FNCE 370
Overview of Corporate Finance
Sample Examination (Solutions)
Part I: Multiple Choice
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FNCE 370 Sample Examination (Solutions)
1/8
May 2006
Part II: Written Response
26.
Agency problems are said to be inherent in the corporate form of an organization. Why do you think this is the case? Do you think agency problems arise in a sole proprietorship or a partnership? What steps would you take to reduce agency problems in a so-called typical corporation?
Suggested Answer
(See pp. 10–15 in the textbook)
Agency problems are inherent in the corporate form of an organization because of the
*…show more content…*

a. If the Grim Reaper Corporation requires a 12% return on investment, should the cemetery business be started? b. The Grim Reaper Corporation is unsure about the assumption of a 6% growth rate in its cash flows. At what constant growth rate would the corporation just break even, if it still requires a 12% return on investment? Suggested Answers Information given: Net Cash Inflow, year 1 = $25,000 g = 0.06 to infinity Initial Investment = $400,000 a. r = 0.12 ∞ NPV = −400,000 + ∑ t =1 25,000 × (1 + 0.06) t −1 (1 + 0.12) t ⎞ ⎛ ⎜ 25,000 1 ⎟⎟ = −400,000 + ⎜ × 1.06 ⎟ ⎜ 1.12 1− ⎟ ⎜ 1.12 ⎠ ⎝ = −400,000 + 416,666.67 = $16,666.67 Since NPV > 0, the cemetery business is worth starting. FNCE 370 Sample Examination (Solutions) 4/8 May 2006 Suggested Answers (question 26 continued) b. Let ∞ NPV = −400,000 + ∑ t =1 25,000 × (1 + r ) t −1 =0 (1 + 0.12) t Then solve for r as follows: ⎛ ⎞ ⎜ 25, 000 1 ⎟ 400, 000 = ⎜ × ⎟ ⎜⎜ 1.12 1 − 1 + r ⎟⎟ 1.12 ⎠ ⎝ r = 0.0575 Thus, at a 5.75% constant growth rate, the corporation would just break even. FNCE 370 Sample Examination (Solutions) 5/8 May 2006 30. ABC Co. and XYZ Co. are identical companies in all respects, except their capital structure. ABC Co. is all-equity financed with $250,000 in stock. XYZ Co. uses both stock and perpetual debt; its stock is worth $125,000, and the interest rate on its debt is 10%. Both firms expect EBIT to be $37,500, and their shares are trading at $20 per share.

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