FIN 6425 – Practice Final Exam Nimalendran

PLEASE DO NOT DISCUSS THIS EXAM WITH ANYONE UNTIL AFTER YOU GET YOUR
GRADE

There are 30 multiple-choice questions. Question 1-20 are each worth 4 points. Questions 21-30 are each
worth 2 points.

College Honor Code WILL Be Strictly ENFORCED

The following is from the University Of Florida Code Of Student Conduct:

The academic community of students and faculty at the University of Florida strives to sustain and
protect an environment of honesty, trust, and respect. Students are expected to pursue knowledge with
integrity. Exhibiting honesty in academic pursuits and reporting violations of the Academic Honesty
Guidelines will encourage others to act with integrity. Violations of the Academic Honesty Guidelines
shall result in judicial action, and a student is subject to the sanctions in paragraph XI of the Student
Conduct Code. Therefore, from now on, the conduct set forth constitutes a violation of the Academic
Honesty Guidelines (University of Florida Rule 6C1-4.017).

Cheating
The improper taking or tendering of any information or material shall be used to determine academic
credit. Taking of information includes, but is not limited to, copying graded homework assignments from
another student; working together with another individual(s) on a take-home test or homework when not
specifically permitted by the teacher; looking or attempting to look at another student's paper during an
examination; looking or attempting to look at text or notes during an examination when not permitted.
The tendering of information includes, but is not limited to, giving of your work to another student to be
used or copied; giving someone answers to exam questions either when the exam is being given or after
taking an exam; giving or selling a term paper or other written materials to another student; sharing
information on a graded assignment
.
Plagiarism
The attempt to represent another's work as the product of one's thought, whether the work is published or
unpublished, or simply the work of a fellow student. Plagiarism includes, but is not limited to, quoting
oral or written materials without citation on an exam, term paper, homework, or other written materials
or oral presentations for an academic requirement; submitting a paper which was purchased from a term
paper service as your work; submitting anyone else's paper as your work.

Please sign below indicating that you will abide by the above code of conduct

Signature

FIN 6425– Practice Final Exam Page 1/18

Questions I-20 (each Question is worth 4 points) – Answer all

1. Security dealers are prepared to buy a stock at one price (bid) and sell it slightly higher (ask).
This leaves them in a dangerous position. Anyone who knows more than the dealer about the
shares' worth will bide his time until the dealer offers too high a price or bids too low. Thus, the
dealers are likely to lose to the better-informed traders. They face ______________.

A. a winner's curse
B. a moral hazard problem
C. an insurance problem
D. an adverse selection problem

Dealers will be adversely selected by informed traders. For example a dealer quotes a price of
$100-Ask price at which she is willing to sell a stock, and $99-Bid (price at which she is willing
to buy). If an informed trader believes that the stock is worth $105, the he will buy the stock at
$100 and make a profit of $5 at the expense of the market maker.

2. Principal-agent problem occurs when stockholders (agents) higher a manager (principal) to

manage the company. The problem can be mitigated (reduced) by ______________.

A. giving stock options to managers

B. the threat of takeover and loss of manager's job
C. managers having a reputation to maintain
D. (A) and (B)
E. (A), (B). and (C) (all three will incentivize the manager to align with the principals)

3. On January 1, 2000, you bought BXX stock for $100, and on January 1, 2010, you sold it for
$200. What was your geometric average annual return?

A. 5.0%
B. 7.2%
C. 10.0%
D. 20.0%
E. 100.0%

Let the geometric average return be “G.” The stock price will have a compounded return of G
each year. If you invest $100 on 1/1/2000 and if this is compounded at the rate G till 2010 (10
years), then the terminal value will be $200.
100*(1+G)^10 =200 or 1+G = [200/100]^(1/10)
G = [200/100]^(1/10) – 1= 0.072 or 7.2%

FIN 6425– Practice Final Exam Page 2/18

 4. Company A and B issue convertible bonds with identical characteristics except that company A's
bond is also callable. Both companies also have identical stock characteristics.

