Corporate Financial Policy

Instructions: Answer all 7 Questions.

1. (15 Points) Compare and contrast the free cash flow to the firm (FCF) and equity free cash flow (EFCF) approaches to valuation.

2. (15 Points) Explainwhy net debt is used in weighted average cost of capital calculations. What are the implications if a company has a negative net debt?

3. (10 Points) Explain the concepts of duration and modified duration.

4. (15 Points) Compare and contrast the three tools used to deal with uncertainty in discounted cash flow analysis: scenario analysis, break-even analysis, and simulation.

5. (15 Points) Explain the problem of using a firm-wide weighted average cost of capital for individual projects. Explain how you would estimate the discount rate for these projects.

6. (10 Points) Explain the concept of Value-at-Risk (VaR). Explain how VaR is calculated.

7. (20 points) In December 1995 Boise Cascade’s stock had a beta of 0.95. The Treasury bill rate at the time was 5.8% and the Treasury bond rate was 6.4% The firm had debt outstanding of $1.7 billion and a market value of equity of $1.5 billion; the corporate tax rate was 36%; the market risk premium is 5.5%
a. Estimate the cost of equity in the company.
b. Estimate the firm’s unlevered beta.
c. Assume the term structure of interest gives a 200 bp (basis point – a basis point is 1/100 of a %) spread between Treasury securities and the yield on debt with the same rating as Boise Cascade. Calculate the firm’s WACC.
d. Assume Boise Cascade’s debt has a duration of 5.0. If Treasury rates rise to 6.3% and 6.9%, respectively and there is a parallel shift in the corporate debt term structure, estimate:
i. The change in the market value of Boise’s debt.
ii. The change in the company’s cost of equity
iii. The change in the firm’s WACC.