Question 1

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%.
-Assume that to fund the investment Taggart will take on $150 million in permanent debt with the remainder of the investment funded by a cut in dividends.Assuming Taggart will incur a 2% underwriting fee on the new debt issue,the NPV of Taggart's new rail line is closest to:

Accepted Answer

B) NPV = V^L - Investment = V^U + T_cD - Investment - (1 - T_c)issuance cost 11ea7e54_8cd1_97c9_ba34_1d41219e9abe_TB1620_00 $150 million - $250 million - (1 - 35%)(2%)($150)

Question 2

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 WACC method is closest to:

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 11ea7e54_8ccd_2ae1_ba34_69a54cf889eb_TB1620_00

Question 3

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 WACC for this project is closest to:

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

Which of the following statements is false?

Accepted Answer

The statement that the FTE method is the preferred method with alternative leverage policies is false. The FTE method becomes more complex with varying debt-equity ratios, and other methods (such as adjusted present value) may be more appropriate.

Question 5

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 6

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 7

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...

Question 8

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:

Accepted Answer

D) NPV = V^L - Investment = V^U + T_cD - Investment 11ea7e54_8cd1_49a7_ba34_b5b44b1d5628_TB1620_00 $250 million - $250 million = $238 million

Question 9

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 .6 then KT's equity cost of capital,r_E,for this project is closest to:

Accepted Answer

C) r_E = r_U + 11ea7e54_8ccb_f259_ba34_3d778b24aeb0_TB1620_00 (r_U - r_D) r_E = .12 + .6(.12 - .07) = .15 or 15%

Question 10

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 assuming Taggart will incur a 2% underwriting fee on the new debt issue,the NPV of Taggart's new rail line is closest to:

Accepted Answer

C) NPV = V^L - Investment = V^U + T_cD - Investment - (1 - T_c)issuance cost 11ea7e54_8cd1_70b8_ba34_0f704e51df3e_TB1620_00 $250 million - $250 million - (1 - 35%)(2%)($250)

Question 11

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%.
-Assume that to fund the investment Taggart will take on $150 million in permanent debt with the remainder of the investment funded through issuance of new equity.Assuming Taggart will incur a 2% underwriting fee on the new debt issue and a 5% underwriting fee on the issuance of new equity,the NPV of Taggart's new rail line is closest to:

Accepted Answer

A) NPV = V^L - Investment = V^U + T_cD - Investment - (1 - T_c)issuance cost 11ea7e54_8cd1_e5ea_ba34_310a2434db13_TB1620_00 $150 million - $250 million - (1 - 35%)(2%)($150) (Note that equity issuance costs are not tax deductible.)

Question 12

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 project based WACC,r_wacc,for this project is closest to:

Accepted Answer

B) r_wacc = r_U - dτ_cr_D 11ea7e54_8ccc_407b_ba34_632d50e508b6_TB1620_00

Question 13

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:

Accepted Answer

D) PV(interest tax shield) 11ea7e54_8cce_6369_ba34_7d74b0698248_TB1620_00 PV(interest tax shield) 11ea7e54_8cce_636a_ba34_fd6d81294bcf_TB1620_00

Question 14

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:

Accepted Answer

A) 11ea7e54_8ccd_c724_ba34_1d747b79f6bd_TB1620_00 11ea7e54_8ccd_c725_ba34_5d28972f75a7_TB1620_00

Question 15

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

Accepted Answer

B) 11ea7e54_8cce_1546_ba34_9588df10cfb2_TB1620_00 11ea7e54_8cce_1547_ba34_e547f582c18f_TB1620_00 11ea7e54_8cce_3c58_ba34_819297e26500_TB1620_00

Question 16

Which of the following statements is false?

Accepted Answer

The FTE (Flow to Equity) method is not usually the most straightforward approach for alternative leverage policies. It is more straightforward when the firm's capital structure is simple and stable. For varying leverage policies, the APV (Adjusted Present Value) method or the WACC (Weighted Average Cost of Capital) method might be more appropriate, as they can more easily accommodate changes in the firm's capital structure over time.

Question 17

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:

Accepted Answer

B) 11ea7e54_8cce_b18b_ba34_a96e018177c4_TB1620_00 11ea7e54_8cce_b18c_ba34_6fdb3018762b_TB1620_00 11ea7e54_8cce_b18d_ba34_4b5f9920debd_TB1620_00 PV(interest tax shield) 11ea7e54_8cce_d89e_ba34_9fbf537105be_TB1620_00 PV(interest tax shield) 11ea7e54_8cce_d89f_ba34_bbdc4a44ed8f_TB1620_00 V^L = V^U + PV(interest tax shield) = $202.10 + $5.26 = $207.36

Question 18

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 .6 then KT's project based WACC,r_wacc,for this project is closest to:

Accepted Answer

B) r_wacc = r_U - dτ_cr_D 11ea7e54_8ccc_196a_ba34_331f1b325a86_TB1620_00

Question 19

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:

Accepted Answer

B) NPV = V^L - Investment 11ea7e54_8ccc_b5af_ba34_3188bb7f4d74_TB1620_00 Investment 11ea7e54_8ccc_dcc0_ba34_bf97562fb421_TB1620_00 = $12.857 million

Question 20

Which of the following statements is false?

Accepted Answer

When we relax the assumption of a constant debt-equity ratio, the APV and FTE methods become easier to implement, not harder. This is because these methods allow for the explicit consideration of the effects of changing debt levels on cash flows and valuation.

Quiz 18: Capital Budgeting and Valuation With Leverage

Which of the following statements is false?

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.

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.

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?

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:

Which of the following statements is false?