Question 1

In the compressed adjusted present value model, the appropriate discount rate for the tax shield is the WACC.

Accepted Answer

A) True 
 B)False

Question 2

Which of the following statements about valuing a firm using the compressed adjusted present value (CAPV) approach is most CORRECT?

Accepted Answer

A)  the horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the cost of debt. 
B)  the horizon value is calculated by discounting the expected earnings at the wacc. 
C)  the horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the wacc. 
D)  the horizon value must always be more than 20 years in the future. 
E)  the horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the levered cost of equity. 
A)  the horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the cost of debt. 
B)  the horizon value is calculated by discounting the expected earnings at the wacc. 
C)  the horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the wacc. 
D)  the horizon value must always be more than 20 years in the future. 
E)  the horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the levered cost of equity.

Question 3

Refer to data for Glassmaker Corporation.Using the compressed adjusted present value model, what will Glassmaker's value of equity be if it successfully implements its planned changes in operations and capital structureσ (Round your answer to the closest thousand dollars.)

Accepted Answer

A)  $16,019,000 
B)  $17,111,000 
C)  $18,916,000 
D)  $22,111,000 
E)  $22,916,000 
A)  $16,019,000 
B)  $17,111,000 
C)  $18,916,000 
D)  $22,111,000 
E)  $22,916,000

Question 4

Suppose a company issued 30-year bonds 4 years ago, when the yield curve was inverted. Since then long-term rates (10 years or longer) have remained constant, but the yield curve has resumed its normal upward slope. Under such conditions, a bond refunding would almost certainly be profitable.

Accepted Answer

A) True 
 B)False

Question 5

Volunteer Enterprises has the following information for the current year. Calculate its free cash flow to equity. $\begin{array}{lr}
\text { FCF } & 1,000 \
\text { Interest expense } & 40 \
\text { Principal payments } & 200 \
\text { New debt } & 300 \
\text { Tax rate } & 25 \%
\end{array}$

Accepted Answer

A)  $1,070 
B)  $1,177 
C)  $1,295 
D)  $1,424 
E)  $1,567 
A)  $1,070 
B)  $1,177 
C)  $1,295 
D)  $1,424 
E)  $1,567

Question 6

The market value of Firm L's debt is $200,000 and its yield is 9%. The firm's equity has a market value of $300,000, its earnings are growing at a rate of 5%, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Using the compressed adjusted present value model, what is Firm L's cost of equity?

Accepted Answer

A)  11.4% 
B)  12.0% 
C)  12.6% 
D)  13.3% 
E)  14.0% 
A)  11.4% 
B)  12.0% 
C)  12.6% 
D)  13.3% 
E)  14.0%

Question 7

NorthWest Water (NWW)
Five years ago, NorthWest Water (NWW) issued $50,000,000 face value of 30-year bonds carrying a 14% (annual payment) coupon. NWW is now considering refunding these bonds. It has been amortizing $3 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NWW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called.
-Refer to the data for NorthWest Water (NWW). What will the after-tax annual interest savings for NWW be if the refunding takes place?

Accepted Answer

A)  $664,050 
B)  $699,000 
C)  $768,900 
D)  $845,790 
E)  $930,369 
A)  $664,050 
B)  $699,000 
C)  $768,900 
D)  $845,790 
E)  $930,369

Question 8

Kitto Electronics Data
Kitto Electronics has an EBIT of $200,000, a growth rate of 6%, and its tax rate is 40%. In order to support growth, Kitto must reinvest 20% of its EBIT in net operating assets. Kitto has $300,000 in 8% debt outstanding, and a similar company with no debt has a cost of equity of 11%.

-Refer to data for Kitto Electronics. Using the compressed adjusted present value model, what is Kitto's value of equity?

Accepted Answer

A)  $1,492,000 
B)  $1,529,300 
C)  $1,567,533 
D)  $1,606,721 
E)  $1,646,889 
A)  $1,492,000 
B)  $1,529,300 
C)  $1,567,533 
D)  $1,606,721 
E)  $1,646,889

Question 9

Holland Auto Parts is considering a merger with Workman Car Parts. Workman's market-determined beta is 0.9, and the firm currently is financed with 20% debt, at an interest rate of 8%, and its tax rate is 25%. If Holland acquires Workman, it will increase the debt to 60%, at an interest rate of 9%, and the tax rate will increase to 35%. The risk-free rate is 6% and the market risk premium is 4%. Using the Compressed APV Model, what will Workman's required rate of return on equity be after it is acquired?

Accepted Answer

A)  7.4% 
B)  8.9% 
C)  9.3% 
D)  9.6% 
E)  9.7% 
A)  7.4% 
B)  8.9% 
C)  9.3% 
D)  9.6% 
E)  9.7%

Question 10

Which of the following statements is most CORRECT?

