accounts data bank

Use the information for the question(s) below.

Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with

each outcome being equally likely. The initial investment required for the project is $80,000, and the project?s cost of

capital is 15%. The risk-free interest rate is 5%.

1) Suppose that to raise the funds for the initial investment, the project is sold to investors as an all-equity firm.

The equity holders will receive the cash flows of the project in one year. The market value of the unlevered

equity for this project is closest to:

A) $94,100

B) $90,000

C) $86,250

D) $98,600

2) Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk free rate, then

the value of the firm?s levered equity from the project is closest to:

A) $0

B) $10,000

C) $6,000

D) $8,600

3) Suppose thatto raise the funds forthe initial investment the firm borrows $80,000 at the risk free rate, then

the cost of capital for the firm?s levered equity is closest to:

A) 45%

B) 25%

C) 15%

D) 95%

4) Two separate firms are considering investing in this project. Firm unlevered plans to fund the entire $80,000

investment using equity, while firm levered plans to borrow $45,000 at the risk-free rate and use equity to

finance the remainder of the initial investment. Calculate the expected returns for both the levered and

unlevered firm.

5) Which of the following is not one of Modigliani and Miller?s set of conditions referred to as perfect capital

markets?

A) All investors hold the efficient portfolio of assets.

B) There are no taxes, transaction costs, or issuance costs associated with security trading.

C) A firm?s financing decisions do not change the cash flows generated by its investments, nor do they

reveal new information about them.

D) Investors and firms can trade the same set of securities at competitive market prices equal to the

present value of their future cash flows.

6) Which of the following statements is false?

A) While debt itself may be cheap, it increases the risk and therefore the cost of capital of the firm?s equity.

B) Although debt does not have a lower cost of capital than equity, we can consider this cost in isolation.

C) We can use Modigliani and Miller?s first proposition to derive an explicit relationship between leverage

and the equity cost of capital.

D) The total market value of the firm?s securities is equal to the market value of its assets, whether the firm

is unlevered or levered.

7) Which of the following statements is false?

A) The levered equity return equals the unlevered return, plus an extra?kick? due to leverage.

B) By holding a portfolio of the firm’s equity and its debt, we can replicate the cash flows from holding its

levered equity.

C) The cost of capital of levered equity is equal to the cost of capital of unlevered equity plus a premium

that is proportional to the market value debt-equity ratio.

D) If a firm is unlevered, all of the free cash flows generated by its assets are available to be paid out to its

equity holders.

8) Which of the following statements is false?

A) With no debt, the WACC is equal to the unlevered equity cost of capital.

B) With perfect capital markets, a firm?s WACC is dependent of its capital structure and is equal to its

equity cost of capital only the firm it is unlevered.

C) As the firm borrows at the low cost of capital for debt, its equity cost of capital rises, but the net effect is

that the firm?s WACC is unchanged.

D) Although debt has a lower cost of capital than equity, leverage does not lower a firm?s WACC.

Use the information for the question(s) below.

9) Suppose that you borrow only $45,000 in financing the project. According to MM proposition II, calculate

the firm?s equity cost of capital.

10) Sisyphean Bolder Movers Incorporated has no debt, a total equity capitalization of $50 billion, and a beta of

2.0. Included in Sisyphean?s assets are $12 billion in cash and risk-free securities. Calculate Sisyphean?s

enterprise value and unlevered cost of equity considering the fact that Sisyphean?s cash is risk-free.