EXAM QUESTIONS:
CASE 1 (20 points)
You work for a medical research laboratory that is contemplating leasing a diagnostic scanner. The
scanner costs €4,000,000, and it would be depreciated straight-line to zero over four years. Because
of radiation contamination, the scanner will be worthless in four years. You can lease the scanner for
€900,000 per year for four years. You can borrow at 5 percent before taxes. Assume that the tax rate
is 20 percent.
Instructions:
a. Complete a lease-versus-buy analysis. Calculate the NPV of leasing. Should you lease or buy? (15
points)
0 1 2 3 4
Cost of asset
After-tax lease payment
Lost depreciation tax shield
Cash flow of lease
b. Explain the impact of leasing on the balance sheet. (5 points)
CASE 2 (35 points)
Suppose stock in William Corporation has a beta of 0.80. The market return is 12 percent, and the
Treasury Bill rate is 6 percent. William’s last dividend was €1.20 per share, and the dividend is expected
to grow at 8 percent indefinitely. The stock currently sells for €45 per share. William’s target capital
structure is 1/3 debt and 2/3 equity. Its cost of debt is 9 percent before taxes. Its tax rate is 21 percent.
Instructions:
a. What is William’s cost of equity capital? Assume that you equally believe in the CAPM approach
and the dividend growth model. (10 points)
b. What is William’s WACC? (5 points)
c. William is seeking €30 million for a new project. The necessary funds will have to be raised
externally. William’s flotation costs for selling debt and equity are 2 percent and 16 percent,
respectively. If flotation costs are considered, what is the true cost of the new project? (10 points)
d. Under what circumstances would it be appropriate for William Corporation to use different costs of
capital for its different operating divisions? What are two techniques you could use to develop a rough
estimate for each division’s cost of capital? (10 points)
CASE 3 (25 points)
Firm Alpha is analysing the possible acquisition of Firm Beta. There are two alternatives for Firm Alpha:
to use cash or stock as payment. Both firms have no debt. You have the following premerger information
(all figures are in millions):
Firm Alpha Firm Beta
Price per share €40 €20
Number of shares 50 20
Total market value €2,000 €400
You estimate that the incremental value of the acquisition is €200.
The board of Firm Beta has indicated that it will agree to a sale if the price is €300, payable in cash or
stock.
Instructions:
a. What is the cost of each alternative? (5 points)
b. What is the NPV of each alternative? (5 points)
c. Which alternative should Firm Alpha choose? (5 points)
d. What are some important factors in deciding whether to use stock or cash in an acquisition? (5
points)
e. Explain what defensive tactics the managers of Firm Beta could use to resist acquisition. (5 points)
CASE 4 (20 points)
Westland Industries was suffering from cash flow insolvency in terms of its earnings before interest,
taxes, and depreciation (EBITDA).
Two scenarios are possible for Westland in Year 3:
Scenario 1 suggests that the results from operations for Year 2 are expected to be repeated in Year 3
and thereafter.
In scenario 2, Westland is expected to have a breakout year in terms of sales of $400,000 and operating
expenses before depreciation of 60 percent of sales. Interest is expected to remain at $40,000 because
of the need to finance the venture’s growth.
Instructions:
a. Prepare basic income statements (from sales to EBIT) under both scenarios. Comment on your
findings. (10 points)
b. Many people believe that when a firm goes into financial distress, it is finished. Is this true? Explain
what options are available in resolving financial distress situations. (5 points)
c. There are various methods of restructuring that firms can follow in the process of turning around a
venture in financial distress. Which do you think are most effective? Explain why. (5 points)
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