Question 1

Given the following data:
FCF1 = $20 million; FCF2 = $20 million; FCF3 = $20 million; free cash flow grows at a rate of 5% for year 4 and beyond. If the weighted average cost of capital is 12%, calculate the value of the firm.

Accepted Answer

First, we need to calculate the present value of the first three years' free cash flow (FCF):
PV of FCF1 = $20 million / (1 + 0.12)^1 = $17.86 million
PV of FCF2 = $20 million / (1 + 0.12)^2 = $15.93 million
PV of FCF3 = $20 million / (1 + 0.12)^3 = $14.20 million
Next, we need to calculate the present value of the indefinite future free cash flows, using the perpetuity model:
PV of future FCFs = FCF4 / (WACC - g)
where g is the growth rate of free cash flow, which is 5% in this case.
PV of future FCFs = $20 million (1 + 0.05) / (0.12 - 0.05) = $285.71 million
Finally, we can calculate the total value of the firm by summing the present value of the first three years' FCF and the present value of the indefinite future FCF:
Total value of the firm = $17.86 million + $15.93 million + $14.20 million + $285.71 million = $ _____ million
The closest choice is B) $261.57 million.

Question 2

Given the following data for year-1:
Profits after taxes = $14 millions; Depreciation = $6 millions; Interest expense = $6 millions; Investment in fixed assets = $12 millions; and Investment in working capital = $3 millions; Calculate the free cash flow (FCF) for year-1:

Accepted Answer

Free cash flow (FCF) = Profits after taxes + Depreciation - Investment in fixed assets - Investment in working capital
FCF = $14 millions + $6 millions - $12 millions - $3 millions
FCF = $5 millions

Question 3

The following situations typically require that the financial manager value an entire business in order to make important decisions:
I. If firm A is about make a takeover offer for firm B, then A's financial managers have to decide how much the combined business A + B is worth under A's management.
II. If firm C is considering the sale of one of its divisions or a business line, it has to decide what the division or the business line is worth in order to negotiate with potential buyers.
III. When a firm goes public, the investment bank must evaluate how much the firm is worth in order to set the price.

Accepted Answer

All three situations require the financial manager to value a business: I involves valuing the combined business for a takeover, II involves valuing a division for sale, and III involves valuing the firm for an IPO.

Question 4

Given the following data: Cost of debt = rD = 6%; Cost of equity = rE = 12.1%; Marginal tax rate = 35%; and the firm has 50% debt and 50% equity. Calculate the after-tax weighted average coat of capital (WACC):

Accepted Answer

The answer of Given the following data: Cost of debt...

Question 5

Total market value of a firm (V): [D = market value of debt; E = market value of equity]

Accepted Answer

The total market value of a firm is the sum of the market value of its debt and equity. This is because the market value of a firm represents the total value of all the claims on the firm's assets, which are held by both creditors (debt holders) and shareholders (equity holders). Therefore, the correct formula is V = D + E.

Question 6

In calculating the weighted average cost of capital, the values used for D, E and V are:

Accepted Answer

The values used for D, E and V in calculating the weighted average cost of capital should reflect market values. Market values reflect the true cost of capital, so using book values or liquidating values can lead to inaccurate calculations.

Question 7

Calculate the IRR for the project.

Accepted Answer

The answer of Calculate the IRR for the project.
...

Question 8

Free cash flow (FCF) and net income (NI) differ in the following ways:
I. net income is the return to shareholders, calculated after interest expense; free cash flow is calculated before interest.
II. net income is calculated after various non-cash expenses, including depreciation; we add back depreciation when we calculate free cash flow.
III. capital expenditures and investments in working capital do not appear in net income calculations; they do reduce free cash flows.
IV. net income is never negative; free cash flows can be negative for rapidly growing firms, even if the firm is profitable, because investments exceed cash flows from operations.

Accepted Answer

I - Correct, net income is calculated after interest expense while FCF is calculated before interest.
II - Correct, net income includes non-cash expenses like depreciation, while we add back depreciation when calculating FCF.
III - Correct, capital expenditures and investments in working capital do not affect net income but they do reduce FCF.
IV - Correct, FCF can be negative for rapidly growing firms even with positive net income, as investments can exceed cash flows from operations.

