# Fi516-Solution for Study Guide for Final Exam Essay

1. (TCO B) Which of the following statements concerning the MM extension with growth is NOT CORRECT? (a) The tax shields should be discounted at the unlevered cost of equity.

(b) The value of a growing tax shield is greater than the value of a constant tax shield.

(c) For a given D/S, the levered cost of equity is greater than the levered cost of equity under MM's original (with tax) assumptions.

(d) For a given D/S, the WACC is greater than the WACC under MM's original (with tax) assumptions.

(e) The total value of the firm is independent of the amount of debt it uses. (Points: 20)

2. (TCO D) Which of the following statements is most CORRECT? (a) In a private placement,

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(b) $896

(c) $945

(d) $997

(e) $1,047 (Points: 20)

Solution:

4. (TCO I) Suppose 90-day investments in Britain have a 6% annualized return and a 1.5% quarterly (90-day) return. In the U.S., 90-day investments of similar risk have a 4% annualized return and a 1% quarterly (90-day) return. In the 90-day forward market, 1 British pound equals $1.65. If interest rate parity holds, what is the spot exchange rate? (a) 1 pound = $1.8000

(b) 1 pound = $1.6582

(c) 1 pound = $1.0000

(d) 1 pound = $0.8500

(e) 1 pound = $0.6031 (Points: 20)

Solution: From the Interest Rate Parity formula it follows that: e0 = (ft)(1 + rf)/(1 + rh) = (1.65 dollars/pound)(1.015)/(1.01) = 1.6582 dollars/ pound.

Another way to think of this is $1 invested today in the United States yields $1.01 90 days from now. Alternatively, investors could put their money in British securities. In this case, the investor would exchange today $1 for (1/1.6582) or 0.6031 pounds in the spot market. This money could be invested in Britain and after 90 days this investment would be worth 0.6031(1.015) = 0.6121 pounds. Given the forward exchange rate, 0.6121 pounds is worth $1.01 90 days from now.

1. (TCO C) D. Paul Inc. forecasts a capital budget of $725,000. The CFO wants to maintain a target capital structure of 45% debt and 55% equity, and it also wants to pay dividends of $500,000. If the