Question 1

Galt's free cash flow to equity (FCFE)is closest to:

Accepted Answer

A) $19.2 million 
B) $20.4 million 
C) $21.2 million 
D) $24.0 million 
A) $19.2 million 
B) $20.4 million 
C) $21.2 million 
D) $24.0 million C

Question 2

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

Accepted Answer

The key steps in the flow-to-equity method for valuing a levered investment are as follows:
1.Determine the free cash flow to equity of the investment.
2.Determine the equity cost of capital,r_E.
3.Compute the equity value,E,by discounting the free cash flow to equity using the equity cost of capital.

Question 3

Which of the following statements is FALSE?

Accepted Answer

A) In the flow-to-equity valuation method,the cash flows to equity holders are then discounted using the weighted average cost of capital. 
B) In the WACC and APV methods,we value a project based on its free cash flow,which is computed ignoring interest and debt payments. 
C) In the flow-to-equity (FT
E) valuation method,we explicitly calculate the free cash flow available to equity holders taking into account all payments to and from debt holders. 
D) The first step in the FTE method is to determine the project's free cash flow to equity (FCF
E) . 
A) In the flow-to-equity valuation method,the cash flows to equity holders are then discounted using the weighted average cost of capital. 
B) In the WACC and APV methods,we value a project based on its free cash flow,which is computed ignoring interest and debt payments. 
C) In the flow-to-equity (FT
E) valuation method,we explicitly calculate the free cash flow available to equity holders taking into account all payments to and from debt holders. 
D) The first step in the FTE method is to determine the project's free cash flow to equity (FCF
E) . A

Question 4

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 5

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 6

Nielson's equity cost of capital is closest to:

Accepted Answer

A) 11.3% 
B) 12.2% 
C) 14.0% 
D) 14.4% 
A) 11.3% 
B) 12.2% 
C) 14.0% 
D) 14.4%

Question 7

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:

Accepted Answer

A) $185 million 
B) $195 million 
C) $200 million 
D) $235 million 
A) $185 million 
B) $195 million 
C) $200 million 
D) $235 million

Question 8

The unlevered cost of capital for Armadillo Industries is closest to:

Accepted Answer

A) 10.3% 
B) 10.0% 
C) 9.5% 
D) 9.9% 
A) 10.3% 
B) 10.0% 
C) 9.5% 
D) 9.9%

Question 9

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 10

Use the following information to answer the question(s)below.
Nielson Motors (NM)is a newly public firm with 25 million shares outstanding.You are doing a valuation analysis of Nielson and you estimate its free cash flow in the coming year to be $40 million.You expect the firm's free cash flows to grow by 4% per year in subsequent years.Because 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 40%,the risk-free rate is 5%,and the expected return on the market portfolio is 10%.
-Nielson's estimated equity beta is closest to:

Accepted Answer

A) 0.95 
B) 1.00 
C) 1.25 
D) 1.45 
A) 0.95 
B) 1.00 
C) 1.25 
D) 1.45

Question 11

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 40%.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:

Accepted Answer

A) $10 million 
B) $13 million 
C) $42 million 
D) $71 million 
A) $10 million 
B) $13 million 
C) $42 million 
D) $71 million

Question 12

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

Question 13

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 marginal tax rate is 35%,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 14

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 15

The WACC for this project is closest to:

Accepted Answer

A) 3.0% 
B) 5.0% 
C) 7.0% 
D) 8.2% 
A) 3.0% 
B) 5.0% 
C) 7.0% 
D) 8.2%

Question 16

The assumption that the firm's debt-equity ratio is constant means:

Accepted Answer

A) the firm's cost of capital will not fluctuate when it accepts a new project. 
B) corporate taxes are the only imperfection. 
C) the risk of its debt and equity will change when it accepts a new project. 
D) the firm adjusts its leverage to maintain a constant debt-equity ratio in terms of book value. 
A) the firm's cost of capital will not fluctuate when it accepts a new project. 
B) corporate taxes are the only imperfection. 
C) the risk of its debt and equity will change when it accepts a new project. 
D) the firm adjusts its leverage to maintain a constant debt-equity ratio in terms of book value.

Question 17

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) $207.35 
C) $207.00 
D) $210.50 
A) $210.15 
B) $207.35 
C) $207.00 
D) $210.50

Question 18

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

Accepted Answer

A) the project's unlevered cost of capital. 
B) the project's dollar amount of debt. 
C) the firm's unlevered cost of debt. 
D) the project's debt to value ratio. 
A) the project's unlevered cost of capital. 
B) the project's dollar amount of debt. 
C) the firm's unlevered cost of debt. 
D) the project's debt to value ratio.

Question 19

The weighted average cost of capital for "Moe" is closest to:

Accepted Answer

A) 10.00% 
B) 7.75% 
C) 8.25% 
D) 8.50% 
A) 10.00% 
B) 7.75% 
C) 8.25% 
D) 8.50%

Question 20

The interest tax shield provided by Omicron's new project in year 1 is closest to:

Accepted Answer

A) $3.00 
B) $1.05 
C) $50.25 
D) $17.60 
A) $3.00 
B) $1.05 
C) $50.25 
D) $17.60

Exam 18: Capital Budgeting and Valuation With Leverage

Galt's free cash flow to equity (FCFE)is closest to:

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

Which of the following statements is FALSE?

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

Nielson's equity cost of capital is closest to:

The unlevered cost of capital for Armadillo Industries is closest to:

Which of the following statements is FALSE?

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:

Consider the following equation: Rwacc = RE + RD(1 - τc) The term rE in this equation is:

The WACC for this project is closest to:

The assumption that the firm's debt-equity ratio is constant means:

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:

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

The weighted average cost of capital for "Moe" is closest to:

The interest tax shield provided by Omicron's new project in year 1 is closest to:

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

Consider the following equation: R_wacc = R_E + R_D(1 - τ_c) The term r_E in this equation is:

Consider the following equation: R_wacc = r_U - τ_cdr_D The termdin this equation is: