Tutorial Sets Bfc2140 2018 S1

Department of Banking and Finance
TUTORIAL QUESTIONS
BFC2140 CORPORATE FINANCE 1

SEMESTER ONE, 2018
Chief Examiner: Emma Zhang
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BFC2140
CORPORATE FINANCE I
TUTORIAL SET 01 (TEACHING WEEK ONE)

INTRODUCTION AND REVIEW
These questions should be attempted BEFORE your tutorial!

IMPORTANT: The questions that we encounter within the tutorial set throughout the semester are an
indication of the standard that you will face in the final examination. Tutors will grade on a randomly selected
basis a sample of students work based on the level of preparation (satisfactory/unsatisfactory) and participation during
the weekly tutorials. Please note that attendance itself is not considered participation
Warm up
1-1 Sam, age 4, has just inherited $100,000 from his Great-Aunt. In his Aunt’s will it is stipulated that
the funds are required to be invested in ordinary shares for a period of no less than 20 years before
these investments maybe realised. As financial advisor for the family you are required to assist with
investing these funds. What is your recommendation from the three options provided? Please justify
this decision in two or three brief sentences. In addition, once you have made the investment decision
once the money is invested, what are your greatest concerns?
Option A) to stake the entire inheritance on one stock (any stock).
Option B) to choose 2 companies in the same industry.
Option C) to invest roughly equal amounts in each of the top 10 largest companies.
Question One
A) What is a Corporation’s key objective?

B) List and discuss the three key decisions facing corporate financial managers.
Question Two
Note that in BFC2140 we assume that all assets are depreciated to zero from purchase price. For
example, when a scrap or residual value exists, we DO NOT subtract this from the initial cost of the asset
when estimating depreciation
Consider a $1000 asset (i.e., a vacuum cleaner) deemed to have a 5 year life for depreciation purposes.
Assume this asset has zero scrap value.
A) Use straight line depreciation
B) Use 33% diminishing value.
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What would be annual depreciation expense be in each of 1) and 2)?
Question Three
You are considering two identical firms, one levered (has debt) and the other not. The ratio of market debt to
market equity is 1.5 for the levered firm. What proportion of the levered firm is financed with debt? How
much of the unlevered firm is financed with debt?
Hint: Remember that Assets = Liabilities + Equity
Question Four
Here is some information about Company XYZ:
Short-Term Debt $5,000,000

Long-Term Debt $10,000,000
Total Debt $15,000,000
Common Equity $500,000

Preferred Equity $250,000
Additional Paid In Capital $6,000,000
Retained Earnings $3,250,000
Total Shareholders' Equity $10,000,000
Using the debt-to-equity formula and the information above, calculate that Company XYZ's debt-to-equity
ratio.
Additional problem from prescribed Text
Chapter 1 (Page 22-24): Problems 2, 8, 10, 14, 15.
SOLUTIONS TO THESE PROBLEMS ARE AVAILABLE ON MOODLE. THE PURPOSE OF THE

ADDITIONAL PROBLEMS IS TO PROVIDE YOU WITH ADDITIONAL PRACTICE. IF YOU NEED
ASSISTANCE WITH THESE PROBLEMS PLEASE ATTEND A HELP SESSION. INFORMATION
ABOUT HELP SESSIONS IS AVAILABLE ON MOODLE.
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BFC2140
CORPORATE FINANCE I
TUTORIAL SET 02 (TEACHING WEEK TWO)

FINANCIAL MATHEMATICS

Warm up
2-1. If you invested $200,000 today in an investment returning 6% p.a. with interest compounding 6
monthly, how much would that investment have grown to at the end of 10 years?
2-2. A bank is quoting an interest rate of 8% p.a. compounding monthly. What is the effective annual
interest rate?
2-3. Fancy Nancy has to borrow funds at 10 percent to purchase a necklace. She has a contract to sell the
necklace for $70,000. Payment is to be received in two years’ time. The necklace cost $60,000 today
and could be sold for this amount. Nancy likes this arrangement as she does not have to give up the
necklace for two years and by then fashions will possibly have changed. What is the borrowing rate
at which she would break even?
Question One.
Find the missing values in the following table.
Present Value ($) Years Interest Rate (%) Future Value ($)
2,250 30 12 (i)
9,310 16 9 (ii)
(iii) 5 4 14,451
(iv) 15 20 550,164
265 3 (v) 307
360 9 (vi) 761
Question Two.
At 6 percent interest, how long does it take to
A) double your money?
B) quadruple it?
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Question Three.
A) You are offered an investment that requires you to put up $3,000 today in exchange for $10,000 15
years from now. What is the annual rate of return on this investment?
B) A bank offers you an interest rate of 8 percent, compounded quarterly. Which one will you choose
(taking the above investment opportunity or investing at this bank)?
Question Four.
An investment has the following cash flows. If the discount rate is 8 per cent, what is the present value
of these flows? What is the net future value of these flows at t=3?
YEAR CASH FLOW
1 $300
2 $600
3 $900
Question Five
Assume that it is presently July 1, 2016, and you need to raise $10,000 by July 1, 2021. You can invest
money in your bank to earn an 8% return compounded annually.
Required:
A) Calculate the amount of a deposit made on July 1, 2016, to give a balance of $10,000 on July 1,
2021.
B) Independent of A), if you receive $7,500 from your father on July 1 2017, calculate the rate of
return you must earn to reach the $10,000 required by July 1, 2021.
Chapter 4 (Pages 116-117): Problems 1, 2, 3, 4, 5, 6.

