A fiRm Is Considering a Project That Will Generate Perpetual

question 192

Multiple Choice

A firm is considering a project that will generate perpetual cash flows of $15,000 per year beginning next year. The project has the same risk as the firm's overall operations and must be
financed externally. Equity costs 14% and debt costs 4% on an after-tax basis. The firm's D/E ratio is
0) 8. What is the most the firm can pay for the project and still earn its required return?

• A) $138,000
• B) $157,000
• C) $164,000
• D) $182,000
• E) $199,000

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Definitions:

Collateralized Debt Obligations

Collateralized debt obligations (CDOs) are complex financial instruments that pool together cash flow-generating assets and repackages this asset pool into discrete tranches that can be sold to investors.

Default Risk

The potential that a borrower will fail to meet the obligations of a loan or debt agreement.

Mortgages

Loans specifically designed for the purchase of real estate, secured by the property itself.

Sarbanes-Oxley Act

A U.S. federal law enacted in 2002 to protect investors from the possibility of fraudulent accounting activities by corporations.