Question 1

Refer to data for Glassmaker Corporation.What is Glassmaker's WACC,based on its current capital structure?
A) 9.02%
B) 9.50%
C) 9.83%
D) 10.01%
E) 11.29%

Accepted Answer

Using the formula for calculating WACC:
WACC = (E/V * Re) + [(D/V * Rd) * (1-T)]
where 
E= Market value of the firm's equity 
D= Market value of the firm's debt 
V= Total Market Value of the company (Debt + Equity)
Re= Cost of Equity 
Rd= Cost of Debt 
T= Tax Rate

Given data: 
Market value of equity (E) = $280 million
Market value of debt (D) = $120 million
Total Market value (V) = $280 million + $120 million = $400 million
Cost of Equity (Re) = 14%
Cost of Debt (Rd) = 7%
Tax Rate (T) = 40%

Putting in the values, we get: 
WACC = [($280/$400) * 0.14] + [($120/$400) * 0.07 * (1-0.40)]
WACC = 0.0983 or 9.83%

Therefore, option C) 9.83% is the correct answer.

Question 2

MM showed that in a world without taxes,a firm's value is not affected by its capital structure.

Accepted Answer

MM (Modigliani-Miller) theorem states that in a world without taxes, the value of a firm is not affected by its capital structure. The theorem implies that the cost of equity and the weighted average cost of capital (WACC) remain constant as the firm changes its capital structure. Therefore, the answer is true.

Question 3

Refer to data for Glassmaker Corporation.Using the compressed adjusted present value model,what will Glassmaker's value of equity be if it successfully implements its planned changes in operations and capital structure? (Round your answer to the closest thousand dollars. )
A) $16,019,000
B) $17,111,000
C) $18,916,000
D) $22,111,000
E) $22,916,000

Accepted Answer

B

Question 4

Which of the following statements concerning the compressed adjusted present value (APV)model is NOT CORRECT?
A) The value of a growing tax shield is greater than the value of a constant tax shield.
B) For a given D/S,the levered cost of equity is greater in the compressed APV model than the levered cost of equity under MM's original (with tax)assumptions.
C) For a given D/S,the WACC is greater in the compressed APV model than the WACC under MM's original (with tax)assumptions.
D) The total value of the firm increases with the amount of debt.
E) The tax shields should be discounted at the cost of debt.

Accepted Answer

The answer of Which of the following statements concerning the...

Question 5

The present value of the free cash flows discounted at the unlevered cost of equity is the value of the firm's operations if it had no debt.

Accepted Answer

The present value of free cash flows discounted at the unlevered cost of equity is used to calculate the value of a firm's operations assuming it has no debt, which is also known as the enterprise value.

Question 6

If the capital structure is stable,and free cash flows are expected to be growing at a constant rate at the horizon date,then the compressed adjusted present value model calculates the horizon value by discounting the post-horizon free cash flows and post-horizon expected future tax shields at the weighted average cost of capital.

Accepted Answer

The compressed adjusted present value (APV) model calculates the horizon value by separately discounting the post-horizon free cash flows at the unlevered cost of capital and the post-horizon expected future tax shields at the cost of debt, rather than using the weighted average cost of capital for both.

Question 7

Using the data for Sallie's Sandwiches and the compressed adjusted present value model,what is the total value (in millions)?
A) $72.37
B) $73.99
C) $74.49
D) $75.81
E) $76.45

Accepted Answer

The answer of Using the data for Sallie's Sandwiches and...

Question 8

Which of the following statements about valuing a firm using the compressed adjusted present value (CAPV)approach is most CORRECT?
A) The value of equity is calculated by discounting the horizon value,the tax shields,and the free cash flows at the cost of equity.
B) The value of operations is calculated by discounting the horizon value,the tax shields,and the free cash flows before the horizon date at the unlevered cost of equity.
C) The value of equity is calculated by discounting the horizon value and the free cash flows at the cost of equity.
D) The CAPV approach stands for the accounting pre-valuation approach.
E) The value of operations is calculated by discounting the horizon value,the tax shields,and the free cash flows at the cost of equity.

Accepted Answer

According to the compressed adjusted present value (CAPV) approach, the value of operations is calculated by discounting the horizon value, tax shields, and free cash flows before the horizon date at the unlevered cost of equity. The value of equity is calculated by adding the value of operations and the present value of tax shields, and then discounting at the cost of equity. Therefore, option B is the most correct statement. Options A and E are partially correct, but they do not consider the difference in discount rates between the value of operations and equity. Option C is incorrect as it does not consider the present value of tax shields. Option D is false as CAPV stands for the compressed adjusted present value approach and not the accounting pre-valuation approach.

