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Exam 17: Dynamic Capital Structures and Corporate Valuation

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Question 21

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Kitto Electronics Data Kitto Electronics has an EBIT of $200,000, a growth rate of 6%, and its tax rate is 40%. In order to support growth, Kitto must reinvest 20% of its EBIT in net operating assets. Kitto has $300,000 in 8% debt outstanding, and a similar company with no debt has a cost of equity of 11%. -Refer to data for Kitto Electronics. Using the compressed adjusted present value model, what is Kitto's value of equity?

A) $1,492,000
B) $1,529,300
C) $1,567,533
D) $1,606,721
E) $1,646,889

F) B) and D)
G) B) and C)

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Question 22

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Holland Auto Parts is considering a merger with Workman Car Parts. Workman's market-determined beta is 0.9, and the firm currently is financed with 20% debt, at an interest rate of 8%, and its tax rate is 25%. If Holland acquires Workman, it will increase the debt to 60%, at an interest rate of 9%, and the tax rate will increase to 35%. The risk-free rate is 6% and the market risk premium is 4%. Using the Compressed APV Model, what will Workman's required rate of return on equity be after it is acquired?

A) 7.4%
B) 8.9%
C) 9.3%
D) 9.6%
E) 9.7%

F) B) and C)
G) C) and D)

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Question 23

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Refer to data for Glassmaker Corporation. According to the compressed adjusted present value model, what discount rate should you use to discount Glassmaker's free cash flows and interest tax savings?

Refer to data for Glassmaker Corporation.Using the compressed adjusted present value model, what will Glassmaker's value of equity be if it successfully implements its planned changes in operations and capital structureσ (Round your answer to the closest thousand dollars.)

Volunteer Enterprises has the following information for the current year. Calculate its free cash flow to equity. $\begin{array}{lr}\text { FCF } & 1,000 \\\text { Interest expense } & 40 \\\text { Principal payments } & 200 \\\text { New debt } & 300 \\\text { Tax rate } & 25 \%\end{array}$  

Which of the following statements is most CORRECT?

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

In the compressed adjusted present value model, the appropriate discount rate for the tax shield is the after-tax cost of debt.

Suppose a company issued 30-year bonds 4 years ago, when the yield curve was inverted. Since then long-term rates (10 years or longer) have remained constant, but the yield curve has resumed its normal upward slope. Under such conditions, a bond refunding would almost certainly be profitable.

If the capital structure is stable, and free cash flows are expected to be growing at a constant rate at the horizon date, then the compressed adjusted present value model calculates the horizon value by discounting the post-horizon free cash flows and post-horizon expected future tax shields at the weighted average cost of capital.

The market value of Firm L's debt is $200,000 and its yield is 9%. The firm's equity has a market value of $300,000, its earnings are growing at a 5% rate, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Using the compressed adjusted present value model, what would Firm L's total value be if it had no debtσ

Which of the following factors would increase the likelihood that a company would call its outstanding bonds at this time?

Gators Incorporated has the following information for the current year and projected for next year. Calculate its projected free cash flow to equity. $\begin{array}{lrr}&\text { Current }\\&\text { year } & \text { Projected } \\\text { FCF }&\text { NA } & 1,000 \\\text { Total debt }& 400 & 600 \\\text { Interest rate on debt }& 6 \% & 6 \% \\\text { Tax rate }& 25 \% & 250\end{array}$    

In the compressed adjusted present value model, the appropriate discount rate for the tax shield is the WACC.

Eta Edibles had free cash flow to equity, required return, and long-term growth rate as indicated below. Eta has no non-operating assets. Calculate Eta's intrinsic value of equity using the FCFE model. $\begin{array}{l}\begin{array} { l } \text { Most recent FCFE}\\\text { Required return on}\\\text { equity}\\\text { Long-term growth rate}\\\end{array}\begin{array} { l } 1000\\90 \%\\\\4 \%\\\end{array}\end{array}$    

Gamma Pharmaceuticals has the following financial information for the current year and projected for next year. Calculate Gamma's projected free cash flow to equity. $\begin{array} { l l r r } & { \text { Curtent } } & \\& \text { year } & \text { Projected } \\\text { NOPAT } & \text { NA } & 1,000 \\\text { Tatal aperating capital } & 2,000 & 2,200 \\\text { Tetal debt } & 900 & 800 \\\text { Interest rate an debt } & 6 \% & 6 \% \\\text { Tar rate } & 25 \% & 25 \%\end{array}$    

The market value of Firm L's debt is $200,000 and its yield is 9%. The firm's equity has a market value of $300,000, its earnings are growing at a rate of 5%, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Using the compressed adjusted present value model, what is Firm L's cost of equity?

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 will the after-tax annual interest savings for NWW be if the refunding takes place?

Five years ago, the State of Oklahoma issued $2,000,000 of 7% coupon, 20-year semiannual payment, tax-exempt bonds. The bonds had 5 years of call protection, but now the state can call the bonds if it chooses to do so. The call premium would be 5% of the face amount. Today 15-year, 5%, semiannual payment bonds can be sold at par, but flotation costs on this issue would be 2%. What is the net present value of the refundingσ Because these are tax-exempt bonds, taxes are not relevant.

A local firm has debt worth $200,000, with a yield of 9%, and equity worth $300,000. It is growing at a 5% rate, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Using the compressed adjusted present value model, what is the value of your firm's tax shield, i.e., how much value does the use of debt add?