Finance and Discount Rate
Chapter #19, Quizz
Quizz, Chapter 19
1.Calculate the weighted-average cost of capital (WACC) for Federated Junkyards of
America, using the following information:
• Debt: $75,000,000 book value outstanding. The debt is trading at 90 percent of par.
The yield to maturity is 9 percent.
• Equity: 2,500,000 shares selling at $42 per share. Assume the expected rate of return on Federated’s stock is 18 percent.
• Taxes: Federated’s marginal tax rate is Tc = .35
What are the key assumptions underlying your calculation? For what type of project would Federated’s weighted-average cost of capital be the right discount rate?
2. Suppose Federated Junkyards decides to move to a more conservative debt policy. A year later its debt ratio is down to 15 percent (D/V =.15 ). The interest rate has dropped to 8.6 percent. Recalculate Federated’s WACC under these new assumptions. The company’s business risk, opportunity cost of capital, and tax rate have not changed. Use the three-step procedure explained in Section 19.3.
3. True or false? Use of the WACC formula assumes
a. A project supports a fixed amount of debt over the project’s economic life.
b. The ratio of the debt supported by a project to project value is constant over the project’s economic life.
c. The firm rebalances debt, each period, keeping the debt-to-value ratio constant.
4. What is meant by the flow-to-equity valuation method? What discount rate is used in this method? What assumptions are necessary for this method to give an accurate valuation? 5. True or false? The APV method
a. Starts with a base-case value for the project.
b. Calculates the base-case value by discounting project cash flows, forecasted assuming all-equity financing, at the WACC for the project.
c. Is especially useful when debt is to be paid down on a fixed schedule.
d. Can be used to calculate an adjusted discount rate for a company or a project.
6. Explain the difference between Financing Rules 1 (debt fixed) and
Quizz, Chapter 19
1.Calculate the weighted-average cost of capital (WACC) for Federated Junkyards of
America, using the following information:
• Debt: $75,000,000 book value outstanding. The debt is trading at 90 percent of par.
The yield to maturity is 9 percent.
• Equity: 2,500,000 shares selling at $42 per share. Assume the expected rate of return on Federated’s stock is 18 percent.
• Taxes: Federated’s marginal tax rate is Tc = .35
What are the key assumptions underlying your calculation? For what type of project would Federated’s weighted-average cost of capital be the right discount rate?
2. Suppose Federated Junkyards decides to move to a more conservative debt policy. A year later its debt ratio is down to 15 percent (D/V =.15 ). The interest rate has dropped to 8.6 percent. Recalculate Federated’s WACC under these new assumptions. The company’s business risk, opportunity cost of capital, and tax rate have not changed. Use the three-step procedure explained in Section 19.3.
3. True or false? Use of the WACC formula assumes
a. A project supports a fixed amount of debt over the project’s economic life.
b. The ratio of the debt supported by a project to project value is constant over the project’s economic life.
c. The firm rebalances debt, each period, keeping the debt-to-value ratio constant.
4. What is meant by the flow-to-equity valuation method? What discount rate is used in this method? What assumptions are necessary for this method to give an accurate valuation? 5. True or false? The APV method
a. Starts with a base-case value for the project.
b. Calculates the base-case value by discounting project cash flows, forecasted assuming all-equity financing, at the WACC for the project.
c. Is especially useful when debt is to be paid down on a fixed schedule.
d. Can be used to calculate an adjusted discount rate for a company or a project.
6. Explain the difference between Financing Rules 1 (debt fixed) and