Question 1

Consider the following equation for the project WACC with a fixed debt schedule: r_wacc = r_U - dτ_c[rD + f(r_U - r_D)] The term f in this equation represents A) the annual adjustment percentage to the amount of debt. B) a measure of the permanence of the debt level. C) the dollar amount of debt outstanding. D) the debt-to-value ratio.

Accepted Answer

The term f represents a measure of the permanence of the debt level, which reflects the extent to which financing decisions are influenced by long-term factors rather than short-term factors. Therefore, option B is the best choice. Option A is incorrect because there is no mention of an annual adjustment percentage to the amount of debt. Option C is incorrect because there is no information given on the dollar amount of debt outstanding. Option D is incorrect because the debt-to-value ratio is not explicitly mentioned in the equation.

Question 2

The reason that the Air Transportation Safety and System Stabilization Act,which established the Air Transportation Stabilization Board (ATSB)in the United States of America,gives the U.S.carriers an advantage over Canadian carriers is because
A) the act enables the U.S. carriers to obtain loans at the same level of interest rate as Canadian air carriers.
B) the act enables the U.S. carriers to obtain loans at a lower interest rate than they would without the guarantee.
C) the act enables the U.S. carriers to obtain loans at the higher level of interest rate as Canadian air carriers.
D) the act breaks the advantages of interest rate that Canadian carriers have enjoyed for many years.

Accepted Answer

The Air Transportation Safety and System Stabilization Act established the Air Transportation Stabilization Board (ATSB) in the United States of America, which provided a guarantee for loans taken out by US airlines. This guarantee enabled US carriers to obtain loans at a lower interest rate than they would without the guarantee, giving them an advantage over Canadian carriers who did not have access to this benefit. Therefore, the correct answer is B.

Question 3

Which of the following statements is false?
A) With perfect capital markets, all securities are fairly priced and issuing securities is a zero-NPV transaction.
B) The fees associated with the financing of the project are independent of the project's required cash flows and should be ignored when calculating the NPV of the project.
C) When a firm borrows funds, a mispricing scenario arises if the interest rate charged differs from the rate that is appropriate given the actual risk of the loan.
D) The WACC, APV, and FTE methods determine the value of an investment incorporating the tax shields associated with leverage.

Accepted Answer

The fees associated with the financing of the project are not independent of the project's required cash flows and should be incorporated when calculating the NPV of the project. Ignoring these fees would lead to an incorrect calculation of the project's profitability. Therefore, statement B is false. The other statements are true.

Question 4

The WACC approach does not require knowledge of ________ tax rates.This fact is important because in practice,estimating the marginal tax rate of the ________ can be very difficult.
A) investors'; investor
B) shareholders'; shareholder
C) debtors'; debtor
D) creditors'; creditor

Accepted Answer

The WACC (Weighted Average Cost of Capital) approach does not require knowledge of investors' tax rates. This is significant because estimating the marginal tax rate of the investor can indeed be challenging in practical scenarios.

Question 5

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:
A) $205
B) $100
C) $164
D) $202

Accepted Answer

D) r_U = 11ea7e5a_6ee8_d35b_9a0a_1184a0cfd4fe_TB1623_11 r_E + 11ea7e5a_6ee8_d35c_9a0a_339ca7e40cd2_TB1623_11 r_D r_U = 11ea7e5a_6ee8_fa6d_9a0a_3dc5a5591dc6_TB1623_11 _.12 + 11ea7e5a_6ee8_fa6e_9a0a_dd646cd18a70_TB1623_11 .07_{= 10.0%} V^U = 11ea7e5a_6ee8_fa6f_9a0a_7d1e4c249b81_TB1623_11 + 11ea7e5a_6ee9_2180_9a0a_99e91f4da0ed_TB1623_11 + 11ea7e5a_6ee9_2181_9a0a_81a1188da0b9_TB1623_11 = $202.10

Question 6

Suppose that to fund this new project,Aardvark borrows $150 million 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

When the firm keeps its interest payments to a target fraction of its FCF,we say it has a(n)________ interest coverage ratio.
A) constant
B) average
C) variable
D) zero

Accepted Answer

The term "constant" best describes this type of interest coverage ratio, as the firm is keeping its interest payments consistent with a specific fraction of its cash flow.

Question 8

Luther Industries is considering borrowing $500 million to fund a new product line.Given investors' uncertainty regarding its prospects,Luther will pay a 7% interest rate on this loan.The firm's management knows that the actual risk of the loan is extremely low and that the appropriate rate on the loan is 5%.Suppose the loan is for four years,with all principal being repaid in the fourth year.If Luther's marginal corporate tax rate is 35%,then the net effect of the loan on the value of the new product line is closest to:
A) $22 million
B) $34 million
C) $35 million
D) $24 million

Accepted Answer

D) Luther Industries is paying (7% - 5% = 2%) more for the loan than the risk demands. However, part of this 2% premium in the interest rate is being offset by the interest tax shield. Therefore the true cost in any year is the amount of debt × (2%) × (1 - τ_c). Cost per year = $500M(.02)(.65) = $6.5M, we need to discount this amount each year by the correct r_D of 5%, this is amount is constant and occurs each year for four years we have an annuity, solving: PMT = 6.5 I = 5% FV = 0 N = 4 Compute PV = $23.04 million

Question 9

Which of the following statements is false?
A) Sometimes management may believe that the securities they are issuing are priced at less than (or more than) their true value. If so, the NPV of the transaction, which is the difference between the actual money raised and the true value of the securities sold, should not be included in the value of the project.
B) An alternative method of incorporating financial distress and agency costs is to first value the project ignoring these costs, and then value the incremental cash flows associated with financial distress and agency problems separately.
C) When the debt level-and therefore the probability of financial distress-is high, the expected free cash flow will be reduced by the expected costs associated with financial distress and agency problems.
D) If the financing of the project involves an equity issue, and if management believes that the equity will sell at a price that is less than its true value, this mispricing is a cost of the project for the existing shareholders.

Accepted Answer

The statement that the NPV of the transaction (the difference between the actual money raised and the true value of the securities sold) should not be included in the value of the project if management believes the securities are priced incorrectly is false. The correct approach would be to adjust the cash flows to reflect the true value of the securities.

Question 10

Suppose that to fund this new project,Aardvark borrows $120 million 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 = 11ea7e5a_6eea_0be8_9a0a_57d1d60f6f36_TB1623_11 r_E + 11ea7e5a_6eea_0be9_9a0a_039b5cb2ab00_TB1623_11 r_D r_U = 11ea7e5a_6eea_0bea_9a0a_c1e4e6309669_TB1623_11 _.12 + 11ea7e5a_6eea_32fb_9a0a_13abcb0986e0_TB1623_11 .07_{= 10.0%} V^U = 11ea7e5a_6eea_32fc_9a0a_33d2bebc28be_TB1623_11 + 11ea7e5a_6eea_32fd_9a0a_c1957ba20adc_TB1623_11 + 11ea7e5a_6eea_32fe_9a0a_358f367bd799_TB1623_11 = $202.10 PV(interest tax shield) = 11ea7e5a_6eea_32ff_9a0a_f9eb3db9e099_TB1623_11 + 11ea7e5a_6eea_5a10_9a0a_e12ba22ed0d1_TB1623_11 + 11ea7e5a_6eea_5a11_9a0a_4dd46e283f80_TB1623_11 PV(interest tax shield) = 11ea7e5a_6eea_5a12_9a0a_7f40705264be_TB1623_11 + 11ea7e5a_6eea_5a13_9a0a_21690f1f2799_TB1623_11 + 11ea7e5a_6eea_5a14_9a0a_1d9ff46a061e_TB1623_11 = $5.2596 V^L = V^U + PV(interest tax shield) = $202.10 + $5.26 = $207.36

Question 11

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

Accepted Answer

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

Question 12

Consider the following equation for the project WACC with a fixed debt schedule: r_wacc = r_U - dτ_c[rD + f(r_U - r_D)] The term d in this equation represents A) a measure of the permanence of the debt level. B) the annual adjustment percentage to the amount of debt. C) the debt-to-value ratio. D) the dollar amount of debt outstanding.

Accepted Answer

The term $d$ in the equation represents the debt-to-value ratio, which is a measure of how much debt is being used to finance the assets relative to the total value of the assets.

Question 13

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 = 11ea7e5a_6ee8_5e27_9a0a_85fa0eed2b39_TB1623_11 r_E + 11ea7e5a_6ee8_8538_9a0a_019c439356e1_TB1623_11 r_D r_U = 11ea7e5a_6ee8_8539_9a0a_977764fe3870_TB1623_11 _.12 + 11ea7e5a_6ee8_853a_9a0a_934dc3c1e5b5_TB1623_11 .07_{= 10.0%}

Question 14

Suppose that to fund this new project,Aardvark borrows $120 million 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) = 11ea7e5a_6ee9_6fa2_9a0a_a3b762411d75_TB1623_11 + 11ea7e5a_6ee9_6fa3_9a0a_e336053d4866_TB1623_11 + 11ea7e5a_6ee9_6fa4_9a0a_6bef57bc91ea_TB1623_11 PV(interest tax shield) = 11ea7e5a_6ee9_96b5_9a0a_af0c4579e304_TB1623_11 + 11ea7e5a_6ee9_96b6_9a0a_b1b0701276a4_TB1623_11 + 11ea7e5a_6ee9_96b7_9a0a_27685df42acc_TB1623_11 = $5.2596

Quiz 21: Capital Budgeting and Valuation With Leverage

Consider the following equation for the project WACC with a fixed debt schedule: r_wacc = r_U - dτ_c[rD + f(r_U - r_D) ] The term f in this equation represents

The reason that the Air Transportation Safety and System Stabilization Act,which established the Air Transportation Stabilization Board (ATSB) in the United States of America,gives the U.S.carriers an advantage over Canadian carriers is because

Which of the following statements is false?

The WACC approach does not require knowledge of tax rates.This fact is important because in practice,estimating the marginal tax rate of the can be very difficult.

Suppose that to fund this new project,Aardvark borrows $150 million 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.

When the firm keeps its interest payments to a target fraction of its FCF,we say it has a(n) ________ interest coverage ratio.

Which of the following statements is false?

Suppose that to fund this new project,Aardvark borrows $120 million 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:

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

Consider the following equation for the project WACC with a fixed debt schedule: r_wacc = r_U - dτ_c[rD + f(r_U - r_D) ] The term d in this equation represents

Suppose that to fund this new project,Aardvark borrows $120 million 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:

Quiz 21: Capital Budgeting and Valuation With Leverage

Consider the following equation for the project WACC with a fixed debt schedule: rwacc = rU - dτc[rD + f(rU - rD) ] The term f in this equation represents

The reason that the Air Transportation Safety and System Stabilization Act,which established the Air Transportation Stabilization Board (ATSB) in the United States of America,gives the U.S.carriers an advantage over Canadian carriers is because

Which of the following statements is false?

The WACC approach does not require knowledge of ________ tax rates.This fact is important because in practice,estimating the marginal tax rate of the ________ can be very difficult.

Suppose that to fund this new project,Aardvark borrows $150 million 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.

When the firm keeps its interest payments to a target fraction of its FCF,we say it has a(n) ________ interest coverage ratio.

Which of the following statements is false?

Suppose that to fund this new project,Aardvark borrows $120 million 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:

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

Consider the following equation for the project WACC with a fixed debt schedule: rwacc = rU - dτc[rD + f(rU - rD) ] The term d in this equation represents

Suppose that to fund this new project,Aardvark borrows $120 million 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:

Consider the following equation for the project WACC with a fixed debt schedule: r_wacc = r_U - dτ_c[rD + f(r_U - r_D) ] The term f in this equation represents

The WACC approach does not require knowledge of tax rates.This fact is important because in practice,estimating the marginal tax rate of the can be very difficult.

Consider the following equation for the project WACC with a fixed debt schedule: r_wacc = r_U - dτ_c[rD + f(r_U - r_D) ] The term d in this equation represents