CFA L2 Apostila 01 Exame 2018 - COMPLETA IMPRESSÃO

LOS 21.e Explain/Calculate Capital BudgetingSchweser B2 pg 179, CFAI V3 pg 49Discount Rate Using the CAPM Point: Must use project beta (not firm beta) Project cost of capital: Use project beta with CAPM to find the appropriate discount rate: Rproject = RF + βproject[E(RMKT) – RF] Calculate project NPV using Rproject (the hurdle rate)© Kaplan, Inc. 24LOS 21.f Describe Capital BudgetingSchweser B2 pg 180, CFAI V3 pg 52 Example: Abandonment OptionA project has an initial outlay of $120,000. Annualafter-tax operating cash flows have a 50% chanceof being either $18,000 or $45,000 for four years.The project can be abandoned after one year, inwhich case the salvage value would be $100,000.However, the project has no salvage value after 4years. The cost of capital is 10% and the projecthurdle rate is 12%.© Kaplan, Inc. 26 ©2018 FK Partne

SS 07 - Corporate FinanceLOS 21.f Describe Capital BudgetingSchweser B2 pg 180, CFAI V3 pg 52 Real Options Point: Managers have the option to make future decisions that can change the value of projects initiated today  Called Real Options  Similar in concept to call and put options  Based on real assets rather than financial assets Big Point: Real options can improve NPV estimates for projects  Difficult to quantify 25© Kaplan, Inc.LOS 21.f Describe Capital BudgetingSchweser B2 pg 180, CFAI V3 pg 52 Solution: Abandonment OptionNPV without considering the option:Initial outlay = $120,000Years 1–4 after-tax operating cash flows:[(0.5)(18,000)+(0.5)(45,000)] = $31,500.NPV @ 12% = –24,323© Kaplan, Inc. 27ers - Exame CFA 7

LOS 21.f Describe Capital BudgetingSchweser B2 pg 180, CFAI V3 pg 52 Solution: Abandonment OptionThe abandonment option will be exercised if thevalue of the remaining cash flows is less than$100,000. The value of $18,000 cash flow per yearfor three years @ 12% is only $43,233.NPV if high cash flows are realized:CF0 = –120,000; C01-C04 = 45,000. NPV = 16,681© Kaplan, Inc. 28 Fixed Income Investments Corporate Finance Corporate Finance 22. Capital Structure ©2018 FK Partne

SS 07 - Corporate FinanceLOS 21.f Describe Capital BudgetingSchweser B2 pg 180, CFAI V3 pg 52 Solution: Abandonment OptionNPV if low cash flows are realized and projectabandoned:CF0 = –120,000; C01 = 18,000+100,000 = $118,000NPV = –14,643Expected NPV = (0.5)(16,681)+(0.5)(–14,643) = $1,019Value of the option = 1,019 – (–24,323) = $25,342© Kaplan, Inc. 29LOS 22.a Explain Capital StructureSchweser B2 pg 208, CFAI V3 pg 94 Capital Structure Objective Goal: Determine the mix of debt and equity that minimizes the firm’s WACC  Also maximizes the firm’s value Called the optimal capital structure Review from Level I: WACC is weighted average of the marginal costs for each type of capital WACC =  wd × kd ×1– t  +  we × ke   © Kaplan, Inc. 31ers - Exame CFA 8

LOS 22.a Explain Capital StructureSchweser B2 pg 208, CFAI V3 pg 94 MM Propositions I and II Modigliani and Miller (MM):  Proposition I: The value of a firm  Proposition II: The WACC Know both with: Think: Four related  No taxes concepts  Taxes Both use some extremely restrictive assumptions© Kaplan, Inc. 32LOS 22.a Explain Capital StructureSchweser B2 pg 208, CFAI V3 pg 94 MM Proposition I (No Taxes): Capital Structure Irrelevance Pie analogy: Pie is the same size no matter how you slice it  VL = VUEquity Debt Equity Debt© Kaplan, Inc. 34 ©2018 FK Partne

SS 07 - Corporate FinanceLOS 22.a Explain Capital StructureSchweser B2 pg 208, CFAI V3 pg 94 MM Proposition I (No Taxes): Capital Structure Irrelevance Point: Value of a firm is unaffected by its capital structure  Levered and unlevered firm have same value  Notation: VL = VU Holds in perfect markets:  No taxes  No transaction costs  No costs of financial distress 33© Kaplan, Inc.LOS 22.a Explain Capital StructureSchweser B2 pg 208, CFAI V3 pg 94 WACC Unchanged by Leverage Cost of equity Cost of capital re = r0 +(r0 – rd ) D increases linearly E as company increases its leverage WACC is WACC unaffected by capital structure r0 WACC =  D rd +  E re Cost of  V   V  debt© Kaplan, Inc. Debt/Equity 35ers - Exame CFA 9

LOS 22.a Explain Capital StructureSchweser B2 pg 208, CFAI V3 pg 94 Concept 1 and 2 Review: MM with NO Taxes Big Point: Both Prop I and Prop II show that in a world with no taxes, capital structure doesn’t matter  The pie is the same however you slice it  WACC is unaffected by leverage Next to consider: The impact of taxes© Kaplan, Inc. 36LOS 22.a Explain Capital StructureSchweser B2 pg 208, CFAI V3 pg 94Concept #4 – MM Prop II (With Taxes) re = r0 + (r0 – rd ) D (1– t) E Cost of capital r0 WACC =  D rd (1– t) +  E re WACC  V   V  Cost of debt (1–T)© Kaplan, Inc. Debt/Equity 38 ©2018 FK Partne

SS 07 - Corporate FinanceLOS 22.a Explain Capital StructureSchweser B2 pg 208, CFAI V3 pg 94 MM Prop I With Taxes Debt creates a tax shield:  Debt interest payments are tax deductible  Tax shield increases the size of the pie!  Result: VL = VU + (tax rate × value of debt)  Big Point: Optimal capital structure = 100% debt© Kaplan, Inc. 37LOS 22.a Explain Capital StructureSchweser B2 pg 208, CFAI V3 pg 94 Concepts 3 and 4 Review – MM With Taxes Big Point: Both Prop I and Prop II show that in a world with taxes, firms should use 100% debt  Why? Debt tax shield increases size of pie! Of course, that doesn’t work in practice because of the risk of bankruptcy Next to consider: Cost of financial distress© Kaplan, Inc. 39ers - Exame CFA 10

LOS 22.a Explain Capital StructureSchweser B2 pg 208, CFAI V3 pg 94 Costs of Financial Distress What?: Costs incurred when company has trouble paying fixed financing costs (interest)  Direct costs (e.g., legal expenses of filing for bankruptcy)  Indirect costs (e.g., loss of customer trust) Probability of financial distress Higher operating or financial leverage leads to higher probability of financial distress Better corporate governance lower probability© Kaplan, Inc. 40LOS 22.b Describe/Explain Capital StructureSchweser B2 pg 216, CFAI V3 pg 107 Static Trade-Off Theory PV of tax Value of levered firm shield (excluding bankruptcy risk)Firm value Cost of financial distress Value of levered firm Value of unlevered firm Optimal capital % of debt in capital structure structure© Kaplan, Inc. 42 ©2018 FK Partne

SS 07 - Corporate FinanceLOS 22.b Describe/Explain Capital StructureSchweser B2 pg 216, CFAI V3 pg 107 Static Trade-Off Theory Think: Tax shield plus cost of financial distress  At some point: Value added by tax-shield is exceeded by value-reducing costs of financial distress  This point is the optimal capital structure© Kaplan, Inc. 41LOS 22.b Describe/Explain Capital StructureSchweser B2 pg 216, CFAI V3 pg 107 Static Trade-Off Theory Cost of equity WACC Cost of capital Cost of debt (1–T) © Kaplan, Inc. Optimal capital Debt/equity 43 structureers - Exame CFA 11

LOS 22.a Explain Capital StructureSchweser B2 pg 208, CFAI V3 pg 94 Agency Costs of Equity Agency costs: Costs of conflict of interest between managers and owners Types of agency costs of equity: 1. Monitoring costs (better corp. governance, lower agency costs) 2. Bonding costs (e.g., non-compete agreement) 3. Residual losses (can’t eliminate) Point: Financial leverage reduces agency costs  Managers have less FCF to squander© Kaplan, Inc. 44LOS 22.b Describe/Explain Capital StructureSchweser B2 pg 216, CFAI V3 pg 107 Pecking Order Theory Management sends signals based on their financing choices Financing choices are from most favored to least favored (pecking order) based on their information content  Internally generated funds (most favored)  Debt  Newly issued equity (least favored)© Kaplan, Inc. 46 ©2018 FK Partne

SS 07 - Corporate FinanceLOS 22.a Explain Capital StructureSchweser B2 pg 208, CFAI V3 pg 94 Costs of Asymmetric Information Asymmetric information: Managers know more about firm prospects than owners Costs higher if complex products or poor financial statements Valuation implications:  Stock offering → negative signal (offering to sell overvalued stock)  Debt offering → positive signal (avoid selling undervalued stock; management confident can make payments) 45© Kaplan, Inc.LOS 22.b Describe/Explain Capital StructureSchweser B2 pg 216, CFAI V3 pg 107 Actual vs. Optimal Capital Structure Point: Target capital structure = optimal capital structure However, capital structure may deviate from optimal  Exploit opportunities in a specific financing source (e.g., cheap equity)  Market value fluctuations© Kaplan, Inc. 47ers - Exame CFA 12

LOS 22.d Explain Capital StructureSchweser B2 pg 217, CFAI V3 pg 110Evaluating Capital Structure Policy Factors to consider:  Changes in capital structure over time  Capital structure of competitors with similar business risk  Agency costs  Higher quality of corporate governance lower agency costs and less debt© Kaplan, Inc. 48LOS 23.b Compare/Explain Dividends andSchweser B2 pg 229, CFAI V3 pg 134 Share Repurchases Dividend Irrelevance Theory MM: Dividend policy is irrelevant  Assumes perfect markets: No corporate taxes, bankruptcy costs, transactions costs Homemade dividends  Investors wanting more dividends can sell shares (or fractions of shares)  Investors wanting less dividends can use dividends to buy new shares (or share fractions)© Kaplan, Inc. 50 ©2018 FK Partne

SS 07 - Corporate Finance Fixed Income Investments Corporate Finance Corporate Finance 23. Dividends and Share Repurchases: AnalysisLOS 23.b Compare/Explain Dividends andSchweser B2 pg 229, CFAI V3 pg 134 Share Repurchases Dividend Preference Theory Dividend Preference: Suggests that investors prefer the certainty of a cash dividend over the uncertainty of a stock price increase (Bird-in-hand argument) Result: Higher dividends lead to higher stock prices (lower cost of equity) © Kaplan, Inc. 51ers - Exame CFA 13

LOS 23.b Compare/Explain Dividends andSchweser B2 pg 229, CFAI V3 pg 134 Share Repurchases Tax Preference Theory Investors prefer small dividend payments to large payments because:  Capital gains are: 1. Sometimes taxed at a lower rate 2. Not taxed until realized Result: Smaller dividends result in higher stock price and lower cost of equity© Kaplan, Inc. 52LOS 23.d Explain Dividends andSchweser B2 pg 231, CFAI V3 pg 137 Share Repurchases Clientele Effects Due to Taxes In the presence of differential taxes on dividends and capital gains, investors would prefer one over other. For a given amount of dividend (D), investor would be indifferent if the price of the stock would drop by ∆P when it goes ex-dividend: P = D ( 1 – TD ) ( 1 – TC G )© Kaplan, Inc. 54 ©2018 FK Partne

SS 07 - Corporate FinanceLOS 23.d Explain Dividends andSchweser B2 pg 231, CFAI V3 pg 137 Share Repurchases Other Dividend Policy TheoriesA. Clientele effect due to:  Tax considerations (next slide)  Requirements of institutional investors  Individual investor preferences© Kaplan, Inc. 53LOS 23.d Explain Dividends andSchweser B2 pg 231, CFAI V3 pg 137 Share RepurchasesOther Dividend Policy Theories (cont.)B. Agency Issues  Between shareholders and managers  Dividends reduce free cash flow for managers to invest in empire building  Between shareholders and bondholders  Dividends transfer wealth from bondholders to shareholders© Kaplan, Inc. 55ers - Exame CFA 14

LOS 23.c Describe Dividends andSchweser B2 pg 230, CFAI V3 pg 141 Share Repurchases Signaling Content of Dividends Signaling due to information asymmetry between managers and investors. Increase: Positive signal Decrease/omission: Negative signal Initiation: Positive signal (usually)  However: Is it great prospects or lack of positive NPV opportunities?© Kaplan, Inc. 56LOS 23.f Calculate/Interpret Dividends andSchweser B2 pg 234, CFAI V3 pg 149 Share Repurchases Effective Tax Rate on Dividends Double taxation and split-rate systems: effective tax rate = tax corporate + (1 – tax corporate)(tax individual) For split-rate system, use the corporate tax rate for distributed income Imputation system: effective tax rate = shareholder’s tax rate© Kaplan, Inc. 58 ©2018 FK Partne

SS 07 - Corporate FinanceLOS 23.e Explain Dividends andSchweser B2 pg 233, CFAI V3 pg 147 Share Repurchases Factors Affecting Dividend Payout Policy1. Investment opportunities2. Expected volatility of future earnings3. Financial flexibility4. Tax considerations5. Flotation costs 6. Contractual and legal restrictions 57© Kaplan, Inc.LOS 23.g Compare/Calculate Dividends andSchweser B2 pg 236, CFAI V3 pg 155 Share Repurchases Residual Dividend Model Point: Dividends = earnings minus funds retained to finance equity portion of capital budget Model based on:  Investment opportunity schedule  Target capital structure  Access to and cost of external capital © Kaplan, Inc. 59ers - Exame CFA 15

LOS 23.g Compare/Calculate Dividends andSchweser B2 pg 236, CFAI V3 pg 155 Share Repurchases Residual Dividend ModelSteps to determine target payout ratio:1. Identify optimal capital budget2. Determine amount of equity needed given target capital structure3. Meet equity requirements to extent possible with retained earnings4. Pay dividends with the residual earnings© Kaplan, Inc. 60LOS 23.g Compare/Calculate Dividends andSchweser B2 pg 236, CFAI V3 pg 155 Share RepurchasesOther Dividend Policy Approaches Target payout adjustment model: Dividends paid out as a percentage of total earnings General approach:  Set target dividend payout based on long-term sustainable earnings  Move slowly toward that target  Avoid cutting or eliminating dividend except in extreme circumstances© Kaplan, Inc. 62 ©2018 FK Partne

SS 07 - Corporate FinanceLOS 23.g Compare/Calculate Dividends andSchweser B2 pg 236, CFAI V3 pg 155 Share Repurchases Other Dividend Policy Approaches Longer-term residual dividend  Forecast capital budget out 5 to 10 years  Allocate leftover earnings as dividends  Pay out in relatively equal amounts  Distribute excess with share repurchases© Kaplan, Inc. 61LOS 23.k Explain Dividends andSchweser B2 pg 242, CFAI V3 pg 167 Share RepurchasesShare Repurchase vs. Cash Dividend If tax treatment is the same, no difference in effect on shareholder wealth  Pwith dividend = Pex-dividend + Dividend Rationales for share repurchase: 1. Tax advantage to shareholders if tax rate on capital gains < tax rate on dividends 2. Signal to shareholders that management believes shares are undervalued© Kaplan, Inc. 63ers - Exame CFA 16

LOS 23.k Explain Dividends andSchweser B2 pg 242, CFAI V3 pg 167 Share RepurchasesRationales for Share Repurchases3. Added Flexibility: Repurchase is not sticky and so can be used whenever there is excess cash4. Offsetting dilution: Prevents EPS dilution from exercise of employee stock options5. Increase leverage: Repurchase shares to increase financial leverage© Kaplan, Inc. 64LOS 23.m,n Calculate/Interpret/Identify Dividends andSchweser B2 pg 246, CFAI V3 pg 179 Share Repurchases Example: Dividend Sustainability Given the following data for Pearson, compute the: (1) dividend payout ratio, (2) dividend coverage ratio, and (3) FCFE coverage ratio Year Ending Dec 31 20X0 Dec 31 20X1 Net Income $2,000 $2,500 CFO $2,700 $2,750 FCInv $1,500 $1,600 Net Borrowing $300 $350 Dividends Paid $1,000 $1,250 Share Repurchases $500 $500© Kaplan, Inc. 66 ©2018 FK Partne

SS 07 - Corporate FinanceLOS 23.m,n Calculate/Interpret/Identify Dividends andSchweser B2 pg 246, CFAI V3 pg 179 Share Repurchases Dividend Coverage Ratios Dividend Payout Ratio = Dividends Net Income D iv id e n d Coverage R atio = Net Incom e D iv id e n dFCFE c o v e ra g e ra tio = D iv id e n d s + FCFE Share Repurchases Higher coverage ratios Higher dividend sustainability© Kaplan, Inc. 65LOS 23.m,n Calculate/Interpret/Identify Dividends andSchweser B2 pg 246, CFAI V3 pg 179 Share Repurchases Dividend Sustainability 67  Dividend Payout Ratio:  20X0: 1,000 / 2,000 = 50%  20X1: 1,250 / 2,500 = 50%  Dividend Coverage Ratio:  20X0: 2,000 / 1,000 = 2x  20X1: 2,500 / 1,250 = 2x  FCFE Coverage Ratio:  FCFE = CFO – FCInv + Net Borrowings  20X0: 2,700 – 1,500 + 300 = 1,500  20X1: 2,750 – 1,600 + 350 = 1,500© Kaplan, Inc.ers - Exame CFA 17

LOS 23.m,n Calculate/Interpret/Identify Dividends andSchweser B2 pg 246, CFAI V3 pg 179 Share Repurchases Dividend Sustainability FCFE Coverage Ratio:  20X0: 1,500/ (1,000 + 500) = 1x  20X1: 1500 / (1,250 + 500) = 0.86x Dividend Coverage Ratio seems to be stable and sustainable (>1) FCFE coverage is declining and below 1 in 20X1— unsustainable—dividend safety is not assured!© Kaplan, Inc. 68 Fixed Income Investments Study Session 7 Discussion Questions CFA Institute Program curriculum, Level II, Volume 3, page 118 Questions 8–13 ©2018 FK Partne

SS 07 - Corporate Finance Capital Structure Other LOS For SS7These LOS are not covered in live class: LOS 21.b Explain LOS 23.a Compare/calculate LOS 21.d Explain LOS 23.h Calculate LOS 21.g Describe LOS 23.i Describe LOS 21.h Describe LOS 23.j Describe LOS 21.i Describe LOS 23.l Compare LOS 22.c Describe LOS 22.e Describe© Kaplan, Inc. 69 Discussion QuestionsThe following information relates to Questions 8–13 Barbara Andrade is an equity analyst who covers the entertainment industry for Greengable Capital Partners, a major global asset manager. Greengable owns a significant position with a large unrealized capital gain in Mosely Broadcast Group (MBG). On a recent conference call, MBG’s management states that they plan to increase the proportion of debt in the company’s capital structure. Andrade is concerned that any changes in MBG’s capital structure will negatively affect the value of Greengable’s investment.© Kaplan, Inc. 71ers - Exame CFA 18

