Stock and Corporate Tax Rate Essay

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FINA 395: Theory of Finance II
Final Examination

Instructor: Nilanjan Basu

Instructions:
Make sure that you submit the question sheet and the formula sheet with your exam.
You are allowed 1sheet (both sides) of letter / A4 sized paper for your formulas. Before the start of the exam you should have your name and student ID number on this sheet. You have to return this sheet with the exam.
Write your name and student ID in at least one place on the question sheet. Return the question sheet with your exam.
You are allowed to use a scientific / financial calculator. If the calculator is programmable, the memory should be cleared prior to the exam. You are not allowed to save any stored text in the calculator memory.
There will be partial credit for some of the problems in Section B. You must show the details of your calculations / reasoning to receive such partial credit.
Answer all questions on the answer sheet – this includes any multiple choice questions as well.
Read the questions carefully and budget your time carefully.
There could be a penalty of up to 20% for a failure to turn in your formula sheet or the question sheet. Please ensure that these are turned in with the exam.
Good luck!

Section A: Answer all questions. Total 42 points – each question in this section carries 3.5 points. Write the responses to ALL questions in your answer sheet.

1. A corporation has 2000 shares outstanding and 6 directors are up for election. The stock features cumulative voting. About how many shares do you have to own to guarantee electing at least yourself to one position on the board of directors (ignoring possible ties)? A) 1000. B) 333. C) 286. D) 1715. E) 343.

2. The written agreement between a corporation and its bondholders might contain a prohibition against paying dividends in excess of current earnings. This prohibition is an example of a(n):
A) maintenance of security provision.
B) collateral restriction.
C) affirmative indenture.
D) restrictive covenant.
E) none of the above.

3. Ignore time value and discounting for this question. If the marginal investor has a tax rate of 33% and a company has announced a dividend of $3.00:
A) the price of stock should decrease by $2.00 immediately after the date of record.
B) the price of stock should decrease by $2.00 immediately after the ex-dividend date.
C) the price of stock should decrease by $4.48 immediately after the date of record.
D) the price of stock should decrease by $4.48 immediately after the ex-dividend date.
E) both b & c.

4. Corporations pay no income taxes. Investors pay no taxes on capital gains, but they pay a 28% income tax on dividends (Applied to ALL investors). Two corporations have exactly the same risk, and both have a current stock price of $100. Corporation A pays no dividend and will have a price of $110 one year from now. Corporation B pays dividends and will have a price of $105 one year from now after payment of a dividend. What is the value of the dividend that investors expect Corporation B to pay?
A) $4.54.
B) $5.00.
C) $5.50.
D) $6.94.
E) It is impossible to calculate the expected dividend.
5. Given the following information, leverage will add how much value to the unlevered firm per dollar of debt?
Corporate tax rate: 34%
Personal tax rate on income from bonds: 0%
Personal tax rate on income from stocks: 0%
A) $0.66.
B) $0.34.
C) -$0.66.
D) -$0.34.
E) None of the above

6. Homemade leverage is a term used to describe:
A) a firm borrowing at the risk-free rate.
B) a firm skipping a dividend payment.
C) individuals borrowing on their own account to buy shares in an unlevered firm.
D) individuals lending on their own account to sell shares in a levered firm.
E) both a and b.

7. The key intuition of a Z-score model like Altman's is:
A) that only publicly traded firms can be evaluated.
B) that one will be just as well off by guessing on default rates.
C) that all corporations will default at
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