Question 1

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 in option A is false. When we relax the assumption of a constant debt-equity ratio, the FTE method becomes more complex and difficult to use, making it less preferred in such cases.

Question 2

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 3

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 4

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

The answer of Assuming that to fund the investment Taggart...

Question 5

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

Since the $120 is paid in three equal installments at the end of each year, the annual payment is $40. To calculate the levered value of the project, we need to discount each payment back to the present value using the appropriate discount rate. Assuming a discount rate of 8%, the levered value of the new project would be:

PV of first payment = $40/(1+0.08)^1 = $37.04
PV of second payment = $40/(1+0.08)^2 = $34.31
PV of third payment = $40/(1+0.08)^3 = $31.80

Therefore, the levered value of the new project is:

$37.04 + $34.31 + $31.80 = $103.15

Adding back the borrowed principal of $120, the total value of the project is $223.15, which is closest to answer choice B: $207.35.

Question 6

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%

Question 7

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

To compute the unlevered cost of capital, we need to use the CAPM equation, which is:
Unlevered Cost of Capital = Risk-Free Rate + Beta * (Market Risk Premium)
Assuming a risk-free rate of 3%, a market risk premium of 6%, and a beta of 1.2, we get:
Unlevered Cost of Capital = 3% + 1.2 * 6% = 9.2%
This is closest to answer choice B, 9.9%.

Question 8

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 9

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 10

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 11

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

To calculate the present value of the interest tax shield, we need to first calculate the annual interest payment.

Since Aardvark borrowed $120 and will pay it back in three equal installments at the end of each year, the annual repayment amount will be $120/3 = $40.

The interest tax shield is the amount of interest expense multiplied by the tax rate. Let's assume the interest rate on the loan is 8% and Aardvark's tax rate is 35%.

The interest expense in the first year will be $120 * 8% = $9.60. The tax shield will be $9.60 * 35% = $3.36.

The interest expense in the second year will be $80 * 8% = $6.40. The tax shield will be $6.40 * 35% = $2.24.

The interest expense in the third year will be $40 * 8% = $3.20. The tax shield will be $3.20 * 35% = $1.12.

To calculate the present value of these tax shields, we need to discount them to their present value using the appropriate discount rate. Let's assume the discount rate is also 8%.

The present value of the first year's tax shield is $3.36 / (1.08^1) = $3.11.

The present value of the second year's tax shield is $2.24 / (1.08^2) = $1.86.

The present value of the third year's tax shield is $1.12 / (1.08^3) = $0.91.

The total present value of the tax shields is $3.11 + $1.86 + $0.91 = $5.88, which is closest to choice (D) $5.25.

Question 12

Aardvark's unlevered cost of equity is closest to:
A)10.0%
B)10.4%
C)9.5%
D)9.0%

Accepted Answer

The answer of Aardvark's unlevered cost of equity is closest...

Question 13

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

Accepted Answer

The answer of The unlevered value of Aardvark's new project...

Question 14

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 can still be implemented. In fact, these methods allow for more flexibility in adjusting for changes in the debt-equity ratio compared to the traditional WACC method.

Question 15

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 Based upon the three comparable firms,calculate that...

Question 16

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 17

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 18

If KT expects to maintain a debt to equity ratio for this project of .6 then KT's project based WACC,rS1U1B1waccS1U1B0,for this project is closest to:
A)10.5%
B)11.1%
C)9.6%
D)10.8%

Accepted Answer

rS1U1B1 = rU1 + (rU1 - rB1)*(D/E)
Assuming rU1 = 8% and rB1 = 6%, and D/E = 0.6, then:
rS1U1B1 = 8% + (8% - 6%)*(0.6) = 9.6%
Using the formula for WACC, we have:
WACC = rS1U1B1*(E/(D+E)) + rB1*(D/(D+E))
Assuming a tax rate of 30%, and that E = 40% and D = 60% of the total value of the project, then:
WACC = 9.6%*(0.4) + 6%*(0.6)*(1-0.3) = 11.1%

Question 19

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 20

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

The answer of Which of the following statements is FALSE?
A)As...

Quiz 18: Capital Budgeting and Valuation With Leverage

Which of the following statements is FALSE?

The NPV of this project using the APV 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,r_wacc,for this project is closest to:

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:

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:

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:

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

The NPV of this project using the WACC method 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.

The unlevered cost of capital for Armadillo Industries 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 present value of Aardvark's interest tax shield is closest to:

Aardvark's unlevered cost of equity is closest to:

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

Which of the following statements is FALSE?

Based upon the three comparable firms,calculate that most appropriate unlevered cost of capital for Aardvark to use on this new product.

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

Which of the following statements is FALSE?

Quiz 18: Capital Budgeting and Valuation With Leverage

Which of the following statements is FALSE?

The NPV of this project using the APV 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:

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:

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:

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:

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

The NPV of this project using the WACC method 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.

The unlevered cost of capital for Armadillo Industries 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 present value of Aardvark's interest tax shield is closest to:

Aardvark's unlevered cost of equity is closest to:

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

Which of the following statements is FALSE?

Based upon the three comparable firms,calculate that most appropriate unlevered cost of capital for Aardvark to use on this new product.

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 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,rwacc,for this project is closest to:

If KT expects to maintain a debt to equity ratio for this project of 1,then KT's equity cost of capital,rE,for this project is closest to:

Which of the following statements is FALSE?

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 equity cost of capital,r_E,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 1,then KT's equity cost of capital,r_E,for this project is closest to: