Question 1

The unlevered cost of capital for Antelope Incorporated is closest to:
A)10.3%
B)9.9%
C)10.1%
D)9.5%

Accepted Answer

B)r_U = 11ea7cce_3cac_8d93_928c_e765a556f7d9_TB1626_11 r_E + 11ea7cce_3cac_b4a4_928c_f9c2ea393185_TB1626_11 r_D 11ea7cce_3cac_b4a5_928c_6d280b7e59bb_TB1626_00

Question 2

Suppose that to fund this new project,Aardvark borrows $120 with the principal to be paid in three equal installments at the end each year.The levered value of Aardvark's new project is closest to:
A)$210.15
B)$207.35
C)$207.00
D)$210.50

Accepted Answer

B)r_U = 11ea7cce_3cb0_3735_928c_b345cd01402d_TB1626_11 r_E + 11ea7cce_3cb0_5e46_928c_e18b8a42cc5b_TB1626_11 r_D r_U = 11ea7cce_3cb0_5e47_928c_f1e1c1e03be3_TB1626_11 _.12 + 11ea7cce_3cb0_5e48_928c_75358947921c_TB1626_11 .07 = 10.0% V^U = 11ea7cce_3cb0_8559_928c_05fd2a51b7a7_TB1626_11 + 11ea7cce_3cb0_855a_928c_0bf0f31c084c_TB1626_11 + 11ea7cce_3cb0_855b_928c_b3cffdd77db2_TB1626_11 = $202.10 PV(interest tax shield)= 11ea7cce_3cb0_ac6c_928c_b5810c18922d_TB1626_11 + 11ea7cce_3cb0_ac6d_928c_8d58054c7941_TB1626_11 + 11ea7cce_3cb0_ac6e_928c_e3f323ce11ce_TB1626_11 PV(interest tax shield)= 11ea7cce_3cb0_d37f_928c_6f5092cefdce_TB1626_11 + 11ea7cce_3cb0_d380_928c_7b3a99837df2_TB1626_11 + 11ea7cce_3cb0_d381_928c_33f065934b60_TB1626_11 = $5.2596 V^L = V^U + PV(interest tax shield)= $202.10 + $5.26 = $207.36

Question 3

The WACC for this project is closest to:
A)3.0%
B)5.0%
C)7.0%
D)8.2%

Accepted Answer

A)Since this project is totally debt financed at the risk free rate,the risk free rate of 5% is the before tax WACC.The after tax wacc is the simply r_f(1 - T_c)= 5%(1 - 40%)= 3%.

Question 4

The NPV of this project using the WACC method is closest to:
A)$10 million
B)$13 million
C)$42 million
D)$71 million

Accepted Answer

B)Since this project is totally debt financed at the risk free rate,the risk free rate of 5% is the before tax WACC.The after tax wacc is the simply r_f(1 - T_c)= 5%(1 - 40%)= 3%. NPV = PV Inflows - Investment = 11ea7cce_3cae_3b51_928c_07cc46d13b2d_TB1626_11 - $150 = 13.11 million

Question 5

If KT expects to maintain a debt to equity ratio for this project of 1 then KT's project based WACC,r_wacc,for this project is closest to: A)11.1% B)10.8% C)9.6% D)10.5%

Accepted Answer

B)r_wacc = r_U - dτ_cr_D r_wacc = .12 - 11ea7cce_3cad_50e9_928c_df3e43cdb446_TB1626_11 (.35)(.07)= .107750 or 10.8%

Question 6

Which of the following statements is FALSE?
A)As a general rule,the WACC method is the easiest to use when the firm will maintain a fixed debt-to-value ratio over the life of the investment.
B)The FTE method is typically used only in complicated settings for which the values of other securities in the firm's capital structure or the interest tax shield are themselves difficult to determine.
C)For alternative leverage policies,the FTE method is usually the most straightforward approach.
D)When used consistently,the WACC,APV,and FTE methods produce the same valuation for the investment.

Accepted Answer

This statement is false because, for alternative leverage policies, the APV method is usually the most straightforward approach, not the FTE method.

Question 7

Use the following information to answer the question(s)below.
Taggart Transcontinental is considering a $250 million investment to launch a new rail line.The project is expected to generate a free cash flow of $32 million per year,and its unlevered cost of capital is 8%.Taggart's marginal corporate tax rate is 35%.
-Assuming that to fund the investment Taggart will take on $250 million in permanent debt and ignoring issuance costs,the NPV of Taggart's new rail line is closest to:
A)$195 million
B)$200 million
C)$235 million
D)$240 million

Accepted Answer

D)NPV = V^L - Investment = V^U + T_cD - Investment = 11ea7cce_3cb2_8145_928c_e1411402f111_TB1626_11 + (35%)$250 million - $250 million = $237.5 million