Discussion Questions To evaluate the potential impact of such a capital structure change on Greengable’s investment, she gathers the information about MBG given in Exhibit 1.Exhibit 1. Current Selected Financial Information for MBG Yield to maturity on debt 8.00% Market value of debt $100 million Number of shares of common stock 10 million Market price per share of common stock $30 Cost of capital if all equity-financed 10.3% Marginal tax rate 35%© Kaplan, Inc. 72 Discussion Questions Question 88. MBG is best described as currently: A. 25% debt-financed and 75% equity-financed. B. 33% debt-financed and 66% equity-financed. C. 75% debt-financed and 25% equity-financed.© Kaplan, Inc. 74 ©2018 FK Partne

SS 07 - Corporate Finance Discussion Questions  Andrade expects that an increase in MBG’s financial leverage will increase its costs of debt and equity. Based on an examination of similar companies in MBG’s industry, Andrade estimates MBG’s cost of debt and cost of equity at various debt-to-total capital ratios, as shown in Exhibit 2.Exhibit 2. Estimates of MBG’s before Tax Costs of Debt and Equity Debt-to-Total Capital Ratio (%) Cost of Debt (%) Cost of Equity (%) 20 7.7 12.5 30 8.4 13.0 40 9.3 14.0 50 16.0 10.4© Kaplan, Inc. 73 Discussion Questions Solution 8Equity MV: $30×10m = $300mDebt MV: = $100mTotal = $400mDebt = 100/400 = 25%Equity = 300/400 = 75% © Kaplan, Inc. 75ers - Exame CFA 19

Discussion Questions Solution 88. MBG is best described as currently: A. 25% debt-financed and 75% equity-financed. B. 33% debt-financed and 66% equity-financed. C. 75% debt-financed and 25% equity-financed.© Kaplan, Inc. 76 Discussion Questions Solution 90.08×(1 – 0.35) = 0.052After-tax cost of debt = 5.2%© Kaplan, Inc. 78 ©2018 FK Partne

SS 07 - Corporate Finance Discussion Questions Question 99. Based on Exhibits 1 and 2, the current after-tax cost of debt for MBG is closest to: A. 2.80%. B. 5.20%. C. 7.65%.© Kaplan, Inc. 77 Discussion Questions Solution 99. Based on Exhibits 1 and 2, the current after-tax cost of debt for MBG is closest to: A. 2.80%. B. 5.20%. C. 7.65%. © Kaplan, Inc. 79ers - Exame CFA 20

Discussion Questions Question 1010.Based on Exhibits 1 and 2, MBG’s current cost of equity capital is closest to: A. 10.30%. B. 10.80%. C. 12.75%.© Kaplan, Inc. 80 Discussion Questions Solution 1010.Based on Exhibits 1 and 2, MBG’s current cost of equity capital is closest to: A. 10.30%. B. 10.80%. C. 12.75%.© Kaplan, Inc. 82 ©2018 FK Partne

SS 07 - Corporate Finance Discussion Questions Solution 10 ke = k0 + (k0 – kd)(1 – t)D/E = 0.103 + (0.103 – 0.08)(1 – 0.35)(100/300) = 10.8%© Kaplan, Inc. 81 Discussion Questions Question 1111.Based on Exhibits 1 and 2, what debt-to-capital ratio would minimize MBG’s weighted average cost of capital? A. 20% B. 30% C. 40%© Kaplan, Inc. 83ers - Exame CFA 21

20% Debt: Discussion Questions Solution 11 (0.2×0.077×0.65) + (0.8×0.125) = 11%30% Debt: (0.3×0.084×0.65) + (0.7×0.130) = 10.74%40% Debt: (0.4×0.093×0.65) + (0.6×0.140) = 10.82%© Kaplan, Inc. 84 Discussion Questions Question 1212.Holding operating earnings constant, an increase in the marginal tax rate to 40 percent would: A. result in a lower cost of debt capital. B. result in a higher cost of debt capital. C. not affect the company’s cost of capital.© Kaplan, Inc. 86 ©2018 FK Partne

SS 07 - Corporate Finance Discussion Questions Solution 1111.Based on Exhibits 1 and 2, what debt-to-capital ratio would minimize MBG’s weighted average cost of capital? A. 20% B. 30% C. 40%© Kaplan, Inc. 85 Discussion Questions Solution 1212.Holding operating earnings constant, an increase in the marginal tax rate to 40 percent would: A. result in a lower cost of debt capital. B. result in a higher cost of debt capital. C. not affect the company’s cost of capital.An increase in the marginal tax rate reduces theafter-tax cost of debt.© Kaplan, Inc. 87ers - Exame CFA 22

Discussion Questions Question 1313.According to the pecking order theory, MBG’s announced capital structure change:A. is optimal because debt is cheaper thanB. equity on an after-tax basis.C. may be optimal if new debt is issued after new equity is made complete use of as a source of capital. may be optimal if new debt is issued after internally generated funds are made complete use of as a source of capital.© Kaplan, Inc. 88 Discussion Questions Solution 1313.According to the pecking order theory, MBG’s announced capital structure change: A. is optimal because debt is cheaper than equity on an after-tax basis. B. may be optimal if new debt is issued after new equity is made complete use of as a source of capital.C. may be optimal if new debt is issued after internally generated funds are made complete use of as a source of capital.© Kaplan, Inc. 90 ©2018 FK Partne

SS 07 - Corporate Finance Discussion Questions Solution 13 Pecking order theory: If internally generated funds have already been fully used, the use of new debt may be optimal, according to the pecking order theory of capital structure.© Kaplan, Inc. 89 Fixed Income Investmentsers - Exame CFA 23

Fixed Income Investments ©2018 FK Partne

SS 07 - Corporate Financeers - Exame CFA 24

Questions – SS07 - Corporate FinanceQuestion 1 - 6Jayco, Inc. is considering the purchase of a new machine for $60,000 that will reduce manufacturingcosts by $5,000 annually.  Jayco will use the MACRS accelerated method (5 year asset) to depreciate the machine, and expects to sell the machine at the end of its 6-year operating life for $10,000. (The percentages for the 5-year MACRS class are, beginning with year 1 and ending with year 6, 20%, 32%, 19%, 12%, 11%, and 6%.)  The firm expects to be able to reduce net working capital by $15,000 when the machine is installed, but required working capital will return to the original level when the machine is sold after 6 years.  Jayco's marginal tax rate is 40%, and the firm uses a 12% cost of capital to evaluate projects of this nature.Question 1What is the first year's modified accelerated cost recovery system (MACRS) depreciation? A) $12,000. B) $15,000. C) $10,000.Question 2The first year's incremental operating cash flow is closest to? A) $7,800. B) $4,800. C) $3,000.Question 3The initial cash outlay is closest to: A) $75,000. B) $45,000. C) $57,000.Question 4What is the project's terminal year after-tax non-operating cash flow? A) ($4,000). B) $21,000. C) ($9,000).Question 5If the NPV using MACRS depreciation rates for this project is negative, changing the depreciation toa straight -line method will result in the sign of the computed NPV being: A) the same; depreciation is non-cash and does not affect the NPV computation. B) the same; as the NPV decreases and is less than the NPV computed under for tthe MACRS method. C) different; as the NPV increases and the NPV is now positive.Question 6The most appropriate discount rate to be used for capital budgeting would be: A) The firm's WACC. B) Yield to maturity on the bonds issued to finance the project. C) The project's hurdle rate. ______________________ 1 ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio.

Question 7 - 12Bijou and Stephenson are old buddies both who have retired from careers in finance. Now in their70s they like to meet once a week to discuss current affairs and finance related topics over a gameof dominoes.Bijou excitedly tells Stephenson that his grandson (Mihir) has got his first job working at a corporatefinance house. Mihir is assessing the cost of capital in three different countries and has asked Bijouif he can help him with any insights.The data Mihir has collect is as follows:Country 1 Company: Carnegie Inc Scenario 1 Scenario 2 Scenario 3Proportion of debt 0% 50% 80%Cost of Equity 15% 16% 18%Cost of Debt 10% 12% 16%Country 2 Company: Sapata Inc Scenario 1 Scenario 2 Scenario 3Proportion of debt 0% 50% 80%Cost of Equity 15% 16% 18%Cost of Debt 10% 12% 16%Country 3 Company Fisher Ltd Scenario 1 Scenario 2 Scenario 3Proportion of debt 0% 50% 80%Cost of Equity 15% 16% 18%Cost of Debt 10% 10% 10%Stephenson turns to Bijou and says \"It's all well and good to study M&M leverage theory but wemust remember that it had a lot of restrictive assumptions. For example M&M's study assumed thatcapital markets are perfectly competitive and investors have homogonous expectations.Bijou agrees with Stephenson but points out \"The purpose of M&M is to tell us that in the real worldcapital structure matters precisely because one or more of these assumptions is violated. Once youintroduce financial distress, irrational investors you move closer and closer to static trade offtheory.\"Mihir joins the discussion and noted that his supervisor mentioned the cost of asymmetricinformation increases as more debt is added to the firm's capital structure. Stephenson responds\"The manager is confused as according to the Pecking Order theory the cost of asymmetricalinformation increases as we add more equity.\"Question 7Country 1 is most consistent with?A) M&M Propositions with taxB) M&M Propositions without taxC) Static trade off theoryQuestion 8Country 2 is most consistent with?A) M&M Propositions without tax 2B) Static trade off theory ______________________ ©2018 FK Partners Todos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio.

C) M&M Propositions with taxQuestion 9Country 3 is most consistent with? A) M&M Propositions without tax B) Static trade off theory C) M&M Propositions with taxQuestion 10Regarding Bijou and Stephenson's comments on M&M and leverage theory: A) Neither comment is correct B) One comment is correct C) Both comments are correctQuestion 11Which factor(s) Bijou and Stephenson would least likely need to consider when evaluating a firm'scapital structure? A) Capital structure of competitors with similar business risk B) Factors affecting agency costs such as credit ratings C) Changes in the firm's capital structure over timeQuestion 12Regarding Mihir's and Stephenson's comments on the cost of asymmetric information: A) Mihir's supervisor is correct B) Neither comment is correct C) Stephenson is correctQuestion 13 - 18Alias, Inc. is a maker of plastic containers for the food and beverage industry. Bruce Atkinson, Alias'director of operations, is looking at upgrading the firm's manufacturing capacity in an effort toimprove the firm's competitive position.Atkinson is being assisted by Linda Ralston, a financial analyst recently hired by Alias. Over the lastthree months, Ralston and Atkinson have been going to trade shows and conducting other researchon different machines and processes used in the plastic container industry. Ralston estimates thattravel and hotel costs expended as a result of their research amounted to $8,000. Atkinson considersthe money well spent because he now had two great ideas for improving Alias' competitiveness inthe industry.The first of these ideas is that Atkinson is considering replacing a bottle blow molding machine. Thismachine was purchased for $50,000 3 years ago and is being depreciated for tax purposes over 5years to a zero salvage value using straight-line depreciation. The firm has 2 years of depreciationremaining on the old machine.If Atkinson decides to make the replacement, the old machine can be sold today for $10,000. Thenew machine will cost the firm $100,000. According to Ralston's projections, the new machine willincrease revenue by $40,000 per year for 3 years but will also increase costs by $5,000 per year.The machine will be depreciated over a modified accelerated cost recovery system (MACRS) 3-yearclass life. At the end of year 3, the equipment will be sold for$20,000. The firm's tax rate is 35%.Atkinson is also considering an investment in a new silk screen labeling machine that can put labelson Alias plastic bottles as part of the manufacturing process. Ralston estimates that the new labelingmachine will cost $50,000, and that shipping and installation costs will be $7,500. The addition ofthe labeling machine will require a $2,000 investment in spare parts inventory at the inception ofthe project, but these parts can be resold for $2,000 at the project's end. Compared with the manualprocess that Alias used to use for putting on labels, Ralston estimates that the new machine willreduce costs by $25,000 per year for 4 years. The labeling machine will be depreciated over aMACRS 5-year class life. At the end of year 4, the equipment will be sold for $8,000. ______________________ 3 ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio.

Depreciation schedules under MACRS are shown in the exhibit below:Before making the final calculations, Atkinson and Ralston discuss net present value analysis for theprojects they are considering. Ralston tells Atkinson, \"when calculating the net present value of thetwo new projects, we also need to account for the costs expended as a result of researching theproject options.\" Atkinson makes a note on his legal pad and says to Ralston, \"There is no need tomake any adjustments for inflation in our estimations of future project cash flows because inflationis included as part of the expected returns used to calculate our weighted average cost of capital.\"After their conversation, Ralston and Atkinson prepare their report to present to Alias' CEO.Question 13The initial investment outlay for purchasing the new bottle blow molding machine is closest to:A) −$100,000.B) −$86,500.C) −$90,000.Question 14The year 1 operating cash flow for the new bottle blow molding machine is closest to:A) $34,300.B) $30,800.C) $22,750.Question 15The total cash flow from the bottle blow molding machine in year 3 is closest to:A) $48,000.B) $43,450.C) $28,000.Question 16The initial cash flow for the labeling machine is closest to:A) −$50,000. 4B) −$57,500. ______________________ ©2018 FK Partners Todos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio.

C) −$59,500.Question 17The year 2 operating cash flow for the labeling machine is closest to: A) $34,650. B) $22,690. C) $21,040.Question 18With regard to the conversation between Ralston and Atkinson concerning NPV analysis: A) Ralston's statement is correct; Atkinson's statement is incorrect. B) Ralston's statement is incorrect; Atkinson's statement is correct. C) Ralston's statement is incorrect; Atkinson's statement is incorrect.Question 19 - 24Peter Lung is the CFO for Moore Industries. Lung is new to the company and has been tasked bythe company's board of directors to review the company's dividend policy. The reason for thisrequest is that two board members have suggested changes be made to the dividend policy, buttheir suggested changes are in opposite directions. One of the board members, Al Gormus, hassuggested that the firm increase dividends so that the dividend payout ratio will be higher, butHarold Lee has suggested that the firm decrease dividends. The board has asked Lung to identifythe effects of these suggested changes on the company's stock.To investigate the firm's ability to pay dividends, Lung decides to look at the dividend coverageratios based on earnings and cash flow. Lung has gathered the financial data below for the mostrecent two years. Additionally, he notes that the stock price was $23.20 in 20X7 and $20.08 in20X6. The shares outstanding were 1.45 billion in 20X7 and 1.50 billion in 20X6.(in $millions) 20X7 20X6 2,195Net income 1,783 4,122 3,266Cash flow from operations 4,054 (615) 1,799 1,585 166Capital expendituresNet borrowing (1,034)Dividends paid 1,691Stock repurchases (176)After analyzing the dividend coverage ratios, Lung begins work on his presentation to the boardregarding the options for paying dividends. One of the options that he wants the board to consideris a residual dividend policy. Lung has gathered the information below regarding the firm's 20X8capital budgeting projects. Additionally, he has determined that the target capital structure is 60%equity and 40% debt. The after-tax cost of debt is 6.5%, and the cost of equity is estimated to be12%. Size of project IRRProject ($m)Project 1 $500 12.0%Project 2 $700 11.0%Project 3 $300 10.0%Project 4 $1,000 9.0%Project 5 $600 8.0%Lung also believes that the firm should use share repurchases to a greater extent. In hispresentation he makes the following statements regarding share repurchases. ______________________ 5 ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio.

Statement 1: A share repurchase strategy can be combined to a greater extent. In his presentationhe makes the low stable divifend. In years with more profitable projects, the firm’s repurchaseswould be higher, while in years with fewer profitable projects, repurchases would be lower.Statement 2: Assuming that share repurchases are financed with debt, such repurchases willincrease the company’s EPS.Question 19Based on the bird-in-hand argument for dividend policy, Gormus' suggested dividend change willmost likely result in: A) No change in the stock price. B) A decrease in the stock price. C) An increase in the stock price.Question 20If the company implements Lee's suggested dividend change, assuming that the change was notanticipated by the market, the signal that this change would send to investors would most likelybe: A) That the company's business prospects are weak. B) Ambiguous and indiscernible to investors. C) That the company's business prospects are strong.Question 21Based on the information collected by Lung, the 20X6 dividend payout ratio is closest to: A) 0.7. B) 0.1. C) 1.4.Question 22Based on the information collected by Lung, the FCFE coverage ratio for 20X7 is closest to: A) 0.7. B) 1.4. C) 0.8.Question 23If the firm's net income in 20X8 is $1,500 and the firm follows a residual dividend policy, thedividend coverage ratio would be: A) undefined. B) 1.67. C) 2.50.Question 24Are Lung's statements regarding share repurchases CORRECT? A) Yes, both statements are correct. B) No, only one of the statements is correct. C) No, both statements are incorrect.Question 25 - 30Liu is the proprietor of a small chain of print shops called Quik Printz, that has grown rapidly overthe last few years. Much of the growth of Quik Printz has come from Liu's ability to provide a quickturnaround on fairly complex orders and from a dedicated staff of graphic designers.Liu is considering replacing his current offset printing machine with a new cutting edge printingmachine that would allow him to expand his range. The new machine would cost £200,000 and beused for a four-year period. If Liu decided to opt for the new machine the old machine could be sold ______________________ 6 ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio.

on for £50,000 immediately. If Liu decides not to go ahead with the project the old machine wouldcontinue to be used for the next four years before finally being scrapped for £10,000.Liu uses straight-line depreciation for tax and accounting purposes and assumes no salvage valuefor accounting purposes. The old machine cost £80,000 and was originally expected to have an 8year life. The old machine is now 4 years old and has a book value of £40,000. Liu expects the newmachine to allow him to produce the 8-fold booklets which can fit in standard sized mailingenvelopes. Liu has spent £5,000 on market research that has established that there is a significantmarket for this product. As a result of the machine Liu expects his yearly sales to be £1,250,000,where as if he continued to use the old machine sales would only be £950,000 per annum.Naturally Liu expects this increase in revenues to have an impact on his cost base. Liu expects tohave to invest a further £40,000 in working capital if he decided to adopt the new machine.Additionally the new machine will result in incremental cash operating expenses of £120,000 perannum.At the end of its four-year operating life the new machine could be sold for £25,000.Quik Printz is currently paying tax at a 40% rate and has a cost of capital of 15%. Liu assumes thatthe new machine will have similar risk to the firm and will be funded using the existing mix of debtand equity.Liu makes a couple of comments to you regarding the impact of inflation on capital budgeting:Comment 1: \"In my estimates of operating cash flows I have included the impact of inflation oncash flows. Since I have used nominal cash flows I can discount them using a cost of capital thatexcludes inflation, such as a real rate\"Comment 2: \"The impact of inflation on the depreciation tax shield is that, while it is constant innominal terms, it's likely to be reduced in real terms\"Liu also wants to consider the stand-a-lone risk of the project and has decided to undertake MonteCarlo simulation. Liu asks you to help him clarify his understanding of the process and makes twocomments:Comment 1: \"The whole process seems to be driven by assumed distributions for each of the inputsof the NPVcalculation. The results I get from Monte Carlo are therefore likely to be affected by the mean andstandard deviation that I assume for each of my inputs\"Comment 2: \"The process of randomly picking values for each input from their associateddistribution is repeated many times with each simulation being used to calculate an NPV. After I'verun the simulation many times I should then calculate the mean of all possible NPVs and thestandard deviation around that mean\"Question 25What would be the initial outlay at t=0 for the replacement project?A) £190,000B) £194,000C) £240,000Question 26The after-tax operating cash flow for year 1 is closest to:A) £128,000B) £124,000C) £222,000Question 27The terminal year after-tax non-operating cash flow is closest to:A) £55,000B) £49,000C) £69,000Question 28The NPV of Liu's replacement project is closest to:A) £188,033 7 ______________________ ©2018 FK Partners Todos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio.

B) £125,283 C) £109,432Question 29Regarding Liu's statements about inflation and capital budgeting: A) Both statements are correct B) Both statements are incorrect C) One statement is correctQuestion 30Regarding Liu's statements about Monte Carlo simulation: A) Both statements are correct B) Both statements are incorrect C) One statement is correct ______________________ 8 ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio.

Answers – SS 07 - Corporate FinanceQuestions 1 - 6Questions 1The correct answer was A) $12,000.The first year MACRS depreciation equals 60,000 × 20%, or 60,000 × 0.2 = $12,000.Question 2The correct answer was A) $7,800.The first year's incremental cash flow equals the after-tax impact of the $5,000 operating savingsand the depreciation tax shield, or (5,000)(0.6) + (60,000)(0.2)(0.4) = 3,000 + 4,800 = 7,800.Question 3The correct answer was B) $45,000.Initial cash outlay = up-front costs (including cost of the machine) and changes in working capital.Here, the price of the machine is 60,000 and the working capital initially decreases by 15,000 (whichis a source of funds). Thus, the initial cash outlay = 60,000 cost − 15,000 working capital = 45,000.Question 4The correct answer was C) ($9,000).Terminal cash flow = [salvage price] − (tax rate) × [salvage price − book value] ± reversal ofchange in working capital.= 10,000 − (0.40) × (10,000 − 0) − 15,000 = 10,000 - 4,000 − 15,000 = −9,000.Question 5The correct answer was B) the same; as the NPV decreases and is less than the NPV computed underfor tthe MACRS method.An accelerated depreciation method such as the MACRS will result in a higher NPV compared to theNPV using a straight-line depreciation method due to higher tax savings in the earlier years. IfMACRS depreciation results in a negative NPV for the project, straight-line depreciation would havemade the NPV even lower and hence it will remain negative.Question 6The correct answer was C) the project's hurdle rate.Project's hurdle rate is the appropriate discount rate reflecting the project's risk. Firm's WACCreflects the firm's risk and not the project's risk. Cost of debt issued to finance the project reflectsthe overall risk of the firm and hence would also be inappropriate.Questions 7 – 12Question 7The correct answer was B) M&M Propositions without taxCountry 1 WACCScenario 1: WACC = re = 12%Scenario 2: WACC = (0 5 x 8%) + (0.5 x 16%) = 12%Scenario 3: WACC = (0.8 x 8%) + (0.2 x 28%) = 12%Not that the WACC is constant regardless of capital structure which is consistent with M&M in a zerotax world.Note that the cost of debt is constant regardless of leverage (no financial distress) and as a resultstatic trade off theory could instantly have been rejected.Question 8The correct answer was B) Static trade off theoryCountry 2 WACCScenario 1: re = WACC = 15%Scenario 2: WACC = (0.5 x 16%) + (0.5 x 12%) = 14%Scenario 3: WACC = (0.2 x 18%) + (0.8 x 16%) = 16.4%Notice that as leverage increases, initially WACC begins to fall but at higher leverage it starts to _________________________ ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio 1

rise. This would suggest that there is an optimal capital structure that minimizes the WACC. Alsothe fact that the cost of debt rose as leverage increased indicates financial distress which would befound according to static trade off theory.Question 9The correct answer was C) M&M Propositions with taxCountry 3 WACCScenario 1: re = WACC = 15%Scenario 2: (0.5 x 16%) + (0.5 x 10%) = 13%Scenario 3: (0.2 x 18%) + (0.8 x 10%) = 11.6%Notice that as leverage increases the WACC is falling indicating support for M&M with tax model.Note that static trade off can't apply as the cost of debt is constant as leverage increases.Question 10The correct answer was C) Both comments are correctBoth statements are correct. M&M theory does assume perfect capital markets. The purpose is ofcourse to indicate the idea capital structure in these theoretical situations. We can then relax theassumptions and move towards static trade of theory.Question 11The correct answer was B) Factors affecting agency costs such as credit ratingsCorporate governance issues affect agency costs.Question 12The correct answer was C) Stephenson is correctStephenson's comment is correct. Managers prefer financing choices that signal least amount ofinformation to the market.Questions 13 – 18Question 13The correct answer was B) −$86,500.The initial outlay is the cost of the new machine minus the market value of the old machineplus/minus any tax consequences that arise from selling the old machine. The new machine's costis $100,000.The old machine can be sold for $10,000, however considering that the machine's initial cost was$50,000 and has 3 years of accumulated straight-line depreciation, the book value of the oldmachine is $50,000 − (3 × 10,000) = $20,000. This means that the sale of the machine will resultin a (10,000 − 20,000) = −10,000 loss. The loss will result in tax savings for Alias equal to 0.35 ×10,000 = $3,500.The total initial investment outlay for the new machine is:−$100,000 + 10,000 + 3,500 = −$86,500Question 14The correct answer was B) $30,800.The operating cash flows equal the after-tax benefit plus the tax savings from depreciation. In thecase of a replacement project, you must take the difference between the additional depreciationfrom the new asset minus the lost depreciation from the old asset. The firm gave up $10,000 peryear for of depreciation on the old asset for years 1 and 2 of the new asset's life.CF1 = (revenue − cost)1 × (1 − tax rate) + net depreciation1 × (tax rate) ((40,000 − 5,000) × 0.65)+ [((0.33 × 100,000) − 10,000) × (0.35)] = $30,800Question 15The correct answer was B) $43,450.The total cash flow for the terminal year is equal to the operating cash flow plus the non-operating(or terminating) cash flow.The operating cash flow equals:CF3 = (revenue − cost)3 × (1 − tax rate) + net depreciation3 × (tax rate) ((40,000 - 5,000) × 0.65) + _________________________ 2 ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio

[((0.15 × 100,000) − 0) × 0.35)] = $28,000The non-operating cash flow equals the market or salvage value plus/minus tax consequences ofselling it. The new machine will be sold for $20,000. The book value after 3 years of depreciation is$100,000 × (1.00 - 0.33 - 0.45 - 0.15) = $7,000. So, the gain equals $20,000 - $7,000 = $13,000.The firm will pay taxes on the gain of:13,000 × 0.35 = $4,550Total terminal year cash flow = $28,000 + $20,000 - $4,550 = $43,450Note: Once we have the project's estimated cash flows, the next step in the process would be tocalculate the net present value and internal rate of return for the project.Question 16The correct answer was C) −$59,500.The initial outlay is the cost of the labeling machine, the shipping and installation costs, and theincrease in net working capital (in this case the increase in spare parts inventory):(−$50,000) + (−$7,500) + (−$2,000) = −$59,500.Question 17The correct answer was B) $22,690.The operating cash flows equal the after-tax benefit plus the tax savings from depreciation.CF2 = Benefit2 × (1 − tax rate) + depreciation2 × (tax rate) ($25,000 × 0.65) + ($57,500 × 0.32 ×0.35) = $22,690Note that the shipping and installation costs are part of the depreciable basis for the machine.Question 18The correct answer was C) Ralston's statement is incorrect; Atkinson's statement is incorrect.The hotel and travel costs expended to research the projects would be expended whether Aliasdecided to take on the projects or not. The research costs are a sunk cost, which is a cash outflowthat has previously been committed or has already occurred. Since these costs are not incremental,they should not be included as part of the analysis. Therefore Ralston's statement is incorrect.Atkinson's statement is also incorrect. Although it is true that the expected inflation is built into theexpected returns used to calculate the weighted average cost of capital, Atkinson and Ralston stillneed to adjust the project cash flows upward to account for inflation. If no adjustments are madeto the project cash flows to account for inflation, the NPV will be biased downward.Questions 19 – 24Question 19The correct answer was C) an increase in the stock price.The bird-in-hand argument for dividend policy argues that a stock's required return will decrease(and price will increase) as the dividend payout increases. Investors are more certain about dividendpayments relative to capital gains, and require a lower rate of return for stocks that have a higherdividend payout ratio.Question 20The correct answer was A) that the company's business prospects are weak.Unexpected dividend decreases are regarded as negative signals about a company's prospects.Unexpected dividend increases generally signal to investors that a company's prospects are strong,while dividend initiations are ambiguous.Question 21The correct answer was A) 0.7.The dividend payout ratio is computed as dividends paid divided by net income. The dividend payoutratio for 20X6 is:Question 22 3The correct answer was C) 0.8. _________________________ ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio

The FCFE coverage ratio is computed as free cash flow to equity divided by the sum of dividendsand share repurchases. The first step is to compute FCFE:FCFE = cash flow from operations − FCInv + net borrowings = 4,054 − 1,799 + (1,034) = 1,221where:FCInv = fixed captial investment The FCFE coverage ratio is then:Question 23The correct answer was C) 2.50.The first step is to compute the WACC as follows:WACC = wd × rd(1 − t) + we × re = 0.40 × 6.5% + 0.60 × 12% = 9.8%The firm will only invest in projects with IRRs that exceed the WACC (Projects 1, 2, and 3). Thetotal investment is $1,500 million, and the portion that will be funded from equity is $900 (= $1,500× 0.60). The remaining portion of net income, $600 (= $1,500 − $900), will be paid out asdividends.The dividend coverage ratio, which is computed as net income divided by dividends, is 2.50 (=$1,500 / $600).Question 24The correct answer was C) No, both statements are incorrect.Statement 1 is incorrect. In years with more profitable projects, the firm's repurchases will be loweras the firm will have less residual cash. In years with fewer profitable projects, repurchases wouldbe higher.Statement 2 is incorrect. Share repurchases will only increase the company's EPS if the after-taxcost of borrowing is less than the firm's earnings yield. In this case, the firms after-tax cost ofborrowing is 6.5%, and the firm's earnings yield for the most recent period is 5.3%. Therefore,share repurchases will actually decrease EPS.EPS = $1,783M / 1.45B shares = $1.2297 per share earnings yield = EPS / share price = $1.2297/ $23.20 = 5.3%Questions 25 – 30Question 25The correct answer was B) £194,000Question 26 4The correct answer was B) £124,000After tax operating cash flows: (S-C)(1-T) + (D x T)Incremental cash sales - incremental operating expenses:£300,000 - £120,000 = £180,000Incremental depreciation:New machine = £200,000/4 = £50,000 p.a.Old machine = £80,000/8 = £10,000 p.a.Incremental depreciation = £40,000OCF = £180,000 (1-0.4) + (£40,000 x 0.4) = £124,000Question 27The correct answer was B) £49,000 _________________________ ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio

Note: If the project is accepted, the old machine is scrapped at t=0 and as a result we forgo theend of life scrap proceeds (and any tax issues).Tax on new machine(Sales Price - Book value) x 40%(£25,000 - £0) x 0.4 = £10,000Saved tax on old machine(£10,000 - £0) x 0.4 = £4,000TNOCF = (SalTNew - SalTOld) + NWCInv - T[(SalTNew - BTNew) - (SalTOld - BTOld)]= (£25,000 - £10,000) + £40,000 - 40%[(£25,000 - £0) - (£10,000 - £0)]Question 28The correct answer was A) £188,033 T0 T1 T2 T3 T4Outlay (194,000)Operating CF 124,000 124,000 124,000 124,000TNOCF 49,000Totals (194,000) 124,000 124,000 124,000 173,000Discounting these cash flows using a 15% discount rate gives an NPV of $188,033.23Question 29The correct answer was C) One statement is correctStatement 1 is false. If inflation is included in cash flows (nominal cash flows) then the discountrate should include inflation too (a nominal discount rate). If inflation is excluded from cash flowsthen inflation should be stripped out of the discount rate by using a real discount rate.Statement 2 is correct. The depreciation tax shield is based on the historic cost of the assets andtherefore does not increase with inflation. Most of the other cash flows will inflate and as a resultthe depreciation tax shield is proportionally smaller (i.e., it has decreased in real terms).Question 30The correct answer was A) Both statements are correctStatement 1 is correct. For Monte Carlo simulations, key inputs are assumed distribution and theirmean/standard deviation.Statement 2 is correct. In a Monte Carlo simulation, large number of simulations are generated witheach simulation based off of randomly generated input variables (from their underlying assumeddistributions). For each simulation, a single point estimate NPV is computed. We can the calculatethe mean NPV value and its standard deviation (as a measure of risk). _________________________ 5 ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio

_________________________ 6 ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio