Question 1

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 requires customized approach in order to minimize costs and maximize profits. Custom-tailored project financing is needed to ensure that the project receives the necessary funding. Special contracts with suppliers and customers help to secure necessary resources and markets. Special arrangements with governments can provide access to necessary permits, regulations and tax incentives. Therefore, all options I, II, III and IV are needed in order to complete the project successfully.

Question 2

The APV method should be used:

Accepted Answer

The APV (Adjusted Present Value) method is particularly useful when the project's level of debt is known over its life, as it allows for the separate valuation of tax shields and other financing effects.

Question 3

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

Accepted Answer

APV (Adjusted Present Value) = NPV + PV of tax shield.
To calculate the PV of tax shield, we can use the perpetuity formula:
PV of tax shield = Annual tax shield amount / Discount rate
= 5 million / 0.06
= $83.33 million
Therefore, the APV = -52 + 83.33 = $31.33 million (rounded to $31 million).
So, option C is correct.

Question 4

The MFC Corporation has decided to build a new facility.It estimates the cost of the facility at $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 flotation cost of raising funds?

Accepted Answer

The total flotation cost is calculated by finding the weighted average of the issue costs based on the debt-to-equity ratio. With a ratio of 1.5, for every $2.5 raised, $1.5 is debt and $1 is equity. The weighted average flotation cost is (1.5/2.5)*1% + (1/2.5)*6% = 2.4%. The total flotation cost is 2.4% of $9.7 million, which is $300,000.

Question 5

The APV method is most useful in analyzing:

Accepted Answer

The APV method (Adjusted Present Value method) is most useful in analyzing large international projects because it takes into account the different risks associated with doing business in different countries, such as changes in exchange rates, political instability, and differences in tax laws. It allows for a more accurate analysis of the project's cash flows and its net present value. On the other hand, for domestic projects, the traditional discounted cash flow method would suffice as there are no additional risks to be accounted for. The APV method is also not recommended for small projects due to its complexity and the costs involved in using the technique.

Question 6

A project costs $14 million and is expected to produce cash flows of $4 million per 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 APV (Adjusted Present Value) is calculated by finding the NPV of the project without considering the financing costs and then adjusting for the costs of issuing stock. The NPV of the cash flows is calculated using the formula for the present value of an annuity. The cost of issuing stock is subtracted from the NPV to get the APV.

Question 7

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

Accepted Answer

The answer of The MM formula for the adjusted cost...

Question 8

When calculating the WACC for a firm,one should use the book values of debt and equity.

Accepted Answer

When calculating the WACC, market values of debt and equity should be used instead of book values. Market values represent the current market price or fair market value of the securities, and provide a more accurate measure of the cost of capital for the firm.

Question 9

Subsidized loans will impact the NPV of a project by:

Accepted Answer

Subsidized loans reduce the cost of debt and hence reduce the WACC, which increases the NPV of the project. As a result, the presence of subsidized loans will increase both the NPV and the APV of the project, and the extent of the increase in the NPV will be greater than the increase in the APV. Therefore, D is the correct option.

Question 10

A project costs $7 million and is expected to produce cash flows of $2 million per 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 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?

Accepted Answer

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

Question 12

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) of the project is calculated by adding the Net Present Value (NPV) of the project using all-equity financing to the present value of the financing effects. Here, the NPV is $40 million, and the cost of raising funds is $20 million, which is a negative effect on the project's value. Therefore, the APV = $40 million - $20 million = $20 million.

Question 13

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 WACC,what should one use for the value of the firm's preferred stock?

Accepted Answer

In calculating the Weighted Average Cost of Capital (WACC), the market value of the securities is used. Therefore, for the preferred stock, its current market price of $9.50 should be used, not its par value or dividend amount.

Question 14

The APV method includes the NPV of a project assuming all-equity financing and then adds in the NPV of financing effects.The financing effects are:

Accepted Answer

The APV method includes the NPV of a project assuming all-equity financing and then adds the NPV of financing effects such as the cost of issuing new securities, cost of financial distress, tax subsidy of debt, and other subsidies.

Question 15

The WACC formula calculates the cost of capital for the "average risk" project.

Accepted Answer

The WACC formula calculates the cost of capital for a company's overall capital structure, taking into account both debt and equity financing. It is used as a benchmark or hurdle rate for evaluating whether a new project will create value for shareholders. However, the WACC does not differentiate between high-risk and low-risk projects, as it assumes that the company's risk profile is reflected in its overall cost of capital. Therefore, it may not be appropriate to use the WACC for projects that have significantly different risk profiles than the company as a whole.

Question 16

The Modigliani-Miller (MM)formula for the after-tax discount rate,for the case of fixed perpetual debt,is given by:

Accepted Answer

The Modigliani-Miller theorem with taxes suggests that the cost of equity decreases with the tax shield from debt, which is represented by the formula r(1 - T_CD/V), where T_C is the corporate tax rate, D is the debt, and V is the firm's value.

Question 17

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 18

Flotation costs are incorporated into the APV framework by:

Accepted Answer

Flotation 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 to the firm.

Question 19

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 20

The BSC Co.was planning to raise $2.5 million in perpetual debt at 11%.However,they just received an offer from the governor of a nearby state to raise the financing for them at 8% if they locate a new facility in that state.What is the total value added from debt financing if the tax rate is 34% and the state subsidizes the loan for the company?

Accepted Answer

First, we need to calculate the annual interest expense for the perpetual debt at 11%:
Annual Interest Expense = $2.5 million x 11% = $275,000

Next, we need to calculate the annual interest expense for the subsidized loan at 8%:
Annual Interest Expense = $2.5 million x 8% = $200,000

Since the state is subsidizing the loan, the actual interest expense for the company would be lower than $200,000. Let's assume it's 6%. Then, the actual annual interest expense would be:
Actual Annual Interest Expense = $2.5 million x 6% = $150,000

To calculate the value added from debt financing, we need to calculate the tax shield for each option:
Tax Shield = Annual Interest Expense x Tax Rate

For the perpetual debt at 11%:
Tax Shield = $275,000 x 34% = $93,500

For the subsidized loan at 6%:
Tax Shield = $150,000 x 34% = $51,000

The difference in tax shields is the value added from debt financing:
Value Added = $93,500 - $51,000 = $42,500

However, we need to remember that the subsidized loan is offering a lower interest rate, which means the company will have lower interest expenses every year. This will increase the present value of the tax shield over time. To calculate this, we need to use the formula for the present value of a growing perpetuity:
PV = C / (r - g)

Where PV is the present value, C is the cash flow (the tax shield), r is the discount rate (the cost of debt), and g is the growth rate (the inflation rate). Let's assume inflation is 2%.

For the perpetual debt at 11%, the present value of the tax shield is:
PV = $93,500 / (11% x (1 - 34%)) = $684,191

For the subsidized loan at 6%, the present value of the tax shield is:
PV = $51,000 / (6% x (1 - 34% - 2%)) = $1,315,789

The difference in present values is the total value added from debt financing:
Value Added = $1,315,789 - $684,191 = $631,598

Therefore, the best choice is C) $1.3 million. The subsidized loan with a lower interest rate and a state subsidy results in a much larger total value added from debt financing.

Quiz 19: Financing and Valuation

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