The flow-to-equity (FTE) approach in capital budgeting is defined to be

the:
A. discounting all cash flows from a project at the overall cost of
capital.
B. scale enhancing discount process.
C. discounting of the levered cash flows to the equity holders for a
project at the required return on equity.
D. dividends and capital gains that may flow to a shareholders of any
firm.
E. discounting of the unlevered cash flows of a project from a levered
firm at the WACC.
Discounting the unlevered after tax cash flows by the _____ minus the
______ yields the ________.
A. cost of capital for the unlevered firm; initial investment; adjusted
present value.
B. cost of equity capital; initial investment; project NPV.
C. weighted cost of capital; fractional equity investment; project NPV.
D. cost of capital for the unlevered firm; initial investment; all-equity
net present value.
E. None of the above.
The APV method is comprised of the all equity NPV of a project and the
NPV of financing effects. The four 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.
E. None of the above.
Although the three capital budgeting methods are equivalent, they all
can have difficulties making computation impossible at times. The
most useful methods or tools from a practical standpoint are:
A. APV because debt levels are unknown in future years.
B. WACC because projects have constant risk and target debt to value
ratios.
C. Flow-to-equity because of constant risk and that managers think in
terms of optimal debt to equity ratios.
D. Both A and B.
E. Both B and C.
The flow-to-equity approach to capital budgeting is a three step
process of:
A. calculating the levered cash flow, the cost of equity capital for a
levered firm, then adding the interest expense when the cash flows are
discounted.
B. calculating the unlevered cash flow, the cost of equity capital for a
levered firm, and then discounting the unlevered cash flows.
C. calculating the levered cash flow after interest expense and taxes,
the cost of equity capital for a levered firm, and then discounting the
levered cash flows by the cost of equity capital.
D. calculating the levered cash flow after interest expense and taxes,
the cost of equity capital for a levered firm, and then discounting the
levered cash flows at the risk free rate.
E. None of the above.
Flotation costs are incorporated into the APV framework by:
A. adding them into the all equity value of the project.
B. subtracting them from the all equity value of the project.
C. incorporating them into the WACC.
D. disregarding them.
E. None of the above.
Which of the following are guidelines for the three methods of capital
budgeting with leverage?
A. Use APV if project's level of debt is known over the life of the project.
B. Use APV if project's level of debt is unknown over the life of the
project.
C. Use FTE or WACC if the firm's target debt-to-value ratio applies to
the project over its life.
D. Both A and C.
E. Both B and C.
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 capital structure is changing.
C. there is no tax shield with the WACC.
D. the value of the levered and unlevered firms are equal.
E. the unlevered and levered cash flows are separated which cannot be
used with the WACC approach.
The value of a corporation in a levered buyout is composed of which
following four parts:
A. unlevered cash flows and interest tax shields during the debt
paydown period, unlevered terminal value, and asset sales.
B. unlevered cash flows and interest tax shields during the debt
paydown period, unlevered terminal value and interest tax shields after
the paydown period.
C. levered cash flows and interest tax shields during the debt paydown
period, levered terminal value and interest tax shields after the
paydown period.
D. levered cash flows and interest tax shields during the debt paydown
period, unlevered terminal value and interest tax shields after the
paydown period.
E. asset sales, unlevered cash flows during the paydown period,
interest tax shields and unlevered terminal value.
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?
A. $170,994
B. $267,628
C. $372,372
D. $543,366
E. $640,000
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%?
A. 7.98%
B. 10.875%
C. 11.000%
D. 12.125%
E. It is impossible to determine WACC without debt and equity betas.
The Felix Filter Corp. 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?
A. 8.38%
B. 11.02%
C. 12.89%
D. 13.00%
E. 14.12%
The Webster Corp. 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%?
A. $428,571
B. $444,459
C. $565,547
D. $1,000,000
E. None of the above is the correct NPV.
The Webster Corp. 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%?
A. $428,571
B. $444,459
C. $565,547
D. $1,000,000
E. None of the above is the correct NPV.
The Tip-Top Paving Co. 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?
A. 0.08%
B. 3.06%
C. 14.0%
D. 16.97%
E. None of the above.
The Tip-Top Paving Co. 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?
A. 0.08%
B. 3.06%
C. 14.0%
D. 16.97%
E. None of the above.
. 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?
A. $0.75 million
B. $1.29 million
C. $3.19 million
D. $3.75 million
E. $8.75 million
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:
A. 5%
B. 6%
C. 11%
D. 15%
E. It is impossible to tell without the expected market return.
The 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?
A. 0.59
B. 0.82
C. 1.06
D. 1.49
E. 1.54
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:
A. 0.53
B. 0.73
C. 0.80
D. 1.14
E. 1.47
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%.
. 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%?
. 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%?
Quick-Link has debt outstanding with a market value of $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 rate for a
scale enhancing project in the hypothetical case that Quick-Link is all
equity financed.
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.
The all equity cost of capital for flat Rock Grinding is 15% and the
company has set a target debt to value ratio of 50%. The current cost of
debt for a firm of this risk is 10% and the corporate tax rate is 34%.
Calculate the WACC for the Flat Rock Grinding Corporation.
Kelly Industries is given the opportunity to raise $5 million in debt
through a local government subsidized program. While Kelly would be
required to pay 12% on its debt issues, the Hampton County program
sets the rate at 9%. If the debt issue expires in 4 years, calculate the
NPV of this financing decision.