Question 1

The term scale enhancing refers to:

Accepted Answer

The answer of The term scale enhancing refers to:
...

Question 2

Brad's Boat Company,a company in the 40% tax bracket,has riskless debt in its capital structure which makes up 30% of the total capital structure,and equity is the other 70%.The beta of the assets for this business is .9 and the equity beta is:

Accepted Answer

First, we need to calculate the asset beta using the weights of debt and equity:

Asset Beta = (Debt/Total) x Beta(Debt) + (Equity/Total) x Beta(Equity)
Asset Beta = (0.3 x 0) + (0.7 x 0.9)
Asset Beta = 0.63

Next, we need to use the asset beta, the tax rate, and the debt-to-equity ratio to find the equity beta using the Hamada equation:

Equity Beta = Asset Beta x [1 + (1 - Tax Rate) x (Debt/Equity)]
Equity Beta = 0.63 x [1 + (1 - 0.4) x (0.3/0.7)]
Equity Beta = 1.13

Therefore, the answer is choice C, with an explanation that we use the Hamada equation to find the equity beta based on the asset beta, tax rate, and debt-to-equity ratio.

Question 3

The Tip-Top Paving Co.wants to be levered at a debt to value ratio of .6.The cost of debt is 11% and the cost of equity for an all equity firm is 14.73%.What will be Tip-Top's cost of equity?

Accepted Answer

The formula to calculate the cost of equity for a levered firm is:

Cost of Equity = Cost of Unlevered Equity + (Debt to Equity * (Cost of Debt - Cost of Unlevered Equity))

First, we need to find the unlevered cost of equity:

Cost of Unlevered Equity = Cost of Equity for All Equity Firm = 14.73%

Next, we can use the given debt-to-value ratio to calculate the debt-to-equity ratio:

Debt-to-Equity Ratio = Debt-to-Value Ratio / (1 - Debt-to-Value Ratio) = 0.6 / (1 - 0.6) = 1.5

Now, we can plug in the values to find the levered cost of equity:

Cost of Equity = 14.73% + (1.5 * (11% - 14.73%)) = 16.97%

Therefore, the answer is D.

Question 4

The Delta Dam Company has a capital structure of 20% risky debt with a β of .9 and 80% equity with a β of 1.7.Their current tax rate is 34%.What is the β for Delta Dam Company?

Accepted Answer

To calculate the β for Delta Dam Company, we need to use the formula:

β = 0.2 × 0.9 × (1 - 0.34) + 0.8 × 1.7

β = 0.054 + 1.36

β = 1.414

Therefore, the β for Delta Dam Company is 1.414 or approximately 1.54. 
The best choice is C.

Question 5

The Webster Corp.is planning construction of a new shipping depot for its single manufacturing plant.The initial cost of the investment is $1 million.Efficiencies from the new depot are expected to reduce costs by $100,000 for each of the next 20 years.The corporation has a total value of $60 million and has outstanding debt of $40 million.What is the NPV of the project if the firm has an after tax cost of debt of 6% and a cost equity of 9%?

Accepted Answer

1. Calculate the present value of the cash flows from the project:
PV of cash flows = ∑ (CFt / (1+r)t)
where CFt = cash flow in year t
r = discount rate
t = year
PV of cash flows = $100,000 * [(1 - (1 / (1 + 0.06)^20)) / 0.06] = $1,452,719.05
2. Calculate the present value of the initial investment:
PV of investment = $1,000,000 / (1+0.09) = $917,431.19
3. Calculate the net present value (NPV) of the project:
NPV = PV of cash flows - PV of investment
NPV = $1,452,719.05 - $917,431.19 = $535,287.86
Since the NPV is positive, the project should be accepted. However, we also need to consider the impact on the firm's value. The increase in firm value due to the project can be calculated as the NPV divided by the firm's cost of capital:
Increase in firm value = NPV / WACC
WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc)
where E = market value of equity
V = total value of the firm
D = market value of debt
Re = cost of equity
Rd = cost of debt
Tc = corporate tax rate
Assuming a corporate tax rate of 35%, we have:
WACC = (0.6 * 0.09) + (0.4 * 0.06 * (1 - 0.35)) = 0.077
Increase in firm value = $535,287.86 / 0.077 = $6,953,987.01
Adding this increase in firm value to the initial firm value of $60 million, we get a new firm value of $66,953,987.01. However, since the project requires an initial investment of $1 million, we need to subtract this from the new firm value to get the total value of equity after the project:
Total value of equity = New firm value - Initial investment
Total value of equity = $66,953,987.01 - $1,000,000 = $65,953,987.01
Finally, we can calculate the new stock price per share by dividing the total value of equity by the number of outstanding shares:
New stock price per share = Total value of equity / Number of shares
Assuming there are 10 million outstanding shares, we have:
New stock price per share = $65,953,987.01 / 10,000,000 = $6.60
Therefore, the best choice is A) $59,401, since it represents the NPV of the project only and not the impact on the firm's value or stock price.

Question 6

The BIM Corporation has decided to build a new facility for its R&D department.The cost of the facility is estimated to be $125 million.BIM wishes to finance this project using its traditional debt-equity 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?

Accepted Answer

The answer of The BIM Corporation has decided to build...

Question 7

Non-market or subsidized financing ________ the APV ____________:

Accepted Answer

Non-market or subsidized financing increases the Adjusted Present Value (APV) by increasing the Net Present Value (NPV) of the loan. This is because the cost of borrowing is lower than market rates, which makes the financing more valuable to the company.

Question 8

Floatation costs are incorporated into the APV framework by:

Accepted Answer

Floatation costs are subtracted from the all equity value of the project in the Adjusted Present Value (APV) framework. This is because these costs represent an initial outlay that reduces the net value of the project or investment.

Question 9

The acronym APV stands for:

Accepted Answer

APV stands for Adjusted Present Value, which takes into account the impact of financing on the present value of an investment.

Question 10

The Free-Float Company,a company in the 36% tax bracket,has riskless debt in its capital structure which makes up 40% of the total capital structure,and equity is the other 60%.The beta of the assets for this business is 0.8 and the equity beta is:

Accepted Answer

The equity beta ($\beta_E$) can be calculated using the formula $\beta_E = \beta_A + (\beta_A - \beta_D) \times \frac{D}{E}$, where $\beta_A$ is the asset beta, $\beta_D$ is the debt beta (which is 0 for riskless debt), $D$ is the proportion of debt in the capital structure, and $E$ is the proportion of equity in the capital structure. Given that $\beta_A = 0.8$, $D = 40\%$, and $E = 60\%$, we can substitute these values into the formula. Since the debt is riskless, its beta ($\beta_D$) is 0, simplifying the formula to $\beta_E = \beta_A (1 + \frac{D}{E})$. Substituting the given values, we get $\beta_E = 0.8 (1 + \frac{0.4}{0.6}) = 0.8 (1 + \frac{2}{3}) = 0.8 \times \frac{5}{3} = 1.33$.

Question 11

Alabaster Incorporated has a beta of 1.05,a cost of debt of 8% and a debt to value ratio of .7.The current risk free rate is 3% and the market rate of return is 12.5%.What is the company's cost of equity capital?

Accepted Answer

First, we need to calculate the cost of capital for the company's debt:

Cost of Debt = 8%

Next, we can use the debt-to-value ratio to determine the equity component of the capital structure:

Equity-to-value ratio = 1 - debt-to-value ratio = 1 - 0.7 = 0.3

Now we can calculate the cost of equity using the CAPM formula:

Cost of Equity = Risk-Free Rate + Beta * (Market Rate of Return - Risk-Free Rate)

Cost of Equity = 3% + 1.05 * (12.5% - 3%) = 12.97%

Therefore, the answer is C (12.97%).

Question 12

A firm is valued at $8 million and has debt of $2 million outstanding.The firm has an equity beta of 1.5 and a debt beta of .60.The beta of the overall firm is:

Accepted Answer

The answer of A firm is valued at $8 million...

Question 13

The non-market rate financing impact on the APV is:

Accepted Answer

The non-market rate financing impact on the APV (Adjusted Present Value) is calculated by determining the NPV (Net Present Value) of the loan using both the market and non-market debt rates. This approach allows for the assessment of the value added or subtracted by financing at a rate different from the market rate.

Question 14

A very large firm has a debt beta of zero.If the cost of equity is 11%,and the risk-free rate is 5%,the cost of debt is:

Accepted Answer

Since the firm has a debt beta of zero, it means that the cost of debt is not influenced by changes in the market. Therefore, the cost of debt is simply the risk-free rate of 5%.

Question 15

The Tip-Top Paving Co.has an equity cost of capital of 16.97% The debt to value ratio is .6 and a cost of debt of 11%.What is the cost of equity if Tip-Top was unlevered?

Accepted Answer

To find the cost of unlevered equity, we need to use the unlevered beta. We can find this by unlevering the levered beta using the debt-to-value ratio. Then, we can use the unlevered beta to find the cost of equity using the CAPM. However, we do not have the levered beta given in the question. Therefore, we cannot directly calculate the unlevered beta. However, we know that if Tip-Top were unlevered, then its equity cost of capital would be equal to the cost of equity. So we can use the given equity cost of capital of 16.97% as the cost of equity. Therefore, the answer is B.

Question 16

The Telescoping Tube company is planning to raise $2,500,000 in perpetual debt at 11% to finance part of their expansion.They have just received an offer from the Albanic County Board of Commissioners to raise the financing for them at 8% if they build in Albanic County.What is the total added value of debt financing to Telescoping Tube if their tax rate is 34% and Albanic raises it for them?

Accepted Answer

First, let's calculate how much Telescoping Tube will pay in interest with their initial plan to raise perpetual debt at 11%:

Interest expense = $2,500,000 x 0.11 = $275,000

Now, let's calculate how much they would pay in interest if Albanic County Board of Commissioners raises the financing for them at 8%:

Interest expense = $2,500,000 x 0.08 = $200,000

The difference in interest expense is:

$275,000 - $200,000 = $75,000

However, we need to take into account the tax rate of 34%. The interest expense is tax deductible, meaning Telescoping Tube will save money on their taxes.

Tax savings = $75,000 x 0.34 = $25,500

The total added value of debt financing is the sum of the interest savings and tax savings:

$75,000 + $25,500 = $100,500

Therefore, the best choice is B, with a total added value of $1,300,000.

Question 17

The Tip-Top Paving Co.has a beta of 1.11,a cost of debt of 11% and a debt to value ratio of .6.The current risk free rate is 9% and the market rate of return is 16.18%.What is the company's cost of equity capital?

Accepted Answer

The answer of The Tip-Top Paving Co.has a beta of...

Question 18

The Free-Float Company,a company in the 36% tax bracket,has a total capital structure breakdown of 40% riskless debt and 60% equity.The beta of the equity is 1.4,and the asset beta is:

Accepted Answer

The answer of The Free-Float Company,a company in the 36%...

Question 19

To calculate the adjusted present value,you:

Accepted Answer

The adjusted present value (APV) formula involves adding the value of the project without financing (all-equity project value) to the present value of the additional effects of financing. These additional effects include the tax shields from interest payments and any costs or benefits from issuing securities. Therefore, option B is the correct answer as it involves adding the additional effects of financing to the all-equity project value.

Question 20

The Delta Dam Company has a capital structure of 80% risky debt with a β of .9 and 20% equity with a β of 1.6.Their current tax rate is 34%.What is the β if Delta Dam was an unlevered firm?

Accepted Answer

The unlevered beta (β) can be calculated using the formula: β_unlevered = β_levered / [1 + (1 - tax rate) * (debt/equity)]. Substituting the given values: β_unlevered = 1.09 / [1 + (1 - 0.34) * (0.8/0.2)] = 0.44.

Quiz 18: Valuation and Capital Budgeting for the Levered Firm