Question 1

Which of the following statements is FALSE?

Accepted Answer

A) When we relax the assumption of a constant debt-equity ratio,the FTE method is relatively straightforward to use and is therefore the preferred method with alternative leverage policies. 
B) When debt levels are set according to a fixed schedule,we can discount the predetermined interest tax shields using the debt cost of capital,rD. 
C) With a constant interest coverage policy,the value of the interest tax shield is proportional to the project's unlevered value. 
D) When the firm keeps its interest payments to a target fraction of its FCF,we say it has a constant interest coverage ratio. 
A) When we relax the assumption of a constant debt-equity ratio,the FTE method is relatively straightforward to use and is therefore the preferred method with alternative leverage policies. 
B) When debt levels are set according to a fixed schedule,we can discount the predetermined interest tax shields using the debt cost of capital,rD. 
C) With a constant interest coverage policy,the value of the interest tax shield is proportional to the project's unlevered value. 
D) When the firm keeps its interest payments to a target fraction of its FCF,we say it has a constant interest coverage ratio.

Question 2

Use the information for the question(s)below.
Suppose Luther Industries is considering divesting one of its product lines.The product line is expected to generate free cash flows of $2 million per year,growing at a rate of 3% per year.Luther has an equity cost of capital of 10%,a debt cost of capital of 7%,a corporate tax rate of 21%,and a debt-equity ratio of 2.This product line is of average risk and Luther plans to maintain a constant debt-equity ratio.
-The unlevered value of Luther's product line is closest to:

Accepted Answer

A) $25 million. 
B) $60 million. 
C) $45 million. 
D) $40 million. 
A) $25 million. 
B) $60 million. 
C) $45 million. 
D) $40 million.

Question 3

Which of the following statements is FALSE?

Accepted Answer

A) Because the WACC incorporates the tax savings from debt,we can compute the levered value of an investment,which is its value including the benefit of interest tax shields given the firm's leverage policy,by discounting its future free cash flow using the WACC. 
B) The WACC incorporates the benefit of the interest tax shield by using the firm's before-tax cost of capital for debt. 
C) When the market risk of the project is similar to the average market risk of the firm's investments,then its cost of capital is equivalent to the cost of capital for a portfolio of all of the firm's securities;that is,the project's cost of capital is equal to the firm's weighted average cost of capital (WAC
C) . 
D) A project's cost of capital depends on its risk. 
A) Because the WACC incorporates the tax savings from debt,we can compute the levered value of an investment,which is its value including the benefit of interest tax shields given the firm's leverage policy,by discounting its future free cash flow using the WACC. 
B) The WACC incorporates the benefit of the interest tax shield by using the firm's before-tax cost of capital for debt. 
C) When the market risk of the project is similar to the average market risk of the firm's investments,then its cost of capital is equivalent to the cost of capital for a portfolio of all of the firm's securities;that is,the project's cost of capital is equal to the firm's weighted average cost of capital (WAC
C) . 
D) A project's cost of capital depends on its risk.

Question 4

Use the following information to answer the question(s)below.
Galt Industries is expected to generate free cash flows of $24 million per year.Galt has permanent debt of $80 million,a corporate tax rate of 21%,and an unlevered cost of capital of 12% and its cost of debt capital is 6%.
-If Galt's debt cost of capital is 6%,then Galt's equity cost of capital is closest to:

Accepted Answer

A) 11.2%. 
B) 12.0%. 
C) 14.8%. 
D) 15.5%. 
A) 11.2%. 
B) 12.0%. 
C) 14.8%. 
D) 15.5%.

Question 5

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.
-Rose's unlevered cost of capital is closest to:

Accepted Answer

A) 8.0%. 
B) 7.5%. 
C) 7.0%. 
D) 9.0%. 
A) 8.0%. 
B) 7.5%. 
C) 7.0%. 
D) 9.0%.

Question 6

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 debt capacity for Omicron's new project in year 1 is closest to:

Accepted Answer

A) $38.50 million. 
B) $48.25 million. 
C) $50.25 million. 
D) $58.00 million. 
A) $38.50 million. 
B) $48.25 million. 
C) $50.25 million. 
D) $58.00 million.

Question 7

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

Accepted Answer

A) 10.00%. 
B) 7.75%. 
C) 8.25%. 
D) 9.00%. 
A) 10.00%. 
B) 7.75%. 
C) 8.25%. 
D) 9.00%.

Question 8

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.
-Alpha Beta Corporation maintains a constant debt-equity ratio of 0.5.The total value of the firm is $30 million,and existing debt is riskless.Over the next three months,news will come out that will either raise or lower Alpha Beta's value by 10%.How will Alpha Beta adjust its debt level in response to keep its debt-equity ratio constant?

