Deck 15: Financing and Valuation

Question 1

Capital budgeting decisions that include both investment and financing decisions can be analyzed by:
I. Adjusting the present value
II. Adjusting the discount rate
III. Ignoring financing mix

A) I only
B) II only
C) III only
D) I and II only

Answer 1

I and II only

Question 2

If the weighted average cost of capital (WACC) is 9% calculate the NPV of the project.

A) -2.5 million
B) +2.5 million
C) zero
D) none of the above

Answer 2

zero

Question 3

The after-tax weighted average cost of capital (WACC) is calculated as:

A) WACC = rD (D/V) + rE (E/V); (where V = D + E)
B) WACC = rD (1 - TC)(D/V) + rE (E/V); (where V = D + E)
C) WACC = rD (D/V) + rE (1 - TC)(E/V); (where V = D + E)
D) None of the above

Answer 3

WACC = rD (1 - TC)(D/V) + rE (E/V); (where V = D + E)

Question 4

Free cash flow (FCF) and net income (NI) differ in the following ways:
I. net income is the return to shareholders, calculated after interest expense; free cash flow is calculated before interest.
II. net income is calculated after various non-cash expenses, including depreciation; we add back depreciation when we calculate free cash flow.
III. capital expenditures and investments in working capital do not appear in net income calculations; they do reduce free cash flows.
IV. net income is never negative; free cash flows can be negative for rapidly growing firms, even if the firm is profitable, because investments exceed cash flows from operations.

A) I only
B) I and II only
C) I, II and III only
D) I, II, III and IV

Question 5

Given the following data:
FCF1 = $7 million; FCF2 = $45 million; FCF3 = $55 million; free cash flow grows at a rate of 4% for year 4 and beyond. If the weighted average cost of capital is 10%, calculate the value
Of the firm.

A) $953.33 million
B) $801.12 million
C) $716.25 million
D) None of the above

Question 6

When using the weighted average cost of capital (WACC) to discount cash flows from a project we assume the following:
I. the project's risk are the same as those of firm's other assets and remain so for the life of the project.
II. the project supports the same fraction of debt to value as the firm's overall capital structure that remains constant for the life of the project.
III. the cash flows from the project is always a perpetuity.

A) I only
B) II only
C) I and II only
D) I, II and III

Question 7

The after-tax weighted average cost of capital is determined by:

A) Multiplying the weighted average after tax cost of debt by the weighted average cost of equity
B) Adding the weighted average before tax cost of debt to the weighted average cost of equity
C) Adding the weighted average after tax cost of debt to the weighted average cost of equity
D) Dividing the weighted average before tax cost of debt to the weighted average cost of equity

Question 8

In calculating the weighted average cost of capital, the values used for D, E and V are:

A) book values
B) liquidating values
C) market values
D) none of the above

Question 9

Given the following data for Golf Corporation:
Market price/share = $12; Book value/share = $10; Number of shares outstanding = 100 million; market price/bond = $800; Face value/bond = $1,000; Number of bonds outstanding = 1 million; Calculate the proportions of debt (D/V) and equity (E/V) for the firm that you would use for estimating the weighted average cost of capital (WACC):

A) 40% debt and 60% equity
B) 50% debt and 50% equity
C) 45.5% debt and 54.5% equity
D) none of the given values

Question 10

Total market value of a firm (V): [D = market value of debt; E = market value of equity]

A) V = D + E
B) V = D + E + tax shield effect of debt
C) V = D + E + tax shield effect of debt-Present value of bankruptcy costs
D) None of the given ones

Question 11

Given the following data:
FCF1 = $20 million; FCF2 = $20 million; FCF3 = $20 million; free cash flow grows at a rate of 5% for year 4 and beyond. If the weighted average cost of capital is 12%, calculate the value of the firm.

A) $300 million
B) $261.57 million
C) $213.53 million
D) None of the above

Question 12

Given the following data for year-1:
Profits after taxes = $14 millions; Depreciation = $6 millions; Interest expense = $6 millions; Investment in fixed assets = $12 millions; and Investment in working capital = $3 millions; Calculate the free cash flow (FCF) for year-1:

A) $4 millions
B) $5 millions
C) $6 millions
D) none of the above

Question 13

The following situations typically require that the financial manager value an entire business in order to make important decisions:
I. If firm A is about make a takeover offer for firm B, then A's financial managers have to decide how much the combined business A + B is worth under A's management.
II. If firm C is considering the sale of one of its divisions or a business line, it has to decide what the division or the business line is worth in order to negotiate with potential buyers.
III. When a firm goes public, the investment bank must evaluate how much the firm is worth in order to set the price.

A) I only
B) I and II only
C) III only
D) I, II and III

Question 14

Given the following data: Cost of debt = rD = 6%; Cost of equity = rE = 12.1%; Marginal tax rate = 35%; and the firm has 50% debt and 50% equity. Calculate the after-tax weighted average coat of capital (WACC):

A) 8%
B) 7.1%
C) 9.05%
D) None of the given values

Question 15

Calculate the IRR for the project.

A) 10%
B) 9%
C) 8%
D) none of the above

Question 16

When weighted average cost of capital (WACC) is used to value a levered firm, the interest tax shield is:

A) ignored.
B) considered by deducting the interest payment from the cash flows.
C) automatically considered because the after-tax cost of debt is used in the WACC formula.
D) none of the above

Question 17

A firm has a total market value of $10 million and debt has a market value of $4 million. What is the after-tax weighted average cost of capital if the before - tax cost of debt is 10%, the cost of equity is 15% and the tax rate is 35%?

A) 13%
B) 11.6%
C) 8.75%
D) None of the given answers

Question 18

Given the following data for Year-1: Profit after taxes = $5 million; Depreciation = $2 million; Investment in fixed assets = $4 million; Investment net working capital = $1 million. Calculate the free cash flow (FCF) for Year-1:

A) $7 million
B) $3 million
C) $11 million
D) $2 million

Question 19

Given the following data for year-1:
Profits after taxes = $20 millions; Depreciation = $6 millions; Interest expense = $4 millions; Investment in fixed assets = $12 millions; and Investment in working capital = $4 millions; Calculate the free cash flow (FCF) for year-1:

A) $4 millions
B) $6 millions
C) $10 millions
D) none of the above

Question 20

Given the following data for Vinyard Corporation:

Calculate the proportions of debt (D/V) and equity (E/V) for the firm that you would use for estimating the weighted average cost of capital (WACC):

A) 40% debt and 60% equity
B) 50% debt and 50% equity
C) 25% debt and 75% equity
D) none of the given values

Question 21

The Marble Paving Co. has an equity cost of capital of 17%. The debt to equity ratio is 1.5 and a cost of debt is 11%. What is the cost of equity if the firm was unlevered? (Assume a tax rate of 33%)

A) 14. 0%
B) 11. 0%
C) 16. 97%
D) None of the above

Question 22

Calculate the value of the firm:

A) $90.4 millions
B) $104 millions
C) $82.6 millions
D) none of the above

Question 23

The Granite Paving Company has a debt equity ratio of 1.5. The before-tax cost of debt is 11% and the unlevered equity is 14%. Calculate the weighted average cost of capital for the firm if the tax rate is 33%.

A) 33%
B) 7.37%
C) 25.1%
D) 11.22%

Question 24

Value of the debt = $30 millions; Calculate the total value of equity of the firm:

A) $100 millions
B) $70 millions
C) $30 millions
D) none of the given values

Question 25

Calculate the present value of the horizon value:

A) $90.4 millions
B) $104 millions
C) $78.1 millions
D) none of the above

Question 26

The Granite Paving Co. wants to be levered at a debt equity ratio of 1.5. The before-tax cost of debt is 11% and the cost of equity for an all equity firm is 14%. What will be the firm's cost of levered equity? (Assume a tax rate of 33%.)

A) 22%
B) 16%
C) 17%
D) None of the above

Question 27

The flow to equity method provides an accurate estimate of the value of a firm if:

A) debt-equity ratio remains constant for the life of the firm
B) amount of debt remains constant for the life of the firm
C) free cash flows remain constant for the life of the firm
D) the financial leverage changes significantly over the life of the firm

Question 28

Value of the debt = $30 millions; Number of shares outstanding = 5 millions; Calculate the value per share for the firm.

A) $20
B) $14
C) $13
D) none of the given values

Question 29

A firm is financed with 30% debt, 60% common equity and 10% preferred equity. The before-tax cost of debt is 5%, the firm's cost of common equity is 15%, and that of preferred equity is 10%. The marginal tax rate is 30%. What is the firm's weighted average cost of capital?

A) 10.05%
B) 11.05%
C) 12.5%
D) None of the above

Question 30

The Miles-Ezzell formula for the adjusted cost of capital assumes that:

A) the firm rebalances once a year and not rebalance continuously
B) the project cash flow is a perpetuity
C) the project is a carbon copy of the firm
D) MM's Proposition I corrected for taxes holds

Question 31

Calculate the value of the firm:

A) $100 millions
B) $65 millions
C) $30 millions
D) none of the given values

Question 32

Lowering debt-equity ratio of a firm can change:
I. financing proportions
II. cost of equity
III. cost of debt
IV. effective tax rate

A) II and III only
B) I only
C) I, II, and III only
D) I, II, III and IV

Question 33

A firm has zero debt in its capital structure. Its overall cost of capital is 8%. The firm is considering a new capital structure with 50% debt. The interest rate on the debt would be 5%. Assuming that the corporate tax rate is 40%, its cost of equity capital with the new capital structure would be?

