Sample CF Final Examination

Question 1:
a) Explain the stock price behavior on the ex-dividend date and why that happens.
b) Discuss what firms should or should not do regarding dividend and payout policy under
two scenarios: firms without sufficient cash, firms with sufficient cash.
Question 2:
a) Explain the reasons for the stock price behavior on the announcement of a Seasoned Equity
Offering.
b) Compare difference between Firm Commitment and Best Effort.
c) ABC corporation is attempting to raise $7,800,000 in new equity with a rights offering.
The subscription price will be $41.5 per share. The stock currently sells for $48 per share
and there are 250,000 shares outstanding. What is the value of a right?
Question 3:
Part A: Why does the lessor often have higher tax rate than the lessee?
Part B: The Myers Inc. is considering the purchase of a new machine for $34,500 . The machine
is expected to save the firm $12,800 per year in operating costs over a 5-year period, and can be
depreciated on a straight-line basis to a zero salvage value over its life. Alternatively, the firm can
lease the machine from Stuart Leasing Company for $6,700 per year for 5 years, with the first
payment due in 1 year. The Myers' tax rate is 25% and the before-tax cost of debt is 9%. The tax
rate of Stuart Leasing is 36%.
a) Using NPV analysis, should Myers lease or buy the machine?
b) Calculate the maximum lease payment that Myers can pay.
c) Calculate the break-even lease payment for Stuart Leasing.
Question 4:
Baking Inc. and Sweet Co. are all-equity firms. Baking Inc. has 97,100 shares of stock outstanding
at a price of $40 a share. Sweet Co. has 64,100 shares of stock outstanding at a price of $29 a
share. Baking Inc. is analyzing the possible acquisition of Sweet Co. Baking Inc. believes the
acquisition will increase its total after-tax annual cash flow by $73,500 indefinitely. The
appropriate discount rate for the incremental cash flows is 20 percent.
a) Baking Inc. is acquiring Sweet Co. for $2,030,000 in cash. What is the NPV of the acquisition?
What is the new share price of the merged firm after the acquisition?
b) Suppose stock consideration is used (Baking Inc. offers to pay Sweet Co. in stock). Sweet Co.
is acquired for the $2,000,000 value of Baking’s stock. What is the new share price of the merged
firm after theacquisition? What is the NPV of the acquisition? Should Baking Inc. pay in cash or
stock?

Nguyễn Việt Tùng – BAFNIU19198 | INTERNATIONAL UNIVERSITY

 Question 1:
a) An individual purchasing the security before the ex-dividend date will receive the dividend,
whereas another individual purchasing the security on or after this date will not receive the
dividend. And everyone knows this information, so the stock price will adjust down immediately
on the ex-dividend date to avoid investors buying a lot of shares just before the ex-dividend date
to receive dividends and immediately sell off stocks after the ex-dividend date.
b) Firm without sufficient cash to pay dividends: For a cashless company, to pay dividends, the
company will have to raise capital/money by issuing new shares or bonds. In fact, the personal
taxation of the state will make the method of raising capital in the form of stock issuance bring
losses to the owners of the shares. In addition, other costs for the issuance come from the
investment bank. The above two factors make the net revenue issued by the company from a new
issuance less than 100% of the total mobilized capital. Therefore, the option of paying dividends
when there is no cash is not feasible for a company financially.
However, in some cases, the company is forced to pay dividends even though its cash resources
are exhausted. In case a company suddenly runs out of cash in a short period (1 year) while in
previous years growing steadily and paying regular dividends. The company owner may still
decide to pay dividends in that year to keep investors' confidence in the stability of the company's
growth and business.

Firm with sufficient cash to pay dividends: First, managers may decide to use cash to invest in
a project with a negative NPV instead of paying dividends to shareholders. The purpose of this job
can be from personal reasons as the manager can increase his position, power, and salary as the
value of the company increases. However, it has a negative effect on shareholders. So, this is
something you shouldn't do.
The company can carry out M&A with the available cash. This strategy has the advantage of
acquiring profitable assets. However, the costs associated with M&A are very large, so it does not
seem to bring any benefits to the acquiring company. Therefore, it is not feasible for a company to
conduct M&A just to avoid paying dividends.
The company may also buy financial assets on top of its available cash to avoid paying dividends
to shareholders. The decision to invest in a company's financial assets or pay a dividend is a
complex one, depending on the company's tax rate, the marginal tax rates of its investors, and the
application of the dividend exclusion. However, these are generally not feasible because of some
tax-related regulations.
Finally, the company can use cash to make stock buybacks instead of paying dividends to
shareholders. This strategy benefits shareholders in the context of high-income tax when receiving
cash dividends. In addition, the company and shareholders can enjoy several benefits from stock
repurchases such as: flexibility of repurchase, keep stock price higher, signal undervalue of the
company, taxes, beautify reports financial, ... Although there are some regulations on price
manipulation that can affect the acquisition process, it is insignificant compared to the benefits.

Nguyễn Việt Tùng – BAFNIU19198 | INTERNATIONAL UNIVERSITY

 Question 2:
a) Shareholders who are not inside the company or investors may think that the company's
management decided to issue more shares because they know their company's shares are
overvalued. It is possible that the company is in a period of financial difficulty, or the risk of
financial difficulty is increasing (the company is heavily indebted or is experiencing liquidity
problems) so the ability to raise the company's capital through debt becomes more difficult than
issuing new shares. All the above inferences lead to the market tending to react negatively to
information about SEOs, leading to a drop in stock prices.
b)
Firm Commitment Best Effort
Underwriter is obligated to buy all the shares of the Underwriter make their “best effort” to sell the securities
company and sell them in the IPO processes. at an agreed-upon offering price
The underwriter bears the risk of not being able to sell The issuing company bears the risk of the issue not being
the entire issue for more than the cost. sold.

The underwriter makes money on the spread between Underwriter earns commission fees for selling the shares
the price paid to the issuer and the price received from in an IPO.
investors when the stock is sold.

c)
Number of new shares: 7,800,000/41.5 = 187,951.8072 shares.
The number of rights needed to buy one share will be the current shares outstanding divided
by the number of new shares offered, so:
Number of rights needed: 250,000/187,951.8072 = 1.33
A shareholder can buy 1.33 rights on shares for: 1.33 × $48 = $63.84
The shareholder can exercise these rights for $41.5, at a total cost of:
$41.5 + $63.84 = $105.34
The investor will then have:
Ex-rights shares: 1 + 1.33 = 2.33
The ex-rights price per share is: 𝑃 = (1.33($48) + $41.5)/2.33 = $45.21
So, the value of a right is: $48 − $45.21 = $2.79
Question 3:
Part A:Lessors often have high tax rate; lessee often has low tax rate. First, we must know that
lessor has many tax benefits. It is a depreciation tax shield since they own the asset and If lessors
finance the asset using debt, they will earn interest tax shield.
In fact, if lessee needed a device, they would have two options. For the first option, they can buy
the device, and become the owner of the device, but they won't get the full tax benefit. Therefore,
lessee will seek to pass this benefit to 3rd party, which is lessor, by signing equipment lease
contract, lessor has high tax rate and hence will also get high tax benefit.

Nguyễn Việt Tùng – BAFNIU19198 | INTERNATIONAL UNIVERSITY

 Part B:
a) After-tax cost debt is 9% × (1 − 25%) = 6.75%
Cashflow - Buying
Year 0 Each Year from 1 to 5
Cost of Machine −34,500
After-Tax Saving 12,800 × (1 − 25%) = 9,600
Depreciation Tax Shield (34,500/5) × 25% = 1,725
Cash Flow −34,500 9,600 + 1,725 = 11,325

Cashflow - Lease
Year 0 Each Year from 1 to 5
Lease Payment −6,700 × (1 − 25%) = −5,025
After-Tax Saving 12,800 × (1 − 25%) = 9,600
Cash Flow 9,600 − 5,025 = 4,575

Cashflow of Lease instead of Buy

Year 0 Each Year from 1 to 5
Cash Flow 0− (−34,500) = 34,500 4,575 − 11,325 = −6,750

NPV of Leasing instead of Buying:

1 1
𝑁𝑃𝑉 = 34,500 − 6,750 × − = 6,637.42
6.75% 6.76% × (1 + 6.75%)
Because the NPV of leasing instead of buying is positive so that Myers should lease.
b)
Year 0 Each Year from 1 to 5
Cost of Machine (did not buy) 34,500
Lost Depreciation Tax Shield −6,900 × 25% = −1,725
After-tax Lease Payment −𝐿 × (1 − 25%) = −0.75𝐿
Cash Flow 34,500 −1,725 − 0.75𝐿

The highest lease payment that Myers can pay is:

1 1
𝑁𝑃𝑉 = 0 = 34,500 + (−1,725 − 0.75𝐿 )× −
6.75% 6.75% × (1 + 6.75%)
𝐿 = $8,843.98
c)

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 Year 0 Each Year from 1 to 5
Cost of Machine −34,500
Depreciation Tax Shield 6,900 × 36% = 2,484
After-tax Lease Payment 𝐿 × (1 − 36%) = 64%𝐿
Cash Flow −34,500 2,484 + 0.64𝐿

The break-even lease payment for Stuart Leasing is:

1 1
𝑁𝑃𝑉 = 0 = −34,500 + (2,484 + 0.64𝐿 )× −
6.75% 6.75% × (1 + 6.75%)
𝐿 = $9,178.09

Question 4:
The Incremental value from acquisition:
73,500
∆𝑉 = = $367,500
20%
a)
The NPV of cash acquisitions:
= 𝑉 ∗ − 𝑐𝑎𝑠ℎ𝑝𝑎𝑖𝑑 = (𝑉 + ∆𝑉) − 𝑐𝑎𝑠ℎ𝑝𝑎𝑖𝑑
= (64,100 × 29 + 367,500) − 2,030,000 = $196,400
Value of the combined firm:
𝑉 = 𝑉 + (𝑉 ∗ − 𝑐𝑎𝑠ℎ𝑝𝑎𝑖𝑑) = 97,100 × 40 + 196,400 = $4,080,400
Number of shares of outstanding after the acquisition = Number of shares of Banking Inc. = 97,100
New price per share after acquisition:
𝑉 4,080,400
= = = 42.02
Number of shares of outstanding after the acquisition 97,100
b)
Value of combined firm:
𝑉 = 𝑉 + 𝑉 ∗ = 𝑉 + 𝑉 + ∆𝑉 = 97,100 × $40 + 64,100 × $29 + $367,500 = $6,110,400
Number of new shares Banking Inc. must issue and give to the target’s shareholders:
2,000,000
= = 50,000 𝑠ℎ𝑎𝑟𝑒𝑠
40

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 Number of shares outstanding after the acquisition: 50,000 + 97,100 = 147,100 shares
Price per share after acquisition:
𝑉 6,110,400
= = = $41.53
Number of shares of outstanding after the acquisition 147,100
Purchase price is:
6,110,400
= 50,000 × = $2,076,954.453
147,100
NPV of stock acquisition:
= 𝑉 ∗ − 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒 𝑃𝑟𝑖𝑐𝑒 = (64,100 × $29 + 367,500) − $2,076,954.453 = $149,445.547
Because the NPV of cash acquisition is higher than the NPV of stock acquisition, Banking Inc
should pay in cash.

Nguyễn Việt Tùng – BAFNIU19198 | INTERNATIONAL UNIVERSITY