A. The coupon on company A's convertible bond will be lower than on company B's bond
B. The coupon on company B's convertible bond will be lower than on company A's bond
C. The coupon on company A's convertible bond will be equal to that on company B's bond
D. It is not possible to determine

Bond Price = Pure Bond Price + Convertible Value – Callable Value

Both bonds have identical characteristics (assume they have the same risk). If both were
convertible and callable then both will sell for the same price. Since A is callable, it is worth
less, hence it must have a higher coupon relative to B to induce investors to buy the bond at
the same price.

5. CVX paid a dividend of $2 per share at the close of trading on December 31, 2018. The dividends
are expected to grow at 10% for the next year and grow at a constant rate of 5% forever. The
required rate of return on the stock is 15%. What is the stock price on December 31, 2018, based
on the dividend discount model after the dividend payment?
A. $20.00
B. $20.10
C. $22.00
D. $23.10
E. $25.20

12/31/2018 12/31/2019 12/31/2020 12/31/2021

G(Div) 0.1 0.05 0.05
Div 2 2.2 2.31
23.2=2.31/(.15-
Price 23.1 .05) -- DGM
P+D 22 25.3 <--2.2+23.1
22=25.3/1.15

FIN 6425– Practice Final Exam Page 3/18

 6. Assume a project has normal cash flows. All else equal, which of the following statements is
CORRECT?

A. A project's IRR increases as the WACC declines.

B. A project's NPV increases as the WACC declines.
C. A project's MIRR is unaffected by changes in the WACC.
D. A project's regular payback increases as the WACC declines.
E. A project's discounted payback increases as the WACC declines.
𝑇
𝐶𝐹𝑡
𝑁𝑃𝑉 = −𝐶𝐹0 + ∑
(1 + 𝑊𝐴𝐶𝐶)𝑡
𝑡=1
𝐶𝐹𝑡
As the WACC decreases, then the PV of the CFs, ∑𝑇𝑡=1 , will increase, assuming that the CFs
(1+𝑊𝐴𝐶𝐶)𝑡
remain the same.

7. You are interested in raising capital by issuing a 10-year bond for your company. Based on your
company's credit rating, you believe that the market requires a 3% default risk premium, and the
relatively small size of the issue would add a 1% liquidly premium to the required interest rate. The
current 10-year Treasury bond rate and 10-year TIPS rates are 3% and 1%, respectively. What
interest rate would you expect to pay on the issue if the 10-year maturity premium is 0.4%?

A. 4.8%
B. 6.4%
C. 6.8%
D. 7.4%
E. 8.4%
𝐵𝑜𝑛𝑑 𝑅𝑎𝑡𝑒 (𝑌𝑖𝑒𝑙𝑑)
= 𝑅𝑒𝑎𝑙 𝑅𝑎𝑡𝑒 (𝑅 ∗ ) + 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑅𝑎𝑡𝑒 (𝐼𝑅) + 𝑀𝑎𝑡𝑢𝑟𝑖𝑡𝑦 𝑅𝑖𝑠𝑘 𝑃𝑟𝑒𝑚𝑖𝑢𝑚 (𝑀𝑅𝑃)
+ 𝐿𝑖𝑞𝑢𝑖𝑑𝑖𝑡𝑦 𝑝𝑟𝑒𝑚𝑖𝑢𝑚 (𝐿𝑃) + 𝐷𝑒𝑓𝑎𝑢𝑙𝑡 𝑅𝑖𝑠𝑘 𝑃𝑟𝑒𝑚𝑖𝑢𝑚 (𝐷𝑅𝑃)

𝑌𝑖𝑒𝑙𝑑 𝑜𝑛 10 − 𝑌𝑟. 𝑇𝑟𝑒𝑎𝑠𝑢𝑟𝑦 = 𝑅 ∗ + 𝐼𝑅 = 3%

𝑇𝐼𝑃𝑆 = 1% = 𝑅 ∗ (𝑁𝑜𝑡 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑠𝑜𝑙𝑢𝑡𝑖𝑜𝑛)
𝐷𝑅𝑃 = 3%
𝑀𝑅𝑃 = 0.4%
𝐿𝑃 = 1%

𝑌𝑖𝑒𝑙𝑑 = 3% + 3% + 0.4% + 1% = 7.4%

FIN 6425– Practice Final Exam Page 4/18

 8. The ZZZ Corporation is all-equity financed. It has a market value of assets of $100 million. The
risk-free rate is 5% per year. The beta of the company's common stock with respect to the market
(MKT) portfolio is 1.5, the beta with respect to the SMB factor is -0.5, and the beta with respect
to the HML factor 0.3. The market (MKT) risk premium is 6%, the risk premium on SMB is 3%,
and the risk premium on HML is 5%. What is the company's cost of equity capital based on the
Fama-French three-factor model?

A. 6.0%
B. 11.0%
C. 14.0%
D. 17.0%
E. 20.1%
𝑅𝐹 = 5%, 𝛽𝑀𝐾𝑇 = 1.5, 𝛽𝑆𝑀𝐵 = −0.5, 𝛽𝐻𝑀𝐿 = 0.3, 𝑅𝑃𝑀 = 6%, 𝑆𝑀𝐵 = 3%, 𝐻𝑀𝐿 = 5%
𝐾𝐸 (𝐶𝑜𝑠𝑡 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦) = 𝑅𝐹 + 𝛽𝑀𝐾𝑇 ∗ 𝑅𝑃𝑀 + 𝛽𝑆𝑀𝐵 ∗ 𝑆𝑀𝐵 + 𝛽𝐻𝑀𝐿 ∗ 𝐻𝑀𝐿
𝐾𝐸 = 5 + 1.5 ∗ 6 + (−.5) ∗ (3) + (. 3) ∗ (5) = 14%

FIN 6425– Practice Final Exam Page 5/18

 9. The value of HILEV firm at the end of one year can be $100 million or $300 million with an
equal probability of 0.5. The firm has debt with a face value of $100 million that matures in one
year. Assume that investors are risk-neutral, and the risk-free rate is zero. The firm's CEO decides
to substitute assets of the firm with more risky assets immediately so that the value of the firm at
the end of one year is either $50 m or $350 m with an equal probability of 0.5. This asset
substitution will lead to

A. a gain of $10 million for stockholders

B. a gain of $10 million for the bondholders
C. a gain of $25 million for the stockholders
D. a gain of $25 million for the bondholders

FIN 6425– Practice Final Exam Page 6/18

 10. Option to expand a project is a (a) ____ option, and the option to abandon a project is a (b) ____
option.
A. (a) = call, (b) = call
B. (a) = call, (b) = put
C. (a) = put, (b) = put
D. (a) = put, (b) = call

11. Which of the following statement is consistent with the trade-off theory of capital structure?

A. Optimal capital structure is reached when the present value of tax savings on additional
borrowing is offset by increases in the present value of costs of financial distress.
B. Optimal capital structure is reached when stockholders' right to default is balanced by the
bondholders' right to get interest and principal payments.
C. Optimal capital structure is reached when the lawyers' claim value offsets the benefits of
limited liability.

12. Underinvestment is characterized as a situation in which,

A. a distressed firm passes up positive NPV projects

B. a distressed firm takes projects with higher risk and lower returns
C. a firm issues senior debt to the existing debt and pays out the proceeds to shareholders
D. a firm strategically defaults on its loan payments to renegotiate debt agreements.

When a firm is in distress, it owes debt holders more than the value of the firm. Hence, any
positive NPV from a project will go to the debt holders. Hence, equity holders will not take the
projects as they do not get anu=y benefit.

FIN 6425– Practice Final Exam Page 7/18

 13. Which of the following can be implied by the winner's curse problem?

I. If you are the highest bidder at an auction for a painting, it is likely that you overpaid for
the item.
II. People with no-deductible auto insurance policies are more likely to have traffic
accidents than those having deductible in their policies.[Moral Hazaed]
III. In 2005, the NFL auctioned off the rights to broadcast Monday Night Football. The
winner was ESPN, which paid 1.1 billion dollars for broadcasting rights over eight years.
This bid was roughly double what ABC was previously paying.

A. I only
B. I and II only
C. I and III only
D. II and III only
E. I, II, and III

14. Generally, underwriters provide the following services to the issuing firm:
(I) underwriting (bearing risk), (II) due diligence, (III) pricing advice, (IV) marketing.

A. I only
B. I and II only
C. I, II, and III only
D. I, II, III, and IV

15. Greeter Soft is a private firm that Sam Sung started for developing specialized software for
greeting card companies. Sam had invested $200,000 in the company. One year later, a venture
firm, Big Bucks, offers Sam $2 million for a ten percent stake in the company. What is the pre-
money value of Greeter Soft?

A. $ 2 Million
B. $ 18 Million
C. $ 20 Million
D. $ 50 Million
E. $ 200 Million

𝐵𝑖𝑔 𝑏𝑢𝑐𝑘𝑠 10% 𝑠𝑡𝑎𝑘𝑒 = 2 𝑚𝑖𝑙𝑙𝑖𝑜𝑛

2
𝑃𝑜𝑠𝑡 𝑚𝑜𝑛𝑒𝑦 𝑣𝑎𝑙𝑢𝑒 = = 20 𝑚
. 10
𝑃𝑟𝑒 𝑚𝑜𝑛𝑒𝑦 𝑣𝑎𝑙𝑢𝑒 = 20 𝑚 − 2 𝑚 = 18 𝑚

FIN 6425– Practice Final Exam Page 8/18

 16. Which of the following method(s) used to value early-stage firms?
(I) DCF, (II) Multiples, (III)VC Method

A. (I) only
B. (I) and (II) only
C. (III) only
D. (I), (II), and (III)

17. The pecking order theory of capital structure implies that firms will use the following sequence of
financing:

A. debt, equity, internal capital

B. internal capital, debt, equity
C. equity, debt, internal capital
D. a convertible bond, warrants, equity

18. Which of the following are associated with the agency costs of financial distress?
(a) Lawyers' fees; (b) Administrative costs; (c) Underinvestment; (d) Asset substitution

A. (a) and (b)

B. (c) and (d)
C. (a), (b), (c), and (d)

19. NetGem went public on January 10, 2019, using the Dutch auction to set the offer price for 20
million shares. The following table gives the bidding. At the close of trading on January 10, 2019,
NeGem's stock price was $25.

Bidder Price ($) Number of Shares (millions) Cumulative

B1 23 2 2
B2 22 6 8
B3 20 2 10
B4 18 10 20
B5 17 20

What was the IPO price underpricing relative to the issue price? =(25-18)/18=38.9%

A. 25.0%
B. 12.0%
C. 38.9%
D. 47.0%

FIN 6425– Practice Final Exam Page 9/18

 20. At the beginning of the year, Apple's management is considering making an offer to buy Mango
Corporation. Mango's projected operating income (EBIT) for the current year is $100 million, but
Apple believes that if the two firms were merged, it could consolidate some operations, reduce
Mango's expenses, and raise Mango's EBIT to $120 million. Neither company uses any debt; both
pay income taxes at a 30% rate. Apple has a better reputation among investors, who regard it as
better managed and also less risky, so Apple's stock has a P/E ratio of 20 versus a P/E of 10 for
Mango. Since Apple's management will be running the entire enterprise after a merger, investors
will value the resulting corporation based on Apple's P/E. Based on expected market values, how
much synergy should the merger create?

A. $ 100 Million
B. $ 200 Million
C. $ 700 Million
D. $ 980 Million
E. $ 1680 Million

Pre- Post-
Merger Merger
Mango Mango
EBIT($ m) 100 120
E =EBIT*(1-Tax) 70 84
P/E 10 20
P(or Value) 700 1680
<--1680-
Synergy 980
700

FIN 6425– Practice Final Exam Page 10/18

Question 21-25 (2 points each)

BigPharam (BP) is a pharmaceutical company that is considering expanding into the biotechnology
business. The expansion project is expected to last 10 years. BP has a market capitalization (market value
of assets) of $1billion, and it has a market-value based Debt/Equity ratio of 1.0. ImmuGen (IG) is a pure
Bio-Technology company, and it has an equity beta of 2.0 and a debt/equity (D/E) ratio of 0.25. The
marginal tax rate for IG is 30%. The target capital structure for BP after the expansion is 30% debt and
70% equity. The marginal tax rate for BP is 25%.

The 10-year Treasury (risk-free) rate is 5% per year, and the risk premium on the market is 5%. BP's debt
is rated "A," and the spread (relative to 10- year Treasury) for the debt is 1%. What is your estimate of the
WACC that BP should use based on CAPM to evaluate the biotechnology business's expansion? Show all
the assumptions and formulas to get partial credit.

For levering and unlevering betas, use the formula:

𝐷
𝛽𝐸 = 𝛽𝐴 ∗ (1 + (1 − 𝑇) ∗ 𝐸 ).

Where, 𝛽𝐸 = 𝐸𝑞𝑢𝑖𝑡𝑦 𝑏𝑒𝑡𝑎, 𝛽𝐴 = 𝐴𝑠𝑠𝑒𝑡 𝑏𝑒𝑡𝑎, 𝑇 = 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒, 𝐷 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑑𝑒𝑏𝑡,
𝐸 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦

21. What is IG's asset beta?

A. 1.60
B. 1.70
C. 1.80
D. 2.00
E. 2.35

𝛽𝐸 2
𝛽𝐴 = = = 1.7
𝐷 (1 + (1 − .3) ∗ (.25)
(1 + (1 − 𝑇𝑎𝑥) ∗ 𝐸

FIN 6425– Practice Final Exam Page 11/18

BigPharam (BP) is a pharmaceutical company that is considering expanding into the biotechnology
business. The expansion project is expected to last 10 years. BP has a market capitalization (market value
of assets) of $1billion, and it has a market-value based Debt/Equity ratio of 1.0. ImmuGen (IG) is a pure
Bio-Technology company, and it has an equity beta of 2.0 and a debt/equity (D/E) ratio of 0.25. The
marginal tax rate for IG is 30%. The target capital structure for BP after the expansion is 30% debt and
70% equity. The marginal tax rate for BP is 25%.

The 10-year Treasury (risk-free) rate is 5% per year, and the risk premium on the market is 5%. BP's debt
is rated "A," and the spread (relative to 10- year Treasury) for the debt is 1%. What is your estimate of the
WACC that BP should use based on CAPM to evaluate the biotechnology business's expansion? Show all
the assumptions and formulas to get partial credit.

For levering and unlevering betas, use the formula:

𝐷
𝛽𝐸 = 𝛽𝐴 ∗ (1 + (1 − 𝑇) ∗ 𝐸 ).

Where, 𝛽𝐸 = 𝐸𝑞𝑢𝑖𝑡𝑦 𝑏𝑒𝑡𝑎, 𝛽𝐴 = 𝐴𝑠𝑠𝑒𝑡 𝑏𝑒𝑡𝑎, 𝑇 = 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒, 𝐷 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑑𝑒𝑏𝑡,
𝐸 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦

22. What is the equity beta that BP should use to evaluate the expansion into bio biotech?(use BPs
target capital structure)

A. 1.60
B. 1.70
C. 1.80
D. 2.25
E. 2.35
Use the tax rate for BP and the target capital structure to find the equity beta.

𝐷 3
𝛽𝐸 = 𝛽𝐴 ∗ (1 + (1 − 𝑇) ∗ ) = 1.7 ∗ (1 + (1 − .25) ∗ ( )) = 2.25
𝐸 7

FIN 6425– Practice Final Exam Page 12/18

BigPharam (BP) is a pharmaceutical company that is considering expanding into the biotechnology
business. The expansion project is expected to last 10 years. BP has a market capitalization (market value
of assets) of $1billion, and it has a market-value based Debt/Equity ratio of 1.0. ImmuGen (IG) is a pure
Bio-Technology company, and it has an equity beta of 2.0 and a debt/equity (D/E) ratio of 0.25. The
marginal tax rate for IG is 30%. The target capital structure for BP after the expansion is 30% debt and
70% equity. The marginal tax rate for BP is 25%.

The 10-year Treasury (risk-free) rate is 5% per year, and the risk premium on the market is 5%. BP's debt
is rated "A," and the spread (relative to 10- year Treasury) for the debt is 1%. What is your estimate of the
WACC that BP should use based on CAPM to evaluate the biotechnology business's expansion? Show all
the assumptions and formulas to get partial credit.

For levering and unlevering betas, use the formula:

𝐷
𝛽𝐸 = 𝛽𝐴 ∗ (1 + (1 − 𝑇) ∗ 𝐸 ).

Where, 𝛽𝐸 = 𝐸𝑞𝑢𝑖𝑡𝑦 𝑏𝑒𝑡𝑎, 𝛽𝐴 = 𝐴𝑠𝑠𝑒𝑡 𝑏𝑒𝑡𝑎, 𝑇 = 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒, 𝐷 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑑𝑒𝑏𝑡,
𝐸 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦

23. What is the cost of debt that BP should use to calculate the WACC for the expansion?
NOTE THAT THE ANSWERS ARE CHANGED FROM THE ORIGINAL EXAM POSTED)

A. 1.0%
B. 5.0%
C. 6.0% = 5%(Treasury Rate) + 1% (spread)
D. 8.0%

FIN 6425– Practice Final Exam Page 13/18

BigPharam (BP) is a pharmaceutical company that is considering expanding into the biotechnology
business. The expansion project is expected to last 10 years. BP has a market capitalization (market value
of assets) of $1billion, and it has a market value-based Debt/Equity ratio of 1.0. ImmuGen (IG) is a pure
Bio-Technology company, and it has an equity beta of 2.0 and a debt/equity (D/E) ratio of 0.25. The
marginal tax rate for IG is 30%. The target capital structure for BP after the expansion is 30% debt and
70% equity. The marginal tax rate for BP is 25%.

The 10-year Treasury (risk-free) rate is 5% per year, and the risk premium on the market is 5%. BP's debt
is rated "A," and the spread (relative to 10- year Treasury) for the debt is 1%. What is your estimate of the
WACC that BP should use based on CAPM to evaluate the biotechnology business's expansion? Show all
the assumptions and formulas to get partial credit.

For levering and unlevering betas, use the formula:

𝐷
𝛽𝐸 = 𝛽𝐴 ∗ (1 + (1 − 𝑇) ∗ 𝐸 ).

Where, 𝛽𝐸 = 𝐸𝑞𝑢𝑖𝑡𝑦 𝑏𝑒𝑡𝑎, 𝛽𝐴 = 𝐴𝑠𝑠𝑒𝑡 𝑏𝑒𝑡𝑎, 𝑇 = 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒, 𝐷 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑑𝑒𝑏𝑡,
𝐸 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦

24. What is the cost of equity that BP should use to calculate the WACC for the expansion?

A. 5.00 %
B. 6.00%
C. 11.25%
D. 15.00%
E. 16.25% = 5% + 2.25*(5%) = 16.25% (CAPM)

FIN 6425– Practice Final Exam Page 14/18

BigPharam (BP) is a pharmaceutical company that is considering expanding into the biotechnology
business. The expansion project is expected to last 10 years. BP has a market capitalization (market value
of assets) of $1billion, and it has a market-value based Debt/Equity ratio of 1.0. ImmuGen (IG) is a pure
Bio-Technology company, and it has an equity beta of 2.0 and a debt/equity (D/E) ratio of 0.25. The
marginal tax rate for IG is 30%. The target capital structure for BP after the expansion is 30% debt and
70% equity. The marginal tax rate for BP is 25%.

The 10-year Treasury (risk-free) rate is 5% per year, and the risk premium on the market is 5%. BP's debt
is rated "A," and the spread (relative to 10- year Treasury) for the debt is 1%. What is your estimate of the
WACC that BP should use based on CAPM to evaluate the biotechnology business's expansion? Show all
the assumptions and formulas to get partial credit.

For levering and unlevering betas, use the formula:

𝐷
𝛽𝐸 = 𝛽𝐴 ∗ (1 + (1 − 𝑇) ∗ 𝐸 ).

Where, 𝛽𝐸 = 𝐸𝑞𝑢𝑖𝑡𝑦 𝑏𝑒𝑡𝑎, 𝛽𝐴 = 𝐴𝑠𝑠𝑒𝑡 𝑏𝑒𝑡𝑎, 𝑇 = 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒, 𝐷 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑑𝑒𝑏𝑡,
𝐸 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦

25. What is the WACC that BP should use for the expansion?

A. 6.00%
B. 10.20%
C. 12.72% = WACC = .7*(16.25) + 0.3*(6%)*(1-.25)
D. 16.25%
E. 20.00%

FIN 6425– Practice Final Exam Page 15/18

Question 26-30 (2 Points Each)

26. Boeing plans to negotiate with Delta airlines to sell the Boeing 787 Dreamliner. As part
of the selling strategy, Boeing plans to give Delta the option to buy the aircraft for a fixed
price in three years for $200 million. The current market price of the aircraft is $190
million. Boeing has hired you to value this option. Based on daily data, you estimate
Boeing stock has a volatility of 3%/day, and Airbus stock has volatility of 4%/day.
Boeing has 50% in defense and 50% in commercial aircraft, while Airbus is 100% in the
commercial aircraft business. The 3-year Treasury rate is 3%, and the 20-year rate is 4%
per year.

What type of option is Boeing giving Delta?

A. Long Stock
B. Short Stock
C. Long Call
D. Short Call  Boeing is giving delta a call (hence short), and delta has a long call
E. Long Put
F. Shot Put

27. Boeing plans to negotiate with Delta airlines to sell the Boeing 787 Dreamliner. As part
of the selling strategy, Boeing plans to give Delta the option to buy the aircraft for a fixed
price in three years for $200 million. The current market price of the aircraft is $190
million. Boeing has hired you to value this option. Based on daily data, you estimate
Boeing stock has a volatility of 3%/day, and Airbus stock has volatility of 4%/day.
Boeing has 50% in defense and 50% in commercial aircraft, while Airbus is 100% in the
commercial aircraft business. The 3-year Treasury rate is 3%, and the 20-year rate is 4%
per year.

What is the underlying asset value for the option?

A. $ 190 Million  the current market value

B. $ 200 Million
C. $ 300 Million
D. $ 400 Million

FIN 6425– Practice Final Exam Page 16/18

 28. Boeing plans to negotiate with Delta airlines to sell the Boeing 787 Dreamliner. As part
of the selling strategy, Boeing plans to give Delta the option to buy the aircraft for a fixed
price in three years for $200 million. The current market price of the aircraft is $190
million. Boeing has hired you to value this option. Based on daily data, you estimate
Boeing stock has a volatility of 3%/day, and Airbus stock has volatility of 4%/day.
Boeing has 50% in defense and 50% in commercial aircraft, while Airbus is 100% in the
commercial aircraft business. The 3-year Treasury rate is 3%, and the 20-year rate is 4%
per year.

What is the exercise price for the option?

A. $ 190 Million
B. $ 200 Million  Fixed purchase price at exercise date
C. $ 390 Million
D. $ 500 Million

29. Boeing plans to negotiate with Delta airlines to sell the Boeing 787 Dreamliner. As part
of the selling strategy, Boeing plans to give Delta the option to buy the aircraft for a fixed
price in three years for $200 million. The current market price of the aircraft is $190
million. Boeing has hired you to value this option. Based on daily data, you estimate
Boeing stock has a volatility of 3%/day, and Airbus stock has a volatility of 4%/day.
Boeing has 50% in defense and 50% in commercial aircraft, while Airbus is 100% in the
commercial aircraft business. The 3-year Treasury rate is 3%, and the 20-year rate is 4%
per year.

What is the time to maturity (Years) of the option?

A. 3
B. 5
C. 10
D. 20

FIN 6425– Practice Final Exam Page 17/18

 30. Boeing plans to negotiate with Delta airlines to sell the Boeing 787 Dreamliner. As part
of the selling strategy, Boeing plans to give Delta the option to buy the aircraft for a fixed
price in three years for $200 million. The current market price of the aircraft is $190
million. Boeing has hired you to value this option. Based on daily data, you estimate
Boeing stock has a volatility of 3%/day, and Airbus has a volatility of 4%/day. Boeing
has 50% in defense and 50% in commercial aircraft, while Airbus is 100% in commercial
aircraft business. The 3-year Treasury rate is 3%, and the 20-year rate is 4% per year.

What is the annual volatility to use for the option valuation (%/Yr.)?
A. 3%
B. 4%
C. 47.6%
D. 63.5%
E. 76.4%

The pure play Air Bus volatility can be used for the project=4% per day
Annual = 4%*Sqrt(252)=63.5%  252 trading days in a year

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