Ch. 19 - Financing & Valuation Flashcards
When calculating the inputs to the WACC formula, one should always use book/ market values?
Market values
When determining the capital structure input into the WACC, what is the ideal estimate?
Ideal: to use the proportion of each source of capital the firm would use in the project if it was standalone - i.e., based on actual financing plan
When the ideal estimation of capital structure is infeasible, firms can use target capital structure. Which of the following is not one of the ways to determine target capital structure?
A) Assume the firm’s current capital structure reflects target
B) Examine trends in the firm’s capital structure and statements regarding intended capital structure
C) Find the future value of the current capital structure market values
D) Use averages of comparable companies’ capital structures
C) Find the future value of the current capital structure market values
When the after-tax WACC is used to value a levered firm, the interest rax shield is:
A) Ignored
B) Considered by deducting the interest payment from the cash flows
C) Automatically considered because the after-tax cost of debt is used in the WACC formula
C) Automatically considered because the after-tax cost of debt is used in the WACC formula
When using the company after-tax WACC to discount CFs from a project, we assume what: (multiple options may be correct)
A) The project’s business risk 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, which remains constant over the life of the project
C) The CFs from the project is always a perpetuity
A) The project’s business risk 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, which remains constant over the life of the project
All variables in the WACC formula refer to company as a whole: WACC is a company cost of capital.
True/ False
True:
Note that one can apply the WACC to projects too, but this prescribes that the project is a carbon copy (same capital structure and and business risk as the company as a whole)
When discounting FCFs at WACC, one assumes that debt is rebalanced to maintain a constant D/V of company or project
True/ False
True
Recall: WACC is a measure assumed to be constant
Standard capital budgeting practice calculates taxes and CFs as if company or project is all-equity financed. I.e., value of interest tax shields is not reflected in higher after-tax cash flows but in lower discount rate.
True/ False
True
The value of business is usually calculated as PV of free cash flows out to a valuation horizon/ projection period, plus forecasted value of business at that horizon/ steady state (horizon value), also discounted back to present terms
True/ False
True
There are two methods by which one can estimate the horizon value of the firm (steady state). Which?
Constant growth model
Multiples
According to the textbook, one should choose a valuation horizon based on the estimated time by which competition is expected to be so strong that PVGO_H < 0
True/ False
False:
One should consider choosing valuation horizon as time where management expects competition to be so strong that PVGO_H=0
The constant growth model is one of the two methods by which one can estimate the steady state (horizon value). This method assumes steady state until ____ after a specific projection period.
A) a number of n years
B) infinity/ perpetuity
B) infinity/ perpetuity
Which discount rate is used in in the unlevered portion of the adjusted present value (APV)?
Unlevered cost of equity
The APV method includes all equity NPV of a project and the NPV of financing effects. Which of the following is not a financing effect?
A) cost of issuing new securities
B) cost of financial distress
C) subsidies
D) interest tax shield
All options are correct
The method to determine the value of a firm if it is all equity financed (following APV)
A) Discounts the CFs after tax by the levered equity rate
B) Discounts the CFs after tax by the WACC
C) Discounts the earnings after tax by the unlevered equity rate (opportunity cost of capital)
D) Discounts the CFs after tax by the unlevered equity rate (opportunity cost of capital)
D) Discounts the CFs after tax by the unlevered equity rate (opportunity cost of capital)
The APV method to value a project should be used when:
A) The project’s level of debt is known over the life of the project
B) When the project’s target D/V is constant over the life of the project
A) The project’s level of debt is known over the life of the project
APV is most useful when financing side effects are
A) numerous and important
B) few and certain
C) few, certain and important
APV is most useful when financing side effects are
A) numerous and important
Under the pure-play method, un-levering the equity beta of the comparable company entails the removal of the business risk component of the equity beta, leaving only the financial risk component of the beta
True/ False
False:
Un-levering the equity beta of the comparable company entails the removal of the financial risk component of the equity beta, leaving only the business risk component of the beta.
Adjusted discount, as opposed to adjusted present value (APV), reflects both the project opportunity cost of capital and its financial side-effects in the discount rate
True/ False
True
Two concepts of cost of capital exist: opportunity cost of capital and adjusted cost of capital. The following description fits which of them?
It is equal to expected rate of return offered in capital markets by equivalent-risk financial assets. This rate depends on the risk of the project’s cash flows. Meanwhile, it is the correct discount rate to be applied for projects that are all equity-financed.
Opportunity cost of capital r_A
The discount rate that adjusts the cost of capital by taking into account the financing side effect of an investment project is referred to as…
Adjusted cots of capital r*
Which rate is the appropriate discount rate to be used for safe nominal cashflows?
After-tax borrowing/interest rate:
r=rD(1-Tc)
What is meant by a carbon copy project? (Select all correct)
A) Project’s business risk is the same as the company’s other assets
B) Project supports the same amount/ level of debt-to-value as in the company’s overall capital structure
C) Project supports the same fraction of debt-to-value as in the company’s overall capital structure
A) Project’s business risk is the same as the company’s other assets
B) Project supports the same amount/ level of debt-to-value as in the company’s overall capital structure
C) Project supports the same fraction of debt-to-value as in the company’s overall capital structure
