Exam 18: Valuation and Capital Budgeting for the Levered Firm

Discuss the adjusted present value,the flow to equity and the weighted average cost of capital methods of capital budgeting with leverage and the guidelines for using each method.

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Question 1

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The adjusted present value is defined as follows: the value of the project to the unlevered firm plus the net present value of financing side effects. There are four side effects: the tax subsidy of debt,the costs of issuing new securities,the costs of financial distress,and subsidies to debt financing. The flow to equity approach is an alternative to adjusted present value. It is the discounted cash flow from a project to the equity holders of the levered firm at the cost of equity. Finally,the weighted average cost of capital approach considers the firm that is financed with both debt and equity and allocates the costs proportionally for each capital component. Essentially,the manager should use the WACC or FTE if the firm's target debt-to-value ratio applies to the project over its life. Alternatively,one should use APV if the project's level of debt is known over the life of the project.

Using APV,the analysis can be tricky in examples of:

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Question 2

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The Tip-Top Paving Co. wants to be levered at a debt to value ratio of .6. The cost of debt is 11%,the tax rate is 34%,and the cost of equity for an all equity firm is 14%. What will be Tip-Top's cost of equity?

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Question 3

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In a leveraged buyout,the equity holders expect a successful buyout if:

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Question 4

A firm is valued at $8 million and has debt of $2 million outstanding. The firm has an equity beta of 1.5 and a debt beta of .60. The beta of the overall firm is:

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Question 5

The APV method to value a project should be used when the:

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Question 6

The all equity cost of capital for flat Rock Grinding is 15% and the company has set a target debt to value ratio of 50%. The current cost of debt for a firm of this risk is 10% and the corporate tax rate is 34%. Calculate the WACC for the Flat Rock Grinding Corporation.

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Question 7

Alabaster Incorporated wants to be levered at a debt to value ratio of .6. The cost of debt is 9%,the tax rate is 35%,and the cost of equity for an all equity firm is 12%. What will be Alabaster's cost of equity?

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Question 8

Flotation costs are incorporated into the APV framework by:

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Question 9

Discounting the unlevered after tax cash flows by the _ minus the yields the ______.

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Question 10

Which capital budgeting tools,if properly used,will yield the same answer?

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Question 11

Although the three capital budgeting methods are equivalent,they all can have difficulties making computation impossible at times. The most useful methods or tools from a practical standpoint are:

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Question 12

The Free-Float Company,a company in the 36% tax bracket,has riskless debt in its capital structure which makes up 40% of the total capital structure,and equity is the other 60%. The beta of the assets for this business is .8 and the equity beta is:

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Question 13

To calculate the adjusted present value,one will:

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Question 14

In calculating the NPV using the flow-to-equity approach the discount rate is the:

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Question 15

The value of a corporation in a levered buyout is composed of which following four parts:

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Question 16

A very large firm has a debt beta of zero. If the cost of equity is 10%,and the risk-free rate is 3%,the cost of debt is:

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Question 17

The Simpson Corp. is planning construction of a new plant. The initial cost of the investment is $5 million. Efficiencies from the new plant are expected to reduce costs by $620,000 forever. The corporation has a total value of $400 million and has outstanding debt of $150 million. What is the NPV of the project if the firm has an after tax cost of debt of 5% and a cost equity of 8%?

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Question 18

The Webster Corp. is planning construction of a new shipping depot for its single manufacturing plant. The initial cost of the investment is $1 million. Efficiencies from the new depot are expected to reduce costs by $100,000 forever. The corporation has a total value of $60 million and has outstanding debt of $40 million. What is the NPV of the project if the firm has an after tax cost of debt of 6% and a cost equity of 9%?

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Question 19

The TRIM Corporation has decided to build a new facility for its R&D department. The cost of the facility is estimated to be $150 million. TRIM wishes to finance this project using its traditional debt-equity ratio of 1.2. The issue cost of equity is 7% and the issue cost of debt is 2%. What is the total flotation cost?

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Question 20

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Exam 18: Valuation and Capital Budgeting for the Levered Firm

Discuss the adjusted present value,the flow to equity and the weighted average cost of capital methods of capital budgeting with leverage and the guidelines for using each method.

Using APV,the analysis can be tricky in examples of:

The Tip-Top Paving Co. wants to be levered at a debt to value ratio of .6. The cost of debt is 11%,the tax rate is 34%,and the cost of equity for an all equity firm is 14%. What will be Tip-Top's cost of equity?

In a leveraged buyout,the equity holders expect a successful buyout if:

A firm is valued at $8 million and has debt of $2 million outstanding. The firm has an equity beta of 1.5 and a debt beta of .60. The beta of the overall firm is:

The APV method to value a project should be used when the:

The all equity cost of capital for flat Rock Grinding is 15% and the company has set a target debt to value ratio of 50%. The current cost of debt for a firm of this risk is 10% and the corporate tax rate is 34%. Calculate the WACC for the Flat Rock Grinding Corporation.

Alabaster Incorporated wants to be levered at a debt to value ratio of .6. The cost of debt is 9%,the tax rate is 35%,and the cost of equity for an all equity firm is 12%. What will be Alabaster's cost of equity?

Flotation costs are incorporated into the APV framework by:

Discounting the unlevered after tax cash flows by the _____ minus the ______ yields the ________.

Which capital budgeting tools,if properly used,will yield the same answer?

Although the three capital budgeting methods are equivalent,they all can have difficulties making computation impossible at times. The most useful methods or tools from a practical standpoint are:

The Free-Float Company,a company in the 36% tax bracket,has riskless debt in its capital structure which makes up 40% of the total capital structure,and equity is the other 60%. The beta of the assets for this business is .8 and the equity beta is:

To calculate the adjusted present value,one will:

In calculating the NPV using the flow-to-equity approach the discount rate is the:

The value of a corporation in a levered buyout is composed of which following four parts:

A very large firm has a debt beta of zero. If the cost of equity is 10%,and the risk-free rate is 3%,the cost of debt is:

Introduction to Corporate Finance

Financial Statements and Cash Flow

Financial Statements Analysis and Financial Models

Discounted Cash Flow Valuation

Net Present Value and Other Investment Rules

Making Capital Investment Decisions

Risk Analysis, Real Options, and Capital Budgeting

Interest Rates and Bond Valuation

Stock Valuation

Risk and Return: Lessons From Market History

Return and Risk: the Capital Asset Pricing Model Capm

An Alternative View of Risk and Return: The Arbitrage Pricing Theory

Risk, Cost of Capital, and Valuation

Efficient Capital Markets and Behavioral Challenges

Long-Term Financing

Capital Structure: Basic Concepts

Capital Structure: Limits to the Use of Debt

Dividends and Other Payouts

Raising Capital

Leasing

Options and Corporate Finance

Options and Corporate Finance: Extensions and Applications

Warrants and Convertibles

Derivatives and Hedging Risk

Short-Term Finance and Planning

Cash Management

Credit and Inventory Management

Mergers, Acquisitions, and Divestitures

Financial Distress

International Corporate Finance

Filters

Discounting the unlevered after tax cash flows by the _ minus the yields the ______.