The Chinese University of Hong Kong
CUHK Business School
FINA3070 Corporate Finance: Theory and Practice
First Term 2014 – 2015
Name:
Student ID:
Lecture:

FINA 3070A (Wed) / FINA 3070B (Tue)

DO NOT TAKE AWAY
Midterm Quiz (Two Hours Closed Book)
24 October 2014 (Friday), 6:45 pm – 8:45 pm
Instructions:
1. Please answer all questions in the answer book.

Any answers written on this

question paper will not be graded.

2. There are 4 questions and the total mark of this midterm is 90.

3. You are allowed to bring ONE A4 formula sheet.

1

Question 1 (25 Marks)
(a) In a world with no taxes, no transaction costs, and no costs of financial distress, is the following statement true, false, or uncertain? If a firm issues equity to repurchase some of its debt, the price per share of the firm’s stock will rise because the shares are less risky. Explain. (10 marks)
(b) Do you agree or disagree with the following statement? A firm’s shareholders will never want the firm to invest in projects with negative net present values.
Why? (10 marks)
(c) When managers are better informed than outside investors, the pecking order theory predicts that there would be a price drop at equity issue announcement.
How would you suggest the managers to minimize the adverse effect if they must issue equity? (5 marks)

2

Question 2 (30 Marks)
Jason is the CEO of CU Café. Jason is considering opening a new café. He has examined the potential for the company’s expansion and determined that the success of the new café will depend critically on the state of the economy over the next few years. CU Café has a bond issue outstanding with a face value of $25 million that is due in one year. Covenants associated with this bond issue prohibit the issuance of any additional debt. The restriction means that the expansion will be entirely financed with equity