63)
Consider the following equation:
rwacc =E
E + D rE+D
E + D rD(1 –c)
the term rD(1 –c) in this equation is?
63)
A)
the required rate of return on debt
B)
the required rate of return on equity
C)
the dollar amount of equity.
D)
the after tax required rate of return on debt
Use the information for the question(s) below.
Suppose Luther Industries is considering divesting one of its product lines. The product line is expected to generate free cash
flows of $2 million per year, growing at a rate of 3% per year. Luther has an equity cost of capital of 10%, a debt cost of
capital of 7%, a marginal tax rate of 35%, and a debt–equity ratio of 2. This product line is of average risk and Luther plans
to maintain a constant debt–equity ratio.
64)
The unlevered value of Luther’s Product Line is closest to:
64)
A)
$45 million
B)
$60 million
C)
$25 million
D)
$40 million
65)
Consider the following equation:
Dt= d ×VL
t
the term d in this equation is?
65)
A)
the firms target debt to value ratio.
B)
the firms target debt to equity ratio.
C)
the dollar amount of debt outstanding at time t.
D)
the investment’s debt capacity.
66)
Which of the following statements is false?
66)
A)
Projects may vary in the amount of leverage they will support–for example, acquisitions of
real estate or capital equipment are often highly levered, whereas investments in intellectual
property are not.
B)
In the real world, specific projects should differ only slightly from the average investment
made by the firm.
C)
We can estimate rUfor a new project by looking at single–division firms that have similar
business risks.
D)
The project’s equity cost of capital depends on its unlevered cost of capital, rU, and the
debt–equity ratio of the incremental financing that will be put in place to support the project.
ESSAY. Write your answer in the space provided or on a separate sheet of paper.
Use the information for the question(s) below.
Suppose that Rose Industries is considering the acquisition of another firm in its industry for $100 million. The acquisition is
expected to increase Rose’s free cash flow by $5 million the first year, and this contribution us expected to grow at a rate of 3%
every year there after. Rose currently maintains a debt to equity ratio of 1, its marginal tax rate is 40%, its cost of debt rD is
6%, and its cost of equity rE is 10%. Rose Industries will maintain a constant debt–equity ratio for the acquisition.
67)
Given that Rose issues new debt of $50 million initially to fund the acquisition, the total value of this acquisition
using the APV method is equal to?
Use the information for the question(s) below.
Omicron Industries’ Market Value Balance Sheet ($ Millions)
and Cost of Capital
Assets Liabilities Cost of Capital
Cash 0Debt 200 Debt 6%
Other Assets 500 Equity 300 Equity 12%
c35%
Omicron Industries New Project Free Cash Flows
Year 0 1 2 3
Free Cash Flows ($100) $40 $50 $60
Assume that this new project is of average risk for Omicron and that the firm wants to hold constant its debt to equity ratio.
68)
Calculate the present value of the interest tax shield provided by Omicron’s new project.
Use the information for the question(s) below.
Aardvark Industries is considering a project that will generate the following free cash flows:
Year 0 1 2 3
Free Cash Flows ($200) $100 $80 $60
You are also provided with the following market value balance sheet and information regarding Aardvark’s cost of capital:
Assets Liabilities Cost of Capital
Cash 0Debt 400 Debt 7%
Other Assets 1000 Equity 600 Equity 12%
c35%
69)
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.
70)
Suppose Luther Industries is considering divesting one of its product lines. The product line is expected to
generate free cash flows of $2 million per year, growing at a rate of 3% per year. Luther has an equity cost of
capital of 10%, a debt cost of capital of 7%, a marginal tax rate of 35%, and a debt–equity ratio of 2. If this
product line is of average risk and Luther plans to maintain a constant debt–equity ratio, what after– tax
amount must it receive for the product line in order for the divestiture to be profitable?
35
Use the information for the question(s) below.
Aardvark Industries is considering a project that will generate the following free cash flows:
Year 0 1 2 3
Free Cash Flows ($200) $100 $80 $60
You are also provided with the following market value balance sheet and information regarding Aardvark’s cost of capital:
Assets Liabilities Cost of Capital
Cash 0Debt 400 Debt 7%
Other Assets 1000 Equity 600 Equity 12%
c35%
71)
Suppose that to fund this new project, Aardvark borrows $150 with the principal to be paid in three equal
installments at the end each year. Calculate the The levered value of Aardvark’s new project.
72)
Describe the key steps in the flow to equity method for valuing a levered investment.
Use the information for the question(s) below.
Omicron Industries’ Market Value Balance Sheet ($ Millions)
and Cost of Capital
Assets Liabilities Cost of Capital
Cash 0Debt 200 Debt 6%
Other Assets 500 Equity 300 Equity 12%
c35%
Omicron Industries New Project Free Cash Flows
Year 0 1 2 3
Free Cash Flows ($100) $40 $50 $60
Assume that this new project is of average risk for Omicron and that the firm wants to hold constant its debt to equity ratio.
73)
Calculate the debt capacity of Omicron’s new project for years 0, 1, and 2.
37
Use the information for the question(s) below.
The Aardvark Corporation is considering launching a new product and is trying to determine an appropriate discount rate
for evaluating this new product. Aardvark has identified the following information for three single division firms that offer
products similar to the one Aardvark is interested in launching:
Comparable Firm
Equity Cost
of Capital
Debt Cost
of Capital
Debt–to–Value
Ratio
Anteater Enterprises 12.50% 6.50% 50%
Armadillo Industries 13% 6.10% 40%
Antelope Inc. 14% 7.10% 60%
74)
Based upon the three comparable firms, calculate that most appropriate unlevered cost of capital for Aardvark
to use on this new product.
Use the information for the question(s) below.
Iota Industries Market Value Balance Sheet ($ Millions) and Cost of Capital
Assets Liabilities Cost of Capital
Cash 250 Debt 650 Debt 7%
Other Assets 1200 Equity 800 Equity 14%
c35%
Iota Industries New Project Free Cash Flows
Year 0 1 2 3
Free Cash Flows ($250) $75 $150 $100
Assume that this new project is of average risk for Iota and that the firm wants to hold constant its debt to equity ratio.
75)
Calculate the NPV for Iota’s new project.
38
Answer Key
Testname: C18
Answer Key
Testname: C18
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Answer Key
Testname: C18
Answer Key
Testname: C18