Chap 19 Test

1.
Capital budgeting projects that incorporate both investment and financing decision side effects can be properly
analyzed by
A. adjusting the project's present value (APV).

B. adjusting the project's discount rate (WACC).
C. relying only on Modigliani-Miller Propositions I and II.
D. adjusting the project's present value (APV) and adjusting the project's discount rate (WACC).
Accessibility: Keyboard Navigation

Difficulty: Intermediate
2. To calculate the total value of the firm (V), one should rely on the
A. market values of debt and equity.

B. market value of debt and the book value of equity.
C. book values of debt and the market value of equity.
D. book values of debt and equity.

Difficulty: Basic
3. One should determine the after-tax weighted average cost of capital by
A. multiplying the weighted average after-tax cost of debt by the weighted average cost of equity.
B. adding the weighted average before-tax cost of debt to the weighted average cost of equity.
C. adding the weighted average after-tax cost of debt to the weighted average cost of equity.
D. dividing the weighted average before-tax cost of debt to the weighted average cost of equity.

4. One calculates the after-tax weighted average cost of capital (WACC) as
A. WACC = rD (D/V) + rE (E/V); (where V = D + E).

B. WACC = rD (1 - TC)(D/V) + rE (E/V); (where V = D + E).
C. WACC = rD (D/V) + rE (1 - TC)(E/V); (where V = D + E).
D. WACC = (1 - TC) × ( rD (D/V) + rE (E/V)); (where V = D + E).
5. While calculating the weighted average cost of capital, which values should one use for D, E, and V?
A. Book values
B. Liquidating values
C. Market values
D. Market value of debt and book value of equity

6. Given are the following data for Vinyard Corporation:

Calculate the proportions of debt (D/V) and equity (E/V) that you would use for estimating Vinyard's
weighted average cost of capital (WACC).
A. 40 percent debt and 60 percent equity

B. 50 percent debt and 50 percent equity
C. 25 percent debt and 75 percent equity
D. 75 percent debt and 25 percent equity
7. Given are the following data for Golf Corporation:
Market price/share = $12; Book value/share = $10; Number of shares outstanding = 100 million; Market
price/bond = $800; Face value/bond = $1,000; Number of bonds outstanding = 1 million. Calculate the
proportions of debt (D/V) and equity (E/V) for Golf Corporation that you should use for estimating its
weighted average cost of capital (WACC).
A. 40 percent debt and 60 percent equity

B. 50 percent debt and 50 percent equity
C. 45.5 percent debt and 54.5 percent equity
D. 66.7 percent debt and 33.3 percent equity

8. Given are the following data: Cost of debt = rD = 6%; Cost of equity = rE = 12.1%; Marginal tax rate = 35%; and
the firm has 50 percent debt and 50 percent equity. Calculate the after-tax weighted average cost of capital
(WACC).
A. 8 percent
B. 7.1 percent
C.9 percent
D. 5.9 percent

Difficulty: Challenge
9. A firm has a total market value of $10 million while its debt has a market value of $4 million. What is the after-tax
weighted average cost of capital if the before-tax cost of debt is 10 percent, the cost of equity is 15 percent, and the
tax rate is 35 percent?
A.13 percent
B.11.6 percent
C. 8.8 percent
D. 10.4 percent

10. Project M requires an initial investment of $25 million. The project is expected to generate $2.25 million in after-
tax cash flow each year forever. If the weighted average cost of capital (WACC) is 9 percent, calculate the NPV of
the project.
A.-2.5 million
B. +2.5 million
C. Zero
D. +2.1 million

11. Project M requires an initial investment of $25 million. The project is expected to generate $2.25 million
in after-tax cash flow each year forever. Calculate the IRR for the project.
A.10 percent
B. 9 percent
C. 8 percent
D. 7 percent

12. When using the weighted average cost of capital (WACC) to discount cash flows from a project, we assume the
following:
A.The project's risks are the same as those of the firm's other assets and remain so for the life of the project.
B. The project supports the same fraction of debt to value as the firm's overall capital structure, and that fraction
remains constant for the life of the project.
C. The project's risks are the same as those of the firm's other assets and remain so for the life of the project, and
the project supports the same fraction of debt to value as the firm's overall capital structure, and that fraction
remains constant for the life of the project.
D. The project's risks are the same as those of the firm's other assets and remain so for the life of the project; the
project supports the same fraction of debt to value as the firm's overall capital structure, and that fraction remains
constant for the life of the project; and the cash flows from the project occur in perpetuity.

13. The following situations typically require that the financial manager value an entire business:
A. If firm A is about make a takeover offer for firm B, then A's financial managers have to decide how much the
combined business A + B is worth under A's management.
B. If firm A is about make a takeover offer for firm B, then A's financial managers have to decide how much the
combined business A + B is worth under A's management; and if firm C is considering the sale of one of its
divisions or a business line, it has to decide what the division or the business line is worth in order to negotiate
with potential buyers.
C. When a firm goes public, the investment bank must evaluate how much the firm is worth in order to set the price.
D. If firm A is about make a takeover offer for firm B, then A's financial managers have to decide how much the
combined business A + B is worth under A's management; if firm C is considering the sale of one of its divisions
or a business line, it has to decide what the division or the business line is worth in order to negotiate with
potential buyers; and when a firm goes public, the investment bank must evaluate how much the firm is worth in
order to set the price.

14. When one uses the after-tax weighted average cost of capital (WACC) to value a levered firm, the interest tax
shield is
A. not accounted for by the use of the WACC.
B. considered by deducting the interest payment from the cash flows.
C. automatically considered because the after-tax cost of debt is included within the WACC formula.
D. capitalized by the levered cost of equity.

15. Free cash flow (FCF) and net income (NI) differ in the following ways:
A. Net income accrues to shareholders, calculated after interest expense; free cash flow is calculated assuming all
flows go to equity holders.
B. Net income accrues to shareholders, calculated after interest expense; free cash flow is calculated assuming
all flows go to equity holders and net income is calculated after various noncash expenses, including
depreciation; FCF adds back depreciation.
C. Net income accrues to shareholders, calculated after interest expense; free cash flow is calculated assuming all
flows go to equity holders; net income is calculated after various noncash expenses, including depreciation; FCF
adds back depreciation; and capital expenditures and investments in working capital do not appear in net income
calculations; they do reduce free cash flows.
D. Net income accrues to shareholders, calculated after interest expense; free cash flow is calculated assuming
all flows go to equity holders; net income is calculated after various noncash expenses, including depreciation;
FCF adds back depreciation; capital expenditures and investments in working capital do not appear in net income
calculations; they do reduce free cash flows; and net income is never negative; free cash flows can be negative
for rapidly growing firms, even if the firm is profitable, because investments can exceed cash flows from
operations.

16. Given are the following data for year 1:
Profits after taxes = $20 million; Depreciation = $6 million; Interest expense = $4 million; Investment in fixed
assets = $12 million; Investment in working capital = $4 million. The corporate tax rate is 25 percent.
Calculate the free cash flow (FCF) for year 1.
A. $4 million
B. $6 million
C. $8 million
D. $13 million

Profits after taxes = $14 million; Depreciation = $6 million; Interest expense = $6 million; Investment in fixed
assets = $12 million; Investment in working capital = $3 million. The corporate tax rate is 25 percent.
Calculate the free cash flow (FCF) for year 1.
A.$4 million
B. $9.5 million
C. $6 million
D. $7 million

Profit after taxes = $5 million; Depreciation = $2 million; Investment in fixed assets = $4 million; Investment
net working capital = $1 million. Calculate the free cash flow (FCF) for year 1.
A. $7 million
B. $3 million
C. $11 million
D. $2 million

19. Consider the following data:

FCF1 = $7 million; FCF2 = $45 million; FCF3 = $55 million. Assume that free cash flow grows at a rate of 4
percent for year 4 and beyond. If the weighted average cost of capital is 10 percent, calculate the value of the
firm.
A. $953.33 million
B. $801.12 million
C. $716.25 million
D. $736.02 million

20. Consider the following data:

FCF1 = $20 million; FCF2 = $20 million; FCF3 = $20 million. Assume that free cash flow grows at a rate of 5
percent for year 4 and beyond. If the weighted average cost of capital is 12 percent, calculate the value of the
firm.
A. $300 million
B. $261.57 million
C. $213.53 million
D. $238.69 million

21. Consider the following data for Kriya Company:
A constant growth rate of 4 percent is sustained forever after year 3. The weighted average cost of capital is 10
percent.
Calculate the value of the firm.
A. $90.4 million
B. $104 million
C. $82.6 million
D. $83.3 million
22. Consider the following data for Kriya Company:

A constant growth rate of 4 percent is sustained forever after year 3. The weighted average cost of capital is 10
percent. Calculate the present value of the horizon value. (Assume that the horizon value includes the 6.24M FCF
in year 4.)
A. $90.4 million
B. $104 million
C. $78.1 million
D. $75.1 million
23. Given are the following data for Outsource Company: PV (of FCFs for years 1-3) = $35 million; PV (horizon
value) = $65 million. Calculate the value of the firm.
A. $100 million
B. $65 million
C. $30 million
D. $170 million

Difficulty: Basic
24. Given are the following data for Outsource Company: PV (of FCFs for years 1-3) = $35 million; PV (horizon
value) = $65 million. Suppose that the market value of the debt = $30 million. Calculate the total market value of
equity of the firm.
A. $100 million
B. $70 million
C. $30 million
D. $35 million

Difficulty: Basic
25. Given are the following data for Outsource Company: PV (of FCFs for years 1–3) = $35 million; PV
(horizon value) = $65 million. Suppose that the market value of the debt = $30 million and the number of
shares outstanding = 5 million. Calculate the share price.
A. $20
B. $14
C. $13
D. $6
26. The flow-to-equity method uses
A. cash flows to equity, after interest and after taxes, and the cost of equity capital as the discount rate.
B. the cost of equity capital as the discount rate and the weighted average cost of capital for discount rate.
C. cash flows to equity, after interest and after taxes, and the weighted average cost of capital for discount rate.
D. the cost of equity capital as the discount rate and after-tax cash flows without considering interest and dividend
payments.

27. The flow to equity method provides an accurate estimate of the value of a firm if
A. the debt-equity ratio remains constant for the life of the firm.
B. amount of debt remains constant for the life of the firm.
C. free cash flows remain constant for the life of the firm.
D. the firm's financial leverage changes significantly over the life of the firm.

28. If a firm has preferred stock, the after-tax weighted average cost of capital (WACC) equals
A. rD (D/V) + rP (P/V) + rE (E/V); (where V = D + P + E).

B. rD (1 - TC)(D/V) + rP (P/V) + rE (E/V); (where V = D + P + E).
C. rD (D/V) + (1 - TC)[rP (P/V) + rE (E/V)]; (where V = D + P + E).
D. (1 - TC)[rD (D/V) + rP (P/V) + rE (E/V)]; (where V = D + P + E).
29. A firm finances itself with 30 percent debt, 60 percent common equity, and 10 percent preferred stock. The
before-tax cost of debt is 5 percent, the firm's cost of common equity is 15 percent, and that of preferred stock is
10 percent. The marginal tax rate is 30 percent. What is the firm's weighted average cost of capital?
A. 10.05 percent
B. 11.05 percent
C. 12.50 percent
D. 10.75 percent

30. A firm uses $30 million of debt, $10 million of preferred stock, and $60 million of common equity to finance its
assets. If the before-tax cost of debt is 8 percent, the cost of preferred stock is 10 percent, and the cost of
common equity is 15 percent, calculate the weighted average cost of capital for the firm assuming a tax rate of 35
percent.
A. 12.40 percent
B. 11.56 percent
C. 10.84 percent
D. 19.27 percent

31. Financial practitioners usually include short-term debt in WACC calculations if
A. short-term debt is at least 10 percent of total liabilities and net working capital is positive.
B. short-term debt is at least 10 percent of total liabilities and net working capital is negative.
C. short-term debt is at least 10 percent of the total assets and net working capital is positive.
D. short-term debt is at least 10 percent of the total assets and net working capital is negative.

32. Lowering the debt-equity ratio of the firm can change the firm's
A. cost of equity and cost of debt.

B. financial leverage.
C. financial leverage, cost of equity, and cost of debt.
D. financial leverage, cost of equity, cost of debt, and effective tax rate.

33. The Miles-Ezzell formula for the adjusted cost of capital assumes that
A. the firm rebalances its debt ratio only once per year.
B. the project cash flow is a perpetuity.
C. the project's risk is a carbon copy of the firm's risk.
D. MM's Proposition I corrected for taxes holds (i.e., T* = TC = 0.35).

34. Mirion, Inc., has a debt-equity ratio of 50 percent, with no preferred stock. However, Mirion now plans to raise
enough preferred stock to retire half of its outstanding common stock. Its common equity is currently valued at $7
million. Which of the following choices displays Mirion's market value capital structure, in market values (i.e., V = D
+ P + E), after the preferred stock issue?
A. 10.5[V] = 3.5[E] + 3.5[P] + 3.5[D].

B. 10.5[V] = 7 [E] + 3.5[P] + 0[D].
C. 14[V] = 3.5[E] + 3.5[P] + 7[D].
D. D) 14[V] = 7[E] + 3.5[P] + 3.5[D].

35. Mirion Tech, Inc., has rE of 12 percent, an rD of 6 percent, at a debt-equity ratio of 0.50. Mirion plans to raise
enough preferred stock to retire half of their outstanding common stock, which currently has a market value of $7
million. If the preferred stock has an expected rate of return of 10 percent, what is the new WACC? (Assume a 35
percent marginal corporate tax rate and that rD remains at 6 percent.)
A. 14.23 percent
B. 11.02 percent
C. 9.30 percent
D. 6.60 percent

36. A firm has debt beta of 0.2 and an asset beta of 1.9. If the debt-equity ratio is 75 percent, what is the levered
equity beta?
A. 1.90
B. 3.18
C. 2.42
D. 2.63

37. Johnston Company has a 7 percent cost of debt, a 50 percent debt ratio, and a 15 percent cost of equity. The
marginal tax rate is 25 percent. What is Johnston's WACC if it were 100 percent equity financed?
A. 11 percent
B. 10.13 percent
C. 7.50 percent
D. 15 percent
38. Which of the following is an important assumption required if using the WACC formula?
A. Companies rebalance their capital structure to maintain a constant debt ratio.

B. WACC must be used on public companies with actively traded securities.
C. Management bonuses must be added back to free cash flows.
D. The firm cannot issue any further debt without adjusting its WACC.
39. The opportunity cost of capital, used to calculate the base-case for adjusted present value analyses, can be
thought of as
A. the promised yield rather than the expected yield of an investment.

B. the rate corresponding to an average debt level among firms in the industry.
C. the WACC of an all-equity financed version of the firm.
D. the return on the opportunities exploited by a firm's competitors.

Difficulty: Basic
40. The Granite Paving Company is all-equity financed and has the following free cash flows in years 1?4: $3
million ($3M); $3.7M; $4M; $4.2M. After year 4, the firm is expected to grow at a sustainable rate of 3 percent per
annum. With a WACC of 12 percent, what is the horizon value in year 4 of Granite Paving Co?
A. $4.3M
B. $4.2M
C. $46.7M
D. $48.1M

41. The 1-year bonds of Casino, Inc., have a 12 percent coupon rate and trade in the market at a yield of 14
percent. There is a 5 percent chance that Casino will default and pay nothing. What cost of debt should be used in
Casino's WACC?
A. 14 percent
B. 8.3 percent
C. 12 percent
D. 9.1 percent
42. The Modigliani-Miller (MM) formula for the after-tax discount rate, for the case of fixed perpetual debt, is given
by
A. rMM = r(1 - TCD/V).
B. rMM = r(1 + TCD/V).
C. rMM = r/(1 - TCD/V).
D. rMM = r/(1 + TCD/V).
43. Flotation costs are incorporated into the APV framework by
A. adding them to 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. Flotation costs should not be included into APV.

Difficulty: Basic
44. What effect will subsidized loans have?
A. They will increase the APV of a project.

B. They will decrease the APV of a project.
C. They will not affect APV.
D. None of the options.

Difficulty: Basic
45. The MFC Corporation needs to raise $200 million for its mega project. The NPV of the project using all-equity
financing is $40 million. If the cost of raising funds for the project is $20 million, what is the APV of the project?
A. $40 million
B. $240 million
C. $20 million
D. $160 million

46. The MFC Corporation has decided to build a new facility. It estimates the cost of the facility at $9.7 million.
MFC wishes to finance this project using its traditional debt-to-equity ratio of 1.5. The issue cost of equity is 6
percent, and the issue cost of debt is 1 percent. What is the total flotation cost of raising funds?
A. $300,000
B. $100,000
C. $600,000
D. $970,000

47. A project costs $15 million and is expected to produce cash flows of $3 million a year for 10 years. The
opportunity cost of capital is 14 percent. If the firm has to issue stock to undertake the project and issue costs are
$500,000, what is the project's APV?
A. -$352,000
B. $148,350
C. $648,350
D. $952,000

48. A project costs $7 million and is expected to produce cash flows of $2 million per year for 10 years. The
$0.5 million, what is the project's APV?
A. $9.67 million
B. $2.17 million
C. $1.67 million
D. $0.67 million

49. A project costs $14 million and is expected to produce cash flows of $4 million per year for 15 years. The
$1 million, what is the project's APV?
A. $3.7 million
B. $4.5 million
C. $4.7 million
D. $3 million
50. The BSC Co. was planning to raise $2.5 million in perpetual debt at 11 percent. However, they just received
an offer from the governor of a nearby state to raise the financing for them at 8 percent if they locate a new facility
in that state. What is the total value added from debt financing if the tax rate is 34 percent and the state subsidizes
the loan for the company?
A. $2.5 million
B. $1.2 million
C. $1.3 million
D. $0.9 million

51. The APV method includes the NPV of a project assuming all-equity financing and then adds in the NPV
of financing effects. The financing effects are
A. tax subsidy of dividends, cost of issuing new securities, subsidies 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.
C. cost of issuing new securities, cost of financial distress, tax subsidy of dividends, and cost of debt financing.
D. subsidies of financial distress, tax subsidy of debt, cost of other debt financing, and cost of issuing new
securities.

52. The APV method is most useful in analyzing
A. large international projects.

B. domestic projects.
C. small projects.
D. projects having the same risk as the firm.

Difficulty: Basic
53. The APV method should be used
A. when the project's level of debt is known over the life of the project.
B. when the project's target debt to value ratio is constant over the life of the project.
C. when the project's debt financing is unknown over the life of the project.
D. when the level of debt doesn't change over the life of the firm.

54. In the case of large international investments, the project might include
A. custom-tailored project financing and special contracts with suppliers.

B. custom-tailored project financing, special contracts with suppliers, and special contracts with customers.
C. custom-tailored project financing, special contracts with suppliers, special contracts with customers, and special
arrangements with governments.
D. special arrangements with governments.

55. Which of the following statements regarding guarantees and government restrictions on international projects
is (are) true?
A. The value of the guarantees is added to the APV and the value of the government restrictions is added to the
APV.
B. The value of the guarantees is subtracted from the APV and the value of the government restrictions is added to
the APV.
C. The value of the guarantees is subtracted from the APV and the value of the government restrictions is
subtracted from the APV.
D. The value of the guarantees is added to the APV and the value of the government restrictions is subtracted from
the APV.

56. A firm has issued $5 par value preferred stock that pays a $0.80 annual dividend. The stock currently sells for
$9.50. In calculating WACC, what should one use for the value of the firm's preferred stock?
A. $0.80
B. $4.20
C. $5
D. $9.50
57. A firm has a project with an NPV of -$52 million. If it has access to risk-free government financing that can
create a permanent annual tax shield of $5 million, what is the APV of the project assuming the risk-free interest
rate is 6 percent?
A. -$52 million
B. $5 million
C. $31 million
D. $83 million

58. APV = NPV(base-case assuming all equity financing) - NPV(financing decisions caused by project financing).
FALSE

Difficulty: Basic
59. The MM formula for the adjusted cost of capital takes into consideration only the effect of the interest tax shield
on permanent debt.
TRUE

60. The WACC formula calculates the cost of capital for the "average risk" project.
TRUE

61. When calculating the WACC for a firm, one should use the book values of debt and equity.
FALSE

Difficulty: Basic
62. Discounting free cash flows at the WACC assumes that debt is rebalanced every period to maintain a constant
ratio of debt to market value of the firm.
TRUE

63. One can estimate the value of a firm by calculating the present value of free cash flows using the WACC
(weighted average cost of capital) for the discount rate.
TRUE

64. The total value of a firm is the present value of its free cash flows minus the present value of its horizon value.
FALSE

65. If expected long-term growth is constant, the firm's horizon value at period H is given by PVH = (FCFH
+ 1)/(WACC - g).
TRUE

66. The computation of a firm's WACC does not change after it issues preferred stock.
FALSE

67. The market value of short-term debt is very close to the book value of debt for healthy firms.
TRUE

68. Adjusted present value is equal to base-case NPV plus the sum of the present values of any financing side
effects.
TRUE

69. The APV method can be used for valuing entire businesses.
TRUE
Difficulty: Basic
70. Generally, subsidized loans decrease the APV of a project.
FALSE

71. Generally, APV is not suitable for international projects.
FALSE

72. Generally, the imposition of government restrictions increases the APV of a project.
FALSE

73. Enterprise zone subsidies, a government program that provides financial incentives to make investments in
a specific location, increase APV.
TRUE

74. Government loan guarantees for firms may increase APV by reducing bankruptcy risk.
TRUE

75. In the second step of the 3-step process to adjust WACC when debt ratios change, one should use the following
formula: rE = r + (r - rD) × (D/V).
FALSE

76. Discuss the advantages and limitations of using the weighted average cost of capital as a discount rate to
evaluate capital budgeting projects.
WACC is relatively simple to calculate and use. A disadvantage is that it applies only to projects having the same
business risk as the firm. It also implies that the debt-equity ratio is held constant. It can only be used when the
debt ratio is known, but the value of the debt need not be known. It automatically takes into account the tax-shield
effect of debt.
77. Discuss why WACC is used most often by managers to make capital budgeting decisions.
The after-tax weighted average cost of capital (WACC) method is the most often used method in practice. It is
conceptually easy to understand and communicate. It relates well with the NPV and IRR methods. It is also used for
valuing businesses.
78. Briefly explain how WACC can be used for valuing a business.
The value of a business can be estimated by calculating the present value of free cash flows (FCF) generated by
a firm using WACC as the discount rate. FCFs are estimated by accounting for profits after taxes, plus
depreciation, less investments in fixed assets, and investments in working capital. From a practical point of view,
FCFs are estimated for a few years and the present value of the horizon value is calculated using a reasonable
constant growth rate for the rest of the horizon. The value of the firm is the present value of free cash flows plus
the present value of its horizon value.
79. Briefly explain how the firm’s equity beta changes with changes in its debt-equity ratio when taxes are
considered.
The equity beta of a firm increases linearly with changes in the debt-equity ratio. The formula for relevering beta
closely resembles MM’s Proposition II, except that betas are substituted for rates of return:
bE = bA +(bA – bD)(D/E).
80. Under which circumstances would it be better to use the adjusted present value approach versus the WACC
approach?
The APV approach is better if there are many side effects from financing. For example, if a firm is getting a
subsidized loan for a project, then the APV method should be used. It is also used when the amount of debt, as
opposed to the debt-equity ratio, is known.
81. Briefly explain how APV can be used for valuing a business.
The value of a business can be estimated by calculating the present value of free cash flows (FCF) generated by a
firm using the firm’s opportunity cost of capital as the discount rate for the life of the firm. This gives the base-case
NPV. Business debt levels, interest, and interest tax shields are calculated. If the debt levels are fixed, then the
interest tax shields are discounted at the borrowing rate to get the present value of interest tax shields. The value of
the firm is the base-case NPV plus the present value of interest tax shields.
82. What discount rate should be used for calculating the present value of safe, nominal cash flows?
The discount rate used for finding the present value of safe, nominal cash flows is the after-tax cost of debt. This
present value is also the value of an equivalent loan that can be paid off using the cash flows.
83. What method would you tend to use for evaluating international projects?
Generally, international projects have numerous and important side effects, like special contracts with
governments, suppliers, and customers. They also have special project financing packages. All of these effects
can be explicitly considered within the APV method.
84. What are some of the additional factors that have to be considered when analyzing an international project?
Briefly explain.
Sometimes international projects have additional features, like special contracts with suppliers, customers, or
governments, which provide guarantees. These guarantees are valuable for the firm and should be added to the
APV. On the other hand, governments sometimes impose special restrictions. These restrictions generally
decrease the value of the project to the firm. The values of the restrictions are subtracted from the APV.
85. "Urban renewal can be assisted by the provision of government tax and loan incentives to businesses, despite
the existence of negative NPV projects." Explain why this may be true.
Investments may have a negative NPV in the absence of other incentives. When the government provides a
financial incentive, in the form of subsidies, tax breaks, or low interest loans, the APV of the project may increase.
If the increase is enough, the NPV may become positive and the firm might make a governmental-favored
investment. This may lead to economic development in areas that would not otherwise receive investments. The
risk, however, is that the eventual elimination of the incentives may cause urban blight to return. In this case, the
government granting the subsidy may have had better uses for the money consumed by the subsidy.
Category # of
Questions
Accessibility: Keyboard Navigation 72
Difficulty: Basic 10
Difficulty: Challenge 25
Difficulty: Intermediate 50

Chap 19 Test

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Chap 19 Test

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1.

A. adjusting the project's present value (APV).

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A. market values of debt and equity.

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3. One should determine the after-tax weighted average cost of capital by

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4. One calculates the after-tax weighted average cost of capital (WACC) as

A. WACC = rD (D/V) + rE (E/V); (where V = D + E).

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6. Given are the following data for Vinyard Corporation:

A. 40 percent debt and 60 percent equity

7. Given are the following data for Golf Corporation:

A. 40 percent debt and 60 percent equity

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16. Given are the following data for year 1:

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17. Given are the following data for year 1:

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18. Given are the following data for year 1:

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19. Consider the following data:

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20. Consider the following data:

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21. Consider the following data for Kriya Company:

Calculate the value of the firm.

22. Consider the following data for Kriya Company:

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26. The flow-to-equity method uses

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A. rD (D/V) + rP (P/V) + rE (E/V); (where V = D + P + E).

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31. Financial practitioners usually include short-term debt in WACC calculations if

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A. cost of equity and cost of debt.

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A. 10.5[V] = 3.5[E] + 3.5[P] + 3.5[D].

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A. Companies rebalance their capital structure to maintain a constant debt ratio.

A. the promised yield rather than the expected yield of an investment.

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43. Flotation costs are incorporated into the APV framework by

A. adding them to the all-equity value of the project.

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44. What effect will subsidized loans have?

A. They will increase the APV of a project.

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