Bus 370 Exam 3 HW

Turnbull Corp. is in the process of constructing a new plant at a cost of $30 million. It expects the project to generate cash flows of $13,000,000, $23,000,000, and 29,000,000 over the next three years. The cost of capital is 20 percent. What is the net present value of this project? (Do not round intermediate computations. Round final answer to nearest million dollars.)

$14 million

A firm has $300 million in outstanding debt and $900 million in outstanding equity. Its cost of equity is 11%, and its cost of debt is 7%. What is the appropriate WACC?

10%

Which of the following is NOT true about capital budgeting?

It allows a firm to reverse the decision of large capital investments at any time.

Suppose the cost of capital of the Gadget Company is 10 percent. If Gadget has a capital structure that is 60 percent debt and 40 percent equity, its before-tax cost of debt is 6 percent, and its marginal tax rate is 20 percent, then its cost of equity capital is closest to:

14.8 percent

Gangland Water Guns, Inc. is expected to pay a dividend of $2.10 one year from today. If the firm's growth in dividends is expected to remain at a flat 3 percent forever, then what is the cost of equity capital for Gangland if the price of its common shares is currently $17.50?

15.00%

Dynamo Corp. produces annual cash flows of $150 and is expected to exist forever. The company is currently financed with 75 percent equity and 25 percent debt. Your analysis tells you that the appropriate discount rates are 10 percent for the cash flows, and 7 percent for the debt. You currently own 10 percent of the stock. How much is Dynamo worth today?

$1500

The Cyclone Golf Resorts is redoing its golf course at a cost of $2,744,320. It expects to generate cash flows of $1,223,445, $2,007,812, and $3,147,890 over the next three years. If the appropriate discount rate for the firm is 13 percent, what is the NPV of this project? (Do not round intermediate computations. Round final answer to nearest dollar.)

$2,092,432

A firm plans to issue $700,000 worth of debt at an YTM of 7.5%. The debt is trading at par. The firm's marginal corporate tax rate is 30%. What is the value of the interest tax shield?

$210,000

Packman Corporation has a reported EBIT of $500, which is expected to remain constant in perpetuity. The firm borrows $2,000, and its coupon rate is 8%. If the company's marginal tax rate is 30% and its average tax rate is 20%, what are its after-tax earnings?

$238

A firm plans to issue $1 million worth of debt at an YTM of 9%. The debt is trading at par. The firm's marginal corporate tax rate is 35%. What is the present value of the tax savings in perpetuity?

$350000

Gao Enterprises plans to build a new plant at a cost of $3,250,000. The plant is expected to generate annual cash flows of $1,225,000 for the next five years. If the firm's required rate of return is 18 percent, what is the NPV of this project? (Do not round intermediate computations. Round final answer to nearest dollar.)

$580,785

Stryder, Inc. has 3 million shares outstanding at a current price of $15 per share. The book value of the shares is $10 per share. The firm also has $30 million in par value of bonds outstanding. The bonds are selling at a price equal to 101 percent of par. What is the market value of the firm?

$75.3 million

Strange Manufacturing Company is purchasing a production facility at a cost of $21 million. The firm expects the project to generate annual cash flows of $7 million over the next five years. Its cost of capital is 18 percent. What is the net present value of this project? (Do not round intermediate computations. Round final answer to nearest dollar.)

$890,197

Radical VenOil, Inc. has a cost of equity capital equal to 22.8 percent. If the risk-free rate of return is 10 percent and the expected return on the market is 18 percent, then what is the firm's beta if the marginal tax rate is 35 percent?

1.60

Cadmium Electronics Inc. currently has a capital structure that is 40% debt and 60% equity. If the firm's cost of equity is 12%, the cost of debt is 8%, and the risk-free rate is 3%, what is the appropriate WACC?

10.4%

Gangland Water Guns, Inc. has a debt-to-equity ratio of 0.5. If the firm's cost of debt is 7% and its cost of equity is 13%, what is the appropriate WACC?

11%

Bellamee, Inc. has a required rate of return on its assets of 12% and a cost of debt of 6.25%. Its current debt-to-equity ratio is 1/5. What is the required rate of return on its equity?

13.15%

Jacque Ewing Drilling, Inc. has a beta of 1.3 and is trying to calculate its cost of equity capital. If the risk-free rate of return is 8 percent and the expected return on the market is 12 percent, then what is the firm's after-tax cost of equity capital if the firm's marginal tax rate is 40 percent?

13.20%

Signet Pipeline Co. is looking to install new equipment that will cost $2,750,000. The cash flows expected from the project are $612,335, $891,005, $1,132,000, and $1,412,500 for the next four years. What is Signet's internal rate of return? (Do not round intermediate computations. Round final answer to the nearest percent.)

15%

You are analyzing the cost of capital for a firm that is financed with $300 million of equity and $200 million of debt. The cost of debt capital for the firm is 9 percent, while the cost of equity capital is 19 percent. What is the overall cost of capital for the firm? Assume there are no taxes.

15.0%

You are analyzing the cost of capital for a firm that is financed with 65 percent equity and 35 percent debt. The cost of debt capital is 8 percent, while the cost of equity capital is 20 percent for the firm. What is the overall cost of capital for the firm?

15.8%

Alpha Inc. has a required rate of return on its assets of 15% and a cost of debt of 4.5%. Their current debt-to-equity ratio is 0.33. What is the required rate of return on their equity?(Do not round intermediate calculations. Round final answer to two decimals.)

18.46%

Binder Corp. has invested in new machinery at a cost of $1,450,000. This investment is expected to produce cash flows of $640,000, $715,250, $823,330, and $907,125 over the next four years. What is the payback period for this project? (Round your answer to two decimal places.)

2.12 years

LaGrange Corp. has forecasted that over the next four years the average annual after-tax income will be $45,731. The average book value of the manufacturing equipment that is used is $167,095. What is the accounting rate of return? (Round your answer to one decimal place.)

27.4%

Strange Manufacturing Company is purchasing a production facility at a cost of $21 million. The firm expects the project to generate annual cash flows of $7 million over the next five years. Its cost of capital is 18 percent. What is the internal rate of return on this project? (Do not round intermediate computations. Round final answer to the nearest percent.)

20%

Dynamo Corporation has semiannual bonds outstanding with 12 years to maturity, and the bonds are currently priced at $1,080.29. If the bonds have a coupon rate of 8 percent, then what is the equivalent annual return (EAR) to the investor for purchasing the bonds at the described price? Round your final percentage answer to two decimal places.

7.12%

Which of the following is a disadvantage of the payback method?

All of the above

In order to use a firm's WACC to evaluate its future project's flows, which of the following must hold?

D. Both A and B choices are correct.

Quick Sale Real Estate Company is planning to invest in a new development. The cost of the project will be $23 million and is expected to generate cash flows of $14,000,000, $11,750,000, and $6,350,000 over the next three years. The company's cost of capital is 20 percent. What is the internal rate of return on this project? (Do not round intermediate computations. Round final answer to the nearest percent.)

22%

Strange Manufacturing Company is purchasing a production facility at a cost of $21 million. The firm expects the project to generate annual cash flows of $7 million over the next five years. Its cost of capital is 18 percent. What is the payback period for this project?

3.0 years

A recent leveraged buyout was financed with $50M. This amount comprised of partner's equity capital of $12M, $20M unsecured debt borrowed at 7% from one bank, and the remainder from another bank at 8.5%. What is the overall after-tax cost of the debt financing if you expect the firm's marginal tax rate to be 33%?

5.17%

A firm wishes to undertake a project that costs $150 million. It currently has $10 million in cash on hand and believes that it can raise $75 million in debt and $100 million in equity if needed. According to the pecking order theory of the capital structure, what percent of the project will be financed by debt?

50%

The Gearing Company has an after-tax cost of debt capital of 3 percent, a cost of preferred stock of 8 percent, a cost of equity capital of 10 percent, and a weighted average cost of capital of 7 percent. Gearing intends to maintain its current capital structure as it raises additional capital. In making its capital-budgeting decisions for the average-risk project, the relevant cost of capital is:

7 percent.

Dot.Com has determined that it could issue $1000 face value bonds with an 10 percent coupon paid semiannually and a 5-year maturity at $913.34 per bond. If Dot.Com's marginal tax rate is 36 percent, its after-tax cost of debt is closest to:

7.9 percent.

The WACC for a firm is 13.00 percent. You know that the firm's cost of debt capital is 10 percent and the cost of equity capital is 20%. What proportion of the firm is financed with debt? Assume there are no taxes.

70%

Beckham Corporation has semiannual bonds outstanding with 13 years to maturity and the bonds are currently priced at $746.16. If the bonds have a coupon rate of 8.5 percent, then what is the after-tax cost of debt for Beckham if its marginal tax rate is 35%? Round your intermediate calculation to two decimal places & final percentage answer to three decimal places.

8.125%

Melba's Toast has a capital structure with 30% debt and 70% equity. Its pretax cost of debt is 6%, and its cost of equity is 10%. The firm's marginal corporate income tax rate is 35%. What is the appropriate WACC?

8.17%

Bellamee, Inc. has semiannual bonds outstanding with five years to maturity, and the bonds are priced at $920.87. If the bonds have a coupon rate of 7 percent, then what is the YTM for the bonds? Round your final percentage answer to two decimal places.

9.0%

According to M&M Proposition 2, which of the following conditions would maximize the value of a firm?

A high debt-to-equity ratio when the cost of debt remains unchanged

Which one of the following statements is NOT true?

Accepting a zero NPV project has a negative impact on shareholder wealth.

Which of these statements about direct bankruptcy costs is NOT true?

Direct bankruptcy costs include payments to suppliers on delivery.

A firm is currently taking on two projects with an individual cost of capital of 10 percent and 12 percent for each of the projects. This means that the before-tax cost of capital for the firm must be between 10 and 12 percent.

False

M&M Proposition 2, which shows that the cost of a firm's common stock is directly related to its debt-equity ratio, does not hold if a firm has preferred stock outstanding.

False

When a firm gets closer to financial distress causing expected bankruptcy costs to increase, lenders will often charge the firm a lower interest rate in order to reduce the chance of an actual bankruptcy occurring.

False

Which of these is NOT an example of indirect bankruptcy costs?

New accountants are brought in to help with the bankruptcy process.

Which of the following need to be excluded from the calculation of a firm's amount of permanent debt?

Revolving lines of credit

If markets are not reasonably efficient, then

estimates of expected returns based on security prices will not be reliable.

One of the main reasons why the discounted payback period is not widely used by managers is that:

it ignores all cash flows that occur after the arbitrary cutoff period.

In order for a firm to estimate its cost of debt capital by observing the price of its debt instruments,

the firm must depend on markets being reasonably efficient.

The underinvestment problem occurs in a financially distressed firm when

the value of investing in a positive NPV project is likely to go to debt holders instead of equity holders.

Consider two companies that operate in the same line of business and have the same degree of operating leverage: the Basic Company and the Grundlegend Company. The Basic Company has no debt in its capital structure, but the Grundlegend Company has a capital structure that consists of 50 percent debt. Which of the following statements is true?

The Grundlegend Company has the same sensitivity of earnings before interest and taxes to changes in sales as the Basic Company.

Which of the following statements about the payback method is true?

There is no economic rational that links the payback method to shareholder wealth maximization.

Milton Corp. issued bonds 10 years ago with a coupon rate of 10 percent at a price of $1,000. The current price of the bonds is $980. The before-tax cost of the debt to the firm is still 10 percent.

True

Under the M&M assumptions with taxes, the value of a firm with debt is the value of the firm without debt plus the present value of the interest tax shield.

True

When evaluating two projects that require different outlays, the IRR does not recognize the difference in the size of the investments.

True

Which of the following is a key disadvantage of the IRR method?

With mutually exclusive projects, the IRR method can lead to incorrect investment decisions.

A construction firm is evaluating two value-adding projects. The first project deals with building access roads to a new terminal at the local airport. The second project is to build a parking garage on a piece of land that the firm owns adjacent to the airport. If both projects are positive-NPV projects, then the firm should

accept both projects because they are independent projects.

The use of debt financing

both increases agency costs between the stockholders and management by limiting the amount of risk the managers take and increases agency costs since managers prefer to keep more retained earnings rather than paying dividend.

Two projects are considered to be independent if

both selecting one would have no bearing on accepting the other and their cash flows are unrelated.

In evaluating capital projects, the decisions using the NPV method and the IRR method may disagree if

both the cash flows pattern is unconventional the projects are mutually exclusive

When evaluating capital projects, the decisions using the NPV method and the IRR method will agree if

both the projects are independent and the cash flow pattern is conventional.