Exam 18: Capital Budgeting and Valuation With Leverage

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

Which of the following is NOT a step in the adjusted present value method?

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 value of this new project is closest to:

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 WACC for this project 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 unlevered value of Omicron's new project is closest to:

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. -The unlevered value of Rose's acquisition is closest to:

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

Which of the following questions is FALSE?

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. -The Free Cash Flow-to-Equity (FCFE)for the acquisition in year 1 is closest to:

Which of the following statements is FALSE?

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.If this product line is of average risk and Luther plans to maintain a constant debt-equity ratio,what after-tax amount must it receive for the product line in order for the divestiture to be profitable?

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 2 is closest to:

Which of the following statements is FALSE?

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 once per year to maintain a constant debt-equity ratio of 50%,then the appropriate WACC for this new project is closest to:

Which of the following is NOT a step in the valuation process using the flow to equity method?

Dusty Donuts has zero coupon debt with a face value of $10 million due in 3 years,and no other debt outstanding.The risk-free rate is 4%,but due to default risk the yield to maturity on the debt is 10%.Dusty's believes that in the event of default,10% of the losses are attributable to bankruptcy and distress costs.Estimate the present value of the distress costs.

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 APV method is closest to:

Consider the following equation: rwacc = rU - τcdrD The term rU in this equation is:

Which of the following questions is FALSE?

Consider the following equation: rwacc = rU - τcdrD The term d in this equation is: