Midterm Exam, Financial Modeling, Spring 2015
Name: _________________________________
Student ID Number: ______________________
Do not start until instructed to do so.
Please use the excel spreadsheet provided to answer each of the following questions. You will need to write
your answers on the exam and submit an excel spreadsheet to me with the filename in the following format:
FINN3103Midterm_Lastname_Firstname
You will have exactly 50 minutes to work on the exam. The exam period will end and exams will be collected
promptly after the allotted time. Please stop working when you are asked to do so.
Do not panic if it seems to you that you are unlikely to get all the answers. As in life, so too with exams – we
don’t have all the answers.
Be mellow. Don’t freak. You are all beautiful. (I have told other classes I have taught that they were beautiful
too, but I did so just to make them feel confident going into the exam. With you guys, I really mean it.)
Version A
PART I:
Use the tab labeled “Part I” on the provided excel spreadsheet to answer the following questions. Before you
begin, enter the following assumptions in the yellow cells:
Unit Sales
Inflation Rate
Real Cost of Capital
Tax Rate
Sales Revenue / Unit
Variable Cost / Unit
Cash Fixed Costs
Investment
5300
1.45%
9.5%
35.0%
$8.15
$6.55
$5,500
$35,250
1. What are the projected unit sales in year 7 if sales are expected to increase by 5% in year 5 and
then fall by 35% in years 6 and 7?
Answer: ___________________
2. Assuming sales revenue per unit, variable cost per unit, and cash fixed costs all increase by the rate
of inflation, what is your projected gross margin in year 7?
Answer: ___________________
3. What is the net present value of this project?
Answer: ___________________
4. In your analysis, you realize that your firm has the option to abandon the project and sell its
specialized equipment at the end of year 7 for $10,000. What is the new NPV of the project?
Answer: ___________________
5. Your boss is apprehensive about your worksheet and your estimation of this project’s NPV. Find
the number of unit sales needed in year one to give you an NPV of zero. Please provide your
answer rounded to the nearest whole number.
Answer: ___________________
PART II:
Use the tab labeled “Part II” on the provided excel spreadsheet to answer the following questions. Before you
begin, enter the following assumptions in the yellow cells:
Required Return on Short-Term Debt
Required Return on Long-Term Debt
Required Return on Equity
Shares Outstanding
Current Stock Price
1.23%
4.68%
13.15%
92.75
50.51
1. What is AGCO’s three-year, average effective tax rate?
Answer: ___________________
2. What is AGCO’s total debt if current liabilities are expected to increase by 18% from 2012 to 2013?
Answer: ___________________
3. What is AGCO’s weighted average cost of capital (WACC) in percentage terms rounded to two decimal
places (i.e., xx.xx%)?
Answer: ___________________
4. Construct a data table showing how AGCO’s WACC changes with changes in its stock price and
changes in its required return on long-term debt. For stock price, go from $40 to $70 in $5 increments.
For required return on debt, go from 4% to 5% in .1% increments.
Answer: ___Construct a Working Data Table in your Excel File________________
5. Now, assuming imperfect markets (and that AGCO could pull this off), tell me how much long-term
debt AGCO would have to issue (if they plan to use the debt to retire their equity) in order to bring
their WACC down to 8.00%?
Answer: ___________________
Part III: Bonus Question (Free-bee! 5 points possible…only the upside!)
From Part II, assuming perfect markets (i.e., no taxes, transactions costs, bankruptcy costs, or other market
frictions), tell me what would happen to AGCO’s WACC if they issued $1 billion in new, long-term debt to
buy-back their equity in a bid to lower their costs of capital? (Hint: think back to our lecture on what determines
a firm’s cost of capital.)
_____________________________________________________________________________________
_____________________________________________________________________________________
_____________________________________________________________________________________
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Part IV:
Gamble Question (Worth +5 points if you’re right and -5 points if you’re wrong…risk and return!)
***You do not have to attempt this problem!***
If you want this question to count towards your grade, you must select the “Yes” checkbox.
□ Yes.
I love risk and would like you to grade this question.
Your boss is not a believer in time value of money (confirming what you have long suspected, he’s less than
capable) so set it aside for a minute. In the example from part one, your boss asks you how many units the firm
will need to sell in the first year to break-even over the entire life of the project. Keeping all else the same (i.e.,
leave all assumptions in place that exist through question 5), please provide an answer for the number of units
you will need to sell in year one in order to break-even based on the total net income over the life of the project.
Units based on Net Income: _______________________
Formula Sheet
TVM:
𝐹𝑉
𝑃𝑉 = (1+𝑖)𝑛 or 𝐹𝑉 = 𝑃𝑉(1 + 𝑖)𝑛
Discount Factor (Rate):
𝐷𝐹 = (1 + 𝑟𝑒𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑐𝑎𝑝𝑖𝑡𝑎𝑙𝑡 ) ∗ (1 + 𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒𝑡 ) − 1
Cumulative Discount Factor:
𝐶𝐷𝐹 = (1 + 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑟𝑎𝑡𝑒𝑡 ) ∗ (1 + 𝐶𝐷𝐹𝑡−1 ) − 1
WACC:
𝑊𝐴𝐶𝐶 = 𝑤𝑑 𝑟𝑑 (1 − 𝑇) + 𝑤𝑝 𝑟𝑝 + 𝑤𝑐 𝑟𝑠
Required return (cost) of Debt:
Equals pre-tax cost of debt times (1-tax rate)
Required return (cost) of Preferred Stock:
𝐷
𝑟𝑝 = 𝑃1 or with floatation costs 𝑟𝑠 = 𝑃
𝐷1
(1−𝐹)
0
0
Required return (cost) of Common Stock (retained earnings):
𝐷
𝑟𝑠 = 𝑃1 + 𝑔
0
Required return (cost) of Common Stock (new issue with floatation costs):
𝐷1
𝑟𝑠 = 𝑃 (1−𝐹)
+𝑔
0
Straight-Line Depreciation:
𝑏𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒−𝑟𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝑣𝑎𝑙𝑢𝑒
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 =
𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑢𝑠𝑒𝑓𝑢𝑙 𝑙𝑖𝑓𝑒
Double-Declining Balance:
2
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑒𝑥𝑝𝑒𝑛𝑠𝑒 = 𝑏𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 ∗ (𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑢𝑠𝑒𝑓𝑢𝑙 𝑙𝑖𝑓𝑒)
Earnings per Share:
𝑛𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒
𝐸𝑃𝑆 = 𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔
Net Present Value:
𝑁𝑃𝑉 = ∑𝑇𝑡=0
𝐶𝐹𝑡
(1+𝑟)𝑡
Internal Rate of Return:
𝑁𝑃𝑉 = 0 = ∑𝑇𝑡=0
or, equivalently, 𝑁𝑃𝑉 = ∑𝑇𝑡=1
𝐶𝐹𝑡
(1+𝐼𝑅𝑅)𝑡
𝐶𝐹𝑡
(1+𝑟)𝑡
− 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
𝐶𝐹
𝑡
or, equivalently, 𝑁𝑃𝑉 = 0 = ∑𝑇𝑡=1 (1+𝐼𝑅𝑅)
𝑡 − 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