A) 9.8%
B) 9.2%
C) 11%
D) None of the above

Question 34

A firm has a debt-to-equity ratio of 0.5. Its cost of equity is 22%, and its cost of debt is 16%. If the corporate tax rate is .40, what would its cost of equity be if the debt-to-equity ratio were 0?

A) 20.62%
B) 16.00%
C) 26.8%
D) None of the above

Question 35

A firm has a debt-to-equity ratio of 1. Its cost of equity is 16%, and its cost of debt is 8%. If the corporate tax rate is 25%, what would its cost of equity be if the debt-to-equity-ratio were 0?

A) 12.57%
B) 13.83%
C) 16.00%
D) None of the above

Question 36

Financial practitioners include short-term debt in WACC calculations:
I. If the short-term debt is at least 10% of total liabilities
II. If the short-term debt is at least 10% of the total assets
III. If the net working capital is negative IV) If the net working capital is positive

A) I and IV only
B) I and III only
C) II and IV only
D) II and III only

Question 37

A firm is using $30 million in debt, $10 million in preferred stock and $60 million in common equity to finance its assets. If the before tax cost of debt is 8%, cost of preferred stock is 10%, and the cost of common equity is 15%; calculate the weighted average cost of capital for the firm assuming a tax rate of 35%.

A) 12.4%
B) 11.56%
C) 10.84%
D) None of the above

Question 38

The Granite Paving Co. wishes to have debt-to-equity ratio of 1.5. Currently it is an unlevered (all equity) firm with a beta of 1.1. What will be the beta of the firm if it goes through the capital restructuring process and attains the target debt-to-equity ratio? Assume a tax rate of 30%.

A) 2.26
B) 1.65
C) 1.5
D) None of the above

Question 39

The Flow-to-equity method:
I. uses cash flows to equity, after interest and after taxes
II. uses cost of equity capital as the discount rate
III. uses weighted average cost of capital for discount rate
IV. uses after-tax cash flows without considering interest and dividend payments

A) I and II only
B) II and III only
C) I and III only
D) II and IV only

Question 40

When preferred stock financing is also used by the firm; the after-tax weighted average cost of capital (WACC) is calculated as follows,

A) WACC = rD (D/V) + rP (P/V) + rE (E/V); (where V = D + P + E)
B) WACC = rD (1 - TC)(D/V) + rP (P/V) + rE (E/V); (where V = D + P + E)
C) WACC = rD (D/V) + (1 - TC)[rP (P/V) + rE (E/V)]; (where V = D + P + E)
D) None of the above

Question 41

The WACC formula works for the "average risk" project.

Question 42

The Granite Paving Company has a debt to total value ratio of 0.5. The cost of debt is 8% and that of unlevered equity is 12%. Calculate the weighted average cost of capital if the tax rate is 30%.

A) 14.8%
B) 10.2%
C) 12.0%
D) None of the above

Question 43

APV = NPV(base-case assuming all equity financing) - NPV(financing decisions caused by project financing).

Question 44

The APV method includes all equity NPV of a project and the NPV of financing effects. The financing effects are:

A) Tax subsidy of dividends, cost of issuing new securities, subsidy of financial distress and cost of debt financing
B) Cost of issuing new securities, cost of financial distress, tax subsidy of debt and other subsidies
C) Cost of issuing new securities, cost of financial distress, tax subsidy of dividends and cost of debt financing
D) Subsidy of financial distress, tax subsidy of debt, cost of other debt financing and cost of issuing new securities

Question 45

APV method is most useful in analyzing:

A) large international projects
B) domestic projects
C) small projects
D) none of the above

Question 46

The MFC Corporation has decided to build a new facility. The cost of the facility is estimated to be $9.7 million. MFC wishes to finance this project using its traditional debt-to- equity ratio of 1.5. The issue cost of equity is 6% and the issue cost of debt is 1%. What is the total floatation cost of raising funds?

A) $300,000
B) $100,000
C) $600,000
D) None of the above

Question 47

The APV method to value a project should be used:

A) When the project's level of debt is known over the life of the project
B) When the project's target debt to value ratio is constant over the life of the project
C) When the project's debt financing is unknown over the life of the project
D) None of the above

Question 48

In the case of large international investments, the project might include:
I. custom-tailored project financing
II. special contracts with suppliers
III. special contracts with customers
IV. special arrangements with governments

A) I and II only
B) I, II and III only
C) I, II, III and IV
D) IV only

Question 49

A project costs $7 million and is expected to produce cash flows if $2 million a year for 10 years. The opportunity cost of capital is 16%. If the firm has to issue stock to undertake the project and issue costs are $0.5 million, what is the project's APV?

A) $9.67 million
B) $2.17 million
C) $1.67 million
D) $0.67 million

Question 50

Subsidized loans have the effect of:

A) Increasing the NPV of the loan, thereby reducing the APV.
B) Decreasing the NPV of the loan, thereby reducing the APV.
C) Decreasing the NPV of the loan, thereby increasing the APV.
D) Increasing the NPV of the loan, thereby increasing the APV.

Question 51

The BSC Co. is planning to raise $2.5 million in perpetual debt at 11%. They have just received an offer from the governor to raise the financing for them at 8%, if they locate themselves in the state. What is the total value added from debt financing if the tax rate is 34% and the state raises the loan for the company?

A) $2.5 million
B) $1.2 million
C) $1.3 million
D) None of the above

Question 52

Which of the following statements regarding guarantees and government restrictions on international projects is (are) true?
I. The value of the guarantees is added to the APV
II. The value of the guarantees is subtracted from the APV
III. The value of the government restrictions is added to the APV
IV. The value of the government restrictions is subtracted from the APV

A) I and III only
B) II and III only
C) II and IV only
D) I and IV only

Question 53

Modigliani-Miller (MM) formula for after-tax discount rate is given by:

A) rMM = r(1 - TCD/V)
B) rMM = r(1 + TCD/V)
C) rMM = r/(1 - TCD/V)
D) None of the above

Question 54

A project costs $15 million and is expected to produce cash flows of $3 million a year for 10 years. The opportunity cost of capital is 14%. If the firm has to issue stock to undertake the project and issue costs are $500,000, what is the project's APV (approximately)?

A) -$352,000
B) $148,350
C) $648,350
D) $952,000

Question 55

A project costs $14 million and is expected to produce cash flows of $4 million a year for 15 years. The opportunity cost of capital is 20%. If the firm has to issue stock to undertake the project and issue costs are $1 million, what is the project's APV?

A) $3.7 million
B) $4.5 million
C) $4.7 million
D) $3.0 million

Question 56

When calculating the WACC for a firm, one should only use the book values of debt and equity.

Question 57

The MM formula for adjusted cost of capital takes into consideration only the effect of interest tax shield on debt.

Question 58

A firm has issued $5 par value preferred stock that pays a $0.80 annual dividend. The stock currently sells for $9.50. In calculating a WACC, what would be the value of the firm's preferred stock?

A) $0.80
B) $4.50
C) $5.00
D) $9.50

Question 59

Floatation costs are incorporated into the APV framework by:

A) Adding them into the all equity value of the project.
B) Subtracting them from all equity value of the project.
C) Incorporating them into the WACC.
D) Disregarding them.

Question 60

The MFC corporation needs to raise $200 million for its mega project. The NPV of the project using all equity financing is $40 million. If the cost of raising funds for the project is $20 million, what is the APV of the project?

A) $40 million.
B) $240 million.
C) $20 million.
D) $160 million.

Question 61

Which is the most often used method by managers to make decisions?

Question 62

What discount rate should be used for calculating the present value of safe, nominal cash flows?

Question 63

Discounting at the WACC assumes that debt is rebalanced every period to maintain a constant ratio of debt to market value of the firm.

Question 64

Briefly explain how APV can be used for valuing a business.

Question 65

What method would you use for evaluating international projects?

Question 66

Generally, subsidized loan decreases the APV of a project.

Question 67

Briefly explain how the rate of return on equity of a firm changes with changes in debt- equity ratio when taxes are considered.

Question 68

The market value of debt is very close to the book value of debt for healthy firms.

Question 69

Enterprise zones, a government program that provides financial incentives to make negative NPV investments, increases APV.

Question 70

Briefly explain how WACC can be used for valuing a business.

Question 71

APV method can be used for valuing businesses.

Question 72

Briefly explain how the beta of equity of a firm changes with changes in debt-equity ratio when taxes are considered.

Question 73

Adjusted present value is equal to base-case NPV plus the sum of the present values of any financing side effects.

Question 74

The value of a firm is the present value of free cash flows minus the present value of horizon value.

Question 75

Generally, APV is not suitable for international projects.

Question 76

The WACC formula does not change when preferred stock is included.

Question 77

Discuss the advantages and limitations of using the weighted average cost of capital as a discount rate to evaluate capital budgeting projects.

Question 78

PVH = (FCFH + 1)/(WACC - g)

Question 79

Generally, the imposition of government restrictions increases the APV of a project.

Question 80

Value of a firm is estimated by calculating the present value of free cash flows using WACC (weighted average cost of capital) for discount rate.