Fight Finance

Question 78  WACC, capital structure

A company issues a large amount of bonds to raise money for new projects of similar risk to the company's existing projects. The net present value (NPV) of the new projects is positive but small. Assume a classical tax system. Which statement is NOT correct?

(a) The debt-to-assets (D/V) ratio will increase.

(b) The debt-to-equity ratio (D/E) will increase.

(c) Firm value is likely to have increased due to the higher amount of interest tax shields, assuming that there will not be any costs of financial distress.

(d) The company's after-tax WACC is likely to have decreased.

(e) The company's before-tax WACC is likely to have decreased.

Question 95  interest tax shield

The equations for Net Income (NI, also known as Earnings or Net Profit After Tax) and Cash Flow From Assets (CFFA, also known as Free Cash Flow to the Firm) per year are:

###NI=(Rev-COGS-FC-Depr-IntExp).(1-t_c)###

###CFFA=NI+Depr-CapEx - \varDelta NWC+IntExp###

For a firm with debt, what is the formula for the present value of interest tax shields if the tax shields occur in perpetuity?

You may assume:

• the value of debt (D) is constant through time,
• The cost of debt and the yield on debt are equal and given by ##r_D##.
• the appropriate rate to discount interest tax shields is ##r_D##.
• ##\text{IntExp}=D.r_D##

(a) ##D.t_c##

(b) ##D.r_D/t_c ##

(c) ##D.r_D.(1-t_c)##

(d) ##D.r_D/(1-t_c)##

(e) ##D.r_D.(t_c-1)##

Question 121  capital structure, leverage, financial distress, interest tax shield

Fill in the missing words in the following sentence:

All things remaining equal, as a firm's amount of debt funding falls, benefits of interest tax shields __________ and the costs of financial distress __________.

(a) Fall, fall.

(b) Fall, rises.

(c) Rise, fall.

(d) Rise, rise.

(e) Remain unchanged, remain unchanged.

Question 298  interest only loan

A prospective home buyer can afford to pay $2,000 per month in mortgage loan repayments. The central bank recently lowered its policy rate by 0.25%, and residential home lenders cut their mortgage loan rates from 4.74% to 4.49%.

How much more can the prospective home buyer borrow now that interest rates are 4.49% rather than 4.74%? Give your answer as a proportional increase over the original amount he could borrow (##V_\text{before}##), so:

###\text{Proportional increase} = \frac{V_\text{after}-V_\text{before}}{V_\text{before}} ###

Assume that:

• Interest rates are expected to be constant over the life of the loan.

• Loans are interest-only and have a life of 30 years.

• Mortgage loan payments are made every month in arrears and all interest rates are given as annualised percentage rates compounding per month.

(a) 0.055679

(b) 0.029631

(c) 0.029547

(d) 0.006245

(e) 0.0025

Question 476  income and capital returns, idiom

The saying "buy low, sell high" suggests that investors should make a:

(a) Positive income return.

(b) Positive capital return.

(c) Negative income return.

(d) Negative capital return.

(e) Positive total return.

Question 501  NPV, IRR, pay back period

The below graph shows a project's net present value (NPV) against its annual discount rate.

Which of the following statements is NOT correct?

(a) When the project's discount rate is 18% pa, the NPV is approximately -$30m.

(b) The payback period is infinite, the project never pays itself off.

(c) The addition of the project's cash flows, ignoring the time value of money, is approximately $20m.

(d) The project's IRR is approximately 5.5% pa.

(e) As the discount rate rises, the NPV falls.

Question 574  inflation, real and nominal returns and cash flows, NPV

What is the present value of a nominal payment of $100 in 5 years? The real discount rate is 10% pa and the inflation rate is 3% pa.

(a) $71.2986

(b) $62.0921

(c) $61.5028

(d) $54.276

(e) $53.5612

Question 659  APR, effective rate, effective rate conversion, no explanation

A home loan company advertises an interest rate of 9% pa, payable monthly. Which of the following statements about the interest rate is NOT correct? All rates are given with an accuracy of 4 decimal places.

(a) The APR compounding monthly is 9.000% pa.

(b) The effective monthly rate is 0.7500% pa.

(c) The effective annual rate is 9.3807% pa.

(d) The effective 6 month rate is 4.5000% pa.

(e) The APR compounding semi-annually is 9.1704% pa.

Question 878  foreign exchange rate, American and European terms

If the Australian dollar quote of 0.8 USD per AUD suddenly falls to 0.7 USD per AUD, has the Australian dollar or against the US dollar?

Question 894  balance of payments, current account, no explanation

Below are four graphs of Australia's external position, published in the RBA's chart pack.

Assume that all assets and liabilities are debt which makes interest income and equity which makes dividend income.

Which of the following statements is NOT correct? As at the end of 2017, Australia’s:

(a) Trade surplus was roughly zero, so Australians exported as much as they imported.

(b) Net Income was negative, so Australians paid more dividends and interest to foreigners than they received. This is probably because Australia has greater gross foreign liabilities than gross foreign assets.

(c) Current account deficit means Australians have to lend to foreigners by buying foreigners’ debt and equity which represent net capital outflows out of Australia.

(d) Net foreign equity liabilities were negative (less than zero) so Australians had positive net foreign equity assets which means that Australians owned more foreign shares than foreigners owned of Australian shares.

(e) Persistent current account deficit will make its net foreign liabilities greater and greater.