Accepted Answer

A) Either increase by $1 million or decrease by $1 million. 
B) Either increase by $1.5 million or decrease by $1.5 million. 
C) Either increase by $3 million or decrease by $3 million. 
D) There will be no change-the debt-equity ratio will remain constant. 
A) Either increase by $1 million or decrease by $1 million. 
B) Either increase by $1.5 million or decrease by $1.5 million. 
C) Either increase by $3 million or decrease by $3 million. 
D) There will be no change-the debt-equity ratio will remain constant.

Question 9

Which of the following statements regarding the adjusted present value method is FALSE?

Accepted Answer

A) The firm's unlevered cost of capital is equal to its pre-tax weighted average cost of capital-that is,using the pre-tax cost of debt,rd,rather than its after-tax cost,rd (1 - τc ). 
B) A firm's levered cost of capital is a weighted average of its equity and debt costs of capital. 
C) When the firm maintains a target leverage ratio,its future interest tax shields have similar risk to the project's cash flows,so they should be discounted at the project's unlevered cost of capital. 
D) The first step in the APV method is to calculate the value of free cash flows using the project's cost of capital if it were financed without leverage. 
A) The firm's unlevered cost of capital is equal to its pre-tax weighted average cost of capital-that is,using the pre-tax cost of debt,rd,rather than its after-tax cost,rd (1 - τc ). 
B) A firm's levered cost of capital is a weighted average of its equity and debt costs of capital. 
C) When the firm maintains a target leverage ratio,its future interest tax shields have similar risk to the project's cash flows,so they should be discounted at the project's unlevered cost of capital. 
D) The first step in the APV method is to calculate the value of free cash flows using the project's cost of capital if it were financed without leverage.

Question 10

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 weighted average cost of capital is closest to:

Accepted Answer

A) 7.10%. 
B) 7.50%. 
C) 9.60%. 
D) 9.10%. 
A) 7.10%. 
B) 7.50%. 
C) 9.60%. 
D) 9.10%.

Question 11

Which of the following statements is FALSE?

Accepted Answer

A) In the real world,specific projects should differ only slightly from the average investment made by the firm. 
B) We can estimate rU for a new project by looking at single-division firms that have similar business risks. 
C) The project's equity cost of capital depends on its unlevered cost of capital,rU,and the debt-equity ratio of the incremental financing that will be put in place to support the project. 
D) Projects may vary in the amount of leverage they will support-for example,acquisitions of real estate or capital equipment are often highly levered,whereas investments in intellectual property are not. 
A) In the real world,specific projects should differ only slightly from the average investment made by the firm. 
B) We can estimate rU for a new project by looking at single-division firms that have similar business risks. 
C) The project's equity cost of capital depends on its unlevered cost of capital,rU,and the debt-equity ratio of the incremental financing that will be put in place to support the project. 
D) Projects may vary in the amount of leverage they will support-for example,acquisitions of real estate or capital equipment are often highly levered,whereas investments in intellectual property are not.

Question 12

Use the information for the question(s)below.
Aardvark Industries is considering a project that will generate the following free cash flows:   You are also provided with the following market value balance sheet and information regarding Aardvark's cost of capital:  
-Suppose that to fund this new project,Aardvark borrows $120 with the principal to be paid in three equal installments at the end each year.The levered value of Aardvark's new project is closest to:

Accepted Answer

A) $210.15. 
B) $205.25. 
C) $207.00. 
D) $210.50. 
A) $210.15. 
B) $205.25. 
C) $207.00. 
D) $210.50.

Question 13

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 debt capacity for Omicron's new project in year 0 is closest to:

Accepted Answer

A) $38.75 million. 
B) $75.50 million. 
C) $50.00 million. 
D) $10.25 million. 
A) $38.75 million. 
B) $75.50 million. 
C) $50.00 million. 
D) $10.25 million.

Question 14

Use the information for the question(s)below.
Aardvark Industries is considering a project that will generate the following free cash flows:   You are also provided with the following market value balance sheet and information regarding Aardvark's cost of capital:  
-Suppose that to fund this new project,Aardvark borrows $150 with the principal to be paid in three equal installments at the end each year.Calculate the present value of Aardvark's interest tax shield.

Accepted Answer

PV(interest tax shie

Question 15

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 Antelope Incorporated is closest to:

Accepted Answer

A) 10.3%. 
B) 9.9%. 
C) 10.1%. 
D) 9.5%. 
A) 10.3%. 
B) 9.9%. 
C) 10.1%. 
D) 9.5%.

Question 16

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

Accepted Answer

A) the annual adjustment percentage to the amount of debt. 
B) a measure of the permanence of the debt level. 
C) the dollar amount of debt outstanding. 
D) the debt-to-value ratio. 
A) the annual adjustment percentage to the amount of debt. 
B) a measure of the permanence of the debt level. 
C) the dollar amount of debt outstanding. 
D) the debt-to-value ratio.

Question 17

Consider the following equation: rwacc =   rE +   rD(1 - τc)
The term rE in this equation is:

Accepted Answer

A) the after-tax required rate of return on debt. 
B) the required rate of return on debt. 
C) the required rate of return on equity. 
D) the dollar amount of equity. 
A) the after-tax required rate of return on debt. 
B) the required rate of return on debt. 
C) the required rate of return on equity. 
D) the dollar amount of equity.

Question 18

Which of the following is NOT one of the simplifying assumptions made for the three main methods of capital budgeting?

Accepted Answer

A) The firm pays out all earnings as dividends. 
B) The project has average risk. 
C) Corporate taxes are the only market imperfection. 
D) The firm's debt-equity ratio is constant. 
A) The firm pays out all earnings as dividends. 
B) The project has average risk. 
C) Corporate taxes are the only market imperfection. 
D) The firm's debt-equity ratio is constant.

Question 19

Use the information for the question(s)below.
KT Enterprises is considering undertaking a new project.Based upon analysis of firms with similar projects,KT has determined that an unlevered cost of equity of 12% is suitable for their project.KT's corporate tax rate is 21%,its borrowing rate is 7%,and KT does not believe that its borrowing rate will change if the new project is accepted.
-If KT expects to maintain a debt to equity ratio for this project of 1,then KT's equity cost of capital,rE,for this project is closest to:

Accepted Answer

A) 17.0%. 
B) 5.0%. 
C) 15.0%. 
D) 12%. 
A) 17.0%. 
B) 5.0%. 
C) 15.0%. 
D) 12%.

Question 20

Use the information for the question(s)below.
Aardvark Industries is considering a project that will generate the following free cash flows:   You are also provided with the following market value balance sheet and information regarding Aardvark's cost of capital:  
-Suppose that to fund this new project,Aardvark borrows $120 with the principal to be paid in three equal installments at the end each year.The present value of Aardvark's interest tax shield is closest to:

Accepted Answer

A) $5.15. 
B) $5.00. 
C) $5.90. 
D) $5.25. 
A) $5.15. 
B) $5.00. 
C) $5.90. 
D) $5.25.

Which of the following statements is FALSE?

Which of the following statements is FALSE?

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

Which of the following statements regarding the adjusted present value method is FALSE?

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 f in this equation represents:

Consider the following equation: rwacc = rE + rD(1 - τc) The term rE in this equation is:

Which of the following is NOT one of the simplifying assumptions made for the three main methods of capital budgeting?

The Corporation

Introduction to Financial Statement Analysis

Financial Decision Making and the Law of One Price

The Time Value of Money

Interest Rates

Valuing Bonds

Investment Decision Rules

Fundamentals of Capital Budgeting

Valuing Stocks

Capital Markets and the Pricing of Risk

Optimal Portfolio Choice and the Capital Asset Pricing Model

Estimating the Cost of Capital

Investor Behavior and Capital Market Efficiency

Capital Structure in a Perfect Market

Debt and Taxes

Financial Distress,managerial Incentives,and Information

Payout Policy

Valuation and Financial Modeling: a Case Study

Financial Options

Option Valuation

Real Options

Raising Equity Capital

Debt Financing

Leasing

Working Capital Management

Short-Term Financial Planning

Mergers and Acquisitions

Corporate Governance

Risk Management

International Corporate Finance

Filters

Exam 18: Capital Budgeting and Valuation With Leverage

Which of the following statements is FALSE?

Which of the following statements is FALSE?

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

Which of the following statements regarding the adjusted present value method is FALSE?

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 f in this equation represents:

Consider the following equation: rwacc = rE + rD(1 - τc) The term rE in this equation is:

Which of the following is NOT one of the simplifying assumptions made for the three main methods of capital budgeting?

The Corporation

Introduction to Financial Statement Analysis

Financial Decision Making and the Law of One Price

The Time Value of Money

Interest Rates

Valuing Bonds

Investment Decision Rules

Fundamentals of Capital Budgeting

Valuing Stocks

Capital Markets and the Pricing of Risk

Optimal Portfolio Choice and the Capital Asset Pricing Model

Estimating the Cost of Capital

Investor Behavior and Capital Market Efficiency

Capital Structure in a Perfect Market

Debt and Taxes

Financial Distress,managerial Incentives,and Information

Payout Policy

Valuation and Financial Modeling: a Case Study

Financial Options

Option Valuation

Real Options

Raising Equity Capital

Debt Financing

Leasing

Working Capital Management

Short-Term Financial Planning

Mergers and Acquisitions

Corporate Governance

Risk Management

International Corporate Finance

Filters