Principles of Finance
SAMPLE THIRD QUIZ
Do all the problems. Include calculations and/or explanations in your answers wherever appropriate. More credit will be given for correct reasoning than for correct arithmetic.
1. Gamma company is about to issue its first bonds, a single issue of 20 year, 5% coupon bonds, which the underwriting investment bank expects to sell for $104.00 per hundred. The underwriter will charge Gamma a 4% commission for its work. Gamma’s tax rate is 33%. What is the cost of Gamma’s new debt capital?
2. Delta’s outstanding securities are listed in the following table:
Number outstanding price k
Common 100,000 sh. $100/sh 22%
Preferred 100,000 sh. $80/sh 14%
Bonds 20,000 bonds $1,000 6%.
What is Delta’s weighted average cost of capital?
3. Two securities A and B are traded, and in one year there is a two hour window within which two units of A may be exchanged costlessly for one unit of B and vice versa. Today the price of A is $50.00.
(a) If neither security pays any cash throw-off, what is the no-arbitrage price of B?
(b) If B sells for $98.00, show how to make an arbitrage profit.
4. Why is it that in the world of perfect markets the value of a firm does not depend on its financing decisions?
5. How could the investment decisions of a firm depend on its financing decisions? At what point in the life of a firm is this problem greatest?