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(FINA399J)[2006](f)midterm~2047^answer_10338.pdf
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Answer Sheet
Hong Kong University of Science and Technology
Finance 399J -L1&L2
Mid-term Exam
Fall 2006

Professor Laura Xiaolei Liu

Section: Lecture _______________________________________
Student Name: _____________________________________________
Student ID Number: ___________________________________________
Instructions:
-This is a one and half hour exam with a total of 60 points.
-Do NOT open this exam paper until you are told to do so.
-This is a closed book examination. No draft paper or notes are allowed.
-Dont tear off any page of this exam paper.
-Honesty and integrity are most essential. You are committed as a student to the

universitys Academic Honor Code. Cheating will lead to serious consequences.
1. Answer true or false for the following statement and give a short explanation for your answers. (5 points)
1a. Value/Sales ratios can never fall below zero, whereas both price/earnings and Value/EBIT ratios can be negative.
True. Total revenue can only be positive and NI and EBIT can be negative.
1b. PE ratio varies with firms expected growth rate but PEG doesnt.
False. PEG also varies with expected growth rate.
1c. Since growth depends on retention ratio, the firm paying no dividend, therefore having retention ratio of 100%, will have the highest value.
False. Growth also depends on ROE. If ROE is lower than discount rate, more investment will not increase value.
1d. The free cash flow to equity will always be lower than the free cash flow to the firm.
False. Free cash flow to equity may be high if firms are issuing debt.
1e. V/EBIT ratio will always be higher than P/E ratio.
False. EBIT can be higher or lower than E, and V will be higher than P. So it is not necessary that V/EBIT is higher than P/E.
2. In late 90s, Dell Computers current price to earnings (PE) ratio is 20, which is at its
industry average. However, Dells market-to-book value of equity ratio (M/B) is 13.86,
which is much higher than the industry M/B ratio, 10.5.
Can you explain why this may happen? (5 points)

M/B=PE*ROE. The higher MB ratio of Dell is because it has higher ROE than other firms in the same industry.
3. Krisyy Kreme Donuts is a fast growing donut store chain that is seeking to topple Dunkin Donuts as the top snackfood store in the U.S. Its dividend payout ratio is 30% in the past and the managers claim that they will maintain the same payout ratio in future. Answer the following questions.
3a. Krispy Kremes stock closed yesterday at price of $30.10 per share. Analysts
predict earnings per share for Krispy Kreme to be $2.9 next year. Analysts also
predict that earnings will grow at a rate of 30% per year from now on.
What is the implied discount rate (cost of equity capital) based on analysts forecast?
(5 points)

Growing Perpetuity Formula: D/(r-g) Therefore, r= E*Payout /P+g = (2.9*30%)/30.10 + 30% = 32.89%
3b. If you believe that the cost of equity cap