Exam 19: Financing and Valuation

Consider the following data: FCF₁ = $7 million; FCF₂ = $45 million; FCF₃ = $55 million. Assume that free cash flow grows at a rate of 4 percent for year 4 and beyond. If the weighted average cost of capital is 10 percent, calculate the value of the firm.

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Question 1

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Briefly explain how the firm's equity beta changes with changes in its debt-equity ratio when taxes are considered.

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Question 2

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The equity beta of a firm increases linearly with changes in the debt-equity ratio. The formula for relevering beta closely resembles MM's Proposition II, except that betas are substituted for rates of return: b_E = b_A +(b_A − b_D)(D/E).

"Urban renewal can be assisted by the provision of government tax and loan incentives to businesses, despite the existence of negative NPV projects." Explain why this may be true.

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Question 3

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Investments may have a negative NPV in the absence of other incentives. When the government provides a financial incentive, in the form of subsidies, tax breaks, or low interest loans, the APV of the project may increase. If the increase is enough, the NPV may become positive and the firm might make a governmental-favored investment. This may lead to economic development in areas that would not otherwise receive investments. The risk, however, is that the eventual elimination of the incentives may cause urban blight to return. In this case, the government granting the subsidy may have had better uses for the money consumed by the subsidy.

Under which circumstances would it be better to use the adjusted present value approach versus the WACC approach?

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Question 4

Generally, APV is not suitable for international projects.

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Question 5

Mirion Tech, Inc., has r_E of 12%, an r_D of 6%, at a debt-equity ratio of 0.50. Mirion plans to raise enough preferred stock to retire half of their outstanding common stock, which currently has a market value of $7 million. If the preferred stock has an expected rate of return of 10%, what is the new WACC? (Assume a 21% marginal corporate tax rate and that r_D remains at 6%.)

(Multiple Choice)

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Question 6

Briefly explain how WACC can be used for valuing a business.

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Question 7

When calculating the WACC for a firm, one should use the book values of debt and equity.

(True/False)

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Question 8

The computation of a firm's WACC does not change after it issues preferred stock.

(True/False)

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Question 9

The WACC formula calculates the cost of capital for the "average risk" project.

(True/False)

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Question 10

The market value of short-term debt is very close to the book value of debt for healthy firms.

(True/False)

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Question 11

Mirion, Inc., has a debt-equity ratio of 50 percent, with no preferred stock. However, Mirion now plans to raise enough preferred stock to retire half of its outstanding common stock. Its common equity is currently valued at $7 million. Which of the following choices displays Mirion's market value capital structure, in market values (i.e., V = D + P +E), after the preferred stock issue?

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Question 12

Briefly explain how APV can be used for valuing a business.

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Question 13

Given are the following data for Vinyard Corporation: Calculate the proportions of debt (D/V)and equity (E/V)that you would use for estimating Vinyard's weighted average cost of capital (WACC).

(Multiple Choice)

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Question 14

Capital budgeting projects that incorporate both investment and financing decision side effects can be properly analyzed by: I.adjusting the project's present value (APV); II.adjusting the project's discount rate (WACC); III.relying only on MM Propositions I and II

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Question 15

The Granite Paving Company is all-equity financed and has the following free cash flows in years 1−4: $3 million ($3M); $3.7M; $4M; $4.2M. After year 4, the firm is expected to grow at a sustainable rate of 3 percent per annum. With a WACC of 12 percent, what is the horizon value in year 4 of Granite Paving Co?

(Multiple Choice)

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Question 16

Given are the following data for Outsource Company: PV (of FCFs for years 1-3)= $35 million; PV (horizon value)= $65 million. Suppose that the market value of the debt = $30 million. Calculate the total market value of equity of the firm.

(Multiple Choice)

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Question 17

The 1-year bonds of Casino, Inc., have a 12 percent coupon rate and trade in the market at a yield of 14 percent. There is a 5 percent chance that Casino will default and pay nothing. What cost of debt should be used in Casino's WACC?

(Multiple Choice)

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Question 18

If expected long-term growth is constant, the firm's horizon value at period H is given by PVH = (FCF_H_{+ 1})/(WACC − g).

(True/False)

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Question 19

Which of the following is an important assumption required if using the WACC formula?

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Question 20

Showing 1 - 20 of 83

Exam 19: Financing and Valuation

Consider the following data: FCF1 = $7 million; FCF2 = $45 million; FCF3 = $55 million. Assume that free cash flow grows at a rate of 4 percent for year 4 and beyond. If the weighted average cost of capital is 10 percent, calculate the value of the firm.

Briefly explain how the firm's equity beta changes with changes in its debt-equity ratio when taxes are considered.

"Urban renewal can be assisted by the provision of government tax and loan incentives to businesses, despite the existence of negative NPV projects." Explain why this may be true.

Under which circumstances would it be better to use the adjusted present value approach versus the WACC approach?

Generally, APV is not suitable for international projects.

Briefly explain how WACC can be used for valuing a business.

When calculating the WACC for a firm, one should use the book values of debt and equity.

The computation of a firm's WACC does not change after it issues preferred stock.

The WACC formula calculates the cost of capital for the "average risk" project.

The market value of short-term debt is very close to the book value of debt for healthy firms.

Briefly explain how APV can be used for valuing a business.

Given are the following data for Vinyard Corporation: Calculate the proportions of debt (D/V)and equity (E/V)that you would use for estimating Vinyard's weighted average cost of capital (WACC).

Capital budgeting projects that incorporate both investment and financing decision side effects can be properly analyzed by: I.adjusting the project's present value (APV); II.adjusting the project's discount rate (WACC); III.relying only on MM Propositions I and II

Given are the following data for Outsource Company: PV (of FCFs for years 1-3)= $35 million; PV (horizon value)= $65 million. Suppose that the market value of the debt = $30 million. Calculate the total market value of equity of the firm.

The 1-year bonds of Casino, Inc., have a 12 percent coupon rate and trade in the market at a yield of 14 percent. There is a 5 percent chance that Casino will default and pay nothing. What cost of debt should be used in Casino's WACC?

If expected long-term growth is constant, the firm's horizon value at period H is given by PVH = (FCFH + 1)/(WACC − g).

Which of the following is an important assumption required if using the WACC formula?

Introduction to Corporate Finance

How to Calculate Present Values

Valuing Bonds

The Value of Common Stocks

Net Present Value and Other Investment Criteria

Making Investment Decisions With the Net Present Value Rule

Introduction to Risk and Return

Portfolio Theory and the Capital Asset Pricing Model

Risk and the Cost of Capital

Project Analysis

How to Ensure That Projects Truly Have Positive Npvs

Agency Problems and Investment

Efficient Markets and Behavioral Finance

An Overview of Corporate Financing

How Corporations Issue Securities

Payout Policy

Does Debt Policy Matter

How Much Should a Corporation Borrow

Understanding Options

Valuing Options

Real Options

Credit Risk and the Value of Corporate Debt

The Many Different Kinds of Debt

Leasing

Managing Risk

Managing International Risks

Financial Analysis

Financial Planning

Working Capital Management

Mergers

Corporate Restructuring

Governance and Corporate Control Around the World

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Consider the following data: FCF₁ = $7 million; FCF₂ = $45 million; FCF₃ = $55 million. Assume that free cash flow grows at a rate of 4 percent for year 4 and beyond. If the weighted average cost of capital is 10 percent, calculate the value of the firm.

If expected long-term growth is constant, the firm's horizon value at period H is given by PVH = (FCF_H_{+ 1})/(WACC − g).