FIN 351 chapter 18
Blue Water Boats is considering a new project with perpetual cash inflows of $435,000, cash costs of $310,000, and a tax rate of 35 percent. The firm plans to issue $250,000 of debt at an interest rate of 7.3 percent to help finance the initial project cost of $475,000. The levered discount rate is 16.7 percent. What is the net present value of this project? A. $190,494.01 B. $84,022.11 C. $128,211.14 C. -$59,505.99 D. -68,424.09
$190,494.01 435,000 (310,000) = 125,000 (250000 * .073) = 106750 * 35% = 69,387.50 / .167 = 415.494.01 (475000 - 250000) =
A project has an unlevered NPV of $1.5 million. To finance the project, debt is being issued with associated flotation costs of $60,000. The flotation costs can be amortized over the project's 5-year life. The debt of $10 million is being issued at the market interest rate of 10 percent, with principal repaid in a lump sum at the end of the fifth year. If the firm's tax rate is 34 percent, calculate the project's APV. A. $2,441,107 B. $1,494,028 88 C. $2,384,312 D. $2,744,334 E. $1,909,417
$2,744,334
TTC is planning to raise $3.25 million for three years at an interest rate of 7.35 percent to finance their expansion. The Alban County Board of Commissioners has just offered the firm the $3.25 million they need at 5.25 percent if the firm builds in Alban County, pays the interest annually, and repays the principal at the end of three years. What is the net present value of the loan to TTC if the firm's tax rate is 34 percent and it accepts the county's offer? A. $293,651.12 B. $212,100.00 C. $329,245.19 D. $186,415.92 E. $346,089.97
$329,245.19 Interest rate * loan amt * 1- TR =-pv(discount rate, loan period, annual interest pmt, amt loan, 0) loan amt - pv
Simpson Enterprises is considering a new project with cash inflows of $325,000 for the indefinite future. Cash costs are 63 percent of the cash inflows. The initial cost of the investment is $425,000. The tax rate is 35 percent and the unlevered cost of equity is 17 percent. What is the net present value of the project? A. $34,779.41 B. $44,347.48 C. $78,162.50 D. $204,584.78 E. $121,089.16
$34,779.41 325,000 - (325000 * .63) = 120,250 * .35 =78,162.50 / .17 = 459,779.41 - 425,000 =
Kelly Industries is given the opportunity to raise $5 million in debt for four years through a local government subsidized program. While Kelly would normally be required to pay 12 percent on its debt issues, the Hampton County program sets the rate at 9 percent. What is the NPV of this subsidized loan? Ignore taxes. A. $518,364.29 B. $296,007.41 C. $384,312.42 D. $455,602.40 E. $0
$455,602.40
BT Corporation has decided to build a new facility for its Ramp;D department. The cost of the facility is estimated at $125 million. BT plans to finance this project using its traditional debt-equity ratio of .65. The issue cost of equity is 6.1 percent and the issue cost of debt is 1.8 percent. What is the amount of the total flotation cost? A. $5,507.575.76 B. $6,003,121.21 C. $6,138,411.92 D. $5,761,427.76 E. $6,202,418.27
$5,761,427.76 125 million/1.65 = 75.757575 75.757575*.65 = 49.24242424 75.757575 * 0.061 + 49.24242424*0.018 = 5.5075757575
A firm is evaluating a project with an initial investment at time 0 of $640,000. The present value of the levered cash flows is $729,400 and the net present value of the project is $157,000. Using the flow-to-equity method of valuation determine the amount borrowed. A. $89,400 B. $246,400 C. $67,600 D. $54,300 E. $64,000
$67,600 NPV 157000 Add : Initial investment 640000 Present value of cash inflow 797000 Less : Present value of Levered cash flow 729400 amount borrowed 67600
Webster Corp. is planning to build a new shipping depot. The initial cost of the investment is $1.18 million. Efficiencies from the new depot are expected to reduce annual costs by $105,000 forever. The corporation has a total value of $62.4 million and has outstanding debt of $38.7 million. What is the NPV of the project if the firm has an aftertax cost of debt of 5.8 percent and a cost equity of 12.6 percent? A. $72,580.87 B. $46,509.07 C. $163,669.25 D. -$102,422.16 E. -$531,736.42
$72,580.87 38.7/62.4 = 0.62 x .058 = 0.03597115 62.4-38.7/62.4 = 0.126 = 0.04785577 Total = 0.0838 WACC 105000 / .0838 - 1180000 =
Joshua Industries is considering a new project with cash inflows of $478,000 for the indefinite future. Cash costs are 68 percent of the cash inflows. The initial cost of the investment is $685,000. The tax rate is 34 percent and the unlevered cost of equity is 14.2 percent. The firm is financing $200,000 of the project cost with debt. What is the adjusted present value of the project? A. $102,429.67 B. $98,311.16 C. $93,940.85 D. $32,408.18 E. $25,940.85
$93,940.85 Cash Inflows 478,000 Costs (478,000 *0.68) (324,040) Profit 152960 Tax at 34% (52006.40) after tax cash flows 100,953.60 NPV = 100,953.60 / 0.142 - 685,000 = 25,940.85 PV of Tax shield = 200,000 x 34% = 68,000 APV = 25,940.85+68,000 = 93,940.85
A project has an initial cost of $480,000, projected cash inflows of $311,500, cash costs of $214,650, a tax rate of 35 percent, and a weighted average cost of capital of 13.8 percent. What is the net present value of the project? A. $24,411.07 B. $15,494.02 C. $1,003.70 D. -$16,497.28 E. -$23,822.46
-$23,822.46 311,500 (214650) = 96,850 * 35% = 62,952.50 /.138 = 456,177.5362 (480,000) =
Delta Company has a capital structure of 38 percent risky debt with a beta of .39 and 62 percent equity with a beta of 1.47. What is the firm beta? A. 1.01 B. .82 C. 1.26 D. 1.49 E. 1.06
1.06 Solution :- Beta of firm = Weight of debt * Beta of debt + Weight of equity * Beta of equity. = 0.35 * 0.56 + 0.65 * 1.34 = 0.196 + 0.871 = 1.067 Conclusion :- Beta of firm = 1.067
Delta Company has a capital structure of 35 percent risky debt with a beta of .56 and 65 percent equity with a beta of 1.34. What is the firm beta? A. 1.07 B. 1.02 C. 1.10 D. 1.31 E. 1.40
1.07 Solution :- Beta of firm = Weight of debt * Beta of debt + Weight of equity * Beta of equity. = 0.35 * 0.56 + 0.65 * 1.34 = 0.196 + 0.871 = 1.067
A firm is valued at $5.8 million and has riskless debt of $2.3 million outstanding. The firm has an equity beta of 1.81. What is the asset beta if there are no taxes? A. 1.11 B. 1.86 C. 1.15 D. 1.09 E. 1.71
1.09 Equity=5.8-2.3=3.5 asset beta =equity beta/(1+(1-tax)*(debt/equities))= 1.81/(1+(1-0)*(2.3/3.5))=1.09 the above is the answer
The Boat Company has a capital structure of 30 percent riskless debt and 70 percent equity. The tax rate is 35 percent. If the asset beta .9, what is the equity beta? A. .63 B. .41 C. 1.15 D. 1.20 E. 1.49
1.15 0.9*(1+(1-0.35)*(0.30/0,70))
Alpha Company has riskless debt, a debt-equity ratio of .46, a tax rate of 35 percent, and an unlevered firm beta of 1.23. What is the equity beta? A. .67 B. .73 C. .86 D. 1.60 E. 1.47
1.60 Beta assets=Beta equity/[1+(1-tax)*debt-equity ratio] 1.23=Beta equity/[1+(0.65*0.46)] 1.23=Beta equity/1.299 hence beta equity=(1.299*1.23) =1.59777.
