Analysis of APV Method - 20 Questions

Assuming two companies have the same FCFF, the same growth rate, and the same operational risk, but one company uses more debt than the other. According to the APV method, which of the following is likely to reduce the value of the company with higher debt?

• Increase the cost of equity

• Increased tax benefits

• Expected bankruptcy costs exceed tax benefits

• Reduce the corporate income tax rate

A company has a current FCFF of 100 million, a growth rate of 4%, and an unlevered cost of equity of 10%. Calculate the value of the unlevered company using the APV method.

• 1,000 million

• 1,733 million

• 2,000 million

• 2,500 million

A company has a current stock beta of 1.5, a D/E ratio of 0.6, and a tax rate of T = 25%. Calculate the unlevered beta of the company.

• 0.93

• 0.98

• 1.03

• 1.12

The company has a debt of 800 million and a corporate income tax rate of 20%. If the debt is perpetual, the tax benefit from the debt is:

• 80 million

• 100 million

• 160 million

• Not determined due to lack of cost of capital

When is the APV method more appropriate than the discounted cash flow method with WACC?

• When the capital structure is stable

• When debt is adjusted to the market

• When the company has negative cash flow

• When the capital structure changes significantly over time

Why does the APV method separate the tax benefits and bankruptcy costs, instead of combining them into the cost of capital like the WACC method?

• To simplify the valuation process

• Because this method can only be used when there is no financial leverage

• To clearly analyze each factor affecting the firm's value

• Because there is no need to calculate the cost of equity

If direct bankruptcy costs account for 8% of the firm's value and the probability of bankruptcy is 15%, the expected value of bankruptcy costs is:

• 1.2%

• 2%

• 8%

• 15%

Company X has FCFF₀ = 300 million, growth 5%, unlevered cost of equity = 12%, current debt 1,500 million, tax rate 25%, probability of bankruptcy 8%, bankruptcy cost = 40% of the value of the unlevered firm. Calculate the firm's value using the APV method.

• 4,500 million

• 4,731 million

• 5,000 million

• 4,356 million

One of the assumptions of the APV method is:

• WACC does not change with capital structure

• Tax benefits do not affect the firm's value

• Tax rate, bankruptcy costs, and operating cash flows can be separated for valuation

• FCFF does not change over time

The analysis below is not a benefit of using the APV method instead of WACC:

• Helps separately assess the impact of taxes and bankruptcy risk

• Suitable for capital structure changing over time

• Easy to apply when the company has negative FCFF

• Completely eliminates the need for estimating the cost of equity