policy of paying out 60 per cent of its net income as cash dividends to its shareholders each year. The company plans to do so again this year, during which GUC earned $50 million in net profits after tax. If the company has 25 million shares outstanding and pays dividends quarterly, what is the company’s nominal dividend payment per share each quarter?
Assuming that GUC’s stock price is $42 per share immediately before ex-dividend date, what is the expected price of GUC stock on the ex-dividend date if there are no personal taxes on dividend income received?
7 marks
Answe
60% x $50 million = $30 million
$30 million/ 4= $7.5 million in dividend quarterly
$7,500,000/25,000,000 shares = $0.3
The expected price ex-dividend will be $42 - $0.3 = $41.70