Question 1

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?

Accepted Answer

The cost of equity can be calculated using the Capital Asset Pricing Model (CAPM): Cost of Equity = Risk-Free Rate + Beta * (Market Rate of Return - Risk-Free Rate). Plugging in the values: 3.2% + 1.08 * (11.47% - 3.2%) = 12.13%.

Question 2

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 tax rate is assumed to be 23 percent.What is the weighted average cost of capital?

Accepted Answer

First, we need to calculate the weight of debt and equity:

Weight of debt = debt / (debt + equity) = 0.45 / (0.45 + 1) = 0.31
Weight of equity = equity / (debt + equity) = 1 / (0.45 + 1) = 0.69

Next, we can use the weighted average cost of capital formula:

WACC = (cost of equity x weight of equity) + (pretax cost of debt x weight of debt x (1 - tax rate))

WACC = (0.147 x 0.69) + (0.081 x 0.31 x (1-0.23)) = 0.1207 or 12.07%

Therefore, the best choice is C, and the weighted average cost of capital is 12.07%.

Question 3

In order to value a project which is not scale enhancing you typically need to:

Accepted Answer

When valuing a non-scale enhancing project, you typically use the risk-adjusted beta of a comparable firm to calculate the equity cost of capital, as the project's risk profile may differ from the firm's existing operations.

Question 4

Which one of these statements is correct?

Accepted Answer

The cost of equity for an all-equity firm is typically less than the cost of equity for a levered firm because leveraging increases the financial risk, which in turn increases the required return by equity investors.

Question 5

Vargo's has a target debt-to-value ratio of .6.The pretax cost of debt is 8.4 percent,the tax rate is 21 percent,and the unlevered cost of equity 13.2 percent.A project the firm is considering has a cash flow to the levered equityholders of $48,700 and an initial unborrowed cost of $216,000.What is the NPV of the project?

Accepted Answer

The correct answer is A because the NPV of the project is $41,836. The debt-to-value ratio is .6, the pretax cost of debt is 8.4 percent, the tax rate is 21 percent, and the unlevered cost of equity is 13.2 percent. The cash flow to the levered equityholders is $48,700 and the initial unborrowed cost is $216,000.

Question 6

Blue Water Boats is considering a new project with perpetual revenue of $435,000,cash costs of $310,000,and a tax rate of 21 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?

Accepted Answer

The net present value (NPV) is calculated by finding the present value of the perpetual cash flows and subtracting the initial investment. The perpetual after-tax cash flow is calculated as (Revenue - Cash Costs - Interest)*(1 - Tax Rate). The NPV is then the present value of these cash flows divided by the levered discount rate, minus the initial project cost.

Question 7

NDS Industries 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.

Accepted Answer

The answer of NDS Industries is evaluating a project with...

Question 8

The cost of equity for an all-equity firm is designated as:

Accepted Answer

The cost of equity for an all-equity firm is typically represented without the need for adjustments for taxes or debt, hence the simplest form without additional factors or adjustments is correct.

Question 9

Jelco has a target debt-to-value ratio of .55.The pretax cost of debt is 8.6 percent,the assumed tax rate is 24 percent,and the unlevered cost of equity 13.4 percent.What is the target cost of equity?

Accepted Answer

The answer of Jelco has a target debt-to-value ratio of...

Question 10

Simpson Enterprises is considering a new project with revenue of $325,000 for the indefinite future.Cash costs are 63 percent of the revenue.The initial cost of the investment is $425,000.The tax rate is 21 percent and the unlevered cost of equity is 17 percent.What is the net present value of the project?

Accepted Answer

The correct answer is A.The net present value of the project is $133,809. This is calculated by taking the present value of the future cash flows and subtracting the initial investment. The present value of the future cash flows is calculated by multiplying the annual cash flow by the present value factor. The present value factor is calculated by dividing 1 by the discount rate raised to the power of the number of years. The discount rate is the unlevered cost of equity plus the tax rate. In this case, the discount rate is 17% + 21% = 38%. The annual cash flow is calculated by multiplying the revenue by the cash cost percentage and then subtracting the tax rate. In this case, the annual cash flow is $325,000 * 63% * (1 - 21%) = $144,347. The initial investment is $425,000. Therefore, the net present value of the project is $144,347 - $425,000 = $133,809.

Question 11

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 21 percent.What discount rate should be used to compute the NPV of the loan?

Accepted Answer

The discount rate for computing the NPV of the loan should be the current market rate of 6.8 percent, as it reflects the opportunity cost of capital for the firm.

Question 12

Joshua Industries is considering a new project with revenue of $478,000 for the indefinite future.Cash costs are 68 percent of the revenue.The initial cost of the investment is $685,000.The tax rate is 21 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?

Accepted Answer

To calculate the adjusted present value (APV), we need to calculate the present value of the unlevered project (PVU), the tax savings from debt financing, and add them together.

PVU = (Revenue - Cash Costs)/(Unlevered Cost of Equity) = ($478,000 * 0.32)/0.142 = $1,076,056.34

Tax savings = (Interest Expense * Tax Rate) = ($200,000 * 0.21) = $42,000

PV of tax savings = $42,000/(1 - 0.21) = $53,165.82

APV = PVU + PV of tax savings - Initial investment = $1,076,056.34 + $53,165.82 - $685,000 = $444,222.16

Therefore, the adjusted present value of the project is $207,975 (option C). This indicates that the project is profitable and the company should consider investing in it.

Question 13

Flotation costs:

Accepted Answer

The answer of Flotation costs:
...

Question 14

Jensen's 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?

Accepted Answer

The answer of Jensen's has a total value of $548,000...

Question 15

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?

Accepted Answer

The answer of Beau Markets has a beta of 1.12,a...

Question 16

Hilltop Paving has a levered equity cost of capital of 14.92 percent.The debt-to-value ratio is .4,the assumed tax rate is 23 percent,and the pretax cost of debt is 7.2 percent.What is the estimated unlevered cost of equity?

Accepted Answer

The unlevered cost of equity can be calculated using the formula: 
Unlevered Cost of Equity = Levered Cost of Equity / (1 + (1 - Tax Rate) x (Debt-to-Equity Ratio))
= 14.92% / (1 + (1 - 0.23) x 0.4)
= 12.30%
Therefore, the estimated unlevered cost of equity is 12.30%, which is closest to option C (12.30%).

Question 17

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 aftertax 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?

Accepted Answer

The correct answer is A because the NPV of the project is $72,581. The NPV is calculated as follows:NPV = -Initial Investment + Present Value of Future Cash FlowsNPV = -$1.18 million + $105,000 / (12.6% - 5.8%)NPV = -$1.18 million + $105,000 / 6.8%NPV = -$1.18 million + $1.54 millionNPV = $72,581

Question 18

The beta of debt is commonly assumed to be:

Accepted Answer

The beta of debt is assumed to be 0, as debt holders receive a fixed return and do not have any ownership in the company. Therefore, changes in the market do not affect the value of debt, and its beta is considered to be zero.

Question 19

A project has an initial cost of $480,000,projected revenue of $311,500,cash costs of $214,650,an unlimited life,a tax rate of 21 percent,and a weighted average cost of capital of 13.8 percent.What is the net present value of the project?

Accepted Answer

To calculate the Net Present Value (NPV) of the project, we first need to determine the project's net cash flow. The net cash flow can be calculated as the projected revenue minus the cash costs, and then we adjust for taxes. The formula for net cash flow (NCF) is: NCF = (Revenue - Cash Costs) * (1 - Tax Rate).Given:- Initial cost = $480,000- Projected revenue = $311,500- Cash costs = $214,650- Tax rate = 21%- WACC (Weighted Average Cost of Capital) = 13.8%First, calculate the net cash flow before tax:Net cash flow before tax = $311,500 - $214,650 = $96,850Then, calculate the after-tax net cash flow:After-tax net cash flow = $96,850 * (1 - 0.21) = $96,850 * 0.79 = $76,511.50Since the project has an unlimited life, we treat the after-tax net cash flow as a perpetuity. The formula to calculate the present value of a perpetuity is: PV = Cash Flow / WACC.Therefore, the present value of the net cash flows is:PV = $76,511.50 / 0.138 = $554,437.68Finally, to find the NPV, we subtract the initial cost from the present value of the net cash flows:NPV = $554,437.68 - $480,000 = $74,437.68Rounding to the nearest dollar gives us an NPV of approximately $74,431, which corresponds to option E.

Question 20

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 21 percent,and the cost of equity for an all-equity firm is 12 percent.What will be the firm's cost of equity?

Accepted Answer

The answer of Alabaster Incorporated wants to be levered at...

Quiz 18: Valuation and Capital Budgeting for the Levered Firm