FINC 324
Given the following data for Kriya Company: year: 1 2 3 4 FCF: 4 5 6 6.24 A constant growth rate of 4% is sustained forever after year 3. The weighted average cost of capital is 10%. Calculate the value of the firm: A. $90.4 millions B. $104 millions C. $82.6 millions D. none of the above
A. PV(firm) = 4/(1.1) + 5/(1.1)^2 + [ 6 + 6.24/(0.1 - 0.04)]/(1.1)^3 = 90.4
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
A. Use market values (in Millions): E = (12) * (100) = $1,200; D = (800) * (1) = $800; V = D + E = $2,000 D/V = 800/2,000 = 0.4 (40%); E/V = 1,200/2,000 = 0.6 (60%)
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
22 = rA + (1 - 0.4) (.5)(rA - 16); rA = 20.62 A
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 rE = 8 + (1 - 0.4)(1)(8 - 5) = 8 + 1.8 = 9.8%
A
APV method is most useful in analyzing: A. large international projects B. domestic projects C. small projects D. none of the above
A
What is the relative tax advantage of debt? Assume that personal and corporate taxes are given by: TC = (corporate tax rate) = 35% TpE = personal tax rate on equity income = 30% and Tp = personal tax rate on interest income = 20%. A. 1.76 B. 1.16 C. 1.35 D. 0.86
A Relative advantage = (1 - 0.2)/[(1 - 0.3)(1 - 0.35)] = 1.76.
According to the trade-off theory of capital structure: A. optimal capital structure occurs when the present value of tax savings on account of additional borrowing just offsets the increase in the present value of costs of distress. B. optimal capital structure occurs when the stockholders' right to default is balanced by the bondholders' right to get interest and principal payments. C. optimal capital structure occurs when the benefits of limited liability is just offset by the value of the firm's lawyers' claims. D. none of the options.
A
Although the use of debt provides tax benefits to the firm, debt also puts pressure on the firm to: I) Meet interest and principal payments, which if not met can put the company into financial distress II) make dividend payments, which if not met can put the company into financial distress III) meet both interest and dividend payments, which when met increase the firm cash flow IV) meet increased tax payments, thereby increasing firm value A. I only B. II only C. II and III only D. III and IV only
A
For every dollar of operating income paid out as interest, the bondholder realizes: A. (1 - Tp) B. (1 - TpE) (1 - TC) C. (1 - TC) D. 1/(1 - TC)
A
Given corporate taxes, why does adding debt to the capital structure increase firm value? I) Extra cash flow goes to the firm's investors rather than the tax authorities. II) Earnings before interest and taxes are fully taxed at the corporate rate. III) Personal tax rates are the same as marginal corporate tax rates. A. I only B. II only C. III only D. II and III only
A
Inclusion of restrictions in a bond contract leads to: A. higher agency costs. B. higher bankruptcy costs. C. higher interest costs. D. lower agency costs.
A
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
A
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
A
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
A
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 0.17 = r + (1.5)(0.67)(r - 0.11); r = 14%
A
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 (i.e., T* = TC = 0.35)
A
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
A
Total market value of a firm (V): [D = market value of debt; E = market value of equity]
A
What does "risk shifting" imply? A. When faced with bankruptcy, managers tend to invest in high-risk, high-return projects. B. When faced with bankruptcy, managers do not invest more equity capital. C. When faced with bankruptcy, managers may make accounting changes to conceal the true extent of the problem. D. When faced with bankruptcy, managers invest in low risk projects to conserve capital.
A
Why does MM Proposition I not hold in the presence of corporate taxes? A. Levered firms pay lower taxes when compared with identical unlevered firms. B. Bondholders require higher rates of return compared with stockholders. C. Earnings per share are no longer relevant with taxes. D. Dividends are no longer relevant with taxes.
A
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-toequity 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
A (0.6)(.01) + (.4)(.06) = 0.03; Total funds needed = 9.7/.97 = $10 millions; Floatation costs = (10) * (0.03) = $0.3 million = $300,000
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 16 = rA + (1 - .25)(1)(rA - 8); rA = 12.57%
A 16 = rA + (1 - .25)(1)(rA - 8); rA = 12.57%
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
A APV = -14 + 4(4.674) - 1 = $3.7 million
If a firm borrows $50 million for one year at an interest rate of 10%, what is the present value of the interest tax shield? Assume a 30% marginal corporate tax rate. A. $1.36 million B. $1.50 million C. $1.00 million D. $4.55 million
A PV of interest tax shield = ((0.3)(50)(0.1))/1.1 = $1.364.
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
A PV(firm) = PV (of FCFs for years 1 - 3) + PV (horizon value) = 35 + 65 = 100; Total value of equity = 100 - 30 = 70
Given the following data for Outsource Company: PV (of FCFs for years 1 - 3) = $35 millions; PV (horizon value) = $65 millions; 23. Calculate the value of the firm: A. $100 millions B. $65 millions C. $30 millions D. none of the given values
A PV(firm) = PV (of FCFs for years 1-3) + PV (horizon value) = 35 + 65 = 100
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
A bl = bo[1 + (D/E) (1 - Tc)] = 1.1 [1 + (1.5)(0.7)] = 2.26
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
A. WACC = (0.5)(1 - 0.35) (6) + (0.5)(12.1) = 8%
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
B Horizon value in year-3 = (55)(1.04)/(0.1 - 0.04) = $953.33 million PV = (7/1.1) + (45/1.1^2) + [(55 + 953.33)/(1.1^3)] = $801.12 million
4. 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
B
Compared to a firm with unlimited liability, the limited liability feature of common equity results in a: A. lower present value of the interest tax shield. B. higher value to equityholders. C. leveraged buyout mechanism. D. higher value to debt holders.
B
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
B
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.
B
For every dollar of operating income paid out as equity income, the shareholder realizes: A. (1 - Tp) B. (1 - TpE) (1 - TC) C. (1 - Tc) D. 1/(1 - TP)
B
In order to calculate the tax shield of interest payments for a corporation, always use the: I) average corporate tax rate II) marginal corporate tax rate III) marginal rate on personal income tax A. I only B. II only C. III only D. I and III only
B
In order to calculate the tax shields provided by debt, the tax rate used is the: A. average corporate tax rate. B. marginal corporate tax rate. C. average of shareholders' equity tax rates. D. average of bondholders' personal tax rates.
B
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
B
The indirect costs of bankruptcy are borne principally by: A. bondholders. B. stockholders. C. managers. D. the federal government.
B
The trade-off theory of capital structure predicts that: A. unprofitable firms should borrow more than profitable ones. B. safe firms should borrow more than risky ones. C. rapidly growing firms should borrow more than mature firms. D. increasing leverage increases firm value, especially at high debt ratios.
B
What is the relative tax advantage of debt? (TC = corporate tax rate, TpE = personal tax rate on equity income, and Tp = personal tax rate on interest income.)
B
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
B
When shareholders pursue strategies such as taking excessive risks or paying excessive dividends, these will result in: I) no action by debtholders since these are equity holder concerns II) positive agency costs, as bondholders act on various restrictions and covenants, which will diminish firm value III) investments of the same risk class that the firm is in A. I only B. II only C. III only D. I and III only
B
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
B (0.3)(1 - 0.3)(5) + (0.6)(15) + (0.1)(10) = 11.05
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
B APV = - 15 + 3(5.2161) - 0.5 = $0.14835 Million = $148,350
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
B APV = -7 + 2(4.8332) - 0.5 = $2.17 million
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
B Horizon value in year 3 = (20)(1.05)/(0.12 - 0.05) = $300 million PV = (20/1.12) + (20/1.12^2) + [(20 + 300)/(1.12^3)] = $261.57 million
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
B PV(firm) = PV (of FCFs for years 1 - 3) + PV (horizon value) = 35 + 65 = 100; Total value of equity = 100 - 30 = 70; Value per share = 70/5 = $14
Assume the marginal corporate tax rate is 30%. The firm has no debt in its capital structure. It is valued at $100 million. What would be the value of the firm if it issued $50 million in perpetual debt and repurchased the same amount of equity? A. $65 million B. $115 million C. $100 million D. $150 million
B VU = 100 (TC)(B) = 0.3(50) = 15 VL = VU + TCB = 100 + 15 = $115.
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
B WACC = (30/100)(1 - 0.35)(8) + (10/100)(10) + (60/100)(15) = 11.56%
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
B WACC = 0.4(0.10)(1 - 0.35) + 0.6(0.15) = 11.6%
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
B rE = 12 + (1)(1 - 0.3)(12 - 8) = 14.8%; WACC = (0.5)(1 - 0.3)(8) + (0.5)(14.8) = 10.2%
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
B FCF = 14 + 6 - 12 - 3 = $5 millions
Project M requires an initial investment of $25 millions. The project is expected to generate $2.25 millions in after-tax cash flows each year forever. Calculate the IRR for the project. A. 10% B. 9% C. 8% D. none of the above
B. 25 + 2.25/(IRR) = 0; IRR = 2.25/25 = 0.09 = 9%
Suppose that a company can direct $1 to either debt interest or capital gains for equity investors. If there were no personal taxes on capital gains, which of the following investors would not care how the money was channeled? (The marginal corporate tax rate is 35%.) A. investors paying personal tax of 17.5% B. investors paying personal tax of 35% C. investors paying personal tax of 53% D. tax-exempt personal investors
B. investors paying personal tax of 35%
3. 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
C
5. 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
C
Assuming that bonds are sold at a fair price, the benefits from the interest tax shield go to the: A. managers of the firm. B. bondholders of the firm. C. stockholders of the firm. D. lawyers of the firm.
C
If a corporation cannot use its interest payments as a tax shield for a particular year because it has suffered a loss, it is still possible to use the tax shield because: I) the carry-back provision allows corporations to carry back the loss and receive a tax refund up to the amount of taxes paid in the previous two years II) the carry-forward provision allows corporations to carry forward the loss and use it to shield income in subsequent years A. I only B. II only C. I and II D. the firm will lose the tax shield
C
In Miller's model, when the quantity (1 - TC)(1 - TpE) = (1 - Tp), then: A. the firm should hold no debt. B. the value of the levered firm is greater than the value of the unlevered firm. C. the tax shield on debt is exactly offset by higher personal taxes paid on interest income. D. the firm should be financed by 100% equity.
C
In order to find the present value of the tax shields provided by debt, the discount rate used is the: A. cost of capital. B. cost of equity. C. cost of debt. D. T-bill rate.
C
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
C
MM's Proposition I corrected for the inclusion of corporate income taxes is expressed as: A. VL = VU. B. VL = VU + D(1 - TC). C. VL = VU + (TC)(D). D. VU = VL + (TC)(D).
C
What are some of the possible consequences of financial distress? I) Bondholders, who face the prospect of getting only part of their money back, will likely want the company to take additional risks. II) Equity investors would like the company to cut its dividend payments to conserve cash. III) Equity investors would like the firm to shift toward riskier lines of business. A. I only B. II only C. III only D. I and II only
C
When financial distress is a possibility, the value of a levered firm consists of: I) value of the firm if all-equity-financed II) present value of tax shield III) present value of costs of financial distress IV) present value of omitted dividend payments A. I only B. I + II C. I + II - III D. I + II - III - IV
C
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
C
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
C
Which of the following statements regarding financial distress is (are) true? I) Firms in financial distress always end up in bankruptcy. II) Firms can postpone bankruptcy for many years. III) Ultimately, the firm may recover from financial distress and avoid bankruptcy altogether. A. I only B. II only C. II and III only D. III only
C
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.
C APV = 40 - 20 = 20
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
C NPVloan = 2.5 - [(0.08) (2.5)(1 0.34)/0.11] = $1.3 million.
A firm has a project with a NPV of -$52 million. If they have access to risk free government financing that can create an annual tax shield of $5 mil, what is the APV of the project assuming the risk free interest rate is 6%? A. -$52 mil B. $5 mil C. $31 mil D. $83 mil
C PV tax shield = 5/.06 = 83.3 mil. APV = -52 + 83.3 = 31.3
Calculate the present value of the horizon value: A. $90.4 millions B. $104 millions C. $78.1 millions D. none of the above
C PV(horizon value) = [6.24/(0.1 - 0.04)]/(1.1)^3 = 78.1
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
C rE = 14 + (1.5) (1 - 0.33)(14 - 11) = 17%
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
C. FCF = 20 + 6 - 12 - 4 = $10 millions
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
C. I, II and III only
Given the following data for Vinyard Corporation: D=1000 V=4000 E=3000 V=4000 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
C. Use market values: D/V = 1,000/4,000 =0.25 (25%); E/V = 3,000/4,000 = 0.75 (75%)
Project M requires an initial investment of $25 millions. The project is expected to generate $2.25 millions in after-tax cash flows each year forever. 10. 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
C. zero NPV = -25 + 2.25/0.09 = 0
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
D
MM Proposition I with corporate taxes states that: I) capital structure can affect firm value by an amount that is equal to the present value of the interest tax shield II) by raising the debt-to-equity ratio, the firm can lower its taxes and thereby increase its total value III) firm value is maximized by using an all-equity capital structure A. I only B. II only C. III only D. I and II
D
One of the indirect costs to bankruptcy is the incentive toward underinvestment. Following this strategy may result in: I) the firm always choosing projects with positive NPVs II) stockholders turning down low-risk, low-return but positive NPV projects III) the firm declaring and paying high cash dividends A. I only B. II only C. III only D. II and III only
D
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.
D
The MM theory with taxes implies that firms should issue maximum debt. In practice, this is not true because: I) debt is more risky than equity II) bankruptcy and its attendant costs are a disadvantage to debt III) the payment of personal taxes may offset the tax benefit of debt A. I only B. II only C. III only D. II and III only
D
The costs of financial distress depend on the: I) probability of financial distress II) corporate and personal tax rates III) magnitude of costs encountered if financial distress occurs A. I only B. I and II only C. I, II, and III D. I and III only
D
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
D
When faced with financial distress, managers of firms acting on behalf of their shareholders' interests will tend to: I) favor high-risk, high-return projects even if they have negative NPV II) refuse to invest in low-risk, low-return projects with positive NPVs III) delay the onset of bankruptcy as long as they can A. I only B. II only C. III only D. I, II, and III
D
When faced with financial distress, managers of firms acting on behalf of their shareholders' interests will tend to: I) issue large quantities of low-quality debt versus low quantities of high-quality debt II) favor paying high dividends to shareholders III) delay the onset of bankruptcy as long as they can A. I only B. II only C. III only D. I, II, and III
D
Which of the following is NOT a potential result from financial distress? A. Suppliers refuse to extend terms to the firm. B. Key employees leave the firm, fearing the firm won't last. C. The firm has difficulty issuing additional bonds. D. Due to interest tax shields, the firm's effective tax rate is very low.
D
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
D
Suppose that a company can direct $1 to either debt interest or to capital gains for equity investors. The capital gains tax rate is 15%. Which investor would not care how the money is channeled? (The marginal corporate tax rate is 35%.) A. investors paying zero personal tax B. investors paying a personal tax rate of 53% C. investors paying a personal tax rate of 17.5% D. investors paying a personal tax rate of 45%
D For an indifferent investor, it must be the case that (1 - TC)(1 - TpE) = (1 - Tp). Or, (1 - 0.35) (1 - 0.15) = (1 - Tp). Tp = 44.75%.
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
D Market price is all that matters.
If a firm borrows $50 million for one year at an interest rate of 9%, what is the present value of the interest tax shield? Assume a 30% marginal corporate tax rate. A. $50.00 million B. $17.50 million C. $1.45 million D. $1.24 million
D PV of interest tax shield = [(0.3)(50)(0.09)]/1.09 = $1.239 million.
V = firm value): According to MM's Proposition I corrected for taxes, what will be the change in company value if Bombay issues $200 of equity and uses it to make a permanent reduction in the company's debt? Assume a 35% marginal corporate tax rate. A. +$140 B. +$70 C. $0 D. -$70
D PV of tax shield = -200 (0.35) = -$70.
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%
D rE = 14 + (1.5)(1 - 0.33)(14 - 11) = 17%;WACC = (3/5)(1 - 0.33)(11) + (2/5)(17) WACC = 11.22%
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
D. FCF = 5 + 2 - 4 - 1 = 2
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
D. I and II only
Firm A and Firm B are identical except that A is incorporated while B is an unlimited liability partnership. Both have assets worth $500,000 ($500K) funded with a debt ratio of 40%. Suppose that the assets suddenly become worthless, what is the maximum possible loss to the equityholders of each company? A. Firm A: $300K Firm B: $500K B. Firm A: $200K Firm B: $300K C. Firm A: $500K Firm B: $200K D. Firm A: $500K Firm B: $500K
a Firm A's equityholders can declare bankruptcy resulting in a maximum loss of their original $300K of equity. Firm B's equityholders cannot escape their debt position. Their equity position has deteriorated from $300K to -$200K, a loss of $500K.
Which of the following entities likely has the highest cost of financial distress? A. A pharmaceuticals development company B. A downtown bayfront hotel C. A yacht leasing company D. A real estate investment trust
a The more tangible the assets available to liquidate, the lower the cost to exercise bankruptcy.
Suppose that your firm's current unlevered value is $800,000, and its marginal corporate tax rate is 35%. Also, you model the firm's PV of financial distress as a function of its debt ratio (D/V) according to the relation: PV of financial distress = 800,000 × (D/V)2. What is the firm's levered value if it issues $200,000 of perpetual debt to buy back stock? A. $820,000. B. $869,555. C. $920,000. D. $350,000.
a Value of firm = value of unlevered firm + PV(tax shield) - PV(cost of financial distress) Value of firm (in 000s) = 800 + (0.35 × 200) - 800 × [(200/800)^2] = 820K.
The main advantage of debt financing for a firm is: I) no SEC registration is required for bond issues II) interest expenses are tax deductible III) unlevered firms have higher value than levered firms A. I only B. II only C. III only D. I and III only
b
If a firm permanently borrows $100 million at an interest rate of 8%, what is the present value of the interest tax shield? (Assume that the marginal corporate tax rate is 30%.) A. $8.00 million B. $5.60 million C. $30.00 million D. $26.67 million
c PV of interest tax shield = (0.3)(100) = $30 million.
If a firm permanently borrows $50 million at an interest rate of 10%, what is the present value of the interest tax shield? Assume a 30% marginal corporate tax rate. A. $50.0 million B. $25.0 million C. $15.0 million D. $1.5 million
c PV of interest tax shield = (0.30)(50) = $15.0 million.