JRE300 FALL 2020 Final Exam - Quercus

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University of Toronto *

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Management

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Feb 20, 2024

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University of Toronto Faculty of Applied Science and Engineering and Rotman School of Management JRE 300H1F – Foundations of Accounting and Finance Final Examination, Fall 2020 Duration: 2.5 hours Please answer all questions on this exam paper. Instructions: • Handwrite your solutions on paper • Submit your solutions to Quercus by taking one picture per page • Submit your ID verification as per instructions Question Grade 1. Multiple Choice /12 2. Project Evaluation /20 3. Time Value of Money /10 4. Bonds /8 5. Cost of Capital/Project Evaluation /20 6. Capital Structure /20 7. Risk Management: Hedging /10 Total : /100

1. MULTIPLE CHOICE (12 MARKS) – SELECT THE BEST ANSWER (2 MARKS EACH) 1. Maple Ltd. has 1 million common shares outstanding. The beta on these common shares is 1.25, and they are trading at a price of $20 per share. Maple paid a dividend of $1.75 per share last year. Analysts anticipate that these dividends will grow at an average annual rate of 2% for the foreseeable future. What is the component cost of new common equity if Maple’s tax rate is 35% and flotation costs on new common equity are 6% before tax? a) 10.93% b) 11.11% c) 11.29% d) 11.49% 2. Tassone Co. recently paid a dividend of $1.25 on its common shares. Dividends are expected to grow at a constant rate of 3%. Investors require a 12% return on Tassone ’s common shares. Today, Tassone ’s CEO announced that the next dividend (to be paid next year) would be only $0.90. This announcement, along with other market conditions, caused investors to reassess Tassone ’s risk, resulting in an increase in their required return to 15% and a reduction of the expected future growth rate of dividends to 1.2%. What would likely happen to the value of Tassone ’s commo n shares following this announcement? a) A decline of $4.73 per share b) A decline of $7.37 per share c) A decline of $7.71 per share d) A decline of $7.79 per share 3. The CFO of Vincent Inc. has gathered the following information: Selling price per unit is $2,000 and variable costs per unit sold are $1,400. During the year, 10,000 units were sold. Net income for the year was $1,225,000. Income taxes for the year were $525,000 and interest expense was $750,000. By how much will operating income increase if sales increase by 10%? a) 27% b) 24% c) 21% d) 18%

4. It is currently the end of 2020, and Vovk Inc. expects to pay dividends as follows: $1.50 in 2021, $2.25 in 2022 and $3.00 in 2023. Dividends are expected to grow at 3% each year thereafter. The current required cost of equity for Vovk common shares is 12%. What is Vovk ’s current share price? a) $23.06 b) $27.09 c) $29.71 d) $39.06 5. Consider the following cash flows for the following projects: Project A: Initial investment = $3,300; Year 1 = $2,000; Year 2 = $1,500; Year 3 = $2,000 Project B: Initial investment = $5,000; Year 1 = $0; Year 2 = $4,500; Year 3 = $5,000 Which of Project A and Project B should you accept if they are mutually exclusive and the required rate of return is 25%? a) Neither project b) Project A c) Both projects d) Project B 6. Selena Corp. has 200,000 common shares outstanding with a book value of $20 per share and a current market price of $30 per share. Selena recently paid a dividend of $2.00 per share that is expected to grow at a rate of 4% for the foreseeable future. Selena also has bonds outstanding with a face value of $5,000,000. The bonds have a coupon rate of 8%, payable semi- annually, and they mature in three years. The bonds currently have a YTM of 7%. Selena’s income tax rate is 20%. Flotation costs will be 3% after tax for new debt issues and 5% before tax on common shares. What is Selena’s weighted average cost of capital ? a) 6.55% b) 8.20% c) 9.09% d) 8.71%

2. PROJECT EVALUATION (20 MARKS) Kerry Company manufactures three different models of paper shredders including the waste container, which serves as the base. Although each model uses a different shredder head, the waste container is the same. The number of waste containers that Kerry will need during the next five years is estimated as follows: 2021 - 50,000 2022 - 50,000 2023 - 52,000 2024 - 55,000 2025 - 55,000 The equipment used to manufacture the waste container must be replaced because it has broken and cannot be repaired. The new equipment would have a purchase price of $715,000 with terms of 2/10, n/30; company policy is to take all purchase discounts. The freight on the equipment would be $11,000, and installation costs would total $22,900. The equipment would be purchased in December 2020 and be placed into service on January 1, 2021. It would have a five-year economic life. This equipment is expected to have a salvage value of $12,000 at the end of its economic life in 2025. The new equipment would be more efficient than the old equipment, resulting in a 25% reduction in both direct materials and variable overhead. The savings in direct materials would result in an additional onetime decrease in working capital requirements of $2,500 due to a reduction in direct materials inventories. This working capital reduction would be recognized at the time of equipment acquisition. The old equipment is fully depreciated and is not included in the fixed overhead. The old equipment from the plant can be sold for a salvage amount of $1,500. Kerry has no alternative use for the manufacturing space at this time, so if the waste containers are purchased, as discussed next, the old equipment would be left in place. Rather than replace the equipment, one of Kerry's production managers has suggested that the waste containers be purchased. One supplier has quoted a price of $27 per container. This price is $8 less than Kerry's current manufacturing cost, which is as follows: Direct materials $10 Direct labor 8 Variable overhead Fixed costs: 6 Supervision $2 Facilities 5 General 4 11 Total manufacturing cost per unit $35 Kerry employs a plantwide fixed overhead rate (i.e. an allocation rate) in its operations. If the waste containers are purchased outside, the salary and benefits of one supervisor, included in the fixed overhead at $45,000, would be eliminated. There would be no other changes in the other cash and noncash items included in fixed overhead, except depreciation on the new

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