Question 9

MM showed that in a world with taxes,a firm's optimal capital structure would be almost 100% debt.

Accepted Answer

Modigliani and Miller (MM) proposed that in a world with taxes, debt financing provides a tax shield (since interest payments are tax-deductible) which can make almost 100% debt financing the optimal capital structure for a firm, as it minimizes the cost of capital by maximizing the tax shield benefit.

Question 10

Which of the following statements concerning the compressed adjusted present value (APV)model is NOT CORRECT?
A) The value of a growing tax shield is greater than the value of a constant tax shield.
B) For a given D/S,the levered cost of equity using the compressed APV model is greater than the levered cost of equity under MM's original (with tax)assumptions.
C) For a given D/S,the WACC in the compressed APV model is less than the WACC under MM's original (with tax)assumptions.
D) The total value of the firm increases with the amount of debt.
E) The tax shields should be discounted at the unlevered cost of equity.

Accepted Answer

The answer of Which of the following statements concerning the...

Question 11

In the compressed adjusted present value model,the appropriate discount rate for the tax shield is the after-tax cost of debt.

Accepted Answer

The answer of In the compressed adjusted present value model,the...

Question 12

In the compressed adjusted present value model,the appropriate discount rate for the tax shield is the unlevered cost of equity.

Accepted Answer

In the compressed adjusted present value model, the tax shield is discounted at the unlevered cost of equity because it represents the cost of equity if the company had no debt.

Question 13

In the compressed adjusted present value model,the appropriate discount rate for the tax shield is the WACC.

Accepted Answer

In the adjusted present value (APV) model, the appropriate discount rate for the tax shield is typically the cost of debt, not the weighted average cost of capital (WACC). The WACC is used to discount the unlevered free cash flows, while the cost of debt is used for the tax shield to reflect the risk associated with the debt financing.

Question 14

Which of the following statements concerning the compressed adjusted present value (APV)model is NOT CORRECT?
A) The value of a growing tax shield is greater than the value of a constant tax shield.
B) For a given D/S,the levered cost of equity in the compressed APV model is greater than the levered cost of equity under MM's original (with tax)assumptions.
C) For a given D/S,the WACC in the compressed APV model is greater than the WACC under MM's original (with tax)assumptions.
D) The total value of the firm is independent of the amount of debt it uses.
E) The tax shields should be discounted at the unlevered cost of equity.

Accepted Answer

The compressed APV model explicitly separates out the value of the operating assets from the value of the tax shields, so the total value of the firm is independent of the amount of debt it uses. This is one of the main advantages of the compressed APV model over the standard WACC approach, which does not make this distinction and implicitly assumes that the value of the tax shields is directly proportional to the amount of debt.

Question 15

Refer to data for Kitto Electronics.According to the compressed adjusted present value model,what is Kitto's unlevered value?
A) $1,296,000
B) $1,440,000
C) $1,600,000
D) $1,760,000
E) $1,936,000

Accepted Answer

The unlevered value of Kitto Electronics can be calculated using the compressed adjusted present value (CAPV) model, which is:

Unlevered value = Enterprise value + (Tax benefit of debt × Debt) - Cash and marketable securities

Plugging in the values from the table, we get:

Unlevered value = $1,600,000 + (0.4 × $600,000) - $400,000
Unlevered value = $1,760,000

Therefore, the correct answer is C, $1,600,000.

Question 16

Which of the following statements about valuing a firm using the compressed adjusted present value (CAPV)approach is most CORRECT?
A) The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the cost of debt.
B) The horizon value is calculated by discounting the expected earnings at the WACC.
C) The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the WACC.
D) The horizon value must always be more than 20 years in the future.
E) The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the levered cost of equity.

Accepted Answer

CAPV approach values a firm based on its future free cash flows, tax savings, and horizon value. The horizon value is the value of the company beyond the forecast horizon calculated by discounting the free cash flows and any tax savings at the weighted average cost of capital (WACC). Therefore, the correct statement is that the horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the WACC (option C is correct). The horizon value does not necessarily have to be more than 20 years in the future, and it is not calculated by discounting expected earnings or the cost of debt. The levered cost of equity may be used to calculate the WACC, but it is not used to discount the free cash flows and any tax savings beyond the horizon date.

Question 17

Refer to data for Glassmaker Corporation.According to the compressed adjusted present value model,what discount rate should you use to discount Glassmaker's free cash flows and interest tax savings?
A) 10.01%
B) 10.06%
C) 11.29%
D) 11.44%
E) 13.49%

Accepted Answer

Using the compressed adjusted present value (CAPV) model, the formula to calculate the discount rate is:
Discount Rate = Risk-Free Rate + (Risk Premium x (1 - Tax Rate)) + (Market Value of Debt / (Market Value of Debt + Market Value of Equity)) x (Cost of Debt – Risk-Free Rate) x (1 - Tax Rate)

Plugging in the given values for Glassmaker Corporation:

Risk-Free Rate = 2.5%
Risk Premium = 6%
Tax Rate = 35%
Market Value of Debt = $600 million
Market Value of Equity = $1,200 million
Cost of Debt = 8%

Discount Rate = 2.5% + (6% x (1 - 35%)) + ($600 million / ($600 million + $1,200 million)) x (8% – 2.5%) x (1 - 35%)
Discount Rate = 11.29%

Therefore, the correct answer is C) 11.29%.

Question 18

In a world with no taxes,MM show that a firm's capital structure does not affect the firm's value.However,when taxes are considered,MM show a positive relationship between debt and value,i.e. ,its value rises as its debt is increased.

Accepted Answer

In the absence of taxes, MM Proposition I states that the capital structure of a firm does not affect its value. However, when taxes are introduced, MM Proposition II states that a firm's value is positively related to its debt level, as the interest paid on debt is tax-deductible, leading to a lower tax burden and a higher after-tax cash flow.

Question 19

According to MM,in a world without taxes the optimal capital structure for a firm is approximately 100% debt financing.

Accepted Answer

According to Modigliani and Miller (MM) theorem, in a world without taxes, transaction costs, or bankruptcy costs, the capital structure of a firm (debt vs. equity financing) does not affect its overall value. This implies there is no optimal capital structure in terms of debt-to-equity ratio.

Question 20

Using the data for Sallie's Sandwiches and the compressed adjusted present value model,what is the appropriate rate for use in discounting the free cash flows and the interest tax savings?
A) 12.0%
B) 13.9%
C) 14.4%
D) 16.0%
E) 16.9%

Accepted Answer

The answer of Using the data for Sallie's Sandwiches and...

Quiz 21: Dynamic Capital Structures and Corporate Valuation

Refer to data for Glassmaker Corporation.What is Glassmaker's WACC,based on its current capital structure?

MM showed that in a world without taxes,a firm's value is not affected by its capital structure.

Refer to data for Glassmaker Corporation.Using the compressed adjusted present value model,what will Glassmaker's value of equity be if it successfully implements its planned changes in operations and capital structure? (Round your answer to the closest thousand dollars. )

Which of the following statements concerning the compressed adjusted present value (APV) model is NOT CORRECT?

The present value of the free cash flows discounted at the unlevered cost of equity is the value of the firm's operations if it had no debt.

Using the data for Sallie's Sandwiches and the compressed adjusted present value model,what is the total value (in millions) ?

Which of the following statements about valuing a firm using the compressed adjusted present value (CAPV) approach is most CORRECT?

MM showed that in a world with taxes,a firm's optimal capital structure would be almost 100% debt.

Which of the following statements concerning the compressed adjusted present value (APV) model is NOT CORRECT?

In the compressed adjusted present value model,the appropriate discount rate for the tax shield is the after-tax cost of debt.

In the compressed adjusted present value model,the appropriate discount rate for the tax shield is the unlevered cost of equity.

In the compressed adjusted present value model,the appropriate discount rate for the tax shield is the WACC.

Which of the following statements concerning the compressed adjusted present value (APV) model is NOT CORRECT?

Refer to data for Kitto Electronics.According to the compressed adjusted present value model,what is Kitto's unlevered value?

Which of the following statements about valuing a firm using the compressed adjusted present value (CAPV) approach is most CORRECT?

Refer to data for Glassmaker Corporation.According to the compressed adjusted present value model,what discount rate should you use to discount Glassmaker's free cash flows and interest tax savings?

In a world with no taxes,MM show that a firm's capital structure does not affect the firm's value.However,when taxes are considered,MM show a positive relationship between debt and value,i.e. ,its value rises as its debt is increased.

According to MM,in a world without taxes the optimal capital structure for a firm is approximately 100% debt financing.

Using the data for Sallie's Sandwiches and the compressed adjusted present value model,what is the appropriate rate for use in discounting the free cash flows and the interest tax savings?