1. One way companies protect themselves from borrowing too much is to put aconstrain the bond rating, i.e., not allow the debt ratio to increase so much that therating (synthetic or estimated) drops below the rating constraint. For a non- financialservice company, that rating constraint is often investment grade (BBB). Which of thefollowing reasons explains this rating constraint?

2.

The argument for debt as a mechanism to discipline management is built around the premise that stockholders generally have little power over managers. If this argument holds true, a company that borrows more money should

3. Agency costs arise any time there is a conflict between stockholder interests andlender interests. Assuming that agency costs are high at a company, relative to the restof the market, which of the following would you expect to observe with the company’sborrowing?

4. A cost that has to be weighed into the debt decision is the expected cost of bankruptcy. As that cost rises, companies should borrow less money. Assume that you are looking at a European power company that has historically enjoyed monopoly power and has funded itself with a significant amount of debt. The power market has now been opened up to competition. What change would you expect to see in the company’s debt policy?

McCormick & Company is considering a project that requires an initial investment of $24 million to build a new plant and purchase equipment. The investment will be depreciated as a modified accelerated cost recovery system (MACRS) seven-year class asset. The new plant will be built on some of the company's land, which has a current, after-tax market value of $4.3 million.

The company will produce bulk units at a cost of $130 each and will sell them for $420 each. There are annual fixed costs of $500,000. Unit sales are expected to be $150,000 each year for the next six years, at which time the project will be abandoned. At that time, the plant and equipment is expected to be worth $8 million (before tax) and the land is expected to be worth $5.4 million (after tax).

To supplement the production process, the company will need to purchase $1 million worth of inventory. That inventory will be depleted during the final year of the project. The company has $100 million of debt outstanding with a yield to maturity of 8 percent, and has $150 million of equity outstanding with a beta of 0.9. The expected market return is 13 percent, and the risk-free rate is 5 percent. The company's marginal tax rate is 40 percent.

Questions

1. What will be the tax depreciation each year?

2. What will be the value of the plant and equipment for tax purposes in year six? Will it be sold for a gain or a loss, and what will the tax effect be?

3. What is the weighted average cost of capital (WACC)?

4. What is the salvage cash flow of the new equipment? Include the income tax effect.

5. What is the total operating cash flows, given the following operating cash flows:

Sales = 150,000 x $420 = $63,000,000

Costs = 150,000 x $130 + $500,000 = $20,000,000

6. Create an after-tax cash flow timeline.

7. What are the total expected cash flows at the end of year six? The $4.3 million is an opportunity cost and must be included at date zero as a cash outflow. If the project is accepted, however, the land can be sold in six years for $5.4 million.

8. Find the NPV using the after-tax WACC as the discount rate.

9. Find the IRR.

10. Should the project be accepted? Discuss whether NPV or IRR creates the best decision rule.

Table 13-7
The Flying Elvis Copter Rides

Refer to Table 13-7. What is the value of G?

Group of answer choices

$120

$220

$270

$30

Multiple choice: The presence of a black hole in a galaxy core can be inferred from (a) the total mass of the galaxy; (b) the speeds of stars near the core; (c) the color of the galaxy; (d) the distance of the galaxy from the Milky Way Galaxy; or (e) the diminished brightness of starlight in the galaxy core, relative to surrounding areas.

Multiple choice: Which one of the following statements about black holes is false? (a) Inside a black hole, matter is thought to consist primarily of iron, the endpoint of nuclear fusion in massive stars. (b) Photons escaping from the vicinity of (but not inside) a black hole lose energy, yet still, travel at the speed of light. (c) Near the event horizon of a small black hole (mass = a few solar masses), tidal forces stretch objects apart. (d) A black hole that has reached an equilibrium configuration can be described entirely by its mass, electric charge, and amount of spin (“angular momentum”). (e) A black hole has an “event horizon” from which no light can escape, according to classical (i.e., non-quantum) ideas.

Multiple choice: Which one of the following statements about black holes is true? (a) The surface of the singularity of a black hole is known as the event horizon. (b) Being more massive, a supermassive black hole has a greater gravitational pull than a stellar-mass black hole, so if you approach the event horizon of a supermassive black hole, you will be torn apart more easily than if you approach the event horizon of a stellar-mass black hole. (c) If the Sun were to become a black hole of the same mass, Earth would spiral into the black hole and be eaten. (d) The “photon sphere” is a region inside a black hole where photons orbit the center, so they cannot escape. (e) In principle, energy can be extracted from a region outside a rotating black hole.

Multiple choice: Which one of the following statements about the detection (or potential detection) of black holes is false? (a) Black holes cannot be detected because they emit no light and are therefore impossible to directly observe. (b) A binary pair of black holes was recently detected through measurements of the gravitational waves emitted when they merged to form a single black hole. (c) The presence of supermassive black holes in the centers of galaxies has been inferred from the motions of stars and gas near them. (d) Evidence for black holes can be found if material in the surrounding accretion disk goes through the event horizon and fades from view, rather than releasing energy as it hits a hard stellar surface. (e) Candidate black holes are sometimes found in binary systems that suddenly brighten at X-ray wavelengths.