Practice Questions week 4

Chapter 14
Q1
Consider two firms, With and Without, that have identical assets that generate identical cash
flows. Without is an all-equity firm, with 1 million shares outstanding that trade for a price of
$24 per share. With has 2 million shares outstanding and $12 million dollars in debt at an
interest rate of 5%.

According to MM Proposition 1, the stock price for With is closest to:

A) $8.00
B) $24.00
C) $6.00
D) $12.00

Q2
Suppose that Taggart Transcontinental currently has no debt and has an equity cost of capital
of 10%. Taggart is considering borrowing funds at a cost of 6% and using these funds to
repurchase existing shares of stock. Assume perfect capital markets. If Taggart borrows
until they achieved a debt -to-value ratio of 20%, then Taggart's levered cost of equity would
be closest to:
A) 8.0%
B) 9.2%
C) 10.0%
D) 11.0%

Use the following information to answer the question(s) below.

Galt Industries has no debt, total equity capitalization of $600 million, and an equity beta of
1.2. Included in Galt's assets is $90 million in cash and risk-free securities. Assume the risk-
free rate is 4% and the market risk premium is 6%.

Q3)
Galt's enterprise value is closest to:
A) $90 million
B) $510 million
C) $600 million
D) $690 million

Q4)
The beta on Galt's operating assets is closest to:
A) 1.1
B) 1.2
C) 1.3
D) 1.4
Q5)
Galt's WbACC to be used to evaluate projects in the line of its current business activities is
closest to:
A) 10.6%
B) 11.2%
C) 11.8%
D) 12.5%

Use the information for the question(s) below.

You are evaluating a new project and need an estimate for your project's beta. You have
identified the following information about three firms with comparable projects:

Firm Equity Debt Debt to

Name Beta Beta Equity Ratio
Lincoln 1.25 0 0.25
Blinkin 1.6 0.2 1
Nod 2.3 0.3 1.5

Q6)

The unlevered beta for Lincoln is closest to:

A) 0.95
B) 1.00
C) 1.05
D) 0.90
Use the table for the question(s) below.

Consider the following income statement for Kroger Inc. (all figures in $ Millions):

Year 2006 2005 2004

Total Sales 60,553 56,434 53,791
Cost of goods sold 45,565 42,140 39,637
Selling, general & admin
expenses 11,688 12,191 11,575
Depreciation 1,265 1,256 1,209
Operating Income 2,035 847 1,370
Other Income 0 0 0
EBIT 2,035 847 1,370
Interest expense 510 557 604
Earnings before tax 1,525 290 766
Taxes (35%) 534 102 268
Net Income 991 189 498
Chapter 15
Q7)
The interest rate tax shield for Kroger in 2006 is closest to:
A) $187 million
B) $332 million
C) $534 million
D) $179 million

Q8)
The total amount available to payout to all the investors in Kroger in 2006 is closest to:
A) $990 million
B) $1,525 million
C) $1,500 million
D) $2,035 million

Shepard Industries expects free cash flow of $10 million each year. Shepard's corporate tax
rate is 35%, and its unlevered cost of equity is 10%. The firm also has outstanding debt of
$40 million and it expects to maintain amount of debt permanently.

Q9)

The value of Shepard Industries without leverage is closest to:

A) $114 million
B) $50 million
C) $100 million
D) $64 million

Q10)

The value of Shepard Industries with leverage is closest to:

A) $64 million
B) $100 million
C) $135 million
D) $114 million