Corporate Finance Harvard Case Solution & Analysis

Corporate Finance Case Study Solution 

Section 1: Multiple Choice (30 questions)

Select the best alternative for each of the multiple choice questions, and fill in your choice in the following table.

Note: 5 marks will be deducted if your answers are not filled in the table below. You do not need to include the questions in your submitted assignment (we’d rather you didn’t, actually), but you must include this table, completed with your answers, in your submitted assignment.

1. Which of the following statements regarding limited partnerships is true?
2. A) There is no limit on a limited partner's liability.
3. B) A limited partner's liability is limited by the amount of his investment.
4. C) A limited partner is not liable until all of the assets of the general partners have been exhausted.
5. D) A general partner's liability is limited by the amount of his investment.
6. If shareholders are unhappy with a CEO's performance, they are most likely to
7. A) buy more shares in an effort to gain control of the firm.
8. B) file a shareholder resolution.
9. C) replace the CEO through a grassroots shareholder uprising.
10. D) sell their shares.
11. By comparing a firm's current assets and current liabilities, one can assess whether the firm has sufficient ________ to meet its ________ needs.
12. A) long-term capital; short-term
13. B) working capital; short-term
14. C) working capital; long-term
15. D) marketable securities; long-term
16. Management is also required to disclose any ________, which are transactions or arrangements that can have a material impact on the firms future performance yet to do not appear on the ________.
17. A) earnings per share; income statement
18. B) investment decision; statement of cash flows
19. C) financing decision; statement of cash flows
20. D) off-balance sheet transactions; balance sheet
21. Consider the following oil prices.

Alaska North Slope Crude Oil (ANS)

$71.75/Bbl

West Texas Intermediate Crude Oil (WTI)

$73.06/Bbl

As an oil refiner, you are able to produce $76 worth of unleaded gasoline from one barrel of Alaska North Slope (ANS) crude oil.  Because of its lower sulfur content, you can produce $77 worth of unleaded gasoline from one barrel of West Texas Intermediate (WTI) crude.

Assuming you currently have 10,000 Bbls of WTI crude, the added benefit (cost) to you if you were to sell the 10,000 Bbls of WTI crude and use the proceeds to purchase and refine ANS crude is closest to:

1. A) ($1,400)
2. B) $1,400
3. C) ($3,908)
4. D) $3,908
5. Consider the following cash flows:  

If the risk-free interest rate is 10%, then of the four projects listed, if could only invest in two of these projects, which two projects would you select?

1. A) Minie & Eenie
2. B) Minie & Meenie
3. C) Eenie & Moe
4. D) Eenie & Meenie
5. Consider the following timeline detailing a stream of cash flows:

If the current market rate of interest is 10%, then the present value of this stream of cash flows is closest to:

1. A) $674
2. B) $600
3. C) $460
4. D) $287
5. Since your first birthday, your grandparents have been depositing $1,000 into a savings account on every one of your birthdays. The account pays 4% interest annually. Immediately after your grandparents make the deposit on your 18th birthday, the amount of money in your savings account will be closest to:
6. A) $25,645
7. B) $36,465
8. C) $12,659
9. D) $18,000

Consider the following investment alternatives:

Which alternative offers you the lowest effective rate of return?

1. A) Investment A
2. B) Investment B
3. C) Investment C
4. D) Investment D
5. The term structure of interest rates predicts that long-term interest rates will exceed short-term interest rates, resulting in an upward sloping yield curve. If Central Banks were to intervene in the financial market to "flatten" the shape of the yield curve, they would attempt this by
6. A) purchasing long-term bonds.
7. B) selling long-term bonds.
8. C) purchasing short-term bonds.
9. D) selling short-term bonds.
10. The Sisyphean Company has a bond outstanding with a face value of $1,000 that reaches maturity in 15 years. The bond certificate indicates that the stated coupon rate for this bond is 8% and that the coupon payments are to be made semi-annually.

Assuming the appropriate YTM on the Sisyphean bond is 9%, then this bond will trade at

1. A) a premium.
2. B) a discount.
3. C) par.
4. D) none of the above
5. Consider the following four bonds that pay annual coupons:

The percentage change in the price of the bond "C" if its yield to maturity increases from 9% to 10% is closest to:

1. A) -17%
2. B) -6%
3. C) -4%
4. D) 4%
5. JRN Enterprises just announced that it plans to cut its dividend from $2.50 to $1.50 per share and use the extra funds to expand its operations. Prior to this announcement, JRN's dividends were expected to grow at 4% per year and JRN's stock was trading at $25.00 per share. With the new expansion, JRN's dividends are expected to grow at 8% per year indefinitely. Assuming that JRN's risk is unchanged by the expansion, the value of a share of JRN after the announcement is closest to:
6. A) $25.00
7. B) $15.00
8. C) $31.25
9. D) $27.50
10. Defenestration Industries plans to pay a $4.00 dividend this year and you expect that the firm's earnings are on track to grow at 5% per year for the foreseeable future. Defenestration's equity cost of capital is 13%.

Suppose that Defenestration decides to pay a dividend of only $2 per share this year and use the remaining $2 per share to repurchase stock. If Defenestration's payout rate remains constant, then Defenestration's stock price is closest to:

50. A) $50.00
51. B) $22.25
52. C) $32.30
53. D) $30.75
54. Consider the following two projects:

The NPV for project Beta is closest to:

24. A) $24.01
25. B) $16.92
26. C) $20.96
27. D) $14.41
28. Boulderado has come up with a new composite snowboard. Development will take Boulderado four years and cost $250,000 per year, with the first of the four equal investments payable today upon acceptance of the project. Once in production the snowboard is expected to produce annual cash flows of $200,000 each year for 10 years.  Boulderado's discount rate is 10%.

The IRR for Boulderado's snowboard project is closest to:

10. A) 10.4%
11. B) 10.0%
12. C) 11.0%
13. D) 15.1%
14. The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30,000 and the machine will be depreciated straight line over its three-year life to a residual value of $0.

The cane manufacturing machine will result in sales of 2,000 canes in year 1.  Sales are estimated to grow by 10% per year each year through year three.  The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant.  The canes have a cost per unit to manufacture of $9 each.

Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts.  It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable.  The firm is in the 35% tax bracket, and has a cost of capital of 10%.

The incremental unlevered net income in the first year for the Sisyphean Corporation's project is closest to:

1. A) $8,000
2. B) $18,000
3. C) $5,200D) $11,700
4. You are considering adding a microbrewery onto one of your firm's existing restaurants. This will entail an investment of $40,000 in new equipment. This equipment will be depreciated straight line over five years. If your firm's marginal corporate tax rate is 35%, then what is the value of the micro brewery's depreciation tax shield in the first year of operation?
5. A) $2,800
6. B) $14,000
7. C) $5,200
8. D) $26,000
9. Consider the following probability distribution of returns for Alpha Corporation:  

The standard deviation of the return on Alpha Corporation is closest to:

22. A) 22.4%
23. B) 19.0%
24. C) 21.8%
25. D) 19.4%
26. Suppose that in the coming year, you expect Exxon-Mobil stock to have a volatility of 42% and a beta of 0.9, and Merck's stock to have a volatility of 24% and a beta of 1.1. The risk free interest rate is 4% and the market's expected return is 12%.

The cost of capital for a project with the same beta as Merck's stock is closest to:

11. A) 11.2%
12. B) 12.8%
13. C) 12.4%
14. D) 11.6%
15. Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT) at $50 per share, 200 shares of Lowes (LOW) at $30 per share, and 100 shares of Ball Corporation (BLL) at $40 per share.

Suppose over the next year Ball has a return of 12.5%, Lowes has a return of 20%, and Abbott Labs has a return of -10%. The weight of Abbott Labs in your portfolio after one year is closest to:

10. A) -10.0%
11. B) 43.5%
12. C) 45.0%
13. D) 50.0%
14. Consider an equally weighted portfolio that contains 20 stocks. If the average variance of these stocks is 35% and the average correlation between the stocks is .4, then the volatility of this equally weighted portfolio is closest to:
15. A) .17
16. B) .41
17. C) .14
18. D) .37
19. Which of the following statements is false?
20. A) When an investor chooses her optimal portfolio, she will do so by finding the tangent line using the risk-free rate that corresponds to her investment horizon.
21. B) If the market portfolio is not efficient, savvy investors who recognize that the market portfolio is not optimal will push prices and expected returns back into balance.
22. C) Even though different investors may research different stocks, their information will not impact the market portfolio since there is no way to share this information with other investors.
23. D) In the real world borrowers pay higher interest rates than savers receive.
24. Consider the following three individuals' portfolios consisting of investments in four stocks:

The beta on Peter's portfolio is closest to:

1. A) 0.7
2. B) 0.8
3. C) 1.8
4. D) 1.0
5. Consider the following graph of the security market line:

Which of the following statements regarding portfolio "B" is/are correct?

1. Portfolio "B" has a positive alpha.
2. Portfolio "B" is overpriced.
3. Portfolio "B" is less risky than the market portfolio.
4. Portfolio "B" should not exist if the market portfolio is efficient.
5. A) 2 and 4
6. B) 4 only
7. C) 1, 3, and 4
8. D) 1 and 4
9. Investors can ________ without reducing their expected return.
10. A) take more risk
11. B) eliminate risk
12. C) take the same risk
13. D) reduce risk
14. Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is 5%.

Corporate Finance Harvard Case Solution & Analysis

Suppose that to raise the funds for the initial investment the firm borrows $40,000 at the risk free rate and issues new equity to cover the remainder. In this situation, the cost of capital for the firm's levered equity is closest to:

1. A) 23%
2. B) 25%
3. C) 15%
4. D) 18%
5. You are evaluating a new project and need an estimate for your project's beta. You have identified the following information about three firms with comparable projects:......................

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