Question 8

Suppose that to fund this new project,Aardvark borrows $120 with the principal to be paid in three equal installments at the end each year.The present value of Aardvark's interest tax shield is closest to:
A)$5.15
B)$5.00
C)$5.90
D)$5.25

Accepted Answer

D)PV(interest tax shield)= 11ea7cce_3caf_c1ff_928c_67f4d5856155_TB1626_11 + 11ea7cce_3caf_c200_928c_ab2bd5c711af_TB1626_11 + 11ea7cce_3caf_c201_928c_6ba778974a25_TB1626_11 PV(interest tax shield)= 11ea7cce_3cb0_1022_928c_51d408ecba05_TB1626_11 + 11ea7cce_3cb0_1023_928c_e1dd2568bdf9_TB1626_11 + 11ea7cce_3cb0_1024_928c_5bf26ee89490_TB1626_11 = $5.2596

Question 9

Use the information for the question(s)below.
Aardvark Industries is considering a project that will generate the following free cash flows:  You are also provided with the following market value balance sheet and information regarding Aardvark's cost of capital: 
-Aardvark's unlevered cost of equity is closest to:
A)10.0%
B)10.4%
C)9.5%
D)9.0%

Accepted Answer

A)r_U = 11ea7cce_3cae_d794_928c_318ca9b8db82_TB1626_11 r_E + 11ea7cce_3cae_d795_928c_2dbecb9bbd14_TB1626_11 r_D r_U = 11ea7cce_3cae_fea6_928c_97f316df97b3_TB1626_11 _.12 + 11ea7cce_3cae_fea7_928c_db7e110c82b3_TB1626_11 .07₌_10.0%

Question 10

Which of the following statements is FALSE? A)When we relax the assumption of a constant debt-equity ratio,the FTE method is relatively straightforward to use and is therefore the preferred method with alternative leverage policies. B)When debt levels are set according to a fixed schedule,we can discount the predetermined interest tax shields using the debt cost of capital,r_D. C)With a constant interest coverage policy,the value of the interest tax shield is proportional to the project's unlevered value. D)When the firm keeps its interest payments to a target fraction of its FCF,we say it has a constant interest coverage ratio.

Accepted Answer

The statement that the FTE method is the preferred method with alternative leverage policies when we relax the assumption of a constant debt-equity ratio is false. In fact, the FTE method becomes more complex and difficult to use when the debt-equity ratio is not constant.

Question 11

Use the information for the question(s)below. KT Enterprises is considering undertaking a new project.Based upon analysis of firms with similar projects,KT has determined that an unlevered cost of equity of 12% is suitable for their project.KT's marginal tax rate is 35%,its borrowing rate is 7%,and KT does not believe that its borrowing rate will change if the new project is accepted. -If KT expects to maintain a debt to equity ratio for this project of 1,then KT's equity cost of capital,r_E,for this project is closest to: A)17.0% B)5.0% C)15.0% D)12%

Accepted Answer

A)r_E = r_U + 11ea7cce_3cac_dbb6_928c_4b255eacef4a_TB1626_11 (r_U - r_D) r_E = .12 + 1(.12 - .07)= .17 or 17%

Question 12

Which of the following statements is FALSE?
A)Rather than set debt according to a target debt-equity ratio or interest coverage level,a firm may adjust its debt according to a fixed schedule that is known in advance.
B)When we relax the assumption of a constant debt-equity ratio,the equity cost of capital and WACC for a project will change over time as the debt-equity ratio changes.
C)When we relax the assumption of a constant debt-equity ratio,the APV and FTE methods are difficult to implement.
D)If a firm is using leverage to shield income from corporate taxes,then it will adjust its debt level so that its interest expenses grow with its earnings.

Accepted Answer

When we relax the assumption of a constant debt-equity ratio, the APV and FTE methods become easier to implement because they allow for the explicit consideration of financing choices and the resulting tax benefits. This statement is false because these methods are not difficult to implement when the debt-equity ratio is not constant.

Question 13

The unlevered cost of capital for Armadillo Industries is closest to:
A)10.3%
B)10.0%
C)9.5%
D)9.9%

Accepted Answer

A)r_U = 11ea7cce_3cac_6680_928c_f75842c60a36_TB1626_11 r_E + 11ea7cce_3cac_6681_928c_ad896aaf8ed8_TB1626_11 r_D 11ea7cce_3cac_6682_928c_375605e22b3d_TB1626_00

Question 14

Use the information for the question(s)below.
The Aardvark Corporation is considering launching a new product and is trying to determine an appropriate discount rate for evaluating this new product.Aardvark has identified the following information for three single division firms that offer products similar to the one Aardvark is interested in launching: 
-Based upon the three comparable firms,calculate that most appropriate unlevered cost of capital for Aardvark to use on this new product.

Accepted Answer

The answer of Use the information for the question(s)below.
The Aardvark...

Question 15

Suppose that to fund this new project,Aardvark borrows $150 with the principal to be paid in three equal installments at the end each year.Calculate the present value of Aardvark's interest tax shield.

Accepted Answer

The answer of Suppose that to fund this new project,Aardvark...

Question 16

The unlevered value of Aardvark's new project is closest to:
A)$205
B)$100
C)$164
D)$202

Accepted Answer

D)r_U = 11ea7cce_3caf_25b8_928c_d9365449ca21_TB1626_11 r_E + 11ea7cce_3caf_4cc9_928c_b3485a5aacf4_TB1626_11 r_D r_U = 11ea7cce_3caf_4cca_928c_596a42d0df71_TB1626_11 _.12 + 11ea7cce_3caf_73db_928c_c126ab7cad8c_TB1626_11 .07_{= 10.0%} V^U = 11ea7cce_3caf_73dc_928c_6998f771a7ee_TB1626_11 + 11ea7cce_3caf_73dd_928c_a59ab75fd5e4_TB1626_11 + 11ea7cce_3caf_9aee_928c_49909de3a0f4_TB1626_11 = $202.10

Question 17

Use the following information to answer the question(s)below.
Rearden Metal is evaluating a project that requires an investment of $150 million today and provides a single cash flow of $180 million for sure one year from now.Rearden decides to use 100% debt financing for this investment.The risk-free rate is 5% and Rearden's corporate tax rate is 40%.Assume that the investment is fully depreciated at the end of the year.
-The NPV of this project using the APV method is closest to:
A)$10 million
B)$13 million
C)$42 million
D)$71 million

Accepted Answer

B)NPV = V^L - Investment = V^U + 11ea7cce_3cad_ed2e_928c_2f4613b13799_TB1626_11 - Investment = 11ea7cce_3cad_ed2f_928c_e5902f272e40_TB1626_11 + 11ea7cce_3cad_ed30_928c_d377a20284b3_TB1626_11 - $150 million = $12.857 million

Question 18

Suppose that to fund this new project,Aardvark borrows $150 with the principal to be paid in three equal installments at the end each year.Calculate the The levered value of Aardvark's new project.

Accepted Answer

The answer of Suppose that to fund this new project,Aardvark...

Question 19

If KT expects to maintain a debt to equity ratio for this project of .6 then KT's project based WACC,r_wacc,for this project is closest to: A)10.5% B)11.1% C)9.6% D)10.8%

Accepted Answer

B)r_wacc = r_U - dτ_cr_D r_wacc = .12 - 11ea7cce_3cad_29d8_928c_db9e5a786d3d_TB1626_11 (.35)(.07)= .1108 or 11.08%

Question 20

If KT expects to maintain a debt to equity ratio for this project of .6 then KT's equity cost of capital,r_E,for this project is closest to: A)5.0% B)12% C)15.0% D)17.0%

Accepted Answer

C)r_E = r_U + 11ea7cce_3cad_02c7_928c_f76d54868b3a_TB1626_11 (r_U - r_D) r_E = .12 + .6(.12 - .07)= .15 or 15%

Quiz 18: Capital Budgeting and Valuation With Leverage

The unlevered cost of capital for Antelope Incorporated is closest to:

Suppose that to fund this new project,Aardvark borrows $120 with the principal to be paid in three equal installments at the end each year.The levered value of Aardvark's new project is closest to:

The WACC for this project is closest to:

The NPV of this project using the WACC method is closest to:

If KT expects to maintain a debt to equity ratio for this project of 1 then KT's project based WACC,rwacc,for this project is closest to:

Which of the following statements is FALSE?

Suppose that to fund this new project,Aardvark borrows $120 with the principal to be paid in three equal installments at the end each year.The present value of Aardvark's interest tax shield is closest to:

Which of the following statements is FALSE?

Which of the following statements is FALSE?

The unlevered cost of capital for Armadillo Industries is closest to:

Suppose that to fund this new project,Aardvark borrows $150 with the principal to be paid in three equal installments at the end each year.Calculate the present value of Aardvark's interest tax shield.

The unlevered value of Aardvark's new project is closest to:

Suppose that to fund this new project,Aardvark borrows $150 with the principal to be paid in three equal installments at the end each year.Calculate the The levered value of Aardvark's new project.

If KT expects to maintain a debt to equity ratio for this project of .6 then KT's project based WACC,rwacc,for this project is closest to:

If KT expects to maintain a debt to equity ratio for this project of .6 then KT's equity cost of capital,rE,for this project is closest to:

If KT expects to maintain a debt to equity ratio for this project of 1 then KT's project based WACC,r_wacc,for this project is closest to:

If KT expects to maintain a debt to equity ratio for this project of .6 then KT's project based WACC,r_wacc,for this project is closest to:

If KT expects to maintain a debt to equity ratio for this project of .6 then KT's equity cost of capital,r_E,for this project is closest to: