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Category: Finance
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Experience:  MBA, CPA
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# Leak Inc. forecasts the free cash flows shown below:

### Customer Question

1. Leak Inc. forecasts the free cash flows (in millions) shown below. If the weighted average cost of capital is 11% and FCF is expected to grow at a rate of 5% after Year 2, what is the Year 0 value of operations, in millions? Assume that the ROIC is expected to remain constant in Year 2 and beyond (and do not make any half-year adjustments).
Year:                   1 2
Free cash flow: –\$50 \$100
a. \$1,456
b. \$1,529
c. \$1,606
d. \$1,686
e. \$1,770

2. Suppose Leonard, Nixon, & Shull Corporation's projected free cash flow for next year is \$100,000, and FCF is expected to grow at a constant rate of 6%. If the company's weighted average cost of capital is 11%, what is the value of its operations?
a. \$1,714,750
b. \$1,805,000
c. \$1,900,000
d. \$2,000,000
e. \$2,100,000

3. Akyol Corporation is undergoing a restructuring, and its free cash flows are expected to be unstable during the next few years. However, FCF is expected to be \$50 million in Year 5, i.e., FCF at t = 5 equals \$50 million, and the FCF growth rate is expected to be constant at 6% beyond that point. If the weighted average cost of capital is 12%, what is the horizon value (in millions) at t = 5?
a. \$719
b. \$757
c. \$797
d. \$839
e. \$883

4. Based on the corporate valuation model, Bernile Inc.'s value of operations
is \$750 million. Its balance sheet shows \$50 million of short-term investments that are unrelated to operations, \$100 million of accounts payable, \$100 million of notes payable, \$200 million of long-term debt, \$40 million of common stock (par plus paid-in-capital), and \$160 million of retained earnings. What is the best estimate for the firm's value of equity, in millions?
a. \$429
b. \$451
c. \$475
d. \$500
e. \$525

5. Which of the following statements is CORRECT?
a.When a company increases its debt ratio, the costs of equity and debt both increase. Therefore, the WACC must also increase.
b.The capital structure that maximizes the stock price is generally the capital structure that also maximizes earnings per share.
c. All else equal, an increase in the corporate tax rate would tend to encourage a company to increase its debt ratio.
d. Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC.
e. Since debt is cheaper than equity, increasing a company's debt ratio will always reduce its WACC.

6.Which of the following statements is CORRECT?
a.The capital structure that maximizes the stock price is also the capital structure that minimizes the weighted average cost of capital (WACC).
b.The capital structure that maximizes the stock price is also the capital structure that maximizes earnings per share.
c.The capital structure that maximizes the stock price is also the capital structure that maximizes the firm's times interest earned (TIE) ratio.
d.Increasing a company's debt ratio will typically reduce the marginal costs of both debt and equity financing; however, this still may raise the company's WACC.
e. If Congress were to pass legislation that increases the personal tax rate but decreases the corporate tax rate, this would encourage companies to increase their debt ratios.

7. Business risk is affected by a firm's operations. Which of the following is NOT associated with (or does not contribute to) business risk?
a. Demand variability.
b. Sales price variability.
c. The extent to which operating costs are fixed.
d. The extent to which interest rates on the firm's debt fluctuate.
e. Input price variability.

8. If debt financing is used, which of the following is CORRECT?
a. The percentage change in net operating income will be greater than a given percentage change in net income.
b. The percentage change in net operating income will be equal to a given percentage change in net income.
c. The percentage change in net income relative to the percentage change in net operating income will depend on the interest rate charged on debt.
d. The percentage change in net income will be greater than the percentage change in net operating income.
e. The percentage change in sales will be greater than the percentage change in EBIT, which in turn will be greater than the percentage change in net income.

9. Vu Enterprises expects to have the following data during the coming year. What is Vu's expected ROE?

Assets \$200,000 Interest rate 8%
D/A 65% Tax rate 40% EBIT \$25,000

a. 12.51%
b. 13.14%
c. 13.80%
d. 14.49%
e. 15.21%
Submitted: 7 years ago.
Category: Finance
Expert:  RD replied 7 years ago.

1. Leak Inc. forecasts the free cash flows (in millions) shown below. If the weighted average cost of capital is 11% and FCF is expected to grow at a rate of 5% after Year 2, what is the Year 0 value of operations, in millions? Assume that the ROIC is expected to remain constant in Year 2 and beyond (and do not make any half-year adjustments).
Year: 1 2
Free cash flow: -\$50 \$100
a. \$1,456
b. \$1,529
c. \$1,606
d. \$1,686
e. \$1,770

2. Suppose Leonard, Nixon, & Shull Corporation's projected free cash flow for next year is \$100,000, and FCF is expected to grow at a constant rate of 6%. If the company's weighted average cost of capital is 11%, what is the value of its operations?
a. \$1,714,750
b. \$1,805,000
c. \$1,900,000
d. \$2,000,000
e. \$2,100,000

3. Akyol Corporation is undergoing a restructuring, and its free cash flows are expected to be unstable during the next few years. However, FCF is expected to be \$50 million in Year 5, i.e., FCF at t = 5 equals \$50 million, and the FCF growth rate is expected to be constant at 6% beyond that point. If the weighted average cost of capital is 12%, what is the horizon value (in millions) at t = 5?
a. \$719
b. \$757
c. \$797
d. \$839
e. \$883

4. Based on the corporate valuation model, Bernile Inc.'s value of operations
is \$750 million. Its balance sheet shows \$50 million of short-term investments that are unrelated to operations, \$100 million of accounts payable, \$100 million of notes payable, \$200 million of long-term debt, \$40 million of common stock (par plus paid-in-capital), and \$160 million of retained earnings. What is the best estimate for the firm's value of equity, in millions?
a. \$429
b. \$451
c. \$475
d. \$500
e. \$525

Link to calculation on above questions

5. Which of the following statements is CORRECT?
a.When a company increases its debt ratio, the costs of equity and debt both increase. Therefore, the WACC must also increase.
b.The capital structure that maximizes the stock price is generally the capital structure that also maximizes earnings per share.
c. All else equal, an increase in the corporate tax rate would tend to encourage a company to increase its debt ratio.
d. Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC.
e. Since debt is cheaper than equity, increasing a company's debt ratio will always reduce its WACC.

6.Which of the following statements is CORRECT?
a.The capital structure that maximizes the stock price is also the capital structure that minimizes the weighted average cost of capital (WACC).
b.The capital structure that maximizes the stock price is also the capital structure that maximizes earnings per share.
c.The capital structure that maximizes the stock price is also the capital structure that maximizes the firm's times interest earned (TIE) ratio.
d.Increasing a company's debt ratio will typically reduce the marginal costs of both debt and equity financing; however, this still may raise the company's WACC.
e. If Congress were to pass legislation that increases the personal tax rate but decreases the corporate tax rate, this would encourage companies to increase their debt ratios.

7. Business risk is affected by a firm's operations. Which of the following is NOT associated with (or does not contribute to) business risk?
a. Demand variability.
b. Sales price variability.
c. The extent to which operating costs are fixed.
d. The extent to which interest rates on the firm's debt fluctuate.
e. Input price variability.

8. If debt financing is used, which of the following is CORRECT?
a. The percentage change in net operating income will be greater than a given percentage change in net income.
b. The percentage change in net operating income will be equal to a given percentage change in net income.
c. The percentage change in net income relative to the percentage change in net operating income will depend on the interest rate charged on debt.
d. The percentage change in net income will be greater than the percentage change in net operating income.
e. The percentage change in sales will be greater than the percentage change in EBIT, which in turn will be greater than the percentage change in net income.

9. Vu Enterprises expects to have the following data during the coming year. What is Vu's expected ROE?

Assets \$200,000 Interest rate 8%
D/A 65% Tax rate 40% EBIT \$25,000

a. 12.51%
b. 13.14%
c. 13.80%
d. 14.49%
e. 15.21%