midterm fnce

Question 1

Six years ago, you purchased a penny stock strictly for capital appreciation (no dividends have
been paid). At 20 cents per share, you purchased 1,000 shares and today the shares trade at
$4.70. Calculate your compound annual growth rate. (2 marks)

Answer 1

1. PV 200
   FV 4700
   n 6
   COMP i = 69.24%

Question 2

2. List and explain two factors that influence the yield or yield rate on a financial asset. Be specific.
   (2 marks)

Answer 2

2. Inflation; fiscal and monetary policy pressure on Canadian dollar; risk of
   company (DOL, DFL); uncertainty; investors’ expectations

Question 3

What would you pay for commercial paper with a face value of $50,000 and maturity of 182 days
if you wanted to achieve an effective annual yield of 12% (2 marks)

Answer 3

3. FV 50000 n 182/365 i 12 Comp PV = 47,252.89

Question 4

What lump sum must you invest now in order to receive an annuity of $3,000 per year during you
retirement? You plan to retire in 15 years, and would like to receive the first payment at the end
of year 16. You want to continue receiving the money for 20 years. Average annual returns are
expected to be 7%. (3 marks)

Answer 4

4. n20
   PMT3,000
   i7 Comp PV = 31,782.04; FV 31,782.04

n15
i 7
Comp PV =
11,519.27

Question 5

5. Your company has two suppliers offering the same product, same quality and same prices, but
   under different credit terms. Sharky co. offers terms of 1/15, n/30, whereas Greedy Co. offers terms of
   2/10, n/80.
   PART A Calculate the cost of foregoing the discount if:
   i) you purchase from Sharky Co. (2 marks)
   ii) you purchase from Greedy Co. (2 marks)

Answer 5

5. Part A:
Kdis = 1/99 x 365/30-15 = 24.57%
Greedy Co: 2/98 x 365/80-10 = 10.64%
Part B:
Purchase from Greedy Co., as it is a cheaper cost, and allows stretching payment
to the 80th day.

Question 6

The EOQ of Ultra Plastics is 4,000 units. The firm’s ordering cost per order is $200 and its
carrying cost per unit is $2. How many units does the company sell each year?

Answer 6

6. √2002S = 4,000; S =80,000

/2

Question 7

Part A

What are two ways a public company can “go private”? (2 marks)

Answer 7

Part A: Can be purchased by a private company or group or repurchase all
publicly-traded shares from the market (may involve leveraged buy-out).
Part B: Advantages: greater flexibility in negotiating with a closely held group of
investors no lengthy and expensive registration process issue costs may be lower
Disadvantages: Investors may require a higher return to compensate for lower
liquidity market may not be as large as public market.

Question 8

Part A
What are two ways a public company can “go private”? (2 marks)

Part B
What are two advantages, and one disadvantage of issuing shares privately? (3 marks)

Answer 8

Part A: Can be purchased by a private company or group or repurchase all
publicly-traded shares from the market (may involve leveraged buy-out).
Part B: Advantages: greater flexibility in negotiating with a closely held group of
investors no lengthy and expensive registration process issue costs may be lower
Disadvantages: Investors may require a higher return to compensate for lower
liquidity market may not be as large as public market.

Question 9

8. Discuss the major difference between companies with shares trading on an organized exchange
   such as the TSE, and those with shares trading only on the OTC (over-the-counter) markets. (2
   marks)

Answer 9

8. Companies that wish to list on an organized exchange such as the TSX must
   satisfy strict requirements as to income, total asset value, etc. This means that
   companies listed on the market are considered to be less risky than those traded
   OTC.

Question 10

QUESTION 3 - SHORT ANSWER (6 MARKS)
Joan, the owner of a large national food chain, is ready to open her 40th location on the south side of
Edmonton. It is estimated that this new location will cost $2,000,000 to set up. It is also estimated that
the food cost (variable costs) will be 60% of sales, while fixed costs will be $350,000. The first year’s
sales estimate is $1,500,000. Two financing alternatives are being considered to finance the initial set-up
cost of $2,000,000: Plan A ) all equity financing; Plan B) 25 percent equity financing and 75% debt at
12%. Common stock can be sold at $5 per share. Joan’s financial analyst managed to calculate the first
plan (A) just before he was hospitalized for an ulcer. Joan has hired you to continue the calculation and
to provide an interpretation. The tax rate is 35%.
Required
a. Compute the Degree of Financial Leverage (DFL) and EPS for Plan B financing plans. (4 marks)
(Show all your calculations)
Plan A Plan B
Financial Leverage (DFL) 1
Earnings Per Share (EPS) $0.406

Answer 10

Question #3: Leverage
A). Plan B A EPS = $.0455 Plan B DFL = 3.57
DFL = 250,000/70,000 = 3.57
EDP = 45,500/100,000 = 0.455
Sales $1,500,000
VC @ 60% (900,000)
CM 600,000
Fixed Costs (350,000)
EBIT 250,000
I (180,000)
EBT 70,000
Tax @30% (24,500)
EAT 45,500
i 75% x $2,000,000 x 12% = $180,000
Shares issued = 25% x $2,000,000 = $500,000raised @ $5/ share = 100,000 new
shares.
Plan B is a better plan, since it results in higher EPS. However this plan is higher
risk and would not be appropriate for a more conservative firm. Also, the state of
the economy will influence the choice: plan B is better when the economy is
booming or when sales are expected to increase, because it can magnify EPS
faster.