Accepted Answer

A)  the key benefits associated with refunding debt are the reduction in the firm's debt ratio and the creation of more reserve borrowing capacity. 
B)  the mechanics of finding the npv of a refunding decision are fairly straightforward. however, the decision of when to refund is not always clear because it requires a forecast of future interest rates. 
C)  if a firm with a positive npv refunding project delays refunding and interest rates rise, the firm can still obtain the entire npv by locking in a low coupon rate when the rates are low, even though it actually refunds the debt after rates have risen. 
D)  suppose a firm is considering refunding and interest rates rise during time when the analysis is being done. the rise in rates would tend to lower the expected price of the new bonds, which would make them cheaper to the firm and thus increase the expected interest savings. 
E)  if new debt is used to refund old debt, the correct discount rate to use in the refunding analysis is the before-tax cost of new debt. 
A)  the key benefits associated with refunding debt are the reduction in the firm's debt ratio and the creation of more reserve borrowing capacity. 
B)  the mechanics of finding the npv of a refunding decision are fairly straightforward. however, the decision of when to refund is not always clear because it requires a forecast of future interest rates. 
C)  if a firm with a positive npv refunding project delays refunding and interest rates rise, the firm can still obtain the entire npv by locking in a low coupon rate when the rates are low, even though it actually refunds the debt after rates have risen. 
D)  suppose a firm is considering refunding and interest rates rise during time when the analysis is being done. the rise in rates would tend to lower the expected price of the new bonds, which would make them cheaper to the firm and thus increase the expected interest savings. 
E)  if new debt is used to refund old debt, the correct discount rate to use in the refunding analysis is the before-tax cost of new debt.

Question 11

Eta Edibles had free cash flow to equity, required return, and long-term growth rate as indicated below. Eta has no non-operating assets. Calculate Eta's intrinsic value of equity using the FCFE model. $\begin{array}{l}
\begin{array} { l } 
\text { Most recent FCFE}\
\text { Required return on}\
\text { equity}\
\text { Long-term growth rate}\
\end{array}
\begin{array} { l } 
1000\
90 \%\
\
4 \%\
\end{array}
\end{array}$

Accepted Answer

A)  $18,909 
B)  $20,800 
C)  $22,880 
D)  $25,168 
E)  $27,685 
A)  $18,909 
B)  $20,800 
C)  $22,880 
D)  $25,168 
E)  $27,685

Question 12

The market value of Firm L's debt is $200,000 and its yield is 9%. The firm's equity has a market value of $300,000, its earnings are growing at a 5% rate, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Using the compressed adjusted present value model, what would Firm L's total value be if it had no debtσ

Accepted Answer

A)  $358,421 
B)  $377,286 
C)  $397,143 
D)  $417,000 
E)  $437,850 
A)  $358,421 
B)  $377,286 
C)  $397,143 
D)  $417,000 
E)  $437,850

Question 13

A local firm has debt worth $200,000, with a yield of 9%, and equity worth $300,000. It is growing at a 5% rate, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Using the compressed adjusted present value model, what is the value of your firm's tax shield, i.e., how much value does the use of debt add?

Accepted Answer

A)  $92,571 
B)  $102,857 
C)  $113,143 
D)  $124,457 
E)  $136,903 
A)  $92,571 
B)  $102,857 
C)  $113,143 
D)  $124,457 
E)  $136,903

Question 14

Five years ago, the State of Oklahoma issued $2,000,000 of 7% coupon, 20-year semiannual payment, tax-exempt bonds. The bonds had 5 years of call protection, but now the state can call the bonds if it chooses to do so. The call premium would be 5% of the face amount. Today 15-year, 5%, semiannual payment bonds can be sold at par, but flotation costs on this issue would be 2%. What is the net present value of the refundingσ Because these are tax-exempt bonds, taxes are not relevant.

Accepted Answer

A)  $278,606 
B)  $292,536 
C)  $307,163 
D)  $322,521 
E)  $338,647 
A)  $278,606 
B)  $292,536 
C)  $307,163 
D)  $322,521 
E)  $338,647

Question 15

If the capital structure is stable, and free cash flows are expected to be growing at a constant rate at the horizon date, then the compressed adjusted present value model calculates the horizon value by discounting the post-horizon free cash flows and post-horizon expected future tax shields at the weighted average cost of capital.

Accepted Answer

A) True 
 B)False

Question 16

Gamma Pharmaceuticals has the following financial information for the current year and projected for next year. Calculate Gamma's projected free cash flow to equity. $\begin{array} { l l r r } 
&  { \text { Curtent } } & \
& \text { year } & \text { Projected } \
\text { NOPAT } & \text { NA } & 1,000 \
\text { Tatal aperating capital }  & 2,000 & 2,200 \
\text { Tetal debt }  & 900 & 800 \
\text { Interest rate an debt }  & 6 \% & 6 \% \
\text { Tar rate }  & 25 \% & 25 \%
\end{array}$

Accepted Answer

A)  $549 
B)  $604 
C)  $664 
D)  $730 
E)  $803 
A)  $549 
B)  $604 
C)  $664 
D)  $730 
E)  $803

Question 17

Gators Incorporated has the following information for the current year and projected for next year. Calculate its projected free cash flow to equity. $\begin{array}{lrr}
&\text { Current }\
&\text { year }  & \text { Projected } \
\text { FCF }&\text { NA }  & 1,000 \
\text { Total debt }& 400 & 600 \
\text { Interest rate on debt }& 6 \% & 6 \% \
\text { Tax rate }& 25 \% & 250
\end{array}$

Accepted Answer

A)  $1,066 
B)  $1,173 
C)  $1,290 
D)  $1,419 
E)  $1,561 
A)  $1,066 
B)  $1,173 
C)  $1,290 
D)  $1,419 
E)  $1,561

Question 18

Which of the following factors would increase the likelihood that a company would call its outstanding bonds at this time?

Accepted Answer

A)  a provision in the bond indenture lowers the call price on specific dates, and yesterday was one of those dates. 
B)  the flotation costs associated with issuing new bonds rise. 
C)  the firm's cfo believes that interest rates are likely to decline in the future. 
D)  the firm's cfo believes that corporate tax rates are likely to be increased in the future. 
E)  the yield to maturity on the company's outstanding bonds increases due to a weakening of the firm's financial situation. 
A)  a provision in the bond indenture lowers the call price on specific dates, and yesterday was one of those dates. 
B)  the flotation costs associated with issuing new bonds rise. 
C)  the firm's cfo believes that interest rates are likely to decline in the future. 
D)  the firm's cfo believes that corporate tax rates are likely to be increased in the future. 
E)  the yield to maturity on the company's outstanding bonds increases due to a weakening of the firm's financial situation.

Question 19

Refer to data for Glassmaker Corporation. According to the compressed adjusted present value model, what discount rate should you use to discount Glassmaker's free cash flows and interest tax savings?

Accepted Answer

A)  10.01% 
B)  10.06% 
C)  11.29% 
D)  11.44% 
E)  13.49% 
A)  10.01% 
B)  10.06% 
C)  11.29% 
D)  11.44% 
E)  13.49%

Question 20

In the compressed adjusted present value model, the appropriate discount rate for the tax shield is the after-tax cost of debt.

Accepted Answer

A) True 
 B)False

Exam 17: Dynamic Capital Structures and Corporate Valuation

In the compressed adjusted present value model, the appropriate discount rate for the tax shield is the WACC.

Which of the following statements about valuing a firm using the compressed adjusted present value (CAPV) approach is most CORRECT?

Refer to data for Glassmaker Corporation.Using the compressed adjusted present value model, what will Glassmaker's value of equity be if it successfully implements its planned changes in operations and capital structureσ (Round your answer to the closest thousand dollars.)

Suppose a company issued 30-year bonds 4 years ago, when the yield curve was inverted. Since then long-term rates (10 years or longer) have remained constant, but the yield curve has resumed its normal upward slope. Under such conditions, a bond refunding would almost certainly be profitable.

Volunteer Enterprises has the following information for the current year. Calculate its free cash flow to equity. FCF 1,000 Interest expense 40 Principal payments 200 New debt 300 Tax rate 25\%

Which of the following statements is most CORRECT?

Eta Edibles had free cash flow to equity, required return, and long-term growth rate as indicated below. Eta has no non-operating assets. Calculate Eta's intrinsic value of equity using the FCFE model. Most recent FCFE Required return on equity Long-term growth rate 1000 90\% 4\%

Gators Incorporated has the following information for the current year and projected for next year. Calculate its projected free cash flow to equity. Current year Projected FCF NA 1,000 Total debt 400 600 Interest rate on debt 6\% 6\% Tax rate 25\% 250

Which of the following factors would increase the likelihood that a company would call its outstanding bonds at this time?

Refer to data for Glassmaker Corporation. According to the compressed adjusted present value model, what discount rate should you use to discount Glassmaker's free cash flows and interest tax savings?

In the compressed adjusted present value model, the appropriate discount rate for the tax shield is the after-tax cost of debt.

An Overview of Financial Management and the Financial Environment

Risk and Return-Part I

Risk and Return-Part II

Bond Valuation

Financial Options

Accounting for Financial Management

Analysis of Financial Statements

Basic Stock Valuation

Corporate Valuation and Financial Planning

Corporate Governance

Determining the Cost of Capital

Capital Budgeting: Decision Criteria

Capital Budgeting-Estimating Cash Flows and Analyzing Risk

Real Options

Distributions to Shareholders-Dividends and Repurchases

Capital Structure Decisions

Initial Public Offerings-Investment Banking: and Financial Restructuring

Lease Financing

Hybrid Financing Preferred Stock-Warrants and Convertibles

Supply Chains and Working Capital Management

Providing and Obtaining Credit

Other Topics in Working Capital Management

Enterprise Risk Management

Bankruptcy-Reorganization and Liquidation

Mergers and Corporate Control

Multinational Financial Management

Time Value of Money

Basic Financial Tools: A review

Pension Plan Management

Financial Management in Not for Profit Businesses

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