Author Question: Which choice has a greater present value if we assume a required rate of return of 10? 1: A lump ... (Read 43 times)

P68T · **on:** Jul 11, 2018

Which choice has a greater present value if we assume a required rate of return of 10?

1: A lump sum cash flow today of 248.69, 2: 100 cash flows occurring one, two, and three years from today, or 3: a single cash flow of 331 three years from today.
A) Choice 1
B) Choice 2
C) Choice 3
D) The choices all have equal present values at a discount rate of 10.

Question 2

Vegan Foods Inc has a current capital structure of 30 debt, 70 equity, and are in a 40 tax bracket. However, after speaking with their investment bankers they have decided to increase their debt to 40 of total capital.

Some of the firm's managers are concerned that there may an increase in risk for stockholders due to the increased financial obligations resulting from the increased debt load. Currently, the levered beta for the firm is 1.20.

Use your knowledge of levered and unlevered betas to estimate the new levered beta for existing shareholders.

asware1 · **Reply #1 on:** Jul 11, 2018

Answer to Question 1

D

Answer to Question 2

To begin we will use the equation U =L/1+(D/E)(1-t) where U =1.20/1+(.30/.70)(1-.40) = 0.9545. The unlevered beta represents the riskiness of the existing assets without regard to how they are financed. With this information we can estimate the value of the levered beta assuming the new capital structure. Here, L =1+ (D/E)(1-t) U L =1+ (.40/.60)(1-.40) 0.9545 = 1.336.