Question 1

Zonk Corp.
The following data pertains to Zonk Corp., a manufacturer of ball bearings (dollar amounts in millions):
 $\begin{array}{l}
\begin{array} { l } 
\text { Tatal assets } \
\text { Interest-bearing debt } \
\text { Average pre-tax borrowring } \
\text { Cammon equity: } \
\text { Badk value } \
\text { Market value } \
\text { Incame tax rate } \
\text { Market equity beta }
\end{array}
\begin{array} { r } 
 \$ 7460\
\$ 3652\
10.5 \%\
\
\$2950 \
\$13685 \
35\% \
1.13
\end{array}
\end{array}$
-Determine the weight on debt capital that should be used to calculate Zonk's weighted-average cost of capital:

Accepted Answer

$\begin{array}{lccc}
  \text {Debt} &\$ 3652 & 21.00 \% \
  \text { Market Value of Equity } &\underline {13.685 }&\underline {79.00\%}\
  \text { Total } &\$ 17.337&100 \%\
\end{array}$

Question 2

Zonk Corp.
The following data pertains to Zonk Corp., a manufacturer of ball bearings (dollar amounts in millions):
 $\begin{array}{l}
\begin{array} { l } 
\text { Tatal assets } \
\text { Interest-bearing debt } \
\text { Average pre-tax borrowring } \
\text { Cammon equity: } \
\text { Badk value } \
\text { Market value } \
\text { Incame tax rate } \
\text { Market equity beta }
\end{array}
\begin{array} { r } 
 \$ 7460\
\$ 3652\
10.5 \%\
\
\$2950 \
\$13685 \
35\% \
1.13
\end{array}
\end{array}$
-Equity-based valuation models are based on all metrics except:

Accepted Answer

Equity-based valuation models are typically based on metrics such as assets, debt, pre-tax borrowing, common equity (including both book value and market value), income tax rate, and market equity beta. Working capital, on the other hand, is more relevant to the assessment of a company's short-term liquidity and operational efficiency. Therefore, choice C is the best answer.

Question 3

Zonk Corp.
The following data pertains to Zonk Corp., a manufacturer of ball bearings (dollar amounts in millions):
 $\begin{array}{l}
\begin{array} { l } 
\text { Tatal assets } \
\text { Interest-bearing debt } \
\text { Average pre-tax borrowring } \
\text { Cammon equity: } \
\text { Badk value } \
\text { Market value } \
\text { Incame tax rate } \
\text { Market equity beta }
\end{array}
\begin{array} { r } 
 \$ 7460\
\$ 3652\
10.5 \%\
\
\$2950 \
\$13685 \
35\% \
1.13
\end{array}
\end{array}$
-Assume that Zonk is a potential leveraged buyout candidate.Assume that the buyer intends to put in place a capital structure that has 70 percent debt with a pretax borrowing cost of 14 percent and 30 percent common equity.Compute the weighted average cost of capital for Zonk based on the new capital structure.

Accepted Answer

New WACC = [.70*.14*(1-.35)]+(.30*.0828)= 8.85%

Question 4

Which of the following is not a problem with using a dividend-based valuation formula?

Accepted Answer

Dividends representing a transfer of wealth to shareholders is not a problem with dividend-based valuation; it is actually a fundamental aspect of dividends. The other options highlight issues such as arbitrary dividend policies, lack of regular dividends, and forecasting challenges.

Question 5

With respect to dividends and priority in liquidation,what has priority over common stock?

Accepted Answer

Preferred stock has priority over common stock both in receiving dividends and in liquidation. Treasury stock (A) represents shares the company has bought back and does not have priority in dividend distribution or liquidation. Debt capital (B) typically has priority over both common and preferred stock in liquidation but not in receiving dividends. Nonconvertible common equity (D) is the same as common stock and does not have priority over preferred stock.

Question 6

Zonk Corp.
The following data pertains to Zonk Corp., a manufacturer of ball bearings (dollar amounts in millions):
 $\begin{array}{l}
\begin{array} { l } 
\text { Tatal assets } \
\text { Interest-bearing debt } \
\text { Average pre-tax borrowring } \
\text { Cammon equity: } \
\text { Badk value } \
\text { Market value } \
\text { Incame tax rate } \
\text { Market equity beta }
\end{array}
\begin{array} { r } 
 \$ 7460\
\$ 3652\
10.5 \%\
\
\$2950 \
\$13685 \
35\% \
1.13
\end{array}
\end{array}$
-Determine the weight on equity capital that should be used to calculate Zonk's weighted-average cost of capital:

Accepted Answer

$\begin{array}{lccc}
  \text {Debt} &\$ 3652 & 21.00 \% \
  \text { Market Value of Equity } &\underline {13.685 }&\underline {79.00\%}\
  \text { Total } &\$ 17.337&100 \%\
\end{array}$

Question 7

Zonk Corp.
The following data pertains to Zonk Corp., a manufacturer of ball bearings (dollar amounts in millions):
 $\begin{array}{l}
\begin{array} { l } 
\text { Tatal assets } \
\text { Interest-bearing debt } \
\text { Average pre-tax borrowring } \
\text { Cammon equity: } \
\text { Badk value } \
\text { Market value } \
\text { Incame tax rate } \
\text { Market equity beta }
\end{array}
\begin{array} { r } 
 \$ 7460\
\$ 3652\
10.5 \%\
\
\$2950 \
\$13685 \
35\% \
1.13
\end{array}
\end{array}$
-Using the above information,calculate Zonk's weighted-average cost of capital:

Accepted Answer

WACC (Zonk)= [.217 * .115 * (1 - .35)] + (.783 * .1189)=[.210*.105*(1-.35)+(.7900*.0828)=

Question 8

Equity valuation models based on dividends,cash flows,and earnings have been the topic of many theoretical and empirical research studies in recent years.All of the following are true regarding these studies except:

Accepted Answer

Unexpected changes in earnings, dividends, and cash flows do have a significant impact on stock prices, as investors use this information to adjust their valuations of the company. Therefore, choice D is false. Choices A, B, and C are true, as equity valuation models can provide a useful framework for understanding how stock prices relate to underlying share value, but there can be temporary deviations due to market sentiment or other factors.

Question 9

Returns on systematic risk-free securities (like U.S.Treasury securities)should exhibit what type of correlation with returns on a diversified market wide portfolio of stocks?

Accepted Answer

Returns on systematic risk-free securities are not affected by the fluctuations in the stock market, therefore they should exhibit no correlation with returns on a diversified market wide portfolio of stocks.

Question 10

Under the cash-flow-based valuation approach,free cash flows can be used instead of dividends as the expected future payoffs to the investor in the numerator of the general valuation model because:

Accepted Answer

The cash-flow-based valuation approach focuses on the cash flows that the firm generates and that are available to shareholders over the life of the firm. Free cash flows represent the amount of cash generated by the firm that is available to both debt and equity holders. While dividends are a distribution of earnings to shareholders, free cash flows represent the cash that is available to the firm's investors. Since free cash flows take into account capital expenditures and other investments that the firm makes, they provide a more comprehensive picture of the cash flows available to investors over the life of the firm. Over the long term, the total amount of free cash flows that are generated by the firm will equal the amount of cash that is paid out in dividends to shareholders. Therefore, free cash flows can be used instead of dividends in the valuation model.

Question 11

Investors typically accept a lower risk-adjusted rate of return on debt capital than on equity capital because:

Accepted Answer

Debt holders have fixed claims on the company's assets and cash flows, which means they bear less residual risk than equity holders. This makes debt a less risky investment, and investors are willing to accept a lower rate of return in exchange for the lower risk.

Question 12

Zonk Corp.
The following data pertains to Zonk Corp., a manufacturer of ball bearings (dollar amounts in millions):
 $\begin{array}{l}
\begin{array} { l } 
\text { Tatal assets } \
\text { Interest-bearing debt } \
\text { Average pre-tax borrowring } \
\text { Cammon equity: } \
\text { Badk value } \
\text { Market value } \
\text { Incame tax rate } \
\text { Market equity beta }
\end{array}
\begin{array} { r } 
 \$ 7460\
\$ 3652\
10.5 \%\
\
\$2950 \
\$13685 \
35\% \
1.13
\end{array}
\end{array}$
-Assume that Zonk is a potential leveraged buyout candidate.Assume that the buyer intends to put in place a capital structure that has 70 percent debt with a pretax borrowing cost of 14 percent and 30 percent common equity.Compute the revised equity beta for Zonk based on the new capital structure.

Accepted Answer

Levered market equity beta = unlevered market equity beta (1 + (1-t)[MV debt\MV equity])
==1.13*(1+(1-.35)[.70/.30]=4.35

Question 13

Firm-specific factors that increase the firm's nondiversifiable risk include all of the following except:

Accepted Answer

Exposure to management competence is a firm-specific factor that may increase the firm's diversifiable risk (specific risk) but not the nondiversifiable risk (market risk) as it is related to the internal operations of the firm and is not affected by the overall market movements. Exposure to interest rate changes, inflation, and cyclicality are firm-specific factors that are correlated with the overall market movements and increase the nondiversifiable risk of the firm.

Question 14

The historical discount rate of the firm may be a good indicator of the appropriate discount
Rate to apply to the firm in the future,when all of the following conditions hold true except:

Accepted Answer

The current mix of debt and equity financing being equal does not necessarily mean it will remain the same in the future, which can affect the discount rate.

Question 15

One rationale for using expected dividends in valuation is:

Accepted Answer

Expected dividends are used in valuation because they are paid in cash, which serves as a measurable common denominator for comparing the future benefits of alternative investment opportunities. This allows investors to make informed decisions on which investment opportunities will provide the highest return on investment.

Question 16

In theory,the value of a share of common equity is the present value of ____________________________________________________________.

Accepted Answer

The answer of In theory,the value of a share of...

Question 17

Zonk Corp.
The following data pertains to Zonk Corp., a manufacturer of ball bearings (dollar amounts in millions):
 $\begin{array}{l}
\begin{array} { l } 
\text { Tatal assets } \
\text { Interest-bearing debt } \
\text { Average pre-tax borrowring } \
\text { Cammon equity: } \
\text { Badk value } \
\text { Market value } \
\text { Incame tax rate } \
\text { Market equity beta }
\end{array}
\begin{array} { r } 
 \$ 7460\
\$ 3652\
10.5 \%\
\
\$2950 \
\$13685 \
35\% \
1.13
\end{array}
\end{array}$
-Assuming that riskless rate is 4.6% and the market premium is 7.3%,calculate Zonk's cost of equity capital:

Accepted Answer

cost of equity capital = .046+1.13(.073)= 8.28

Question 18

If a firm has a market beta of 0.9,is subject to an income tax rate of 35 percent,has a risk-free rate of 6 percent,a market risk premium of 7 percent,and has a market value of debt to market value of equity ratio of 60 percent,what does the market expect the firm to generate in terms of equity returns using CAPM?

Accepted Answer

12.3% = [.06 + (0.9 x .07)]

Question 19

When deriving the equity value of a firm,an analyst forecasts the real dividends expected to be paid in the future.In this case,which discount rate should be used?

Accepted Answer

When forecasting real dividends, it is appropriate to use the real rate of return as the discount rate. This is because the real rate of return accounts for changes in inflation, which can affect the real value of the dividends. The nominal rate of return includes an inflation component, which may already be included in the forecasted dividends, leading to double counting if used as the discount rate. The risk-free rate of return and the risk-adjusted rate of return are not relevant in this scenario, as they are not directly related to the forecasted dividends.

Question 20

All of the following are steps in the analysis and valuation framework used to understand the fundamentals of a business and determine estimates of its value except:

Accepted Answer

Obtaining the national ranking of the firm's external auditors is not typically a step in the analysis and valuation framework used to understand the fundamentals of a business and determine estimates of its value. The other three choices are generally part of the framework.

Quiz 11: Risk-Adjusted Expected Rates of Return and the Dividends Valuation Approach