Last year hot shots exterminators, inc. conducted an IPO

1. Last year Hot Shots Exterminators, Inc. conducted an IPO, issuing 1 million common shares with a par value of $1 to investors at a price of $10 per share. During its first year of operation, Hot Shots earned a net income of $0.15 per share and paid a dividend of $0.01 per share. At the end of the year, the company's stock was selling for $20 per share. Construct the equity accounts for Hot Shots at the end of its first year in business, and calculate the firm's market capitalization.

2. Couglin Inc. has net operating income of $120,000 per year. Couglin uses no debt in its capital structure and the required rate of return to equity holders is 12 percent.
a. Calculate the value of the unlevered firm if the firm has a marginal tax rate of 0%.
b. Calculate the value of the unlevered firm if the firm has a marginal tax rate of 30%.
c. Interpret the difference in your findings to parts a. and b.
d. If your answer to part a. is less than your answer to part b, can we increase firm value by taking on debt? If so, will these benefits always continue as we add more and more debt?



3. If a firm operates in a perfect capital market, has a required return on its outstanding debt of 8%, a required return on its common stock of 16%, and a WACC of 13%, what is the firm's debt-to-equity ratio?



4. An unlevered corporation has net income of $50,000 and a required rate of return of 14%. What would the value of this firm be if it borrowed $125,000 to buy back some of its stock? Assume a corporate tax rate of 35%.


4. Given the following information.

Equity Corporation Debt Corporation
Cost of equity 12% 18%
Debt -------- $2,500,000
Pretax cost of debt -------- 8%
EBIT $500,000 $ 500,000

Calculate the market value of Equity Corporation, Debt Corporation, and the present value of the tax shield to Debt Corporation if both companies have a tax rate of 40%. Assume there are no financial distress or agency costs and that expected growth of EBIT is zero.







5. Which of the following would lead to an increase in leverage in a firm's optimal capital structure according to the agency cost/tax shield trade-off model?
a. A decline in the corporate tax rate
b. An increase in the agency costs of outside equity
c. An increase in indirect bankruptcy costs
d. An increase in the agency costs of outside debt
e. All of the above


6. Assume the assumptions underlying the APV are relevant. Brakes and Rakes Co. (BRR) has required return on levered equity equal to 20%, required return on debt of 9%, and corporate tax rate of 25%. The required return on the market is 15%. BRR has debt with market value $30 million and equity with market value $6 million. What is BRR’s unlevered cost of capital?
a. 10.26%
b. 10.83%
c. 11.32%
d. 12.71%
e. 13.89%



7. Cactus Cushions, a non-traditional pillow manufacturer, is considering a new capital investment project that requires a $40 million investment today. Next year, the project will generate expected pre-tax cash flows of $2 million, all of which are taxable. The following year, expected cash flows will grow by 2.5%, and constant annual growth will continue forever. Assume that the project will always be backed by debt equal to 60% of the contemporaneous project value. The tax rate is 34%, debt will have required return 6%, and equity will have required return 9%. What is the project NPV according to the WACC method?


8. You purchase a European call option with one year to expiration for $2.50. The exercise price is $25 per share and the current stock price is $22. You also purchase a put option on the same stock with the same exercise price and the same expiration date for $5. If the stock price rises to $26 at the end of the year the call option payoff is __________ and the put option payoff is __________.
a. $1; -$1
b. –$1; $1
c. $0; $1
d. $1; $0
e. none of the above


9. A stock is worth $40 today. In the next six months it may increase to $46 or decrease to $35. The risk-free rate of interest is 4% per year. Use the binomial model to determine the price of a put option with a strike price of $40 and an expiration date in six months.
a. 3.62
b. 1.85
c. 2.32
d. 3.10
e. 2.50


9. A stock is worth $40 today. In the next six months it may increase to $46 or decrease to $35. The risk-free rate of interest is 4% per year. Use the binomial model to determine the price of a put option with a strike price of $40 and an expiration date in six months.
a. 3.62
b. 1.85
c. 2.32
d. 3.10
e. 2.50



10. Send-it-Soon (SIS) will ship goods valued at euro 100,000 to a German buyer in three months. Payment will occur upon delivery. The current spot exchange rate is euro 0.95/$ and the three-month forward rate is euro 0.92/$. If the actual exchange rate in three months is euro 0.98/$, SIS would experience a __________ of __________ if it remained unhedged versus hedging in the forward market.
a. profit; $108,696
b. profit; $6,000
c. profit; $6,655
d. loss; $6,000
e. loss; $6,655



11. According to the sustainable growth model, if a firm finances its assets with 75 percent debt and 25 percent equity, and retains $3 million in earnings in a given year, the firm can afford to borrow an additional __________ to maintain the desired mix of debt and equity.
a. $9 million
b. $5.25 million
c. $2.25 million
d. $1 million
e. none of the above



12. Treefold’s Corporation has projected sales of $65,000 in January, $76,000 in February, and $84,000 in March. November’s sales were $68,000, and December’s sales were $72,000. Treefold’s makes 60% of their sales on credit. Of these credit sales, 70% is collected in one month, and 27% in two months. Purchases average 65% of sales. Purchases are made on credit and paid in the following month. Wages and overhead are $7,000 a month. If the firm has a cash balance of $122,000 at the beginning of January, what will its cash balance be in March?