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BFC2140
CORPORATE FINANCE I
TUTORIAL SET 03 (TEACHING WEEK THREE)

FINANCIAL MATHEMATICS
Warm up
3-1. How much income per annum would a $600,000 lump sum provide for 20 years if it was invested at
7% per annum compounded annually. (Assume the investment is amortised over the 20 years.)
3-2. What is the present value of a four-period annuity of $200 per year that begins two years from today
if the discount rate is 9%?
3-3. Your client is interested in buying a small company that has fairly reliable cash flows in the future.
The projected cash flows are as follows:
YEAR NET CASH INFLOW

1 $20,000
2-5 $30,000
6-infinity $50,000
Required: What is the maximum price that your client should pay for this company if the appropriate
discount rate for evaluating this type of company is 12%?
Question One
Assume that it is presently July 1, 2016, and you need to raise $10,000 by July 1, 2021. You can invest
money in your bank to earn an 8% return compounded annually.
Required:
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A) If you decide to make equal annual payments beginning on July 1, 2017, calculate the value of
each payment.
B) Your father offers to make the payments calculated above, or to give you $7,500 on July 1,
2017, which would you select?
C) Your father now offers to deposit $1,860 annually from July 1, 2017, calculate the annual
compound rate of interest you must earn to reach your target.
D) Your father offers you $4,000 today, if you obtain a part-time job and earn sufficient to make
equal half-yearly deposits. As well, the bank agrees to compound its 8% rate of interest semi-
annually. Calculate the value of each deposit you must earn.
E) Calculate the annual effective rate of the bank’s offer in part (d).
Question Two
You are saving for the four-year college education of your two children. They are two years apart in
age; one will begin college 15 years from today and the other will begin 17 years from today. You
estimate your children’s college expenses to be $21,000 per year per child, payable at the start of each
school year. The annual interest rate is 15 percent. How much money must you deposit in an account
each year to fund your children’s education? Your deposits begin one year from today. You will make
your last deposit when your oldest child enters college.
Question Three
Consider that you need to finance the purchase of a house. The purchase of the house is $400,000 and
you will require 100% financing. The loan term is 30 years and the terms of the contract require
monthly end of period payments (including interest and principle). The current variable rate offered
by your bank is 7% per annum.
Required:
A) What is the monthly mortgage payment?
B) If you are selling the house 5 years after the mortgage start, how much do you still owe the
bank?
C) How much will your monthly payment increase if the interest rate is increased by 50 basis
point 5 years after the mortgage start?
D) If you can’t afford the extra payment, how much longer will you have to pay the mortgage at
the original monthly payment?
Chapter 4 (Pages 117-120): Problems 7, 8, 10, 11, 12, 15, 24, 25, 27, 31.

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BFC2140
CORPORATE FINANCE I
TUTORIAL SET 04 (TEACHING WEEK FOUR)

VALUATION OF BONDS AND SHARES
Warm up
4-1 Anjelkovic-148 is a new fragrance, guaranteed to attract the opposite sex and is the proud new
invention of Bombastic Lova Lova Corporation. To obtain financing Bombastic Lova Lova
Corporation has issued a bond that bears a coupon rate of 8 percent per annum and has a par value of
$30,000. Interest payments are made semi-annually. The required yield to maturity is 16%. The
bond matures in ten years. Calculate the price of the bond.
4-2 Buyonline Ltd is expanding rapidly. Its dividend growth rate for the coming year is projected at 25
percent. This rate will decline by 5 percentage points per year until it reaches the industry average of
5 percent. Once it reaches 5 percent, it will stay there indefinitely. The most recent dividend was
$0.85 per share, and the market requires a return of 16 percent on investments such as this one. What
is the price per share for Buyonline?
Question One
Several years ago Pies in the Skies Ltd issued $100 bonds at par value with a yield to maturity of 8 per
cent. Now, with 8 years left to maturity on the bonds, the company is experiencing difficulties to the
extent that the yield to maturity on the bonds has increased to 12 per cent.
Required:
A) Without calculating, explain what you expect to have happened to the price of the bond since it was
issued? Why/ How do you know this?
B) Calculate the price of the bond following the increase in the yield to 12%. Explain what has
happened to the price since issue of the bond.
C) Investors believe that Pies in the Skies Ltd can pay the promised coupon payments, but that the
company will go bankrupt when the bond matures and the principal repayments become due.
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Investors expect that they will only receive 80 percent of the face value at maturity. If an investor
were to purchase the bond today, calculate the price the investor is willing to pay for this bond?
Question Two
Lahey Industries has a $1,000 par value bond with an 8% coupon interest rate outstanding. The bond
has 12 years remaining to its maturity date.
Required:
A) If interest is paid annually, what is the value of the bond when the YTM is 7%?
B) Using a 10% required return, find the bond’s value when interest is paid semi annually.
C) In which of the above cases is the bond at a discount? a premium? or at par value?
Question Three
A firm issued a new series of bonds on January 1, 1992. The bonds were sold at par ($1,000), have a
12 percent coupon, and mature in thirty years. Coupon payments are made semi-annually (on June 30
and December 31). Hint: draw a timeline!
Required:
A) What was the yield to maturity of the bond on 1/1/92?
B) Calculate the price of the bond on 1/1/97, five years later, assuming that the level of interest
rates have fallen to 10 percent.
C) If, on July 1, 2012, an investor expects the bonds to sell for $896.64. What is the expected yield
to maturity on the bonds at that date?
Question Four
A) Brig Company just paid a cash dividend of $0.20 per share. Investors require a 16% return from
investments such as this. If the dividend is expected to grow at a steady 8% per year, what is the
current value of a share? What will be the share worth in five years?
B) Networks Ltd is experiencing a period of rapid growth. Earnings and dividends are expected to
grow at a rate of 18% during the next two years, 15% in the third, and then at a constant rate of 6
per cent thereafter. Networks’ last dividend, which has just been paid, was $0.115. If the required
return on the shares is 12%, what is the price of the share today?
Chapter 6 (Pages 179-182): Problems 1, 2, 5, 6, 8, 11, 13, 14, 15, 23, 27.
Chapter 7 (Pages 211-213): Problems 1, 3, 4, 6, 8, 10, 15, 16.

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BFC2140
CORPORATE FINANCE I
TUTORIAL SET 05 (TEACHING WEEK FIVE)

CAPITAL BUDGETING I
Warm up
5-1. Burke Inc. is considering the purchase of Small Ltd. The acquisition would cost $190,000 but would
increase Burke’s cash flows by $30,000 per year for the foreseeable future. If Burke’s cost of capital
is 15%, should it go ahead with the acquisition of Small?
5-2. You are a top finance graduate from Monash University. Your friend Nigel is a management
graduate and therefore has little chance of finding a job outside the fast-food industry. Luckily for
him, Nigel's rich uncle has left him $20 million in his will. Having been a management student,
Nigel partied while you studied. In fact he took no courses in finance and thus knows nothing about
investment. In a drunken stupor, late one Saturday night Nigel watched an interview with the
Maharishi Yogi Berra. The Maharishi claims material wealth lies beneath the ground in Dromana. It
is clear from the tone of the interview, the title of the documentary was "An interview with a
crackpot," that the interviewer and the "experts" on the show think the Maharishi is insane.
However, Nigel believes in the Maharishi because his management training taught him to believe in
gurus (Peter Drucker, for example). Nigel decides to use his new found fortune to prove the
Maharishi correct, making himself one of the richest people in Australia in the process!
Nigel knows you have superior intellect (otherwise you wouldn't be in Finance) and asks you to
work out the details. After some discreet investigation you find the homes and land can be
purchased for $15 million. In addition the local council insist on a $4 million fee for defacing the
views from the city. Finally, it costs $1 million to lease the mining equipment.
You and Nigel meet with the Maharishi and after several hours of meditation the Maharishi provides
you with estimated annual after-tax cash-flows. These cash-flows are provided to you below in
table 5-2. Nigel thinks the cash-flows sound fantastic (compared to a career flipping burgers. Who
wouldn't), you however decide to check the numbers using what you have learned in Finance. You
believe the project is very risky and therefore in consultation with Westpac Bank Risk Management
team decide to use a discount rate of 23%. Should Nigel invest his fortune based on the crackpot's
ideas? a) Calculate the Net Present Value and the Internal Rate of Return. Would your decision
change if you used a discount rate of b) 18% c) 10%.
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Table 5-2
Projected Cash Flows
Projected Cash flow Projected Cash flow

Year 1 $1,500,000 Year 11 $2,500,000
Year 2 $3,278,000 Year 12 $2,500,000
Year 3 $5,000,000 Year 13 $2,500,000
Year 4 $6,450,000 Year 14 $2,500,000
Year 5 $2,500,000 Year 15 $2,500,000
Year 6 $2,500,000 Year 16 $2,500,000
Year 7 $2,500,000 Year 17 $2,500,000
Year 8 $2,500,000 Year 18 $2,500,000
Year 9 $2,500,000 Year 19 $2,500,000
Year 10 $2,500,000 Year 20 $2,500,000
Question One
Taylor Made Inc. is considering two mutually exclusive projects. The projects’ expected net cash flows are
provided in the table below.
YEAR PROJECT 1 PROJECT 2

0 ($300,000) ($599,000)
1 (387,000) 234,000
2 (193,000) 234,000
3 100,000 234,000
4 600,000 234,000
5 1,270,000 234,000
Required
A) Sketch the NPV profiles for projects A and B. Be careful to ensure that you label all axes, lines and
points carefully.
B) If you were told that each project’s cost of capital is 10%, which project should be selected? You are
required to calculate the NPV for each project to receive full credit.
C) Calculate the crossover rate exactly. Explain in one or two sentences the importance of the cross over
rate. Specifically, in your answer, detail the range for cost of capital that project 1 would be preferable to
project 2?
Question Two
State clearly if you would accept the following independent projects? Assume the opportunity cost of
capital is 12% for each project and that the cash flows generated for each project are conventional. If you
decide to undertake an investment in a project explain why? If you decide not to undertake investment in a
project explain why not?
(i) “Project alpha” has a small, but negative, NPV.

(ii) “Project beta” has a very small positive NPV when discounted at 10%.
(iii) “Project gamma” has a cost of capital that exceeds its rate of return.
(iv) “Project delta” has a zero NPV when discounted at 14%.
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Question Three
Define and explain the Payback Method, the Net Present Value Method, and the Internal Rate of
Return Method. In your discussion state the criteria for accepting or rejecting an investment under
each rule. You should also discuss the strengths and weaknesses associated with the use of each
alternative method.
Chapter 8 (Pages 251-254): Problems 1, 2, 3, 4, 5, 6, 7, 11, 12, 17, 18, 24, 26.

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BFC2140
CORPORATE FINANCE I
TUTORIAL SET 06 (TEACHING WEEK SIX)

CAPITAL BUDGETING II
Warm up
6-1. Mr Burns the President of the Springvale Electrical Company is sick and tired of falling cash flows
and as a result decreasing NPV. The company itself is responsible for making electrical components,
but of late has been suffering from decreasing output as the result of one particularly lazy employee.
The financial director, Mr Burns son, George, has come up with an idea of how to overcome this
problem.
"It's easy, the guy sits around all day stuffing his face with food and sleeping, it's no wonder output
has fallen substantially. All we have to do to get things rolling again is to replace him with a new
fully automated machine."
This replacement would mean the need for one less employee, "That lazy ……., Homer" generating
salary and benefit savings. The following day the director carries out a feasibility study and the
following data is presented to the President.
 It would cost $60,000 to purchase the new automated machine and it would be expected to have a
life expectancy of 20 years.
 Annual maintenance would be $8,000.
 The replaced employee's salary is $25,500.
 The machine will be depreciated on a straight-line basis over 20 years to a zero salvage value.
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 The firm's marginal tax rate is 30 percent.
 The firm's current cost of capital is estimated to be 15%.
On the basis of the net present value criterion, should the automated machine be purchased and the lazy
operator fired? Confirm that your answer is correct by calculating the Internal Rate of Return. Does your
answer make sense? Comment.
Question One
Billy was asked to choose between the following mutually exclusive projects:
Expected Net Cash Flows
Year Project S Project L
0 ($100,000) ($100,000)
1 60,000 33,500
2 60,000 33,500
3 33,500
4 33,500
The projects provide a necessary service, so whichever one is selected is expected to be repeated into
the foreseeable future. Both projects have a 10 percent cost of capital.
Required:
A) What is each project’s initial NPV without replication?
B) Repeat the analysis assuming now replication takes place. Hint: Use the equivalent annual
annuity approach and lowest common multiple methods introduced in class.
Question Two
International Foods (IFC) currently processes seafood with a unit it purchased several years ago. The
unit, which originally cost $500,000, currently has a book value of $250,000. IFC is considering
replacing the existing unit with a newer, more efficient one. The new unit will cost $700,000 and will
also require an initial increase in net working capital of $40,000. Additionally, in order to make the
new unit operational shipping and installation costs will require a further $50,000 investment.
The new unit will be depreciated on a straight-line basis over 5 years to a zero balance. The new unit
will have a salvage value of $75,000 at the end of the projects life in 5 years. The existing unit is being
depreciated at a rate of $50,000 per year. IFC can sell the existing machine today for $275,000.
Assume IFC’s tax rate is 30 percent.
If IFC purchases the new unit, annual revenues are expected to increase by $100,000 in annuity (due
to increased capacity), and annual operating costs (exclusive of depreciation) are expected to
decrease by $20,000 in annuity. IFC estimates that in addition it will need to make ongoing
contributions to net working capital in years 1, 2, 3 and 4 in the amount of $10,000. Accumulated net
working capital will be recovered at the end of 5 years. IFC has a company cost of capital that can be
used for discounting purposes of 12%.
In addition the company has to borrow $100,000 to fund the new project. The loan is interest only
requiring monthly payments at an interest rate of 18% per annum. Repayment of the principal will
occur after the sale of the new unit.
Required: Advise whether the company should replace the unit or not? [use an incremental analysis
approach to solve this cash flow analysis]. We will also teach you an alternative approach to that of
the incremental analysis. The approach you will be taught in tutorials will allow you to arrive at the
same answer but will evaluate the two decisions; (1) the decision to keep the old machine; and (2) the
replacement decision; in isolation.
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Chapter 8 (Pages 254-255): Problems 28, 29.

Chapter 9 (Pages 284-286): Problems 1, 2, 3, 7, 13, 22.
BFC2140
CORPORATE FINANCE I
TUTORIAL SET 07 (TEACHING WEEK SEVEN)

CLASS TEST DISCUSSION
IMPORTANT: Tutors will be working through the marking guide for your In-Semester test. It is critical that
you attend this tutorial as otherwise you will miss out on very important feedback at the mid point of the
unit. Also note that you will still be assessed on tutorial participation.
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BFC2140
CORPORATE FINANCE I
TUTORIAL SET 8 (TEACHING WEEK EIGHT)

WORKING CAPITAL MANAGEMENT
IMPORTANT: The mid semester test will be handed back to students in their allocated tutorial in teaching
week 8. It is absolutely imperative that you attend this class. Tutors will be handing back the test paper for
viewing. If you have concerns with how your paper has been graded you should raise these concerns and
make an appointment with your tutor for further discussion in their consultation sessions. Your test paper
will be collected at the end of class and you will not be permitted to take the paper home. We maintain
copies of the test for record keeping purposes.

Warm up
8-1. Define net working capital, and discuss the importance of working capital management.
8-2. What are some of the trade-offs required in the management of working capital accounts?
Question One
Given the aggregate balance sheet and income statement for Sifty Sasha's Burbon Exporters, calculate the
cash conversion cycle.
Income Statement Balance Sheet
Start 2015 End 2015
Sales 3,635 Inventory 390 420
COGS 3,257 A/R 403 432
A/P 249 272
Question Two
Listed below are three different transactions that Sifty Sasha Burbon exporters might make. Indicate how
each transaction would affect each of the following (a) Cash, (b) Working Capital
Your responses should be: Increase, Decrease or No change.
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Transaction Cash Net Working Capital
(i) Your company makes a
sale of inventory for cash at
cost.
(ii) Your company takes
delivery of $1,000 worth of
inventory on 30 days credit.
(iii) Your company arranges
for $1,000,000 worth of short
term debt to be refinanced
with debt of 4 years maturity.
(iv) Your Company donates
$40,000 to charity.
Question Three
The credit terms for each of three suppliers are shown in the following table.
Supplier Credit terms

A 1/10 net 55
B 2/10 net 30
C 2/20 net 60
Required
A) Determine the approximate cost of giving up the cash discount from each supplier. Assume a 360
day year.
B) Assuming your firm needs short-term financing, recommend whether it would be better to give up
the cash discount or take the discount and borrow from a bank at 15% annual interest. Evaluate each
supplier separately using your findings in a.
C) What impact, if any, would the fact that your firm could stretch its accounts payable (net period
only) by 20 days from supplier C have on your answer in (b) relative to this supplier?
Question Four
What effect will the following events have on the cash conversion cycle?
A) Higher financing rates induce the firm to reduce its level of inventory.
B) The firm obtains a new line of credit that enables it to avoid stretching payables to its suppliers.
C) The firm factors its accounts receivable.
D) A recession occurs, and the firm’s customers increasingly stretch their payables
Chapter 19 (Pages 593-594): Problems 1, 2, 3, 4, 5, 6, 7, 8.

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BFC2140
CORPORATE FINANCE I
TUTORIAL SET 9 (TEACHING WEEK NINE)

CAPITAL BUDGETING III
Question One
Which of the following is a reason why incremental earnings may be different from incremental
cash flows?
(a) Changes in accounts receivable reflects non-cash sales present in incremental earnings
that are not incremental cash flows.
(b) Depreciation is a cash expense, but does not appear in incremental earnings.
(c) Capital expenditures appear on the income statement. However, as these costs are
depreciated over time, they should not be present in incremental cash flows.
(d) Firms pay taxes based on incremental cash flows, not incremental earnings.
(e) After-tax salvage is not important to incremental cash flows, but does factor into
revenues on the income statement.
Question Two
In 2016, Project Soothsayer is expected to produce incremental earnings (after taxes and depreciation) of
$19.2 million. The expected depreciation charge in that fiscal year is $2.6 million. Expected capital
expenditures total $9.0 million and after tax salvage is expected to be $3.2 million. The project’s net
working capital needs (in millions of dollars) from 2015 through 2016 are given in the table below:
Year 2015 2016 2017

Net working capital $1.00 $5.60 $5.00
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What are the expected cash flows from the project in 2016?
Question Three
A firm expects a project to have the following incremental Income Statement (all values in millions of
dollars):
Fiscal year 2015 2016 2017
Revenues $56.70 $69.60 $61.80
Costs -34.8 -42.7 -37.9
Depreciation -1.9 -1.9 -1.9
EBIT 20 25 22
The project’s incremental pro-forma balance sheet is expected to contain the following working capital
items at the end of those fiscal years (all values in millions of dollars):
Assets Liabilities
Fiscal year 2015
Inventories $2.80 Accounts payable $2.00
Accounts receivable 1.3
Fiscal year 2016

Inventories 3.5 Accounts payable 2.5
Fiscal year 2017

Inventories 3.1 Accounts payable 2.2
In 2016, expected incremental capital expenditures total $2.9 million and incremental after tax salvage is
expected to be $5.0 million. The tax rate for the project is 30%. What are the expected incremental cash
flows from the project in 2016?
Question Four
Wernham-Mifflin is considering launching a new line of pentagonal-shaped paper. You have the
following information:
 Revenues due to the sale of the new product are expected to be $90 million annually.
 Total paper production costs will increase from the current level of $22 million annually to
$63 million annually after the product launch.
 Top sales agent Michael Scarn will be reassigned from other projects to sell the new product
line. Sales of those other products are expected to decline by $12 million annually.
 The project will make use of an existing paper mill, built last year at a cost of $38 million.
The mill is being depreciated using prime cost over a useful life of 16 years.
 Wernham-Mifflin currently pays taxes at a marginal rate of 26%.
 Total annual incremental cash flows for the project are expected to remain constant for the
next 16 years. After this period, the project’s total incremental cash flows will decline at a
rate of 5% annually and will be received in perpetuity.
What is the present value of the project if the annual project discount rate is 6.0%?
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BFC2140
CORPORATE FINANCE I
TUTORIAL SET 10 (TEACHING WEEK TEN)

