Exam 18: Capital Budgeting and Valuation With Leverage

Use the following information to answer the question(s)below. Taggart Transcontinental is considering a $250 million investment to launch a new rail line.The project is expected to generate a free cash flow of $32 million per year,and its unlevered cost of capital is 8%.Taggart's corporate tax rate is 21%.Taggert has 4 million shares of stock outstanding. -Assume that to fund the investment Taggart will take on $150 million in permanent debt with the remainder of the investment funded through issuance of new equity.Assume Taggart will incur a 2% (after-tax)underwriting fee on the new debt issue and a 5% underwriting fee on the issuance of new equity.If management believes Taggart's current share price of $25 is $3 less than its true value,then the NPV of Taggart's new rail line is closest to:

Use the information for the question(s)below. Omicron Industries' Market Value Balance Sheet ($ Millions) and Cost of Capital Omicron Industries' New Project Free Cash Flows (Millions) Assume that this new project is of average risk for Omicron and that the firm wants to hold constant its debt to equity ratio. -Omicron's unlevered cost of capital is closest to:

Use the table for the question(s)below. Consider the information for the following four firms: -The weighted average cost of capital for "Meenie" is closest to:

Use theUse the firm has only been listed on the stock exchange for a short time,you do not have an accurate assessment of Nielson's equity beta.However,you do have the following data for another firm in the same industry: Nielson has a much lower debt-equity ratio of .5,which is expected to remain stable,and Nielson's debt is risk free.Nielson's corporate tax rate is 21%,the risk-free rate is 5%,and the expected return on the market portfolio is 10%. -Nielson's estimated equity beta is closest to:

Use the following information to answer the question(s)below. Taggart Transcontinental is considering a $250 million investment to launch a new rail line.The project is expected to generate a free cash flow of $32 million per year,and its unlevered cost of capital is 8%.Taggart's corporate tax rate is 21%.Taggert has 4 million shares of stock outstanding. -Assuming that to fund the investment Taggart will take on $250 million in permanent debt and assuming Taggart will incur a 2% (after-tax)underwriting fee on the new debt issue,the NPV of Taggart's new rail line is closest to:

Which of the following statements is FALSE?

Consider the following equation for the project WACC with a fixed debt schedule: rwacc = rU - dτc[rD + f(rU - rD)] The term d in this equation represents:

Use the information for the question(s)below. Suppose that Rose Industries is considering the acquisition of another firm in its industry for $100 million.The acquisition is expected to increase Rose's free cash flow by $5 million the first year,and this contribution is expected to grow at a rate of 3% every year thereafter.Rose currently maintains a debt to equity ratio of 1,its corporate tax rate is 21%,its cost of debt rD is 6%,and its cost of equity rE is 10%.Rose Industries will maintain a constant debt-equity ratio for the acquisition. -Given that Rose issues new debt of $50 million initially to fund the acquisition,the present value of the interest tax shield for this acquisition is closest to:

Use the information for the question(s)below. Omicron Industries' Market Value Balance Sheet ($ Millions) and Cost of Capital Omicron Industries' New Project Free Cash Flows (Millions) Assume that this new project is of average risk for Omicron and that the firm wants to hold constant its debt to equity ratio. -Calculate the present value of the interest tax shield provided by Omicron's new project.

Which of the following statements is FALSE?

Use the following information to answer the question(s)below. Rearden Metal is evaluating a project that requires an investment of $150 million today and provides a single cash flow of $180 million for sure one year from now.Rearden decides to use 100% debt financing for this investment.The risk-free rate is 5% and Rearden's corporate tax rate is 21%.Assume that the investment is fully depreciated at the end of the year. -The NPV of this project using the WACC method is closest to:

Describe the key steps in the flow to equity method for valuing a levered investment.

Use the information for the question(s)below. Suppose that Rose Industries is considering the acquisition of another firm in its industry for $100 million.The acquisition is expected to increase Rose's free cash flow by $5 million the first year,and this contribution is expected to grow at a rate of 3% every year thereafter.Rose currently maintains a debt to equity ratio of 1,its corporate tax rate is 21%,its cost of debt rD is 6%,and its cost of equity rE is 10%.Rose Industries will maintain a constant debt-equity ratio for the acquisition. -Given that Rose issues new debt of $50 million initially to fund the acquisition,the total value of this acquisition using the APV method is equal to?

Use the information for the question(s)below. The Aardvark Corporation is considering launching a new product and is trying to determine an appropriate discount rate for evaluating this new product.Aardvark has identified the following information for three single division firms that offer products similar to the one Aardvark is interested in launching: -The unlevered cost of capital for Armadillo Industries is closest to:

Use theUse the firm has only been listed on the stock exchange for a short time,you do not have an accurate assessment of Nielson's equity beta.However,you do have the following data for another firm in the same industry: Nielson has a much lower debt-equity ratio of .5,which is expected to remain stable,and Nielson's debt is risk free.Nielson's corporate tax rate is 21%,the risk-free rate is 5%,and the expected return on the market portfolio is 10%. -Nielson's share price is closest to:

Use the table for the question(s)below. Consider the information for the following four firms: -The unlevered cost of capital for "Eenie" is closest to:

Use the information for the question(s)below. Omicron Industries' Market Value Balance Sheet ($ Millions) and Cost of Capital Omicron Industries' New Project Free Cash Flows (Millions) Assume that this new project is of average risk for Omicron and that the firm wants to hold constant its debt to equity ratio. -The NPV for Omicron's new project is closest to:

Use the table for the question(s)below. Consider the information for the following four firms: -The weighted average cost of capital for "Eenie" is closest to:

Use the following information to answer the question(s)below. Taggart Transcontinental is considering a $250 million investment to launch a new rail line.The project is expected to generate a free cash flow of $32 million per year,and its unlevered cost of capital is 8%.Taggart's corporate tax rate is 21%.Taggert has 4 million shares of stock outstanding. -Assume that to fund the investment Taggart will take on $150 million in permanent debt with the remainder of the investment funded through issuance of new equity.Assuming Taggart will incur a 2% (after-tax)underwriting fee on the new debt issue and a 5% underwriting fee on the issuance of new equity,the NPV of Taggart's new rail line is closest to:

Use the following information to answer the question(s)below. Wyatt Oil is considering an investment in a new project with an unlevered cost of capital of 11%.Wyatt's corporate tax rate is 21% and its debt cost of capital is 6%.The project has free cash flows of $25 million per year which are expected to decline by 3% per year. -If Wyatt adjusts its debt continuously to maintain a constant debt-equity ratio of 50%,then the appropriate WACC for this new project is closest to: