Question 1

The appropriate cost of debt to the firm is:

Accepted Answer

C

Question 2

The APV method is comprised of the all equity NPV of a project and the NPV of financing effects.The four side effects are:

Accepted Answer

The APV method includes the NPV of financing effects such as the cost of issuing new securities, cost of financial distress, tax subsidy of debt, and other subsidies to debt financing.

Question 3

The flow-to-equity (FTE) approach in capital budgeting is defined to be the:

Accepted Answer

The flow-to-equity (FTE) approach in capital budgeting involves discounting the levered cash flows to the equity holders for a project at the required return on equity. This approach is specifically focused on determining the potential returns for equity investors in a project, rather than the overall cost of capital or potential cash flow outcomes for all stakeholders.

Question 4

Discounting the unlevered after tax cash flows by the _____ minus the ______ yields the ________.

Accepted Answer

Discounting the unlevered after-tax cash flows by the cost of capital for the unlevered firm minus the initial investment yields the all-equity net present value.

Question 5

Non-market or subsidized financing ________ the APV ___________.

Accepted Answer

Non-market or subsidized financing increases the APV by increasing the NPV of the loan due to the lower interest rates compared to market rates.

Question 6

The acceptance of 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 may result in:

Accepted Answer

The interplay between capital budgeting decisions and capital structure decisions can result in firms accepting some negative NPV equity projects because changing the capital structure adds enough positive leverage tax shield value to create a positive NPV. Therefore, option D is the correct choice. Option A is incorrect because firms may use debt to finance projects and still obtain a positive NPV. Option B is incorrect because capital budgeting projects need to be evaluated on their own merit before considering the impact on the capital structure. Option C is incorrect because capital structure decisions should not be determined before valuing the project. Option E is incorrect because firms may change their capital structure if it is beneficial to the project.

Question 7

To calculate the adjusted present value, one will:

Accepted Answer

To calculate the adjusted present value, one needs to add the additional effects of financing to the all equity project value. This is because APV is a valuation method that considers the impact of financing choices on the value of a project. Thus, the all equity project value needs to be adjusted to take into account the benefits and costs of financing.

Question 8

In calculating the NPV using the flow-to-equity approach the discount rate is the:

Accepted Answer

In the flow-to-equity approach, the NPV is calculated by discounting the cash flows to equity using the cost of equity for the levered firm. This is because the cash flows being discounted are the cash flows available to equity shareholders after payment of all debts and taxes. Therefore, the cost of equity for the levered firm reflects the risk associated with investing in the equity of a company that has borrowed money.

Question 9

Flotation costs are incorporated into the APV framework by:

Accepted Answer

The answer of Flotation costs are incorporated into the APV...

Question 10

A leveraged buyout (LBO) is when a firm is acquired by:

Accepted Answer

A leveraged buyout (LBO) is when a small group of equity investors finance the majority of the purchase price with debt. Management may or may not be involved in the acquisition, but the key feature is the high amount of debt used to finance the transaction, which is typically repaid using the cash flow of the acquired company. A and C do not fully capture the characteristic of an LBO, and D is incorrect as an LBO typically involves the acquisition of the entire company, not just its assets.

Question 11

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

Accepted Answer

The answer of In order to value a project which...

Question 12

Although the three capital budgeting methods are equivalent, they all can have difficulties making computation impossible at times.The most useful methods or tools from a practical standpoint are:

Accepted Answer

The WACC method is useful because it takes into account the risk and the target debt to value ratios, which are important factors in the decision-making process. The Flow-to-equity method is also useful because it considers the optimal debt to equity ratios which is how managers typically think. These two methods provide a more comprehensive approach in evaluating investment opportunities compared to APV method, which is limited by the unknown debt levels in future years. Therefore, the best choice is E, Both B and C.

Question 13

The APV method to value a project should be used when the:

Accepted Answer

The Adjusted Present Value (APV) method is best used when the project's level of debt is known over the life of the project, as it allows for the separate valuation of the project's base case (all-equity) value and the value of the tax shield from debt.

Question 14

Using APV, the analysis can be tricky in examples of:

Accepted Answer

All three options (tax subsidy to debt, interest subsidy, and flotation costs) can add complexity to the analysis when using APV. A tax subsidy to debt can change the effective cost of capital, while an interest subsidy can change the cash flows associated with debt payments. Flotation costs, meanwhile, can affect the value of a project at the outset, and must be taken into account when calculating net present value (NPV) or APV. Therefore, the best answer is D, as all three options can make the APV analysis more difficult.

Question 15

Which capital budgeting tools, if properly used, will yield the same answer?

Accepted Answer

The answer of Which capital budgeting tools, if properly used,...

Question 16

A key difference between the APV, WACC, and FTE approaches to valuation is:

Accepted Answer

The key difference lies in how each approach considers the effects of debt. APV explicitly values the tax shield from debt separately, WACC incorporates the tax shield into the discount rate, and FTE adjusts the cash flows for the effects of debt.

Question 17

The flow-to-equity approach to capital budgeting is a three step process of:

Accepted Answer

The flow-to-equity approach involves calculating the levered cash flow after interest and taxes, determining the cost of equity capital for a levered firm, and then discounting the levered cash flows by the cost of equity capital. This accounts for the effect of leverage on the cash flows and the required return for equity investors in a levered firm. Therefore, choice C is the correct answer.

Question 18

The weighted average cost of capital is determined by:

Accepted Answer

The weighted average cost of capital (WACC) is the average of the cost of all financing sources for a company. It is calculated by adding the weighted average after tax cost of debt (the cost of borrowing money) to the weighted average cost of equity (the cost of investors' equity in the company). Therefore, the correct choice is C.

Question 19

The term (B x rb) gives the:

Accepted Answer

The answer of The term (B x rb) gives the:
...

Question 20

The acronym APV stands for:

Accepted Answer

APV stands for adjusted present value, which is a method used in capital budgeting to find the value of a project by adjusting the cost of equity to include the effects of financing.

Quiz 18: Valuation and Capital Budgeting for the Levered Firm