FIN 540 MIDTERM Question 1 Which of the following statements about valuing a firm using the APV approach is most CORRECT? Answer The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the levered cost of equity. The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the cost of debt. The horizon value is calculated by discounting the expected earnings at the WACC. The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the WACC. The horizon value must always be more than 20 years in the future. 8 points Question 2 Operating leases often have terms that include Answer maintenance of the equipment by the lessor . full amortization over the life of the lease. very high penalties if the lease is cancelled. restrictions on how much the leased property can be used. much longer lease periods than for most financial leases. 8 points Question 3 From the lessee viewpoint, the riskiness of the cash flows, with the possible exception of the residual value, is about the same as the riskiness of the lessee's Answer equity cash flows. capital budgeting project cash flows. debt cash flows. pension fund cash flows. sales. 8 points Question 4 Which of the following is generally NOT true and an advantage of going public? Answer Facilitates stockholder diversification. Increases the liquidity of the firm's stock. Makes it easier to obtain new equity capital. Establishes a market value for the firm. Makes it easier for owner - managers to engage in profitable self - dealings . 8 points Question 5 Which of the following statements is NOT CORRECT? Answer When a corporation’s shares are owned by a few individuals who own most of the stock or are part of the firm’s management, we say that the firm is “closely, or privately, held.” “Going public” establishes a firm’s true intrinsic value and ensures that a liquid market will always exist for the firm’s shares. Publicly owned companies have sold shares to investors who are not associated with management, and they must register with and report to a regulatory agency such as the SEC. When stock in a closely held corporation is offered to the public for the first time, the transaction is called “going public,” and the market for such stock is called the new issue market. It is possible for a firm to go public and yet not raise any additional new capital. 8 points Question 6 Which of the following statements is most CORRECT? Answer Tax considerations often play a part in mergers. If one firm has excess cash, purchasing another firm exposes the purchasing firm to additional taxes. Thus, firms with excess cash rarely undertake mergers. The smaller the synergistic benefits of a particular merger, the greater the scope for striking a bargain in negotiations, and the higher the probability that the merger will be completed. Since mergers are frequently financed by debt rather than equity, a lower cost of debt or a greater debt capacity are rarely relevant considerations when considering a merger. Managers who purchase other firms often assert that the new combined firm will enjoy benefits from diversification, including more stable earnings. However, since shareholders are free to diversify their own holdings, and at what’s probably a lower cost, diversification benefits is generally not a valid motive for a publicly held firm. Operating economies are never a motive for mergers. 8 points Question 7 Which of the following statements is most CORRECT? Answer A conglomerate merger is one where a firm combines with another firm in the same industry. Regulations in the United States prohibit acquiring firms from using common stock to purchase another firm. Defensive mergers are designed to make a company less vulnerable to a takeover. Hostle mergers always create value for the acquiring firm. In a tender offer, the target firm’s management always remain after the merger is completed. 8 points Question 8 Which of the following statements is most CORRECT? Answer If new debt is used to refund old debt, the correct discount rate to use in the refunding analysis is the before - tax cost of new debt. The key benefits associated with refunding debt are the reduction in the firm's debt ratio and the creation of more reserve borrowing capacity.