Cf2.C3.sum

The flow-to-equity (FTE) approach in capital budgeting is defined as the:

A. scale enhancing discount process.

B. discounting of a project’s levered cash flows to the equityholders at the required return on equity.

C. dividends and capital gains that may flow to shareholders of a firm.

D. discounting of a project’s unlevered cash flows to the equityholders at the WACC.

• A

• B

• C

• D

If you discount a project’s unlevered aftertax cash flows by the _____ and then subtract the initial investment you will calculate the:

A. cost of capital for the unlevered firm; adjusted present value.

B. cost of equity capital; project NPV.

C. weighted cost of capital; project NPV.

D. cost of capital for the unlevered firm; all-equity net present value.

• A

• B

• C

• D

A capital budgeting project is usually evaluated on its own merits. That is, capital budgeting decisions are treated separately from capital structure decisions. In reality, these decisions may be highly interwoven. This interweaving is most apt to result in:

A. firms rejecting positive NPV, all-equity projects because changing to a capital structure with debt will always create negative net present values.

B. firms foregoing project analysis and just making decisions at random.

C. corporate financial managers first checking with their investment bankers to determine the best type of capital to raise before valuing a project.

D. firms accepting some negative NPV all-equity projects because changing the capital structure adds enough positive leverage tax shield value to create a positive NPV.

• A

• B

• C

• D

The APV method is comprised of the all-equity NPV of a project plus the NPV of financing effects. The four financing side effects are:

A. tax subsidy of dividends, cost of issuing new securities, subsidy of financial distress, and cost of debt financing.

B. cost of issuing new securities, cost of financial distress, tax subsidy of debt, and other subsidies to debt financing.

C. cost of issuing new securities, cost of financial distress, tax subsidy of dividends, and cost of debt financing.

D. subsidy of financial distress, tax subsidy of debt, cost of other debt financing, and cost of issuing new securities.

• A

• B

• C

• D

In calculating NPV using the flow-to-equity approach the discount rate is the:

A. all-equity cost of capital.

B. cost of equity for the levered firm.

C. all-equity cost of capital minus the weighted average cost of debt.

D. weighted average cost of capital.

• A

• B

• C

• D

The adjusted present value method (APV), the flow to equity (FTE) method, and the weighted average cost of capital (WACC) method produce equivalent results, but each can have difficulties making computation impossible at times. Given this, which one of these is a correct statement?

A. The WACC method is preferred when evaluating a leveraged buyout.

B. Use the FTE method when the level of debt is known over a project’s life.

C. Use the WACC method when the level of debt is known over a project’s life.

D. The WACC method is appropriate when the target debt-to-value ratio applies over a project’s life.

• A

• B

• C

• D

(this is the difficult question)

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

A. there is greater risk with a LBO.

B. the future reductions in debt are known at the time of the LBO.

C. there is no interest tax shield with the WACC.

D. the value of the levered and unlevered firms are equal in an LBO.

• A

• B

• C

• D

Which of these methods discount levered cash flows?

A. APV

B. FTE

C. WACC

D. both APV and WACC

• A

• B

• C

• D

Filter Corp. maintains a debt-equity ratio of .45. The cost of equity is 14.7 percent, the pretax cost of debt is 8.1 percent, and the marginal tax rate is 34 percent. What is the weighted average cost of capital?

A. 8.38%

B. 11.02%

C. 11.80%

D. 13.00%

• A

• B

• C

• D

Webster Corp. is planning to build a new shipping depot. The initial cost of the investment is $1.18 million. Efficiencies from the new depot are expected to reduce annual costs by $105,000 forever. The corporation has a total value of $62.4 million and has outstanding debt of $38.7 million. What is the NPV of the project if the firm has an aftertax cost of debt of 5.8 percent and a cost equity of 12.6 percent?

A. $72,580.87

B. $46,509.07

C. $163,669.25

D. -$102,422.16

• A

• B

• C

• D