RISK AND RETURN
indication of the standard that you will face in the final examination. Tutors will grade on a randomly
selected basis a sample of students work based on the level of preparation (satisfactory/unsatisfactory) and
participation during the weekly tutorials. Please note that attendance itself is not considered participation
Warm up
9-1. Explain the relation between risk and return.
9-2. Describe the two components of a total holding period return, and calculate this return for an asset.
9-3. Determining Portfolio Weights: What are the portfolio weights for a portfolio that has 135 shares of
Stock A that sell for $47 per share and 105 shares of Stock B that sell for $41 per share?
9-4. Portfolio Expected Return: You own a portfolio that is 25 percent invested in Stock A, 40 percent in
Stock B, and 35 percent in Stock C. The expected returns on these three stocks are 11 percent, 17
percent, and 14 percent, respectively. What is the expected return on this portfolio?
Question One
A) Total risk can be decomposed into systematic risk and unsystematic risk. Explain each component of
risk, and how each is affected by increasing the number of securities in the portfolio.
B) The table gives information on two risky assets A and B:
Asset Expected Standard deviation Correlations

return (%) of return (%) A B
A 12.5 40 1.00 0.20
B 16 45 0.20 1.00
There is also a risk free asset F whose expected return is 8%.
(i) Portfolio 1 consists of 40 per cent asset A and 60 per cent Asset B. Calculate its expected return and
standard deviation.
(ii) Portfolio 2 consists of 40 per cent Asset A and 60 per cent in the risk free asset. Calculate its
expected return and standard deviation. Compare your answers to (i) and comment.
20
Question Two
Mr. Henry can invest in Highbull stock and Slowbear stock. His projection of the returns on these two stocks
is as follows:
State of Probability of Return on Return on

Economy State Occurring Highbull Stock (%) Slowbear Stock (%)
Recession 0.25 -0.02 0.05
Normal 0.60 0.092 0.062
Boom 0.15 0.154 0.074
Required:
A) Calculate the expected return on each stock.
B) Calculate the standard deviation of returns on each stock.
C) Calculate the covariance and correlation between returns on the two stocks.
D) Create an equally weighted portfolio and calculate the expected return and standard deviation for this
portfolio.
Question Three
The following table provides a sample of the last six monthly percentage price changes for two market
indexes. You are encouraged to make use of the statistical functionality available with your calculator when
answering this question.
Month Nikkei Russell_2000

1 0.08 0.12
2 0.15 0.09
3 -0.12 -0.07
4 0.11 0.13
5 0.09 0.04
6 -0.06 -0.14
Required:
A) The expected monthly rate of return and standard deviation for each series
B) The covariance between the rates of return for Nikkei–Russell_2000
C) The correlation coefficient for Nikkei-Russell_2000
Question Four
You have been provided the following annual return data about 4 shares over a sample period 2011-2015.
YEAR Share A Share B Share C Share D

2011 10% 12% 7% -3%
2012 7% 12% -12% -11%
2013 11% 11% 32% 22%
2014 9% 9% 15% 2%
2015 18% 10% -13% -1%
Required:
A) Compute the expected return for each share?
B) Compute the risk measure for each share?
C) Identify which security you would suggest investing funds in if you had to select only one?
Explain your decision.
21
Chapter 11 (Pages 348-350): Problems 1, 4, 7, 8.

22
BFC2140
CORPORATE FINANCE I
TUTORIAL SET 11 (TEACHING WEEK ELEVEN)
COST OF CAPITAL
Warm up:
12-1. Explain what the weighted average cost of capital for a company is and why it is often used as a
discount rate to evaluate projects.
12-2. How do taxes affect the cost of debt?

12-3. Calculating Cost of Equity: The Dybvig Corporation’s common stock has a beta of 1.21. If the
risk-free rate is 3.5 percent and the expected return on the market is 11 percent, what is Dybvig’s
cost of equity capital?
12-4. Calculating WACC: Mullineaux Corporation has a target capital structure of 70 percent common stock
and 30 percent debt. Its cost of equity is 13 percent, and the cost of debt is 6 percent. The relevant tax rate is
35 percent. What is Mullineaux’s WACC?
Problems:
Question One
Gayle’s Cricket Farm issued a 30-year, 6 percent semiannual bond 8 years ago. The bond currently sells for
96 percent of its face value. The company’s tax rate is 35 percent.
Required
A) What is the pretax cost of debt?
B) What is the aftertax cost of debt?
C) Which is more relevant, the pretax or the aftertax cost of debt? Why?
Question Two
Rooster Inc has 9 million shares of common stock outstanding. The current share price is $52 and the book
value per share is $4. Rooster also has two bond issues outstanding. The first bond issue has a face value of
23
$80 million, has an 8 percent coupon and sells for 104 percent of par. The second issue has a face value of
$50 million, has a 7.5 percent coupon, and sells for 102 percent of par. The first issue matures in 10 years,
the second in 6 years. Ignore tax.
Required
A) What are Rooster’s capital structure weights on a book value basis?
B) What are Rooster’s capital structure weights on a market value basis?
C) Which are more relevant, the book or market value weights? Why?
Question Three
In Question 2) suppose the most recent dividend paid was $3.10 and the dividend growth rate is 7 percent.
Assume that the overall cost of debt is the weighted average of that implied by the two outstanding debt
issues. Both bonds make semiannual payments. The tax rate is 35 percent. What is the company’s WACC?
Question Four
An all-equity firm is considering the following projects:
Project Beta Expected Return

W 0.40 9%
X 0.95 11%
Y 1.06 15%
Z 2.20 19%
Assume a risk-free rate of 6 percent and an expected return on the market equal to 13 percent. The
company has a 13 percent cost of capital.
A) Making use of the security market line (depict grpahically) identify which projects should be accepted?
B) Which projects will be incorrectly accepted and which projects will be incorrectly rejected if the
firm’s overall cost of capital is adopted as a hurdle rate?
C) What assumption is made in the above problem with regards to the risk of the projects?
Question Five
Goetzmann Industries stock has a beta of 1.20. The company has just paid a dividend of $0.80, and the
dividends are expected to grow at 5 percent. The expected return on the market is 13 percent, and the
Treasury bill rate is currently 6 percent. The most recent stock price for Goetzmann is $53.00.
A) Calculate the cost of equity using the DCF method.
B) Calculate the cost of equity using the SML method.
C) Why do you think your estimates in (A) and (B) are so different?
Question Six
Och, Inc., is considering a project that will result in initial after-tax cash savings of $3.5 million at the end of
the first year, and these savings will grow at a rate of 4 percent per year indefinitely. The firm has a target
debt-equity ratio of 0.55, a cost of equity of 13 percent, and an after-tax cost of debt of 5.5 percent. The cost-
saving proposal is somewhat riskier than the usual projects the firm undertakes; management uses the
subjective approach and applies an adjustment factor of +2 percent to the cost of capital for such risky
projects. Under what circumstances should Och take on the project?
24
Chapter 13 (Pages 408-409): Problems 1, 2, 3, 5, 7, 8, 11, 15, 17, 18, 19.

25
BFC2140
CORPORATE FINANCE I
TUTORIAL SET 12 (TEACHING WEEK TWELVE)
CAPITAL STRUCTURE
These questions should be attempted BEFORE your exam!
Question One
Absent tax effects, why can’t we change the cost of capital of the firm by using more debt financing and less
equity financing?
Question Two
Explain what is wrong with the following argument: ‘If a firm issues debt that is risk free because there is no
possibility of default, the risk of the firm’s equity does not change. Therefore, risk-free debt allows the firm
to get the benefit of a low cost of capital of debt without raising its cost of capital of equity.’
Question Three
Telfast expects perpetual earnings before interest and taxes of $2 million per year. The firm’s pre-tax cost of
debt is 15% per annum and its annual interest expense is $100,000. Company analysts estimate that the
unlevered cost of Telfast’s equity is 20%. The company tax rate is 30%. What is the value of the firm?
Question Four
Levered Inc. and Unlevered Inc. are identical in every way except their capital structures. Each company
expects to earn $96 million before interest per year in perpetuity, with each company distributing all its
earnings as dividends. Levered’s perpetual debt has a market value of $275 million and costs 8% per annum.
Levered has 4.5 million shares outstanding currently worth $100 per share. Unlevered has no debt and 10
million shares outstanding, currently worth $80 per share. Neither firm pays taxes. Is Lever’s stock a better
buy than Unlevered’s stock?
26
Chapter 16 (Pages 495-497): Problems 1, 2, 3, 10.

27
BFC2140
CORPORATE FINANCE I
TUTORIAL SET 13 (SWOT VAC – SELF STUDY)
MARKET EFFICIENCY AND PAY OUT POLICY
IMPORTANT: There is no tutorial arrangement during the week of SWOT VAC. This set of tutorial
questions are related to the last lecture topic of the unit: Market efficiency and payout policy. This topic is
EXAMINABLE. Students are highly encouraged to attempt the questions at your own before referring to the
solutions.
Part 1: Market Efficiency
1. Efficient Market Hypothesis: Define the three forms of market efficiency.
2. Efficient Market Hypothesis: Which of the following statements are true about the efficient market
hypothesis?
a. It implies perfect forecasting ability.
b. It implies that prices reflect all available information.
c. It implies an irrational market.
d. It implies that prices do not fluctuate.
e. It results from keen competition among investors.
3. Semistrong Efficiency: If a market is Semistrong form efficient, is it also weak form efficient?
Explain.
4. Efficient Market Hypothesis: For each of the following scenarios, discuss whether profit
opportunities exist from trading in the stock of the firm under the conditions that (1) the market is not
weak form efficient, (2) the market is weak form but not semistrong form efficient, (3) the market is
semistrong form but not strong form efficient, and (4) the market is strong form efficient.
a. The stock price has risen steadily each day for the past 30 days.
b. You observe that the senior management of a company has been buying a lot of the company’s
stock on the open market over the past week.
Part 2: Dividend Policy
1. Dividend policy and company value: You have just encountered two identical companies with
identical investment opportunities, as well as the ability to fund these opportunities. You have found
that one of the companies has just announced an introductory dividend policy, whereas the other has
continued with a no-dividend policy. Which of the two companies is worth more? Explain.
28
2. Share buyback (repurchase): Explain what a share buy-back is and how companies buy back their
shares.
3. Dividend policy: Discuss the benefits and costs associated with dividend payments, and compare the
relative advantages and disadvantages of dividends and share buy-backs.
4. Dividend policy and company value: Is it possible for a company to retain its shareholders using its
dividend policy? Explain your answer. Your answer should also include a definition/discussion of
imputation tax system.
5. Dividend and Stock Price Last month, Central Virginia Power Company, which had been having
trouble with cost overruns on a nuclear power plant that it has been building, announced that it was
“temporarily suspending dividend payments due to the cash flow crunch associated with its
investment program.” The company’s stock price dropped from $28.5 to $25 when this
announcement was made. How would you interpret this change in the stock price? (That is, what
would you say caused it?)
29

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Department of Banking and Finance

BFC2140 CORPORATE FINANCE 1

Chief Examiner: Emma Zhang

TUTORIAL SET 01 (TEACHING WEEK ONE)

These questions should be attempted BEFORE your tutorial!

A) What is a Corporation’s key objective?

Hint: Remember that Assets = Liabilities + Equity

Here is some information about Company XYZ:

Short-Term Debt $5,000,000

Common Equity $500,000

Additional problem from prescribed Text

Chapter 1 (Page 22-24): Problems 2, 8, 10, 14, 15.

SOLUTIONS TO THESE PROBLEMS ARE AVAILABLE ON MOODLE. THE PURPOSE OF THE

TUTORIAL SET 02 (TEACHING WEEK TWO)

These questions should be attempted BEFORE your tutorial!

Find the missing values in the following table.

Additional problem from prescribed Text

Chapter 4 (Pages 116-117): Problems 1, 2, 3, 4, 5, 6.

SOLUTIONS TO THESE PROBLEMS ARE AVAILABLE ON MOODLE. THE PURPOSE OF THE

TUTORIAL SET 03 (TEACHING WEEK THREE)

These questions should be attempted BEFORE your tutorial!

YEAR NET CASH INFLOW

Additional problem from prescribed Text

SOLUTIONS TO THESE PROBLEMS ARE AVAILABLE ON MOODLE. THE PURPOSE OF THE

TUTORIAL SET 04 (TEACHING WEEK FOUR)

These questions should be attempted BEFORE your tutorial!

Additional problem from prescribed Text

SOLUTIONS TO THESE PROBLEMS ARE AVAILABLE ON MOODLE. THE PURPOSE OF THE

TUTORIAL SET 05 (TEACHING WEEK FIVE)

These questions should be attempted BEFORE your tutorial!

Projected Cash flow Projected Cash flow

YEAR PROJECT 1 PROJECT 2

(i) “Project alpha” has a small, but negative, NPV.

Additional problem from prescribed Text

SOLUTIONS TO THESE PROBLEMS ARE AVAILABLE ON MOODLE. THE PURPOSE OF THE

TUTORIAL SET 06 (TEACHING WEEK SIX)

These questions should be attempted BEFORE your tutorial!

Chapter 8 (Pages 254-255): Problems 28, 29.

TUTORIAL SET 07 (TEACHING WEEK SEVEN)

TUTORIAL SET 8 (TEACHING WEEK EIGHT)

These questions should be attempted BEFORE your tutorial!

Supplier Credit terms

Additional problem from prescribed Text

Chapter 19 (Pages 593-594): Problems 1, 2, 3, 4, 5, 6, 7, 8.

SOLUTIONS TO THESE PROBLEMS ARE AVAILABLE ON MOODLE. THE PURPOSE OF THE

TUTORIAL SET 9 (TEACHING WEEK NINE)

These questions should be attempted BEFORE your tutorial!

Year 2015 2016 2017

Fiscal year 2016

Fiscal year 2017

TUTORIAL SET 10 (TEACHING WEEK TEN)

9-1. Explain the relation between risk and return.

B) The table gives information on two risky assets A and B:

Asset Expected Standard deviation Correlations

There is also a risk free asset F whose expected return is 8%.

State of Probability of Return on Return on

Month Nikkei Russell_2000

YEAR Share A Share B Share C Share D

Chapter 11 (Pages 348-350): Problems 1, 4, 7, 8.

SOLUTIONS TO THESE PROBLEMS ARE AVAILABLE ON MOODLE. THE PURPOSE OF THE

12-2. How do taxes affect the cost of debt?

An all-equity firm is considering the following projects:

Project Beta Expected Return