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Series of Finance Questions

1. Bon Corp. has net operating assets measured at fair market value in the balance sheet of $1,000,000 on 12/31/2010 and an after tax income reported from those assets in the income statement for 2011 of $200,000. The required return on operating asset is 15%. Did Bon earn a residual operating income on its net operating assets (and if so how much)?

2. Bon Corp. has net financial obligations measured at fair market value in the balance sheet of $400,000 on 12/31/2010 and an after tax expense reported from those liabilities in the income statement for 2011 of $40,000. The required return on debt is 10%. Did Bon earn a residual operating income or loss on its financial obligations (and if so how much)?

3. Bon Corp. has common stockholder's equity in the balance sheet of $600,000 on 12/31/2010 and an after tax comprehensive income in the income statement (balance sheet) for 2011 of $160,000. The required return on stockholder's equity is 18.333%. Did Bon earn a residual operating income or loss on stockholder's equity (and if so how much)?

4. Con Corp. has a cost of equity of 12%, and an after tax cost of debt of 8%. Using market values Con's debt is 40% of the value of the firm and Con's equity is 60% of the value of the firm. What is Con Corp. weighted average cost of capital?

5. Don Corp. can borrow at 10% and is has a 35% marginal tax rate. What is Don's after tax cost of debt?

6. Fon Corporation has a beta of 1.25 the risk free rate is expected to be 4.5% and the market risk premium is expected to be 6%. Using the Capital Asset Pricing Model (on page 112 in the textbook), what is Fon's after tax cost of equity?

7. Why is it not necessary to adjust for taxes in question 6 (like we did in question 5)?

8. what drives the risk of the company the equity or the operations?

9. Dell has a cost of equity capital of 11.3% and a cost of capital for operations of 13.7%. While General Mills has a cost of equity capital of 6.3% and a cost of capital for operations of 5.8%. What accounts for equity cost of capital being lower than the operations cost of capital for Dell (and the reverse for General Mills)?

10. Leverage does not drive the risk of the company, but it can magnify or demagnify the risk overall risk. How can leverage (or reverse leverage) demagnify the risk of the company? In other word what is reverse leverage.

11. The larger the spread between RNOA and net borrowing cost the (larger, smaller, no effect) the benefits of leverage.

12. Levered price-to-book ratios are always higher than unlevered price-to-book ratios. Is this correct?

13. Management ties employee bonuses to return on common equity. They then repurchase some of the firm's outstanding shares. What is the effect of this transaction on shareholders' wealth?

14. Over the 1963 to 2003 period, were levered price to book ratios typically higher or lower than unlevered price to book ratios?

15. Please fill in the missing data below:

Summary Income Statement, 2009
Operating income $ 1,500
Interest expense $ 400
Net income $ 1,100

Summary Balance Sheet 12/31/2008
Net operating assets $ 10,000
Financing debt $ 4,000
Common equity $ 6,000

Required return on equity 14.0%
Required return for operations 11.6%
Required return for debt 8.0%

Net income $ 1,100
Required return for equity $ ???
Residual earnings $ ???

Operating income $ 1,500
Required return for operations $ ???
Residual operating income $ ???

Interest expense $ 400
Required return for debt $ ???
Residual operating income $ ???

Solution Preview

** Please see the attached file for the complete solution response **

Hi,

Answer:
1. Given that,
Net Operating Asset=$1,000,000
NOPAT=$200,000
Required rate of return, k=15%
We have,
(please see the attached file)

2. Given that,
Net obligations=$400,000
After tax expense from liabilities=$40,000
Required return on debt=10%
We have,
(please see the attached file)

No, Bon cop did not earn any residual income or loss.

3. Given that,
Common shareholder's equity=$600,000
After tax comprehensive income=$40,000
Required rate of return on shareholder's equity=18.333%
We have,
(please see the attached file)

4. Given that,
Cost of equity, ke=12%
After tax cost of equity, kd=8%
Weight of debt, Wd=40%
Weight of equity, We=60%
We have,
(please see the attached file)

5. Given that,
Cost of borrowing, kd=10%
Tax rate, T=35%
We have,
(please see the attached file)

6. Given that,
Beta, ...

Solution Summary

This solution provides detailed answers to the given list of financial questions.

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