SD11- The Adjusted Present Value Model

SD11- The Adjusted Present Value Model - CHAPTER 11 THE...

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CHAPTER 11 THE ADJUSTED PRESENT VALUE MODEL LEARNING OBJECTIVES 1. How the adjusted present value model works. 2. The different ways in which the free cash flow and adjusted present value models capture the valuation benefits of leverage. 3. The Modigliani-Miller Propositions on capital structure irrelevance. 4. How the “side effects” of leverage can affect firm value. 5. How the relationship between the marginal corporate tax rate, the marginal tax rate on personal interest deductions, and the marginal tax rate on personal income from equity securities determine the tax benefits of leverage for a firm. 6. How to estimate the value of leverage to a firm. 7. How financial distress can affect a firm’s value. 8. The pros and cons of the adjusted present value model. TRUE/FALSE QUESTIONS 1. To understand the adjusted present value model (APV), the analyst needs to understand the relationship between value and leverage. (easy, L.O. 1, Section 1, true) 2. The APV model estimates the value of a firm’s core operations in two parts, one without leverage, the other using leverage to add value to core operations. (moderate, L.O. 1, Section 2, true) 3. The APV model captures the value created by leverage better than the free cash flow model. (moderate, L.O. 2, Section 2, true) 4. The APV model discounts the free cash flow stream at the weighted-average cost of capital. (moderate, L.O. 2, Section 2, false) 5. Whether analysts use the APV or free cash flow models, the value effect of leverage is always the same. (difficult, L.O. 2, Section 2, true) 6. The Modigliani-Miller (MM) propositions are to corporate finance what the law of the preservation of mass is to physics. (moderate, L.O. 3, Section 3, true) 7. The concept of capital structure irrelevance is not useful in the valuation of a firm. (moderate, L.O. 3, Section 3, false) 8. The MM propositions explain that the value of an asset is not related to how that asset is financed. (moderate, L.O. 3, Section 3, false) 9. In the MM proposition without taxes, debt is substituted for equity, demonstrating that leverage creates value. (difficult, L.O. 3, Section 3, false) 71
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10. The MM proposition with taxes shows that leverage creates value due to the results of tax benefits the firm receives. (moderate, L.O. 3, Section 3, true) 11. When analysts say that financial distress is costly, this simply means that shareholders might lose their investment. (moderate, L.O. 3, Section 3, false) 12. There is no evidence that a firm’s capital structure can influence its operating decisions. (moderate, L.O. 3, Section 3, false) 13. A managerial perquisite such as a corporate jet is called the agency cost of free cash flow.
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SD11- The Adjusted Present Value Model - CHAPTER 11 THE...

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