10 million common shares outstanding, each trading at a price of $90.
1 million preferred shares which have a face (or par) value of $100 and pay a constant dividend of 9% of par. They currently trade at a price of $120 each.
Debentures that have a total face value of $60,000,000 and a yield to maturity of 6% per annum. They are publicly traded and their market price is equal to 90% of their face value.
The risk-free rate is 5% and the market return is 10%.
Market analysts estimate that the company's common stock has a beta of 1.2. The corporate tax rate is 30%.
What is the company's after-tax Weighted Average Cost of Capital (WACC)? Assume a classical tax system.
A firm changes its capital structure by issuing a large amount of debt and using the funds to repurchase shares. Its assets are unchanged.
The firm and individual investors can borrow at the same rate and have the same tax rates.
The firm's debt and shares are fairly priced and the shares are repurchased at the market price, not at a premium.
There are no market frictions relating to debt such as asymmetric information or transaction costs.
Shareholders wealth is measured in terms of utiliity. Shareholders are wealth-maximising and risk-averse. They have a preferred level of overall leverage. Before the firm's capital restructure all shareholders were optimally levered.
According to Miller and Modigliani's theory, which statement is correct?
(a) The firm's share price and shareholder wealth will both decrease. This is because the firm will have more debt and therefore more risk so the discount rate applied to its cash flows will be higher, decreasing the value of the firm and therefore the value of the firm's equity and share price.
(b) The firm's share price and shareholder wealth will both increase. This is because the firm will have more debt which will amplify the returns of equity investors. This will mean that returns on equity can be much higher and investors will pay a premium for this, leading to an increase in the stock price.
(c) The firm's share price and shareholder wealth will both increase since it has more debt and therefore more tax shields.
(d) The firm's share price will increase due to the higher value of tax shields. But shareholder wealth will remain unchanged because capital structure is irrelevant when investors can use home-made leverage to create tax-shields themselves.
(e) The firm's share price and shareholder wealth will both increase. This is because the cost of debt is cheaper than equity, leading to a lower (before and after tax) WACC. This lower WACC will lead to a higher value of the firm and a higher share price.
You have just sold an 'in the money' 6 month European put option on the mining company BHP at an exercise price of $40 for a premium of $3.
Which of the following statements best describes your situation?
(a) You have bought the right to buy a BHP share for $40 in 6 months.
(b) You have bought the right to sell a BHP share for $40 in 6 months.
(c) You have bought the obligation to sell a BHP share for $40 in 6 months.
(d) You have sold the right that allows your counterparty to buy a BHP share from you for $40 in 6 months. This means that you have the obligation to sell a BHP share to your counterparty for $40 in 6 months if he wants to buy it.
(e) You have sold the right that allows your counterparty to sell a BHP share to you for $40 in 6 months. This means that you have the obligation to buy a BHP share from your counterparty for $40 in 6 months if he wants to sell it.
Which of the following companies is most suitable for valuation using PE multiples techniques?
(a) A company with positive earnings that does not have any comparable firms.
(b) A company with positive earnings that has comparable firms with positive earnings.
(c) A company with positive earnings that has comparable firms with negative earnings.
(d) A company with negative earnings that has comparable firms with negative earnings.
(e) A company with negative earnings that has comparable firms with positive earnings.
In the dividend discount model (DDM), share prices fall when dividends are paid. Let the high price before the fall be called the peak, and the low price after the fall be called the trough.
Which of the following statements about the DDM is NOT correct?
(a) In between dividends, the stock price is expected to grow by the total return ‘r’.
(b) From trough to trough, the stock price is expected to grow by the capital return ‘g’.
(c) From peak to peak, the stock price is expected to grow by the capital return ‘g’.
(d) Dividends are expected to grow by the total return ‘r’.
(e) If the stock’s dividends are re-invested by using the cash to buy more stocks, then the growth rate of the shareholder’s wealth will be the total return ‘r’.