Question 9

Given the following data:
FCF1 = $7 million; FCF2 = $45 million; FCF3 = $55 million; free cash flow grows at a rate of
4% for year 4 and beyond. If the weighted average cost of capital is 10%, calculate the value
Of the firm.

Accepted Answer

The answer of Given the following data:
FCF1 = $7 million;...

Question 10

When weighted average cost of capital (WACC) is used to value a levered firm, the interest tax shield is:

Accepted Answer

The interest tax shield is automatically considered in the WACC formula when the after-tax cost of debt is used. This is because the WACC formula includes weights for the firm's cost of equity and cost of debt, which reflect the proportion of financing provided by each source. The after-tax cost of debt reflects the benefit of the interest tax shield, as it reduces the overall cost of debt financing. Therefore, the interest tax shield is already accounted for in the WACC calculation.

Question 11

Given the following data for Vinyard Corporation:

Calculate the proportions of debt (D/V) and equity (E/V) for the firm that you would use for estimating the weighted average cost of capital (WACC):

Accepted Answer

The answer of Given the following data for Vinyard Corporation:

Calculate...

Question 12

The after-tax weighted average cost of capital (WACC) is calculated as:

Accepted Answer

The after-tax WACC takes into account the after-tax cost of debt, which is multiplied by (1-TC), where TC is the corporate tax rate. This is important since interest payments on debt are tax deductible. The equity cost is also included in the formula, weighted by the proportion of equity in the company's capital structure. The value of the firm (V) is the sum of the total debt (D) and equity (E) in the company's capital structure.

Question 13

When using the weighted average cost of capital (WACC) to discount cash flows from a project we assume the following:
I. the project's risk are the same as those of firm's other assets and remain so for the life of the project.
II. the project supports the same fraction of debt to value as the firm's overall capital structure that remains constant for the life of the project.
III. the cash flows from the project is always a perpetuity.

Accepted Answer

The WACC assumes that the project's risk is the same as the firm's other assets, which is statement I. It also assumes that the project's capital structure (debt to value ratio) will remain consistent with the firm's overall capital structure, which is statement II. However, statement III is not always true as the cash flows from a project may have a finite life rather than being a perpetuity.

Question 14

If the weighted average cost of capital (WACC) is 9% calculate the NPV of the project.

Accepted Answer

The answer of If the weighted average cost of capital...

Question 15

Capital budgeting decisions that include both investment and financing decisions can be analyzed by:
I. Adjusting the present value II) Adjusting the discount rate
III. Ignoring financing mix

Accepted Answer

To accurately analyze capital budgeting decisions that involve both investment and financing decisions, it is important to adjust both the present value and the discount rate. The present value should be adjusted based on the financing mix, such as the cost of debt or equity. The discount rate should also reflect the financing mix by adjusting for the cost of capital or the weighted average cost of capital. Therefore, options I and II are both necessary. Ignoring financing mix (option III) would result in an inaccurate analysis.

Question 16

Given the following data for Year-1: Profit after taxes = $5 million; Depreciation = $2 million; Investment in fixed assets = $4 million; Investment net working capital = $1 million. Calculate the free cash flow (FCF) for Year-1:

Accepted Answer

The answer of Given the following data for Year-1: Profit...

Question 17

A firm has a total market value of $10 million and debt has a market value of $4 million. What is the after-tax weighted average cost of capital if the before - tax cost of debt is 10%, the cost of equity is 15% and the tax rate is 35%?

Accepted Answer

Step 1: Calculate the weights of equity and debt

Weight of equity = Market value of equity / Total market value
= (10 million - 4 million) / 10 million
= 0.6

Weight of debt = Market value of debt / Total market value
= 4 million / 10 million
= 0.4

Step 2: Calculate the after-tax cost of debt

After-tax cost of debt = Before-tax cost of debt x (1 - Tax rate)
= 10% x (1 - 35%)
= 6.5%

Step 3: Calculate the weighted average cost of capital (WACC)

WACC = (Weight of equity x Cost of equity) + (Weight of debt x After-tax cost of debt)
= (0.6 x 15%) + (0.4 x 6.5%)
= 11.6%

Question 18

Given the following data for Golf Corporation:
Market price/share = $12; Book value/share = $10; Number of shares outstanding = 100 million; market price/bond = $800; Face value/bond = $1,000; Number of bonds outstanding
= 1 million; Calculate the proportions of debt (D/V) and equity (E/V) for the firm that you would use for estimating the weighted average cost of capital (WACC):

Accepted Answer

The answer of Given the following data for Golf Corporation:
Market...

Question 19

Given the following data for year-1:
Profits after taxes = $20 millions; Depreciation = $6 millions; Interest expense = $4 millions; Investment in fixed assets = $12 millions; and Investment in working capital = $4 millions; Calculate the free cash flow (FCF) for year-1:

Accepted Answer

Free cash flow (FCF) can be calculated using the formula: 
FCF = Profits after taxes + Depreciation - Investment in fixed assets - Investment in working capital

Substituting the given values, we get:

FCF = $20m + $6m - $12m - $4m 
= $10m

Therefore, the correct answer is C) $10 millions.

Question 20

The after-tax weighted average cost of capital is determined by:

Accepted Answer

The after-tax weighted average cost of capital (WACC) is calculated by adding the weighted average cost of equity to the weighted average after-tax cost of debt. This is because the after-tax cost of debt is lower than the before-tax cost of debt, and since the cost of equity remains the same, the overall WACC will decrease when factoring in the after-tax cost of debt. Option A is incorrect because it multiplies the after-tax cost of debt with the cost of equity. Option B is incorrect because it only considers the before-tax cost of debt. Option D is incorrect because it involves dividing two averages, which is not the correct calculation for WACC.

Quiz 19: Financing and Valuation

Given the following data: FCF1 = $20 million; FCF2 = $20 million; FCF3 = $20 million; free cash flow grows at a rate of 5% for year 4 and beyond. If the weighted average cost of capital is 12%, calculate the value of the firm.

Given the following data for year-1: Profits after taxes = $14 millions; Depreciation = $6 millions; Interest expense = $6 millions; Investment in fixed assets = $12 millions; and Investment in working capital = $3 millions; Calculate the free cash flow (FCF) for year-1:

Given the following data: Cost of debt = rD = 6%; Cost of equity = rE = 12.1%; Marginal tax rate = 35%; and the firm has 50% debt and 50% equity. Calculate the after-tax weighted average coat of capital (WACC) :

Total market value of a firm (V) : [D = market value of debt; E = market value of equity]

In calculating the weighted average cost of capital, the values used for D, E and V are:

Calculate the IRR for the project.

Given the following data: FCF1 = $7 million; FCF2 = $45 million; FCF3 = $55 million; free cash flow grows at a rate of 4% for year 4 and beyond. If the weighted average cost of capital is 10%, calculate the value Of the firm.

When weighted average cost of capital (WACC) is used to value a levered firm, the interest tax shield is:

Given the following data for Vinyard Corporation: Calculate the proportions of debt (D/V) and equity (E/V) for the firm that you would use for estimating the weighted average cost of capital (WACC) :

The after-tax weighted average cost of capital (WACC) is calculated as:

If the weighted average cost of capital (WACC) is 9% calculate the NPV of the project.

Capital budgeting decisions that include both investment and financing decisions can be analyzed by: I. Adjusting the present value II) Adjusting the discount rate III. Ignoring financing mix

Given the following data for Year-1: Profit after taxes = $5 million; Depreciation = $2 million; Investment in fixed assets = $4 million; Investment net working capital = $1 million. Calculate the free cash flow (FCF) for Year-1:

A firm has a total market value of $10 million and debt has a market value of $4 million. What is the after-tax weighted average cost of capital if the before - tax cost of debt is 10%, the cost of equity is 15% and the tax rate is 35%?

Given the following data for year-1: Profits after taxes = $20 millions; Depreciation = $6 millions; Interest expense = $4 millions; Investment in fixed assets = $12 millions; and Investment in working capital = $4 millions; Calculate the free cash flow (FCF) for year-1:

The after-tax weighted average cost of capital is determined by: