Question 1

Raymond Supply, a national hardware chain, is considering purchasing a smaller chain, Strauss & Glazer Parts (SGP) . Raymond's analysts project that the merger will result in the following incremental free cash flows, tax shields, and horizon values:   Year 1234 Free cash flow $1$3$3$7 Unlevered harizan value 75 Tax sheld 1123 Harizon value of tar shield 32\begin{array} { l c c c r } 	ext { Year } & 1 & 2 & 3 & 4 \ 	ext { Free cash flow } & \$ 1 & \$ 3 & \$3  & \$ 7  \	ext { Unlevered harizan value } & & & & 75 \	ext { Tax sheld } & 1 & 1 & 2 & 3 \	ext { Harizon value of tar shield } & & & &32\end{array} Year  Free cash flow  Unlevered harizan value  Tax sheld  Harizon value of tar shield ​1$11​2$31​3$32​4$775332​ 
Assume that all cash flows occur at the end of the year. SGP is currently financed with 30% debt at a rate of 10%. The acquisition would be made immediately, and if it is undertaken, SGP would retain its current $15 million of debt and issue enough new debt to continue at the 30% target level. The interest rate would remain the same. SGP's pre-merger beta is 2.0, and its post-merger tax rate would be 34%. The risk-free rate is 8% and the market risk premium is 4%. Using the compressed adjusted present value approach, what is the value of SGP to Raymond?

Accepted Answer

A)   $53.40 million
B)   $61.96 million
C)   $64.64 million
D)   $76.96 million
E)   $79.64 million F) A) and B)
G) C) and D) B

Question 2

NorthWest Water (NWW) 
Five years ago, NorthWest Water (NWW)  issued $50,000,000 face value of 30-year bonds carrying a 14% (annual payment)  coupon. NWW is now considering refunding these bonds. It has been amortizing $3 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NWW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called.
-Refer to the data for NorthWest Water (NWW) . What is the required after-tax refunding investment outlay, i.e., the cash outlay at the time of the refunding?

Accepted Answer

A)   $5,049,939
B)   $5,315,725
C)   $5,595,500
D)   $5,890,000
E)   $6,200,000F) A) and B)
G) C) and D)

Question 3

NorthWest Water (NWW) 
Five years ago, NorthWest Water (NWW)  issued $50,000,000 face value of 30-year bonds carrying a 14% (annual payment)  coupon. NWW is now considering refunding these bonds. It has been amortizing $3 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NWW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called.
-Refer to the data for NorthWest Water (NWW) . What is the NPV if NWW refunds its bonds today?

Accepted Answer

A)   $1,746,987
B)   $1,838,933
C)   $1,935,719
D)   $2,037,599
E)   $2,241,359F) B) and C)
G) D) and E)

Question 4

Theta Therapeutics has the following information and projections. Use the FCFE model to calculate the intrinsic value of Theta's equity.   EBIT (operating profit)  Operating assets Operating liabilities Total Debt Tax rate Interest rate on debt long-term growth rate Required return on equity Cunent  Year  Year 1  Year 2  Year 3 NA 1,0001,1001,2001,2001,3001,5001,6003003004005001,0009001,1001,200 NA 25%25%25% NA 6%6%6%4%9%\begin{array}{l}\begin{array} { l } \ \	ext { EBIT (operating profit) }\	ext { Operating assets}\	ext { Operating liabilities}\	ext { Total Debt}\	ext { Tax rate}\	ext { Interest rate on debt}\	ext { long-term growth rate}\	ext { Required return on equity}\\end{array}\begin{array} { l } 	ext { Cunent }\	ext { Year } && 	ext { Year 1 } & 	ext { Year 2 } & 	ext { Year } 3 \&	ext { NA } & 1,000 & 1,100 & 1,200 \&1,200 & 1,300 & 1,500 & 1,600 \&300 & 300 & 400 & 500 \&1,000 & 900 & 1,100 & 1,200 \&	ext { NA } & 25 \% & 25 \% & 25 \% \&	ext { NA } & 6 \% & 6 \% & 6 \%\4\%\9\%\end{array}\end{array} EBIT (operating profit)  Operating assets Operating liabilities Total Debt Tax rate Interest rate on debt long-term growth rate Required return on equity​ Cunent  Year 4%9%​ NA 1,2003001,000 NA  NA ​ Year 1 1,0001,30030090025%6%​ Year 2 1,1001,5004001,10025%6%​ Year 31,2001,6005001,20025%6%​​

Accepted Answer

A)   $14,156
B)   $15,572
C)   $17,129
D)   $18,842
E)   $20,726 F) C) and D)
G) All of the above

Question 5

MM showed that in a world with taxes, a firm's optimal capital structure would be almost 100% debt.

Accepted Answer

A) True 
 B)False

Question 6

Using the data for Sallie's Sandwiches and the compressed adjusted present value model, what is the appropriate rate for use in discounting the free cash flows and the interest tax savings?

Accepted Answer

A)   12.0%
B)   13.9%
C)   14.4%
D)   16.0%
E)   16.9%F) C) and E)
G) B) and E)

Question 7

Stanovich Enterprises has 10-year, 12.0% semiannual coupon bonds outstanding. Each bond is now eligible to be called at a call price of $1,060. If the bonds are called, the company must replace them with new 10-year bonds. The flotation cost of issuing new bonds is estimated to be $45 per bond. How low would the yield to maturity on the new bonds have to be in order for it to be profitable to call the bonds today, i.e., what is the nominal annual "breakeven rate"?

Accepted Answer

A)   9.29%
B)   9.78%
C)   10.29%
D)   10.81%
E)   11.35%F) A) and B)
G) A) and C)

Question 8

Palmer Company has $5,000,000 of 15-year maturity bonds outstanding. Each bond has a maturity value of $1,000, an annual coupon of 12.0%. The bonds can be called at any time with a premium of $50 per bond. If the bonds are called, the company must pay flotation costs of $10 per new refunding bond. Ignore tax considerationsσassume that the firm's tax rate is zero.σσThe company's decision of whether to call the bonds depends critically on the current interest rate on newly issued bonds. What is the breakeven interest rate, the rate below which it would be profitable to call in the bonds?

Accepted Answer

A)   9.57%
B)   10.07%
C)   10.60%
D)   11.16%
E)   11.72%F) C) and D)
G) B) and E)

Question 9

Epsilon Consultants has the following projected free cash flows to equity and other information. It has no non-operating assets. Calculate Epsilon's intrinsic value of equity using the FCFE model.   Year 1  Year 2  Year 3 FCFE 1,0001,2001,260 Long-term FCFE growth 5% Required return on equity 9%\begin{array} { l c c c } & 	ext { Year 1 } & 	ext { Year 2 } & 	ext { Year } 3 \ 	ext { FCFE } & 1,000 & 1,200 & 1,260\	ext { Long-term FCFE growth }&5\%\	ext { Required return on equity }&9\% \end{array} FCFE  Long-term FCFE growth  Required return on equity ​ Year 1 1,0005%9%​ Year 2 1,200 Year 31,260

Accepted Answer

A)   $28,440
B)   $31,284
C)   $34,413
D)   $37,854
E)   $41,640 F) D) and E)
G) B) and C) A

Question 10

The rate used to discount projected merger cash flows should be the cost of capital of the new consolidated firm because it incorporates the actual capital structure of the new firm.

Accepted Answer

A) True 
 B)False

Question 11

Using the data for Sallie's Sandwiches and the compressed adjusted present value model, what is the total value (in millions) ?

Accepted Answer

A)   $72.37
B)   $73.99
C)   $74.49
D)   $75.81
E)   $76.45F) A) and B)
G) D) and E)

Question 12

In a world with no taxes, MM show that a firm's capital structure does not affect the firm's value. However, when taxes are considered, MM show a positive relationship between debt and value, i.e., its value rises as its debt is increased.

Accepted Answer

A) True 
 B)False

Question 13

When a firm refunds a debt issue, the firm's stockholders gain and its bondholders lose. This points out the risk of a call provision to bondholders and explains why a non-callable bond will typically command a higher price than an otherwise similar callable bond.

Accepted Answer

A) True 
 B)False

Question 14

Which of the following statements concerning the compressed adjusted present value (APV)  model is NOT CORRECT?

Accepted Answer

A)   the value of a growing tax shield is greater than the value of a constant tax shield.
B)   for a given d/s, the levered cost of equity using the compressed apv model is greater than the levered cost of equity under mm's original (with tax)  assumptions.
C)   for a given d/s, the wacc in the compressed apv model is less than the wacc under mm's original (with tax)  assumptions.
D)   the total value of the firm increases with the amount of debt.
E)   the tax shields should be discounted at the unlevered cost of equity.F) A) and E)
G) B) and E)

Question 15

Refer to data for Kitto Electronics. Using the compressed adjusted present value model, what is the value of Kitto's tax shield?

Accepted Answer

A)   $156,385
B)   $164,616
C)   $173,280
D)   $182,400
E)   $192,000F) B) and E)
G) C) and E)

Question 16

The appropriate discount rate to use when analyzing a refunding decision is the after-tax cost of new debt, in part because there is relatively little risk of not realizing the interest savings.

Accepted Answer

A) True 
 B)False

Question 17

Which of the following statements concerning the compressed adjusted present value (APV)  model is NOT CORRECT?

Accepted Answer

A)   the value of a growing tax shield is greater than the value of a constant tax shield.
B)   for a given d/s, the levered cost of equity is greater in the compressed apv model than the levered cost of equity under mm's original (with tax)  assumptions.
C)   for a given d/s, the wacc is greater in the compressed apv model than the wacc under mm's original (with tax)  assumptions.
D)   the total value of the firm increases with the amount of debt.
E)   the tax shields should be discounted at the cost of debt.F) C) and D)
G) A) and E)

Question 18

In the compressed adjusted present value model, the appropriate discount rate for the tax shield is the unlevered cost of equity.

Accepted Answer

A) True 
 B)False  True

Question 19

Which of the following statements about valuing a firm using the compressed adjusted present value (CAPV)  approach is most CORRECT?

Accepted Answer

A)   the value of equity is calculated by discounting the horizon value, the tax shields, and the free cash flows at the cost of equity.
B)   the value of operations is calculated by discounting the horizon value, the tax shields, and the free cash flows before the horizon date at the unlevered cost of equity.
C)   the value of equity is calculated by discounting the horizon value and the free cash flows at the cost of equity.
D)   the capv approach stands for the accounting pre-valuation approach.
E)   the value of operations is calculated by discounting the horizon value, the tax shields, and the free cash flows at the cost of equity.F) C) and D)
G) B) and E)

Question 20

Refer to data for Glassmaker Corporation. What is Glassmaker's WACC, based on its current capital structure?

Accepted Answer

A)   9.02%
B)   9.50%
C)   9.83%
D)   10.01%
E)   11.29%F) A) and B)
G) A) and D)

Exam 17: Dynamic Capital Structures and Corporate Valuation

Correct Answer
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B

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MM showed that in a world with taxes, a firm's optimal capital structure would be almost 100% debt.

Correct Answer
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Using the data for Sallie's Sandwiches and the compressed adjusted present value model, what is the appropriate rate for use in discounting the free cash flows and the interest tax savings?

Correct Answer
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A

The rate used to discount projected merger cash flows should be the cost of capital of the new consolidated firm because it incorporates the actual capital structure of the new firm.

Correct Answer
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Using the data for Sallie's Sandwiches and the compressed adjusted present value model, what is the total value (in millions) ?

Correct Answer
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In a world with no taxes, MM show that a firm's capital structure does not affect the firm's value. However, when taxes are considered, MM show a positive relationship between debt and value, i.e., its value rises as its debt is increased.

Correct Answer
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When a firm refunds a debt issue, the firm's stockholders gain and its bondholders lose. This points out the risk of a call provision to bondholders and explains why a non-callable bond will typically command a higher price than an otherwise similar callable bond.

Correct Answer
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Which of the following statements concerning the compressed adjusted present value (APV) model is NOT CORRECT?

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Refer to data for Kitto Electronics. Using the compressed adjusted present value model, what is the value of Kitto's tax shield?

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The appropriate discount rate to use when analyzing a refunding decision is the after-tax cost of new debt, in part because there is relatively little risk of not realizing the interest savings.

Correct Answer
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Which of the following statements concerning the compressed adjusted present value (APV) model is NOT CORRECT?

Correct Answer
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In the compressed adjusted present value model, the appropriate discount rate for the tax shield is the unlevered cost of equity.

Correct Answer
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True

Which of the following statements about valuing a firm using the compressed adjusted present value (CAPV) approach is most CORRECT?

Correct Answer
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Refer to data for Glassmaker Corporation. What is Glassmaker's WACC, based on its current capital structure?

Correct Answer
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Exam 17: Dynamic Capital Structures and Corporate Valuation

Correct AnswerverifiedB

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

MM showed that in a world with taxes, a firm's optimal capital structure would be almost 100% debt.

Correct AnswerverifiedShow Answer

Using the data for Sallie's Sandwiches and the compressed adjusted present value model, what is the appropriate rate for use in discounting the free cash flows and the interest tax savings?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedA

The rate used to discount projected merger cash flows should be the cost of capital of the new consolidated firm because it incorporates the actual capital structure of the new firm.

Correct AnswerverifiedShow Answer

Using the data for Sallie's Sandwiches and the compressed adjusted present value model, what is the total value (in millions) ?

Correct AnswerverifiedShow Answer

In a world with no taxes, MM show that a firm's capital structure does not affect the firm's value. However, when taxes are considered, MM show a positive relationship between debt and value, i.e., its value rises as its debt is increased.

Correct AnswerverifiedShow Answer

When a firm refunds a debt issue, the firm's stockholders gain and its bondholders lose. This points out the risk of a call provision to bondholders and explains why a non-callable bond will typically command a higher price than an otherwise similar callable bond.

Correct AnswerverifiedShow Answer

Which of the following statements concerning the compressed adjusted present value (APV) model is NOT CORRECT?

Correct AnswerverifiedShow Answer

Refer to data for Kitto Electronics. Using the compressed adjusted present value model, what is the value of Kitto's tax shield?

Correct AnswerverifiedShow Answer

The appropriate discount rate to use when analyzing a refunding decision is the after-tax cost of new debt, in part because there is relatively little risk of not realizing the interest savings.

Correct AnswerverifiedShow Answer

Which of the following statements concerning the compressed adjusted present value (APV) model is NOT CORRECT?

Correct AnswerverifiedShow Answer

In the compressed adjusted present value model, the appropriate discount rate for the tax shield is the unlevered cost of equity.

Correct AnswerverifiedTrue

Which of the following statements about valuing a firm using the compressed adjusted present value (CAPV) approach is most CORRECT?

Correct AnswerverifiedShow Answer

Refer to data for Glassmaker Corporation. What is Glassmaker's WACC, based on its current capital structure?

Correct AnswerverifiedShow Answer

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B

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A

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True

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