Exam 19: Financing and Valuation

Given are the following data: Cost of debt = r_D = 6.0%; Cost of equity = r_E = 12.1%; Marginal tax rate = 21%; and the firm has 50 percent debt and 50 percent equity. Calculate the after-tax weighted average cost of capital (WACC).

The flow-to-equity method uses: I.cash flows to equity, after interest and after taxes; II.the cost of equity capital as the discount rate; III.the weighted average cost of capital for discount rate; IV.after-tax cash flows without considering interest and dividend payments

The Miles-Ezzell formula for the adjusted cost of capital assumes that

The MM formula for the adjusted cost of capital takes into consideration only the effect of the interest tax shield on permanent debt.

The APV method includes the NPV of a project assuming all-equity financing and then adds in the NPV of financing effects. The financing effects are

A project costs $7 million and is expected to produce cash flows of $2 million per year for 10 years. The opportunity cost of capital is 16 percent. If the firm has to issue stock to undertake the project and issue costs are $0.5 million, what is the project's APV?

In the case of large international investments, the project might include I.custom-tailored project financing; II.special contracts with suppliers; III.special contracts with customers; IV.special arrangements with governments

The APV method can be used for valuing entire businesses.

Discuss the advantages and limitations of using the weighted average cost of capital as a discount rate to evaluate capital budgeting projects.

Given are the following data for year 1: Profit after taxes = $5 million; Depreciation = $2 million; Investment in fixed assets = $4 million; Investment net working capital = $1 million. Calculate the free cash flow (FCF)for year 1.

Enterprise zone subsidies, a government program that provides financial incentives to make investments in a specific location, increase APV.

The flow to equity method provides an accurate estimate of the value of a firm if

Generally, the imposition of government restrictions increases the APV of a project.

When using the weighted average cost of capital (WACC)to discount cash flows from a project, we assume the following: I.The project's risks are the same as those of the firm's other assets and remain so for the life of the project. II.The project supports the same fraction of debt to value as the firm's overall capital structure, and that fraction remains constant for the life of the project. III.The cash flows from the project occur in perpetuity.

A project costs $14 million and is expected to produce cash flows of $4 million per year for 15 years. The opportunity cost of capital is 20 percent. If the firm has to issue stock to undertake the project and issue costs are $1 million, what is the project's APV?

Consider the following data: FCF₁ = $20 million; FCF₂ = $20 million; FCF₃ = $20 million. Assume that free cash flow grows at a rate of 5 percent for year 4 and beyond. If the weighted average cost of capital is 12 percent, calculate the value of the firm.

A firm finances itself with 30 percent debt, 60 percent common equity, and 10 percent preferred stock. The before-tax cost of debt is 5 percent, the firm's cost of common equity is 15 percent, and that of preferred stock is 10 percent. The marginal tax rate is 30 percent. What is the firm's weighted average cost of capital?

Government loan guarantees for firms may increase APV by reducing bankruptcy risk.

When one uses the after-tax weighted average cost of capital (WACC)to value a levered firm, the interest tax shield is

A firm has a total market value of $10 million while its debt has a market value of $4 million. What is the after-tax weighted average cost of capital if the before-tax cost of debt is 10 percent, the cost of equity is 15 percent, and the tax rate is 21 percent? (Round to the nearest decimal place).