Question 1

Which of the following questions is FALSE?

Accepted Answer

A) Sometimes management may believe that the securities they are issuing are priced at less than (or more than)their true value.If so,the NPV of the transaction,which is the difference between the actual money raised and the true value of the securities sold,should not be included in the value of the project. 
B) An alternative method of incorporating financial distress and agency costs is to first value the project ignoring these costs,and then value the incremental cash flows associated with financial distress and agency problems separately. 
C) When the debt level-and,therefore,the probability of financial distress-is high,the expected free cash flow will be reduced by the expected costs associated with financial distress and agency problems. 
D) If the financing of the project involves an equity issue,and if management believes that the equity will sell at a price that is less than its true value,this mispricing is a cost of the project for the existing shareholders. 
A) Sometimes management may believe that the securities they are issuing are priced at less than (or more than)their true value.If so,the NPV of the transaction,which is the difference between the actual money raised and the true value of the securities sold,should not be included in the value of the project. 
B) An alternative method of incorporating financial distress and agency costs is to first value the project ignoring these costs,and then value the incremental cash flows associated with financial distress and agency problems separately. 
C) When the debt level-and,therefore,the probability of financial distress-is high,the expected free cash flow will be reduced by the expected costs associated with financial distress and agency problems. 
D) If the financing of the project involves an equity issue,and if management believes that the equity will sell at a price that is less than its true value,this mispricing is a cost of the project for the existing shareholders.

Question 2

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 Anteater Enterprises is closest to:

Accepted Answer

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

Question 3

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

Accepted Answer

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

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 40%,and an unlevered cost of capital of 12% and its cost of debt capital is 6%.
-The value of Galt's equity using the APV 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 5

The NPV for Omicron's new project is closest to:

Accepted Answer

A) $23.75 
B) $27.50 
C) $28.75 
D) $25.75 
A) $23.75 
B) $27.50 
C) $28.75 
D) $25.75

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   Assume that this new project is of average risk for Omicron and that the firm wants to hold constant its debt to equity ratio.
-Calculate the debt capacity of Omicron's new project for years 0,1,and 2.

Accepted Answer

r_wacc = @#IMG-DLM& r_E + @#IMG-DLM& r_D(1 - τ_c),where D = net debt

Question 7

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 8

Which of the following statements is FALSE?

Accepted Answer

A) If the debt-equity ratio changes over time,the risk of equity - and,therefore,its cost of capital - will change as well. 
B) The FTE method can offer an advantage when calculating the value of equity for the entire firm,if the firm's capital structure is complex and the market values of other securities in the firm's capital structure are not known. 
C) The FTE approach does not have the same disadvantage associated with the APV approach.We don't need to compute the project's debt capacity to determine interest and net borrowing before we can make the capital budgeting decision. 
D) The WACC and APV methods compute the firm's enterprise value,so that a separate valuation of the other components of the firm's capital structure is needed to determine the value of equity. 
A) If the debt-equity ratio changes over time,the risk of equity - and,therefore,its cost of capital - will change as well. 
B) The FTE method can offer an advantage when calculating the value of equity for the entire firm,if the firm's capital structure is complex and the market values of other securities in the firm's capital structure are not known. 
C) The FTE approach does not have the same disadvantage associated with the APV approach.We don't need to compute the project's debt capacity to determine interest and net borrowing before we can make the capital budgeting decision. 
D) The WACC and APV methods compute the firm's enterprise value,so that a separate valuation of the other components of the firm's capital structure is needed to determine the value of equity.

Question 9

Given that Rose issues new debt of $50 million initially to fund the acquisition,the present value of the interest tax shield for this acquisition is closest to:

Accepted Answer

A) $24 million 
B) $50 million 
C) $20 million 
D) $15 million 
A) $24 million 
B) $50 million 
C) $20 million 
D) $15 million

Question 10

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:

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 11

Calculate the NPV for Iota's new project.

Accepted Answer

r_wacc = @#IMG-DLM& r_E + @#IMG-DLM& r_D(1 - τ_c),where D =

Question 12

Consider the following equation:
Dt = d ×

The term Dt in this equation is:

Accepted Answer

A) the firms target debt to value ratio. 
B) the firms target debt to equity ratio. 
C) the investment's debt capacity. 
D) the dollar amount of debt outstanding at time t. 
A) the firms target debt to value ratio. 
B) the firms target debt to equity ratio. 
C) the investment's debt capacity. 
D) the dollar amount of debt outstanding at time t.

Question 13

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 marginal tax rate of 35%,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?

Accepted Answer

r_wacc = @#IMG-DLM& (.10)+ @#IMG-DLM& (.07)

Question 14

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.Assuming 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,the NPV of Taggart's new rail line is closest to:

Accepted Answer

A) $195 million 
B) $200 million 
C) $235 million 
D) $240 million 
A) $195 million 
B) $200 million 
C) $235 million 
D) $240 million

Question 15

Which of the following statements is FALSE?

Accepted Answer

A) The project's free cash flow to equity shows the expected amount of additional cash the firm will have available to pay dividends (or conduct share repurchases)each year. 
B) The value of the project's FCFE should be identical to the NPV computed using the WACC and APV methods. 
C) The value of the project's FCFE represents the gain to shareholders from the project. 
D) Because interest payments are deducted before taxes,we adjust the firm's FCF by their before-tax cost. 
A) The project's free cash flow to equity shows the expected amount of additional cash the firm will have available to pay dividends (or conduct share repurchases)each year. 
B) The value of the project's FCFE should be identical to the NPV computed using the WACC and APV methods. 
C) The value of the project's FCFE represents the gain to shareholders from the project. 
D) Because interest payments are deducted before taxes,we adjust the firm's FCF by their before-tax cost.

Question 16

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

Accepted Answer

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

Question 17

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 marginal corporate tax rate is 35% 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 appropriate WACC for this new project is closest to:

Accepted Answer

A) 7.5% 
B) 8.6% 
C) 10.3% 
D) 10.8% 
A) 7.5% 
B) 8.6% 
C) 10.3% 
D) 10.8%

Question 18

The Debt Capacity for Iota's new project in year 0 is closest to:

Accepted Answer

A) $263.25 
B) $87.75 
C) $50.25 
D) $118.00 
A) $263.25 
B) $87.75 
C) $50.25 
D) $118.00

Question 19

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:

Accepted Answer

A) 7.5% 
B) 8.67% 
C) 10.27% 
D) 10.8% 
A) 7.5% 
B) 8.67% 
C) 10.27% 
D) 10.8%

Exam 18: Capital Budgeting and Valuation With Leverage

Which of the following questions 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 "Eenie" is closest to:

The NPV for Omicron's new project is closest to:

The unlevered value of Luther's Product Line is closest to:

Which of the following statements is FALSE?

Given that Rose issues new debt of $50 million initially to fund the acquisition,the present value of the interest tax shield for this acquisition is closest to:

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:

Calculate the NPV for Iota's new project.

Consider the following equation: Dt = d × The term Dt in this equation is:

Which of the following statements is FALSE?

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

The Debt Capacity for Iota's new project in year 0 is closest to:

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:

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: D^{t = d ×} The term D^t in this equation is:

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