International Capital Budgeting quiz (Detail Answer)

This International Capital Budgeting Quiz provides you details answers and explanation for all calculate question and conceptional question in question set. This can be the way help you to overcome hard questions in the upcoming exam.

Chapter 18 International Capital Budgeting

1 Before you pose these next seven questions to your students, give consideration to their

finance backgrounds At my school (University of Missouri at Columbia) capital budgeting questions in this level of detail would be "fair game" because the students have had plenty of capital budgeting before in a prior finance course Just glancing at equations 18-1 through 18-2f

is not preparation for these seven questions There are plenty of easier questions in this test bank.

Tiger Towers, Inc is considering an expansion of their existing business, student apartments Thenew project will be built on some vacant land that the firm has just contracted to buy The land cost $1,000,000 and the payment is due today Construction of a 20-unit office building will cost pretax $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the value of the land and building in year 30 will be $18,000,000 The $3,000,000

construction cost is to be paid today The project will not change the risk level of the firm The firm will lease 20 offices suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year Variable cost is $3,500 per suite Fixed costs, excluding depreciation, are $75,000 per year The project will require a $10,000 investment in net working capital

2 What is the unlevered after-tax incremental cash flow for year 0?

4 What is the unlevered after-tax incremental cash flow for year 30?

Awarding partial credit on a multiple choice test isn't hard Import their responses into Excel Use

"if" statements The advantage of path-dependent grading is that you can get the same level of discrimination in grading on a multiple choice test as on an essay test

5 For the next 3 questions, assume that the firm will partially finance the project with a

$3,000,000 interest-only 30-year loan at 10.0 percent APR with annual payments

What is the levered after-tax incremental cash flow for year 0?

6 For the next 3 questions, assume that the firm will partially finance the project with a

$3,000,000 interest-only 30-year loan at 10.0 percent APR with annual payments.What is the levered after-tax incremental cash flow for year 1?

7 For the next 3 questions, assume that the firm will partially finance the project with a

$3,000,000 interest-only 30-year loan at 10.0 percent APR with annual payments.What is the levered after-tax incremental cash flow for year 30?

the right answer is your response to Q5 - $300,000  0.66 - $3,000,000

You should consider awarding partial credit on this according to this rubric:

$9,027,390 is correct if Q5 = 2)

$9,234,300 is correct if Q5 = 1)

$9,134,300 is correct if Q5 = 3)

$9,287,000 is correct if Q5 = 4)

8 Assume that the firm will partially finance the project with a subsidized $3,000,000 interest

only 30-year loan at 8.0 percent APR with annual payments Note that eight percent is less than

the 10 percent that they normally borrow at What is the NPV of the loan?

A $198,469

B $53,979.83

C $102,727.55

D $1,334,851.09

E None of the above

Using the cash flow menu on a financial calculator:

9 The firm's tax rate is 34% The firm's pre-tax cost of debt is 8%; the firm's debt-to-equity ratio

is 3; the risk-free rate is 3%; the beta of the firm's common stock is 1.5; the market risk premium

is 9% What is the firm's cost of equity capital?

A 33.33%

B 10.85%

C 13.12%

D 16.5%

E None of the above

16.5% = rasset + 3  [ r asset - rdebt]  (1-.34)

11 For the next two questions consider a project with the following data

The 5-year project requires equipment that costs $100,000 If undertaken, the shareholders will contribute $20,000 cash and borrow $80,000 at 6% with an interest-only loan with a maturity of

5 years and annual interest payments The equipment will be depreciated straight-line to zero over the 5-year life of the project There will be a pre-tax salvage value of $5,000 There are no other start-up costs at year 0 During years 1 through 5, the firm will sell 25,000 units of product

at $5; variable costs are $3; there are no fixed costs

12 What is the NPV of the project using the WACC methodology?

Using the cash flow menu of a financial calculator: CF0 = -$100,000; C01 = $39,800; F01 = 4;

C02 = $43,100; I = rWACC = 8.74; NPV = $58,028.68

13 What is the NPV of the project using the APV methodology?

A $49,613.03

B $198,469

C $102,727.55

D $149,580.12

E None of the above

APV = -Cost + Base-case NPV + NPV depreciation tax shield + NPV interest tax shield =

The project does not cost $100,000 but rather $98,937.49 = -$100,000 + $1,062.51

(100,000 less the present value of after tax salvage value discounted at rasset = 12%)

For the next 3 questions consider a project with the following data

The 5-year project requires equipment that costs $100,000 If undertaken, the shareholders will contribute $25,000 cash and borrow $75,000 with an interest-only loan with a maturity of 5 yearsand annual interest payments The equipment will be depreciated straight-line to zero over the 5-year life of the project There will be a pre-tax salvage value of $5,000 There are no other start-

up costs at year 0 During years 1 through 5, the firm will sell 25,000 units of product at $5; variable costs are $3; there are no fixed costs

14 What is the NPV of the project using the WACC methodology?

A $58,028.68

B $49,613.03

C $48,300.47

D $102,727.55

E None of the above

Using the cash flow menu of a financial calculator: CF0 = -$100,000; C01 = $39,800; F01 = 4;

E None of the above

Using a financial calculator's cash flow menu: N = 5; PMT = $6,800 = $20,000  34 I/YR = rdebt

= 10%; PVdepreciation tax shield = $25,777.35

16 When using the APV methodology, what is the NPV of the interest tax shield?

A $9,666.51

B $12,019.32

C $9,377.31

D $7,000.73

E None of the above

using a financial calculator, N = 5; PMT = $2,550 = 10  $75,000  34; I/YR = rdebt = 10%;

17 Today is January 1, 2009 The state of Iowa has offered your firm a subsidized loan It will be

in the amount of $10,000,000 at an interest rate of 5% and have ANNUAL (amortizing)

payments over 3 years The first payment is due today and your taxes are due January 1 of each year on the previous year's income The yield to maturity on your firm's existing debt is 8% What is the APV of this subsidized loan?

Note that I did not round my intermediate steps If you did, your answer may be off by a bit Select the answer closest to yours

First, get your financial calculator into begin mode and 1 payment per year:

PV = 10,000,000

N= 3

I= 5%

PMT = -$3,497,224.43

Amortize the loan

The size and timing of the cash flows of the loan are:

18 Today is January 1, 2009 The state of Iowa has offered your firm a subsidized loan It will be

in the amount of $10,000,000 at an interest rate of 5% and have ANNUAL (amortizing)

payments over 3 years The first payment is due December 31, 2009 and your taxes are due January 1 of each year on the previous year's income The yield to maturity on your firm's existing debt is 8% What is the APV of this subsidized loan?

Note that I did not round my intermediate steps If you did, your answer may be off by a bit Select the answer closest to yours

A -$3,497,224.43

B $417,201.05

C $840,797

D None of the above

First, enter the loan into a financial calculator and solve for the payment:

PV=10,000,000

N= 3

I= 5%

PMT = 3,672,085

Then amortize the loan:

Now find the APV of the loan as shown in the book:

19 The required return on assets is 18% The firm can borrow at 12.5%; firm's target debt to value ratio is 3/5 The corporate tax rate is 34%, and the risk-free rate is 4% and the market risk premium is 9.2 percent What is the weighted average cost of capital?

The interest will be deductible at the time that you pay What is the APV of this below-market loan to your firm? I did not round any of my intermediate steps You might be a little bit off Pickthe answer closest to yours

A $64,157.38

B $417,201.05

C $840,797

D None of the above

First, enter the loan into a financial calculator to find the payment:

PV=1,000,000

N= 2

I= 5%

PMT = 537,804.88

Next amortize the loan to find out how much interest is paid in each period (it's deductible)

Finally, find the APV of the loan as the NPV of the after-tax cash flows at 8%:

21 The firm's tax rate is 34% The firm's pre-tax cost of debt is 8%; the firm's debt-to-equity ratio is 3; the risk-free rate is 3%; the beta of the firm's common stock is 1.5; the market risk premium is 9%.Calculate the weighted average cost of capital

A 33.33%

B 8.09%

C 9.02%

D 16.5%

E None of the above

NOTE TO FACULTY: the next six questions are similar to the six that follow them, but have

different answers as the debt-equity ratio changes from 2 to 3 This can discourage cheating, especially if you only give credit to students who have the right answers on the right test!

Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:

The firm's tax rate is 34%; the firm's bonds trade with a yield to maturity of 8%; the current and target debt-equity ratio is 2; if the firm were financed entirely with equity, the required return would be 10%

22 Using the APV method, what is the value of the debt side effects?

NOTE TO FACULTY: the next six questions are similar to the last six, but have different answers as the debt-equity ratio changed from 2 to 3 This can discourage cheating, especially if you only give credit to students who have the right answers on the right test!

Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:

The firm's tax rate is 34%; the firm's bonds trade with a yield to maturity of 8%; the current and target debt-equity ratio is 3; if the firm were financed entirely with equity, the required return would be 10%

23 Using the weighted average cost of capital methodology, what is the NPV? I didn't round my intermediate steps If you do, you're not going to get the right answer

Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:

The firm's tax rate is 34%; the firm's bonds trade with a yield to maturity of 8%; the current and target debt-equity ratio is 3; if the firm were financed entirely with equity, the required return would be 10%

For the next 5 questions, the firm will partially finance the project with an 8% interest-only year loan

4-24 What is the levered after-tax incremental cash flow for year 2?

28 Using the APV method, what is the value of the debt side effects?

A $4,729,622.75

B $2,014,579.93

C $0

D $196,929.88

E None of the above

Using a financial calculator: N = 5; I/Y = 8% PMT = -$2,000,000 solve for PV = $7,985,420.07The state is giving you $10,000,000 for a promise that's worth only $7,985,420.07 The value of that is $2,014,579.93

30 What proportion of the firm is financed by debt for a firm that expects a 15% return on equity, a 12% return on assets, and a 10% return on debt? The tax rate is 25%

From Modigliani-Miller Proposition II (perhaps not displayed to its best advantage in footnote 2,but surely something students know coming into the course) we can find the debt-equity ratio.

With a debt equity ratio, it's easy to find debt to value:

31 The required return on equity for a levered firm is 10.60% The debt to equity ratio is ½ the tax rate is 40%, the pre-tax cost of debt is 8% Find the cost of capital if this firm were financed entirely with equity

A 10%

B 12%

C 8.67%

D None of the above

From Modigliani and Miller proposition 2 the required return on equity for a levered firm is K l =

K u + (1- )(K u - i)(Debt/Equity)

Instructors note: some students will select b) the WACC Students who have had corporate finance should know M&M proposition 2 Good questions for graduate courses

32 The required return on equity for an all-equity firm is 10.0% They are considering a change

in capital structure to a debt-to-equity ratio of ½ the tax rate is 40%, the pre-tax cost of debt is 8% Find the new cost of capital if this firm changes capital structure

A 14.93%

B 8.67%

C 7.40%

D None of the above

From Modigliani and Miller proposition 2 that the required return on equity for a levered firm is

K l = K u + (1- )(K u - i)(Debt/Equity)

Instructors note: Students who have had corporate finance should know M&M proposition 2 A common mistake will be a); a grievous mistake confusing D/E and D/V would be c) Good questions for graduate courses.\

33 The required return on equity for an all-equity firm is 10.0% They currently have a beta of one and the risk-free rate is 5% and the market risk premium is 5% They are considering a change in capital structure to a debt-to-equity ratio of ½ the tax rate is 40%, the pre-tax cost of debt is 8% Find the beta if this firm changes capital structure

A 1.12

B 1

C 7.4%

D None of the above

From Modigliani and Miller proposition 2: K l = K u + (1- )(K u - i)(Debt/Equity)

Instructors note: Students who have had corporate finance should know M&M proposition 2 and the difference between an asset beta and an equity beta Good questions for graduate courses

34 What is the expected return on equity for a tax-free firm with a 15% expected return on assets that pays 12% on its debt, which totals 25% of assets?

36 Assume that XYZ Corporation is a leveraged company with the following information:

K l = cost of equity capital for XYZ = 13%

i = before-tax borrowing cost = 8%

t = marginal corporate income tax rate = 30%

Calculate the debt-to-total-market-value ratio that would result in XYZ having a weighted average cost of capital of 9.3%

37 Today is January 1, 2009 The state of Iowa has offered your firm a subsidized loan It will be

in the amount of $10,000,000 at an interest rate of 5% and have ANNUAL (amortizing)

payments over 3 years The first payment is due today and your taxes are due January 1 of each year on the previous year's income The yield to maturity on your firm's existing debt is 8%

What is the APV of this subsidized loan? Note that I did not round my intermediate steps If you did, your answer may be off by a bit Select the answer closest to yours

A $406,023.10

B $840,797

C $64,157.38

D $20,659.77

E None of the other answers are within $100 of my answer

First, get into begin mode

and 1 payment per year:

PV = 10,000,000

N= 3

I= 5%

PMT = -$3,497,224.43

Amortize the loan

The size and timing of the cash flows of the loan are:

38 An Italian firm is considering selling its line of coin-operated cappuccino machines in the U.K The business risk will be identical to the firm's existing line of business in the euro zone,

the cost of capital in the euro zone is i€ = 10% The expected inflation rate over the next two years in the U.K is 3% per year and 2% per year in the euro zone The spot exchange rates are

$1.80 = 1.00 and $1.15 = €1.00

The pound sterling denominated cash flows are as follows:

What is the €-denominated NPV of this project? I did not round my intermediate steps, if you did, select the answer closest to yours