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Exam#060590 Corporate Finance Part A: Answer each of the following questions in one to three sentences, and perform calculations as requested. The following table summarizes a portion of U.S. federal corporate tax rates for the 2007 tax year. Explain whether corporate tax rates are progressive, regressive, of flat. Use a very simple example from the table to make your position and explanation clear. Taxable Income More than Taxable Income Less than Tax Rate $0 $50,000 15% $50,001 $75,000 25% $75,001 $100,000 34% Recall that the net present value (NPV) and internal rate or return (IRR) techniques take the time value of money into consideration. Compare and contrast these two techniques, focusing on IRR when the NPV is positive, zero and negative. Be sure to include a discussion of NPV discount rate in your response. Recall that the security market line (SML) illustrates the relationship between systematic risk and expected returns. Perhaps the most famous and practical application of the SML is the capital asset pricing model (CAPM), as follows: E(R1) = RF + [E(RM) – RF] X ?i Define each of the variables or terms in this equation. Calculate the E(Ri), assuming that E(RM) equals 12% Rf equals 6% and ?i equals 1.2. Describe the differences between an ordinary annuity, an annuity due, and perpetuity. Assume that a project has a negative net present value (NPV) of $500 and an internal rate or return (IRR) of 10%. Is the discount rate used to calculate the NPV higher than, lower than, or equal to 10%? Compare and contrast these two techniques, using this example, and focusing on IRR when the NPV is positive, zero and negative. Part B: Answer each of the following questions in a composition of 1-2 paragraphs, or perform calculations as requested. Each answer is worth 20 points. Explain the concept of venture capital. Include a definition of the term venture capital, describe who will need to obtain venture capital financing, and explain the type of return that’s required from a venture capital firm. In a typical loan amortization, the principal component of a fixed payment increases and the interest component decreases with each payment. The following figure illustrates this relation for a hypothetical 30-year mortgage. Interest Component Of payment Principal Component Of payment Assume that someone borrows $5,000 at an interest rate of 9 percent per year for five years, and agrees to make interest and principal payments in the amount of $1,285.46 at the end of each year. Prepare a loan amortization schedule for each of the five years, showing the beginning principal balance, the total payment of $1,285.46, the interest component of the payment, the principal component of the payment, and the ending principal balance. Fill in the blank spaces in the following framework to complete your answer: LOAN AMORTIZATION SCHEDULE For a Loan of $5,000 at 9% interest, Over 5 years Year Beginning Balance Total Payment Interest Paid Principal Paid Ending Balance 1 $50,000 $1,285.46 ? ? ? 2 ? $1,285.46 ? ? ? 3 ? $1,285.46 ? ? ? 4 ? $1,285.46 ? ? ? 5 ? $1,285.46 ? ? ? 6427.30 ? $50,000 ? The weighted average cost of capital (WACC) can be related to the basic accounting equation, as follows: A = L + OE Compare and contrast the WACC to this basic accounting equation. Does the WACC contain a profit component? How does the WACC relate to the discount rate used in a net present value (NPV) computation, using a case where NPV equals zero to make your point?

Exam#060590

Corporate Finance

Part A: Answer each of the following questions in one to three sentences, and perform calculations as requested.

    1. The following table summarizes a portion of U.S. federal corporate tax rates for the 2007 tax year. Explain whether corporate tax rates are progressive, regressive, of flat. Use a very simple example from the table to make your position and explanation clear.
Taxable Income More than Taxable Income Less than Tax Rate
$0 $50,000 15%
$50,001 $75,000 25%
$75,001 $100,000 34%
    1. Recall that the net present value (NPV) and internal rate or return (IRR) techniques take the time value of money into consideration. Compare and contrast these two techniques, focusing on IRR when the NPV is positive, zero and negative. Be sure to include a discussion of NPV discount rate in your response.

 

    1. Recall that the security market line (SML) illustrates the relationship between systematic risk and expected returns. Perhaps the most famous and practical application of the SML is the capital asset pricing model (CAPM), as follows:

E(R1) = RF + [E(RM) – RF] X ?i

    1. Define each of the variables or terms in this equation.

 

    1. Calculate the E(Ri), assuming that E(RM) equals 12% Rf equals 6% and ?i equals 1.2.
    1. Describe the differences between an ordinary annuity, an annuity due, and perpetuity.

 

    1. Assume that a project has a negative net present value (NPV) of $500 and an internal rate or return (IRR) of 10%. Is the discount rate used to calculate the NPV higher than, lower than, or equal to 10%? Compare and contrast these two techniques, using this example, and focusing on IRR when the NPV is positive, zero and negative.

Part B: Answer each of the following questions in a composition of 1-2 paragraphs, or perform calculations as requested. Each answer is worth 20 points.

    1. Explain the concept of venture capital. Include a definition of the term venture capital, describe who will need to obtain venture capital financing, and explain the type of return that’s required from a venture capital firm.

 

    1. In a typical loan amortization, the principal component of a fixed payment increases and the interest component decreases with each payment. The following figure illustrates this relation for a hypothetical 30-year mortgage.
Interest

Component

Of payment

Principal

Component

Of payment

 

Assume that someone borrows $5,000 at an interest rate of 9 percent per year for five years, and agrees to make interest and principal payments in the amount of $1,285.46 at the end of each year. Prepare a loan amortization schedule for each of the five years, showing the beginning principal balance, the total payment of $1,285.46, the interest component of the payment, the principal component of the payment, and the ending principal balance. Fill in the blank spaces in the following framework to complete your answer:

LOAN AMORTIZATION SCHEDULE
For a Loan of $5,000 at 9% interest, Over 5 years
Year Beginning Balance Total Payment Interest Paid Principal Paid Ending Balance
1 $50,000 $1,285.46 ? ? ?
2 ? $1,285.46 ? ? ?
3 ? $1,285.46 ? ? ?
4 ? $1,285.46 ? ? ?
5 ? $1,285.46 ? ? ?
6427.30 ? $50,000 ?
    1. The weighted average cost of capital (WACC) can be related to the basic accounting equation, as follows:

A = L + OE

Compare and contrast the WACC to this basic accounting equation. Does the WACC contain a profit component? How does the WACC relate to the discount rate used in a net present value (NPV) computation, using a case where NPV equals zero to make your point?

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