For each of the four questions below, identify whether the statement made in each question is correct or not and provide explanations. (b) When it comes to determining whether to take a project, the firm needs to calculate the NPV and assess the risk of it. For a highly leveraged firm, if the NPV is negative and the project is very risky, taking it is not beneficial for the firm. More specifically, the equity and debt holders will lose money because the overall firm value is highly likely decreased by that NPV.

For each of the four questions below, identify whether the statement made in each question is correct or not and provide explanations. (b) When it comes to determining whether to take a project, the firm needs to calculate the NPV and assess the risk of it. For a highly leveraged firm, if the NPV is negative and the project is very risky, taking it is not beneficial for the firm. More specifically, the equity and debt holders will lose money because the overall firm value is highly likely decreased by that NPV.

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Which of the following statements is true? Group of answer choices a. Undertaking a negative NPV project may increase the value of a firmʹs equity while decreasing overall firm value b. In order to maximize firm value, management should commit to take on no projects that could decrease the value of the existing debt c. In order to maximize firm value, management should undertake all projects that will maximize the value of its equity d. Undertaking a positive NPV project will always increase the values of both the firmʹs debt and its equity
8. Which of the following statements is FALSE? When a firm faces financial distress, it may choose not to finance new, positive-NPV projects. An under-investment problem occurs when shareholders choose to not invest in a positive-NPV project. Agency costs represent another cost of increasing the firm's leverage that will affect the firm's optimal capital structure choice. The agency costs of debt can arise only if there is no chance the firm will default and impose losses on its debt holders.
1) What is the company's WACC? 2) Should the company take the projects? Assume that the projects have the same risk as an average project for your firm. 3) If one project is depended on the other in a way that the company can only take both projects, should it take it?
may force the firm to forgo positive NPV projects or to rely on costly external equity financing. A Moving to another question will save this response.
Which of the following statements is FALSE? a) The Capital Asset Pricing Model is the most important method for estimating the cost of capital that is used in practice. b) Because the risk that determines expected returns is unsystematic risk, which is measured by beta, the cost of capital for an investment is the expected return available on securities with the same beta. c) A common assumption is that a project has the same risk as the firm. d) To determine a project's cost of capital we need to estimate its beta.
“The stand-alone risk of an individual corporate project may be quite high, but viewed in the context of its effect on stockholders’ risk, the project’s true risk may be much lower." How does the correlation between returns on a project and returns on the firm’s other assets affect the project’s risk?
Consider the following statements about a firm: I. The debt beta of a firm is usually quite low. If we assume that the debt beta is zero, the equity beta of a firm must exceed the asset beta of the firm. II. If the WACC is used to evaluate a project that is more risky than the other operations of the firm, then there is a chance that a project will be rejected incorrectly III. Shareholders, as residual claimants to the profits of a firm, tend to remain owners of highly leveraged firms when they feel that the benefits of the tax deductibility of interest payments to their creditors outweighs the risk of bankruptcy. It is apparent that: a) only statement I is true b) only statement II is true c) only statement III is true d) only statements I and II are true e) only statements I and III are true
Choose all statement(s) that is (are) FALSE. Select one or more alternatives: One advantage of using leverage is that it allows the original owners of the firm to maintain their equity stake. One disadvantage of using leverage is that it always reduces the expected return to equity owners of the firm. In a highly-leveraged firm, an over-investment problem could occur when shareholders choose to invest in a negative-NPV project which reduces the debtholders value. In a highly-leveraged firm, an under-investment problem could occur when shareholders choose to invest in a negative-NPV project which reduces the debtholders value.
Many firms still use the internal rate of return rule instead of net present value. When used properly, the two rules lead to the same decision, but the internal rate of return rule has several pitfalls that can trap the unwary.Explain with reasons, THREE (3) pitfalls of using the internal rate of return rule in appraising capital investment.
firm is considering Projects S and L, whose cash flows are shown below. These projects are matually exclusive, equally ricky, and not repeatable. The CEO wants to use the IRR erterion, while the CFO favor the NPV method. You wer ired to advise the firm on the best procedure. If the wrong decision criterion is used, how much potential value would the firm lose? NACC CFS CFL Ⓒ422001 Ob121617 0 1440 O 4318224 O18647 0 $1.025 $2.150 1 5380 $765 $75 2 $380 3 $380 $765 4 1380 5765
A company should accept for investment all positive NPV investment alternatives when which of the following conditions is true?a. The company has extremely limited resources for capital investment.b. The company has excess cash on its balance sheet.c. The company has virtually unlimited resources for capital investment.d. The company has limited resources for capital investment but is planning to issue new equity to finance additional capital investment.

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