A firm has a total value of $548,000 and debt valued at $262,000. What is the weighted average cost of capital if the aftertax cost of debt is 7.2 percent and the cost of equity is 12.6 percent? A. 11.13% B. 10.88% C. 10.02% D. 12.13% E. 11.48%
10.02% weight of debt = 262000/548000 = 0.47810219 weight of equity = 548000 - 262000 = 286000/548000 = 0.52189781 WACC = weight of equity * cost of equity + weight of debt * cost of debt = 0.52189781 * 12.6% + 0.47810219 * 7.2% = 10.02%
Filter Corp. maintains a debt-equity ratio of .45. The cost of equity is 14.7 percent, the pretax cost of debt is 8.1 percent, and the marginal tax rate is 34 percent. What is the weighted average cost of capital? A. 8.38% B. 11.02% C. 11.80% D. 13.00% E. 14.12%
11.80% WACC = (0.45/1.45) × (0.081) × (1 - 0.34) + (1/1.45) × (0.147) = 0.01659 + 0.10138 = 0.1180 or 11.80%
Winston's has a beta of 1.08 and a cost of debt of 8 percent. The current risk free rate is 3.2 percent and the market rate of return is 11.47 percent. What is the company's cost of equity capital? A. 8.93% B. 16.93% C. 12.13% D. 20.13% E. 16.13%
12.13% 0.032 + 1.08 ( 0.1147 - 0.032) =
Hilltop Paving has a levered equity cost of capital of 14.92 percent. The debt-to-value ratio is .4, the tax rate is 34 percent, and the pretax cost of debt is 7.2 percent. What is the estimated unlevered cost of equity? A. 12.08% B. 13.06% C. 12.56% D. 10.97% E. 11.23%
12.56% 14.92%=R0+(0.4/0.6)*(1-34%)*(R0-7.2%) 14.92%=R0+0.44*R0-0.44*7.2% R0=(14.92%+0.44*7.2%)/1.44 =12.56%
Alabaster Incorporated wants to be levered at a debt-to-value ratio of .6. The cost of debt is 9 percent, the tax rate is 35 percent, and the cost of equity for an all-equity firm is 12 percent. What will be Alabaster's cost of equity? A. 8.31% B. 10.45% C. 12.08% D. 14.93% E. 13.56%
14.93% Alabaster's cost of equity = Unlevered Cost of Equity + ( Unlevered Cost of Equity-cost of debt )*debt to value ratio/(1-debt to value ratio) *(1-tax rate) Alabaster's cost of equity = 12% + (12%-9%)*0.6/(1-0.6)*(1-35%) Alabaster's cost of equity = 14.925%
Beau Markets has a beta of 1.12, a cost of debt of 8.6 percent, and a debt-to-value ratio of .6. The current risk-free rate is 3.22 percent and the market rate of return is 14.47 percent. What is the company's cost of equity capital? A. 12.97% B. 10.95% C. 15.82% D. 11.49% E. 13.96%
15.82% Cost of Equity Capital = Risk Free rate + (Market rate of Return - Risk Free rate ) * Beta = 3.22 % + ( 14.47% - 3.22% ) *1.12 = 15.82%
Jelco has a target debt-to-value ratio of .55. The pretax cost of debt is 8.6 percent, the tax rate is 35 percent, and the unlevered cost of equity 13.4 percent. What is the target cost of equity? A. 15.72% B. 16.48% C. 14.09% D. 17.21% E. 15.12%
17.21% =13.4%+(13.4%-8.6%)*(.55/.45)*(1-35%) =17.21%
Banisters is valued at $8.6 million and has debt of $2.1 million outstanding. The unlevered firm beta is 1.72, the debt beta is zero, and the tax rate is 34 percent. What is the levered equity beta? A. .86 B. 1.18 C. 2.09 D. 1.98 E. 1.30
2.09 1.72*(1+(1-0.34)*(2.1/6.5)
A global conglomerate has a debt beta of zero. If the cost of equity is 12.23 percent, and the risk-free rate is 4.36 percent, what is the firm's pretax cost of debt? A. 4.36% B. 8.30% C. 7.87% D. 0% E. 12.23%
4.36%
A firm currently has debt outstanding with a coupon rate of 7 percent. The firm is obtaining subsidized financing for a new project at a rate of 5.5 percent. The current market rate is 6.8 percent and the firm's tax rate is 35 percent. What discount rate should be used to compute the NPV of the loan? A. 5.5 percent B. 3.575 percent C. 6.8 percent D. 4.42 percent E. 7 percent
6.8 percent
If a project's debt level is known over the life of the project, one should use
APV.
When the debt-to-value ratio changes over time, the best method(s) to use when evaluating a project is: A. APV. B. FTE. C. WACC. D. either APV or WACC. E. either FTE or WACC.
APV.
Which of these methods discount levered cash flows? A. APV B. FTE C. WACC D. both APV and WACC E. both APV and FTE
FTE
The cost of equity for an all-equity firm is designated as: A. Rs B. RD C. RS(1 - tC) D. R0 E. R0(1 - tC)
R0
Given the all-equity cost of capital, the cost of levered equity can be computed as: A. RS = (B /S)(R0) + (1 - tc)B. B. RS = R0 + (B / S)(1 - tc)(R0 - RB). C. RS = R0 + (1 - tc)B. D. R0 = Rs + (B / S)(1 - tc)(R0 - RB). E. R0 = Rs + (1 - tc)B.
RS = R0 + (B / S)(1 - tc)(R0 - RB).
The adjusted present value method (APV), the flow to equity (FTE) method, and the weighted average cost of capital (WACC) method produce equivalent results, but each can have difficulties making computation impossible at times. Given this, which one of these is a correct statement? A. The WACC method is preferred when evaluating a leveraged buyout. B. The APV method is the most commonly used method in actual practice. C. Use the FTE method when the level of debt is known over a project's life. D. Use the WACC method when the level of debt is known over a project's life. E. The WACC method is appropriate when the target debt-to-value ratio applies over a project's life.
The WACC method is appropriate when the target debt-to-value ratio applies over a project's life.
Which one of these statements is correct? A. Flotation costs increase the value of RS. B. The weighted average cost of capital is equal to B /S(RS)(1 - tc). C. The discount rate for levered equity is unaffected by the debt-equity ratio. D. The cost of equity for an all-equity firm is less than the cost of equity for a levered firm. E. The cost of levered equity is indirectly related to beta.
The cost of equity for an all-equity firm is less than the cost of equity for a levered firm
The APV method to value a project should be used when A. a project's level of debt is known over the life of the project. B. a project's target debt-to-value ratio is constant over the life of the project. C. a project's debt financing is unknown over the life of the project. D. there are no subsidies to debt financing. E. level of market interest rates is expected to vary over the project's life.
a project's level of debt is known over the life of the project.
To calculate the adjusted present value, you should A. multiply the additional effects of debt by the all-equity project value. B. add the additional effects of debt to the all-equity project value. C. divide the project's levered cash flow by the risk-free rate. D. divide the project's levered cash flow by the risk-adjusted rate. E. add the pretax cost of debt to the project's all-equity NPV.
add the additional effects of debt to the all-equity project value
The weighted average cost of capital is determined by _____ the weighted average cost of equity. A. multiplying the weighted average aftertax cost of debt by B. adding the weighted average pretax cost of debt to C. adding the weighted average aftertax cost of debt to D. dividing the weighted average pretax cost of debt by E. dividing the weighted average aftertax cost of debt by
adding the weighted average aftertax cost of debt to
The acronym APV stands for:
adjusted present value.
The appropriate cost of debt to the firm is the: A. pretax market cost of debt. B. levered equity rate. C. aftertax market borrowing rate. D. pretax coupon rate. E. aftertax coupon rate.
aftertax market borrowing rate.
Flotation costs: A. are amortized using a declining-balance method over the life of the loan. B. are amortized using the straight-line method over the life of the loan. C. are deducted as a business expense in the year incurred. D. cannot be deducted as a business expense. E. are deducted as a business expense at the time the loan is repaid in full.
are amortized using the straight-line method over the life of the loan
In order to value a project which is not scale enhancing you typically need to: A. calculate the equity cost of capital using the risk-adjusted beta of another firm. B. double the firm's beta value when computing the project WACC. C. apply the firm's current WACC to the project's cash flows. D. discount the project's cash flows using the market rate of return since the project will diversify the firm's operations. E. replace the risk-free rate with the market rate of return when computing the project's discount rate.
calculate the equity cost of capital using the risk-adjusted beta of another firm.
The flow-to-equity approach to capital budgeting involves all of the following except: A. calculating the levered cost of equity. B. determining the amount of the investment that is not borrowed. C. computing the PV of the cash flows using the cost of equity for an all-equity firm. D. discounting the levered cash flows using the levered cost of equity. E. computing the project's NPV.
computing the PV of the cash flows using the cost of equity for an all-equity firm.
If you discount a project's unlevered aftertax cash flows by the _____ and then subtract the initial investment you will calculate the: A. cost of capital for the unlevered firm; adjusted present value. B. cost of equity capital; project NPV. C. weighted cost of capital; project NPV. D. cost of capital for the unlevered firm; all-equity net present value. E. cost of equity capital for the levered firm; all-equity net present value.
cost of capital for the unlevered firm; all-equity net present value.
In calculating NPV using the flow-to-equity approach the discount rate is the: A. all-equity cost of capital. B. cost of equity for the levered firm. C. all-equity cost of capital minus the weighted average cost of debt. D. weighted average cost of capital. E. all-equity cost of capital plus the weighted average cost of debt.
cost of equity for the levered firm.
The APV method is comprised of the all-equity NPV of a project plus the NPV of financing effects. The four financing side 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 to debt financing. 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. E. cost of financial distress, tax subsidy of debt, increased cost of equity capital, and cost of issuing new securities.
cost of issuing new securities, cost of financial distress, tax subsidy of debt, and other subsidies to debt financing.
The flow-to-equity (FTE) approach in capital budgeting is defined as the: A. discounting of all project cash flows at the overall cost of capital. B. scale enhancing discount process. C. discounting of a project's levered cash flows to the equityholders at the required return on equity. D. dividends and capital gains that may flow to shareholders of a firm. E. discounting of a project's unlevered cash flows to the equityholders at the WACC.
discounting of a project's levered cash flows to the equityholders at the required return on equity.
A capital budgeting project is usually evaluated on its own merits. That is, capital budgeting decisions are treated separately from capital structure decisions. In reality, these decisions may be highly interwoven. This interweaving is most apt to result in: A. firms rejecting positive NPV, all-equity projects because changing to a capital structure with debt will always create negative net present values. B. firms foregoing project analysis and just making decisions at random. C. corporate financial managers first checking with their investment bankers to determine the best type of capital to raise before valuing a project. D. firms accepting some negative NPV all-equity projects because changing the capital structure adds enough positive leverage tax shield value to create a positive NPV. E. firms never changing their capital structure because all capital budgeting decisions will be overridden by capital structure decisions.
firms accepting some negative NPV all-equity projects because changing the capital structure adds enough positive leverage tax shield value to create a positive NPV.
Subsidized financing ________ the APV ___________. A. has no impact on; as the lower interest rate is offset by the lower discount rate B. decreases; by decreasing the NPV of the loan C. increases; by increasing the NPV of the loan D. has no impact on; as the interest tax deduction is not allowed for subsidized loans E. increases; because subsidies offset all tax payments.
increases; by increasing the NPV of the loan
The term (RBB) represents the: A. pretax cost of debt interest payments per period. B. pretax cost of equity dividend payments per year. C. average pretax cost of debt. D. average pretax cost of equity. E. weighted average cost of capital.
pretax cost of debt interest payments per period
The APV method is least useful in which one of these situations? A. leveraged buyout B. project involving interest subsidies C. project based on a target debt-to-value ratio D. project with flotation costs E. lease-versus-purchase decision
project based on a target debt-to-value ratio
The WACC approach to valuation is not as useful as the APV approach in leveraged buyouts because A. there is greater risk with a LBO. B. the future reductions in debt are known at the time of the LBO. C. there is no interest tax shield with the WACC. D. the value of the levered and unlevered firms are equal in an LBO. E. WACC only applies to unlevered projects.
the future reductions in debt are known at the time of the LBO.
The beta of debt is commonly assumed to be: A. 1.0 B. .50 C. zero D. -1 E. -5
zero
The cost of equity should be lowest when the debt to equity ratio is: A. zero. B. .20 C. .25 D. .50 E. 1.00
zero.
