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FNCE20005 CORPORATE FINANCIAL DECISION MAKING
Semester TWO, 2021
Exam Duration: Three (3) Hours writing time
15 minutes reading time
30 minutes upload time (Section B – Gradescope only)
Instruction to Candidates
1. This is an OPEN BOOK examination.
2. No formulae sheet provided.
3. The exam must be submitted within the relevant deadlines for each section.
4. Late submissions will attract a 10% penalty of the total maximum mark for the exam for each
30 minutes immediately after the submission deadline (e.g., an exam submitted two minutes
after the deadline will lose 8 marks of an exam worth 80%). Submissions made or attempted
1 hour after the submission deadline will not be marked. Students who were prevented from
submitting due to technical difficulties will need to apply for technical consideration with
supporting documentation.
5. This examination contains TWO SECTIONS for a total of 100 marks.
Marks Total
Questions
Required Submission
Method
Section A –
Multiple Choice
Questions
60 20 Attempt ALL questions Canvas
Quiz
Section B –
Short Answer Questions
40 10 Attempt ALL questions Gradescope
Total 100 30 Attempt ALL questions
6. For Section A, you will need to attempt the questions in Canvas Quiz.
a. The Quiz saves your answers as you go, but once you press “Submit” at the
conclusion, it cannot be reopened. Do not submit until you are certain that you do not
need to go back to change your responses.
7. For section B, you will need to upload answers to Gradescope.
a. The answers must be handwritten unless otherwise stated. If you submit typed
answers for questions that ask for handwritten answers, you will receive zero marks.
b. You can use a tablet and stylus to write your answers. However, you are responsible
for any related tech issues.
c. Start each question on a NEW PAGE and include question number and student
number on the top of each answer.
d. Please note that when uploading answers to Gradescope, you need to assign specific
pages to each of the question.
8. Please scan your answers using a scanner or a mobile device.
All answers submitted MUST BE LEGIBLE,
illegible (unreadable) answers will be awarded ZERO marks.
9. The Exam Support tool in CANVAS will be available from 3:00 PM AEST on November
11th to 3:45 PM AEST on November 11th, subject coordinators and the tutor-in-charge will
be there assisting in resolving issues related to exam contents. Please make sure that the issue
is clearly stated.
10. Once the Exam Support tool is closed (i.e., at 3:45 PM AEST), students are advised to
contact 13MELB. Inside Australia: 13MELB (13 6352) (13 6352 - Option 1 - Exams; from
Outside Australia: +61 3 9035 5511) if they have queries on exam content.
11. For any issues other than exam content (including those arising during the first 45 minutes of
the exam), students are also recommended to contact 13MELB (13 6352 - Option 1 - Exams;
from Outside Australia: +61 3 9035 5511)
12. Collusion between students is absolutely forbidden and will result in very serious
consequences.
This paper CAN NOT be lodged with the Baillieu Library AT ANY TIME.
Section B. Short Answer Questions
This section consists of 10 questions. Attempt ALL questions.
All answers must be handwritten unless otherwise stated, and uploaded to Gradescope.
In order to get marks, you need to show your detailed workings along with the final
answers.
Question 21.
Pinder Co. currently has 100 million shares outstanding, which are trading at $12 per share.
Additionally, it has issued three tranches of stock options to its management to enhance
managerial incentives and reduce agency costs. The first tranche consists of 1.25 million (call)
options with an exercise price of $9. The second tranche consists of 1 million options with an
exercise price of $10. The third tranche consists of 2.25 million options with an exercise price of
$15. Pinder Co accounts for these stock options using the treasury stock method. Pinder Co has
also issued $100 million in convertible bonds with a conversion price of $20. Pinder Co accounts
for this convertible bond using the if-converted method. What is the fully diluted number of
shares outstanding for Pinder Co? (Show all your work. Answer must be handwritten)
Solution
100 + 1.25 + 1 – (1.25*9 + 1*10)/12 + 100/20 = 105.4792 million shares.
Question 22.
Pinder LLC is planning on a leveraged buyout of Value Co. To finance the buyout, Pinder
approaches two banks for conditions on their term loans. Bank A offers Pinder LLC a $4 billion
term loan with a Libor floor of 1% and a spread of 5%. However, the conditions of the loan
prevents Pinder LLC from borrowing additional funds by issuing senior notes. Bank B offers
Pinder LLC a $2 billion term loan with a Libor floor of 1.25% and a spread of 4.50%. The loan
from Bank B does not prevent Pinder LLC from borrowing additional funds by issuing senior
notes. Which option gives Pinder LLC a higher IRR on its investment? Assume that all other
conditions of the buyout are identical to the assumptions in the lecture.
(For this question, the answer does not need to be handwritten. You only need to copy paste the
relevant sensitivity tables containing the entry and exit multiples at 8.0x EBITDA after making
the necessary changes to the template. Make sure the assumptions in the lecture are correctly
inputted in the template – the IRR prior to making changes should be 19.7%.)
Solution
IRR with loan from Bank A
IRR with loan from Bank B
The term loan from Bank A gives a higher IRR
22.9% 7.0x 7.5x 8.0x 8.5x 9.0x
7.0x 30.7% 33.6% 36.3% 38.9% 41.2%
Entry 7.5x 23.2% 26.0% 28.6% 31.0% 33.2%
Multiple 8.0x 17.8% 20.4% 22.9% 25.2% 27.3%
8.5x 13.5% 16.1% 18.4% 20.6% 22.7%
9.0x 10.0% 12.5% 14.8% 16.9% 18.9%
IRR - Assuming Exit in 2017E
Exit Multiple
18.9% 7.0x 7.5x 8.0x 8.5x 9.0x
7.0x 23.3% 25.8% 28.1% 30.3% 32.3%
Entry 7.5x 18.4% 20.8% 23.0% 25.1% 27.0%
Multiple 8.0x 14.4% 16.8% 18.9% 20.9% 22.8%
8.5x 11.2% 13.4% 15.5% 17.4% 19.3%
9.0x 8.4% 10.6% 12.6% 14.5% 16.3%
IRR - Assuming Exit in 2017E
Exit Multiple
Question 23.
Briefly explain why the discounted cash flow (DCF) method allows the analyst to directly assess
the effects of operational improvements and other synergistic efficiencies. (Answer must be
handwritten)
Solution
In a DCF set-up, the analyst can easily modify input variables such as growth (from year to
year), reduction in costs, increase in operational efficiency (margins) etc. and compute the
change in value of the target in the future.
Question 24.
Tasty Pies is expanding its business and wants to open a new facility to make frozen pies, which
requires a new automated pie maker. One such pie maker can be purchased for $300,000.
Alternatively, it can be leased for $52,000 per year for seven years and lease rentals need to be
paid annually in advance. The management informs you that the new pie maker can be fully
depreciated to zero using the straight-line method over four years and that its scrap/residual value
is expected to be $5,000 at the end of the lease. Tasty Pies has estimated that the appropriate
after-tax opportunity cost of capital of the expansion is 19% per annum, and the net present value
of the expansion is expected to $10,000.
Tasty Pies pays tax at the rate of 30% and it can borrow funds at a before-tax rate of 11% per
annum. All cash-flows have been quoted on a before-tax basis. Would you recommend that
Tasty Pies buy or lease the pie maker? What is the incremental wealth associated with your
decision? (Show all your work. Answer must be handwritten)
Solution
Answer:
Question 25.
You are an analyst employed to evaluate a financial lease relating to a piece of machinery. You
are provided with the following information:
Purchase price of machinery $200,000
Useful life of machinery 5 years
Corporate tax rate 30%
Net operating cash flows (before tax)
produced by the machine at the end of each
year
$70,000
Required rate of return from the machine
itself (after tax)
17% p.a.
Cost of debt capital used to purchase the
machine (before tax)
9% p.a.
The company accountant tells you the asset will be fully depreciated over its useful life and will
have zero residual value. You are also told that the machine is integral to a project that
management has already decided the company will proceed with.
What is the maximum lease payment that the company should be willing to pay? (Show all your
work. Answer must be handwritten)
Solution
Question 26.
You are an analyst for a financial services firm that was engaged one month ago to conduct
sensitivity analysis on a new project for a client. Fortunately, the client is an alum of the
University of Melbourne and has asked that the approach taught in Corporate Financial Decision
Making be used. The project involves a contract with a high quality and low risk customer who
has guaranteed that they will pay $60 per unit of the product to your client at the end of each of
each of the eight years of the project’s life. The only uncertainty your client faces is how many
units their customer will purchase (as determined by the quality of your item relative to
competitors) and the variable cost per unit your client faces in producing the product – with most
of that variable cost being taken up by the cost of labour. You collect the following information.
Variable Pessimistic estimate Expected Optimistic estimate
Sales volume
demanded p.a.
40,000 60,000 80,000
Variable cost per unit $55 $40 $35
You also know that the project will require an initial investment of $500,000 at the
commencement of the project and then another investment of $500,000 six months into the
project. The required rate of return from the project is 13% p.a.
Utilising the principles discussed during class, provide a ranking of the variables from most to
least important. (Show all your work. Answer must be handwritten)
