Question 1

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

Accepted Answer

A) Determine the equity cost of capital,rE. 
B) Compute the equity value,E,by discounting the free cash flow to equity using the
Equity cost of capital. 
C) Determine the free cash flow to equity of the investment. 
D) Determine the before-tax cost of capital,rU. 
A) Determine the equity cost of capital,rE. 
B) Compute the equity value,E,by discounting the free cash flow to equity using the
Equity cost of capital. 
C) Determine the free cash flow to equity of the investment. 
D) Determine the before-tax cost of capital,rU.

Question 2

Which of the following statements 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 3

Which of the following statements is FALSE?

Accepted Answer

A) For capital budgeting purposes,the project's financing is the incremental financing that results if the firm takes on the project. 
B) Projects with safer cash flows can support more debt before they increase the risk of financial distress for the firm. 
C) If the positive free cash flow from a project will increase the firm's cash holdings,then this growth in cash is equivalent to a reduction in the firm's leverage. 
D) The incremental financing of a project corresponds directly to the financing that is directly tied to the project. 
A) For capital budgeting purposes,the project's financing is the incremental financing that results if the firm takes on the project. 
B) Projects with safer cash flows can support more debt before they increase the risk of financial distress for the firm. 
C) If the positive free cash flow from a project will increase the firm's cash holdings,then this growth in cash is equivalent to a reduction in the firm's leverage. 
D) The incremental financing of a project corresponds directly to the financing that is directly tied to the project.

Question 4

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:

Accepted Answer

A) 6.0% 
B) 5.5% 
C) 7.5% 
D) 6.5% 
A) 6.0% 
B) 5.5% 
C) 7.5% 
D) 6.5%

Question 5

Which of the following statements is FALSE?

Accepted Answer

A) The WACC can be used throughout the firm as the company wide cost of capital for new investments that are of comparable risk to the rest of the firm and that will not alter the firm's debt-equity ratio. 
B) A disadvantage of the WACC method is that you need to know how the firm's leverage policy is implemented to make the capital budgeting decision. 
C) The intuition for the WACC method is that the firm's weighted average cost of capital represents the average return the firm must pay to its investors (both debt and equity holders)on an after-tax basis. 
D) To be profitable,a project should generate an expected return of at least the firm's weighted average cost of capital. 
A) The WACC can be used throughout the firm as the company wide cost of capital for new investments that are of comparable risk to the rest of the firm and that will not alter the firm's debt-equity ratio. 
B) A disadvantage of the WACC method is that you need to know how the firm's leverage policy is implemented to make the capital budgeting decision. 
C) The intuition for the WACC method is that the firm's weighted average cost of capital represents the average return the firm must pay to its investors (both debt and equity holders)on an after-tax basis. 
D) To be profitable,a project should generate an expected return of at least the firm's weighted average cost of capital.

Question 6

Luther Industries is considering borrowing $500 million to fund a new product line.Given investors' uncertainty regarding its prospects,Luther will pay a 7% interest rate on this loan.The firm's management knows,that the actual risk of the loan is extremely low and that the appropriate rate on the loan is 5%.Suppose the loan is for four years,with all principal being repaid in the fourth year.If Luther's marginal corporate tax rate is 35%,then the net effect of the loan on the value of the new product line is closest to:

Accepted Answer

A) $22 million 
B) $34 million 
C) $35 million 
D) $24 million 
A) $22 million 
B) $34 million 
C) $35 million 
D) $24 million

Question 7

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 8

Which of the following statements is FALSE?

Accepted Answer

A) The APV approach explicitly values the market imperfections and therefore allows managers to measure their contribution to value. 
B) We need to know the debt level to compute the APV,but with a constant debt-equity ratio we need to know the project's value to compute the debt level. 
C) The WACC method is more complicated than the APV method because we must compute two separate valuations: the unlevered project and the interest tax shield. 
D) Implementing the APV approach with a constant debt-equity ratio requires solving for the project's debt and value simultaneously. 
A) The APV approach explicitly values the market imperfections and therefore allows managers to measure their contribution to value. 
B) We need to know the debt level to compute the APV,but with a constant debt-equity ratio we need to know the project's value to compute the debt level. 
C) The WACC method is more complicated than the APV method because we must compute two separate valuations: the unlevered project and the interest tax shield. 
D) Implementing the APV approach with a constant debt-equity ratio requires solving for the project's debt and value simultaneously.

Question 9

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

Accepted Answer

A) $63 million 
B) $50 million 
C) $167 million 
D) $100 million 
A) $63 million 
B) $50 million 
C) $167 million 
D) $100 million

Question 10

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

Accepted Answer

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

Question 11

The value of Galt's equity using the WACC method is closest to:

Accepted Answer

A) $150 million 
B) $180 million 
C) $230 million 
D) $240 million 
A) $150 million 
B) $180 million 
C) $230 million 
D) $240 million

Question 12

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

Accepted Answer

A) 9.50% 
B) 8.75% 
C) 6.75% 
D) 8.25% 
A) 9.50% 
B) 8.75% 
C) 6.75% 
D) 8.25%

Question 13

Which of the following statements is FALSE?

Accepted Answer

A) As a general rule,the WACC method is the easiest to use when the firm will maintain a fixed debt-to-value ratio over the life of the investment. 
B) The FTE method is typically used only in complicated settings for which the values of other securities in the firm's capital structure or the interest tax shield are themselves difficult to determine. 
C) For alternative leverage policies,the FTE method is usually the most straightforward approach. 
D) When used consistently,the WACC,APV,and FTE methods produce the same valuation for the investment. 
A) As a general rule,the WACC method is the easiest to use when the firm will maintain a fixed debt-to-value ratio over the life of the investment. 
B) The FTE method is typically used only in complicated settings for which the values of other securities in the firm's capital structure or the interest tax shield are themselves difficult to determine. 
C) For alternative leverage policies,the FTE method is usually the most straightforward approach. 
D) When used consistently,the WACC,APV,and FTE methods produce the same valuation for the investment.

Question 14

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

Accepted Answer

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

Question 15

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 equations represents:

Accepted Answer

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

Question 16

If KT expects to maintain a debt to equity ratio for this project of 1 then KT's project based WACC,rwacc,for this project is closest to:

Accepted Answer

A) 11.1% 
B) 10.8% 
C) 9.6% 
D) 10.5% 
A) 11.1% 
B) 10.8% 
C) 9.6% 
D) 10.5%

Question 17

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.

Accepted Answer

A) $138 million 
B) $138 thousand 
C) $1.38 million 
D) $1.38 thousand 
A) $138 million 
B) $138 thousand 
C) $1.38 million 
D) $1.38 thousand

Question 18

The unlevered value of Aardvark's new project is closest to:

Accepted Answer

A) $205 
B) $100 
C) $164 
D) $202 
A) $205 
B) $100 
C) $164 
D) $202

Question 19

If Wyatt adjusts its debt once per year to maintain a constant debt-equity ratio of 50%,then the value of this new project is closest to:

Accepted Answer

A) $188 million 
B) $188.5 million 
C) $320 million 
D) $340 million 
A) $188 million 
B) $188.5 million 
C) $320 million 
D) $340 million

Question 20

The Debt Capacity for Omicron's new project in year 2 is closest to:

Accepted Answer

A) $55.25 
B) $38.75 
C) $22.00 
D) $33.00 
A) $55.25 
B) $38.75 
C) $22.00 
D) $33.00

Exam 18: Capital Budgeting and Valuation With Leverage

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

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 unlevered cost of capital for "Eenie" is closest to:

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

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:

The value of Galt's equity using the WACC method is closest to:

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

Which of the following statements is FALSE?

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

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 equations represents:

If KT expects to maintain a debt to equity ratio for this project of 1 then KT's project based WACC,rwacc,for this project is closest to:

The unlevered value of Aardvark's new project is closest to:

If Wyatt adjusts its debt once per year to maintain a constant debt-equity ratio of 50%,then the value of this new project is closest to:

The Debt Capacity for Omicron's new project in year 2 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 D in this equation is:

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

Consider the following equation for the Project WACC with a fixed debt schedule: R_wacc = r_U - dτ_c[rD + f(r_U - r_D)] The term d in this equations represents:

If KT expects to maintain a debt to equity ratio for this project of 1 then KT's project based WACC,r_wacc,for this project is closest to: