Question 1

Subsidized loans have the effect of:

Accepted Answer

Subsidized loans come with lower interest rates, making them cheaper for borrowers. This reduces the NPV (net present value) of the loan as the cost of borrowing is lower. However, since the loan becomes cheaper, it increases the APV (adjusted present value) as the borrower can afford to take on more debt. Therefore, the correct choice is D – increasing the NPV (by reducing the cost of borrowing) and increasing the APV (by increasing affordability).

Question 2

A project costs $15 million and is expected to produce cash flows of $3 million a year for
10 years. The opportunity cost of capital is 14%. If the firm has to issue stock to undertake the project and issue costs are $500,000, what is the project's APV (approximately)?

Accepted Answer

The answer of A project costs $15 million and is...

Question 3

APV = NPV(base-case assuming all equity financing) - NPV(financing decisions caused by project financing).

Accepted Answer

APV (Adjusted Present Value) = NPV (base-case assuming all equity financing) + NPV (financing decisions caused by project financing). APV adds the value of financing effects to the NPV of the project under all-equity financing.

Question 4

The MFC Corporation has decided to build a new facility. The cost of the facility is estimated to be $9.7 million. MFC wishes to finance this project using its traditional debt-to- 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 of raising funds?

Accepted Answer

To maintain a debt-to-equity ratio of 1.5, for every $1 of equity, $1.5 of debt is needed. Let equity be x, then debt is 1.5x. So, x + 1.5x = $9.7 million, solving gives x = $3.88 million (equity) and 1.5x = $5.82 million (debt). The floatation cost is 6% of equity + 1% of debt = 0.06 * $3.88 million + 0.01 * $5.82 million = $0.2328 million + $0.0582 million = $0.291 million, approximately $300,000.

Question 5

The MM formula for adjusted cost of capital takes into consideration only the effect of interest tax shield on debt.

Accepted Answer

The MM formula for adjusted cost of capital includes the effect of interest tax shield on both debt and equity.

Question 6

APV method is most useful in analyzing:

Accepted Answer

The APV (Adjusted Present Value) method is most useful in analyzing large international projects because it takes into account the specific risks and costs associated with such projects, including currency risk and political risk. Domestic projects and small projects may not require the same level of complexity in analysis and may be better suited for simpler methods such as discounted cash flows or payback periods.

Question 7

A project costs $14 million and is expected to produce cash flows of $4 million a year for
15 years. The opportunity cost of capital is 20%. If the firm has to issue stock to undertake the project and issue costs are $1 million, what is the project's APV?

Accepted Answer

The Adjusted Present Value (APV) is calculated by finding the Net Present Value (NPV) of the project without considering the financing costs and then adjusting for the costs of issuing stock. First, calculate the NPV of the cash flows using the opportunity cost of capital (20%). Then, subtract the issue costs ($1 million) from the NPV to get the APV. The correct APV is $3.7 million.

Question 8

The APV method to value a project should be used:

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 value and the value of financing effects.

Question 9

A firm has a project with a NPV of -$52 million. If they have access to risk free government financing that can create an annual tax shield of $5 mil, what is the APV of the project assuming the risk free interest rate is 6%?

Accepted Answer

The APV (Adjusted Present Value) is calculated by adding the NPV of the project to the present value of the financing side effects. The tax shield is $5 million annually, and the present value of this perpetuity is $5 million / 0.06 = $83.33 million. Therefore, APV = -$52 million + $83.33 million = $31.33 million, which rounds to $31 million.

Question 10

A project costs $7 million and is expected to produce cash flows if $2 million a year for
10 years. The opportunity cost of capital is 16%. If the firm has to issue stock to undertake the project and issue costs are $0.5 million, what is the project's APV?

Accepted Answer

The answer of A project costs $7 million and is...

Question 11

A firm has issued $5 par value preferred stock that pays a $0.80 annual dividend. The stock currently sells for $9.50. In calculating a WACC, what would be the value of the firm's preferred stock?

Accepted Answer

The value of the firm's preferred stock in the context of WACC is the current market price, which is $9.50.

Question 12

The Granite Paving Company has a debt to total value ratio of 0.5. The cost of debt is 8% and that of unlevered equity is 12%. Calculate the weighted average cost of capital if the tax rate is 30%.

Accepted Answer

The WACC is calculated as follows: WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc), where E/V = 0.5, D/V = 0.5, Re = 12%, Rd = 8%, and Tc = 30%. Plugging in the values, WACC = 0.5 * 12% + 0.5 * 8% * (1 - 0.3) = 6% + 2.8% = 8.8%.

Question 13

Which of the following statements regarding guarantees and government restrictions on international projects is (are) true?
I. The value of the guarantees is added to the APV
II. The value of the guarantees is subtracted from the APV
III. The value of the government restrictions is added to the APV
IV. The value of the government restrictions is subtracted from the APV

Accepted Answer

The answer of Which of the following statements regarding guarantees...

Question 14

The BSC Co. is planning to raise $2.5 million in perpetual debt at 11%. They have just received an offer from the governor to raise the financing for them at 8%, if they locate themselves in the state. What is the total value added from debt financing if the tax rate is
34% and the state raises the loan for the company?

Accepted Answer

Since the state is offering a lower interest rate of 8%, the company would save 3% in interest expense. This savings in interest would reduce the company's taxable income by $75,000 per year ($2.5 million x 3%). At a tax rate of 34%, the company's tax savings would be $25,500 per year ($75,000 x 0.34). Therefore, the annual net savings for the company from the lower interest rate and tax savings would be $100,500 per year ($75,000 + $25,500). The total value added from debt financing would be the present value of this perpetual annual savings, which would be $1.3 million (($100,500 / 0.08) x (1 - 0.34)). Therefore, the best choice is C as it represents the total value added from debt financing.

Question 15

Floatation costs are incorporated into the APV framework by:

Accepted Answer

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

Question 16

The APV method includes all equity NPV of a project and the NPV of financing effects. The financing effects are:

Accepted Answer

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

Question 17

The WACC formula works for the "average risk" project.

Accepted Answer

The WACC formula is used to calculate the expected return on investment for a project based on its cost of capital. It takes into account the cost of debt and equity financing, as well as the relative weights of each. The formula assumes that the project has an average level of risk, so it may not be appropriate for all types of projects or investments.

Question 18

In the case of large international investments, the project might include:
I. custom-tailored project financing
II. special contracts with suppliers
III. special contracts with customers
IV. special arrangements with governments

Accepted Answer

Large international investments often require customized project financing, as well as special contracts with both suppliers and customers to ensure a successful outcome. In addition, special arrangements with governments may be necessary to navigate local regulations and ensure the investment is viable. Therefore, all options I, II, III and IV are likely to be included in large international investments.

Question 19

Modigliani-Miller (MM) formula for after-tax discount rate is given by:

Accepted Answer

The Modigliani-Miller (MM) formula for after-tax discount rate is rMM = r(1 - TCD/V), where r is the before-tax required rate of return, TCD is the corporate tax rate, and V is the value of the firm. This formula adjusts the before-tax required rate of return (r) by the tax shield provided by deductible interest payments (TCD/V), resulting in a lower after-tax discount rate (rMM). Therefore, the correct choice is A.

Question 20

The MFC corporation needs to raise $200 million for its mega project. The NPV of the project using all equity financing is $40 million. If the cost of raising funds for the project is
$20 million, what is the APV of the project?

Accepted Answer

The Adjusted Present Value (APV) is calculated by taking the NPV of the project and subtracting the cost of raising funds. Here, APV = NPV - Cost of raising funds = $40 million - $20 million = $20 million.

Quiz 19: Financing and Valuation