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Exam 18: Capital Budgeting and Valuation With Leverage

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Question 51

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Which of the following statements is false?

A) Because the WACC incorporates the tax savings from debt, we can compute the levered value of an investment, which is its value including the benefit of interest tax shields given the firm's leverage policy, by discounting its future free cash flow using the WACC.
B) The WACC incorporates the benefit of the interest tax shield by using the firm's before-tax cost of capital for debt.
C) When the market risk of the project is similar to the average market risk of the firm's investments, then its cost of capital is equivalent to the cost of capital for a portfolio of all of the firm's securities; that is, the project's cost of capital is equal to the firm's weighted average cost of capital (WACC) .
D) A project's cost of capital depends on its risk.

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Question 52

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Use the information for the question(s) below. Iota Industries' Market Value Balance Sheet ($ millions) and Cost of Capital Iota Industries' New Project Free Cash Flows Assume that this new project is of average risk for Iota and that the firm wants to hold constant its debt-to-equity ratio. -The NPV for Iota's new project is closest to:

A) $25.25
B) $13.25
C) $9.00
D) $18.50

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Question 53

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Use the information for the question(s) below. Omicron Industries' Market Value Balance Sheet ($ millions) and Cost of Capital Omicron Industries' New Project Free Cash Flows Assume that this new project is of average risk for Omicron and that the firm wants to hold constant its debt-to-equity ratio. -The interest tax shield provided by Omicron's new project in year 1 is closest to:

The APV method is the approach that determines the ________ level of debt according to the tradeoff theory.

Which of the following statements is false?

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 is expected to grow at a rate of 3% every year thereafter. Rose currently maintains a debt-to-equity ratio of 1, its marginal tax rate is 40%, its cost of debt r_D is 6%, and its cost of equity r_E is 10%. Rose Industries will maintain a constant debt-equity ratio for the acquisition. -Given that Rose issues new debt of $50 million initially to fund the acquisition,the present value of the interest tax shield for this acquisition is closest to:

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

The three main methods of capital budgeting are

The APV method is more complicated than the WACC method because we must compute two separate valuations: ________.

The WACC incorporates the benefit of the ________ by using the firm's ________ cost of capital for debt.

Which of the following statements is false?

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

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 is expected to grow at a rate of 3% every year thereafter. Rose currently maintains a debt-to-equity ratio of 1, its marginal tax rate is 40%, its cost of debt r_D is 6%, and its cost of equity r_E is 10%. Rose Industries will maintain a constant debt-equity ratio for the acquisition. -Rose's unlevered cost of capital is closest to:

Use the table for the question(s) below. Consider the information for the following four firms: -The weighted average cost of capital for "Moe" is closest to: