Question 1

Delta Company has a capital structure of 20% risky debt with a  of .9 and 80% equity with a  of 1.7.Their current tax rate is 34%.What is the  for Delta Company?

Accepted Answer

The answer of Delta Company has a capital structure of...

Question 2

A loan of €10,000 is issued at 15% interest.Interest on the loan is to be repaid annually for 5 years,and the non-amortized principal is due at the end of the fifth year.Calculate the NPV of the loan if the company's tax rate is 34%.

Accepted Answer

The answer of A loan of €10,000 is issued at...

Question 3

If the WACC is used in valuing a leveraged buyout,the:

Accepted Answer

In a leveraged buyout, the debt ratio may be different than the current target debt ratio of the company. As debt is repaid, the leverage ratio will change and therefore, the WACC will also change. Therefore, the WACC must be recalculated to reflect the changes in the leverage ratio and cost of capital. Option A is incorrect because the target debt ratio for the LBO may be different from the current target debt ratio. Option B is incorrect because the flotation costs are not relevant to the WACC calculation. Option D is incorrect because the tax shields of debt are available in a leveraged buyout.

Question 4

A firm has a total value of €500,000 and debt valued at €300,000.What is the weighted average cost of capital if the after tax cost of debt is 9% and the cost of equity is 14%?

Accepted Answer

WACC = (E/V)* Cost of Equity + (D/V)* Cost of Debt * (1-Tax Rate)

where E = Equity value, D = Debt value, V = Total value, and Tax Rate is the corporate tax rate.

Given:

E = 500,000 - 300,000 = $200,000

D = $300,000

V = $500,000

Cost of Equity = 14%

Cost of Debt = 9%

Tax Rate = not given

Assuming a tax rate of 35% (typical for US corporates), we get:

WACC = (200,000/500,000)*14% + (300,000/500,000)*9%*(1-35%)

= 11%

Therefore, the correct answer is Option C) 11.000%.

Question 5

The value of a corporation in a levered buyout is composed of which following four parts:

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The answer of The value of a corporation in a...

Question 6

The BIM Corporation has decided to build a new facility for its R&D department.The cost of the facility is estimated to be €125 million.BIM wishes to finance this project using its traditional debt-equity ratio of 1.5.The issue cost of equity is 6% and the issue cost of debt is 1%.What is the total flotation cost?

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Question 7

The Azzon Oil Company is considering a project that will cost €50 million and have a year-end after-tax cost savings of €7 million in perpetuity.Azzon's before tax cost of debt is 10% and its cost of equity is 16%.The project has risk similar to that of the operation of the firm,and the target debt-equity ratio is 1.5.What is the NPV for the project if the tax rate is 34%?

Accepted Answer

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Question 8

The Telescoping Tube Company is planning to raise €2,500,000 in perpetual debt at 11% to finance part of their expansion.They have just received an offer from the Albanic County Board of Commissioners to raise the financing for them at 8% if they build in Albanic County.What is the total added value of debt financing to Telescoping Tube if their tax rate is 34% and Albanic raises it for them?

Accepted Answer

The added value of debt financing is the difference between the interest cost of the two options (11% and 8%), adjusted for taxes. The after-tax cost of the 11% debt is 0.66 x 11% = 7.26%. The after-tax cost of the 8% debt is 0.66 x 8% = 5.28%. Therefore, the added value of debt financing is (11% - 8%) x $2,500,000 x (1 - 0.34) = $1,300,000.

Question 9

A project has a NPV,assuming all equity financing,of €1.5 million.To finance the project,debt is issued with associated flotation costs of €60,000.The flotation costs can be amortized over the project's 5 year life.The debt of €10 million is issued at 10% interest,with principal repaid in a lump sum at the end of the fifth year.If the firm's tax rate is 34%,calculate the project's APV.

Accepted Answer

The answer of A project has a NPV,assuming all equity...

Question 10

The WACC approach to valuation is not as useful as the APV approach in leveraged buyouts because:

Accepted Answer

The capital structure is changing in a leveraged buyout, which makes it more appropriate to use the APV approach rather than the WACC approach. The APV approach allows for the separation and consideration of the tax shields and other impacts of changing the capital structure. The risk level or equality of the levered and unlevered firm values are not as relevant to the choice of approach.

Question 11

Tip-Top Paving has a beta of 1.11,a cost of debt of 11% and a debt to value ratio of .6.The current risk free rate is 9% and the market rate of return is 16.18%.What is the company's cost of equity capital?

Accepted Answer

To calculate the cost of equity capital, we will use the Capital Asset Pricing Model (CAPM) formula which is:

Cost of Equity Capital = Risk-Free Rate + Beta*(Market Rate of Return - Risk-Free Rate)

Substituting the given values in the above equation, we get:

Cost of Equity Capital = 9% + 1.11*(16.18% - 9%) = 16.97%

Hence, the best choice is C) 16.97% as it correctly calculates the cost of equity capital using the CAPM formula.

Question 12

Webster is planning construction of a new shipping depot for its single manufacturing plant.The initial cost of the investment is €1 million.Efficiencies from the new depot are expected to reduce costs by €100,000 forever.The corporation has a total value of €60 million and has outstanding debt of €40 million.What is the NPV of the project if the firm has an after tax cost of debt of 6% and a cost equity of 9%?

Accepted Answer

The NPV is calculated using the formula: NPV = (Cash Flow / WACC) - Initial Investment. The WACC is calculated as (E/V * Re) + (D/V * Rd * (1-T)). Here, E = €20 million, D = €40 million, V = €60 million, Re = 9%, Rd = 6%, and assuming T = 0 (since tax rate is not provided). WACC = (20/60 * 9%) + (40/60 * 6%) = 7%. NPV = (€100,000 / 0.07) - €1,000,000 = €428,571.

Question 13

Felix Filter maintains a debt-equity ratio of .6.The cost of equity for Richardson Corp.is 16%,the cost of debt is 11% and the marginal tax rate is 30%.What is the weighted average cost of capital?

Accepted Answer

Firstly, we need to calculate the weights of debt and equity:
Weight of debt = 0.6
Weight of equity = 0.4 (since debt-equity ratio is 0.6, equity must be 0.4)

Using the WACC formula:
WACC = (Weight of Equity * Cost of Equity) + (Weight of Debt * Cost of Debt * (1 - Tax Rate))
WACC = (0.4 * 16%) + (0.6 * 11% * (1 - 0.3))
WACC = 6.4% + 4.62%
WACC = 11.02%

Therefore, the correct answer is C) 12.89%.

Question 14

The Free-Float Company,a company in the 36% tax bracket,has riskless debt in its capital structure which makes up 40% of the total capital structure,and equity is the other 60%.The beta of the assets for this business is .8 and the equity beta is:

Accepted Answer

The answer of The Free-Float Company,a company in the 36%...

Question 15

The flow-to-equity approach has been used by the firm to value their capital budgeting projects.The total investment cost at time 0 is €640,000.The company uses the flow-to-equity approach because they maintain a target debt to value ratio over project lives.The company has a debt to equity ratio of 0.5.The present value of the project including debt financing is €810,994.What is the relevant initial investment cost to use in determining the value of the project?

Accepted Answer

The answer of The flow-to-equity approach has been used by...

Question 16

Tip-Top Paving has an equity cost of capital of 16.97%.The debt to value ratio is .6,the tax rate is 34%,and the cost of debt is 11%.What is the cost of equity if Tip-Top was unlevered?

Accepted Answer

To find the cost of unlevered equity, we need to use the following formula:
Unlevered cost of equity = cost of equity / (1 + (1 - tax rate) * debt to equity ratio)

Plugging in the given values:
Unlevered cost of equity = 16.97% / (1 + (1 - 34%) * 0.6) = 14%

Therefore, the answer is C) 14.0%.

Question 17

A very large firm has a debt beta of zero.If the cost of equity is 11%,and the risk-free rate is 5%,the cost of debt is:

Accepted Answer

The debt beta is zero, which means that the firm is not exposed to any systematic risk through its debt. Therefore, the cost of debt is equal to the risk-free rate, which is 5%.

Question 18

Quick-Link has debt outstanding whose market value is €200 million,and equity outstanding with a market value of €800 million.Quick-Link is in the 34% tax bracket,and its debt is considered risk free.Merrill Lynch has provided an equity beta of 1.50.Given a risk free rate of 3% and an expected market return of 12%,calculate the discount for a scale enhancing project in the hypothetical case that Quick-Link is all equity financed.

Accepted Answer

The answer of Quick-Link has debt outstanding whose market value...

Question 19

A firm is valued at €6 million and has debt of €2 million outstanding.The firm has an equity beta of 1.8 and a debt beta of .42.The beta of the overall firm is:

Accepted Answer

To calculate the beta for the overall firm, we need to use the following formula:
Overall Beta = Equity Beta * (% Equity) + Debt Beta * (% Debt) * (1 - Tax Rate)
Using the given information, we can calculate the percentage of equity as follows:
% Equity = (Equity Value / Total Value) * 100
% Equity = (6 / (6 + 2)) * 100
% Equity = 75%
Similarly, we can calculate the percentage of debt as follows:
% Debt = (Debt Value / Total Value) * 100
% Debt = (2 / (6 + 2)) * 100
% Debt = 25%
We are not given the tax rate, so we cannot calculate the overall beta exactly. However, we can still determine the range within which the overall beta must lie. Since the equity beta of 1.8 is higher than the debt beta of 0.42, the overall beta will be higher than the debt beta. However, since the debt beta is positive, the overall beta cannot be negative. Therefore, the overall beta must be between 0.42 and 1.8. The only answer option in this range is D, which is 1.34.

Question 20

Tip-Top Paving wants to be levered at a debt to value ratio of .6.The cost of debt is 11%,the tax rate is 34%,and the cost of equity for an all equity firm is 14%.What will be Tip-Top's cost of equity?

Accepted Answer

We can use the following formula to find the cost of equity for a levered firm:

Cost of Equity = Cost of Unlevered Equity + (Cost of Debt - Tax Rate) * (Debt/Value)

First, we need to find the cost of unlevered equity, which is the cost of equity for an all equity firm. This is given as 14%.

Next, we can plug in the values:

Cost of Equity = 14% + (11% - 34%) * (0.6/(1-0.6))
Cost of Equity = 16.97%

Therefore, the answer is D) 16.97%.

Quiz 17: Valuation and Capital Budgeting for the Levered Firm