Question 1

A balance sheet that uses market value of expected cash flows is referred to as a:&#10;A) cash flow statement.&#10;B) finance balance sheet.&#10;C) market value balance sheet.&#10;D) such balance sheet does not exist.

Accepted Answer

To understand how financial analysts estimate their companies' costs of capital, you must be familiar with a concept that we call the finance balance sheet. The finance balance sheet is like the accounting balance sheet. The main difference is that it is based on market values rather than book values.

Question 2

Chapman Ltd has a preference share issue outstanding with a current price of $26.57. The company is expected to pay a dividend of $1.86 per share a year from today. What is the company's cost of preference shares?

A) 6.50%.
B) 7.00%.
C) 7.50%.
D) 8.00%.

7.00%.

Accepted Answer

The cost of preference shares is calculated by dividing the annual dividend by the current price of the preference share. Here, $1.86 / $26.57 = 0.07 or 7.00%.

Question 3

The Rhapsody Day Spa Co has invested 40 percent of the company's assets in a project with a beta of 0.4 and the remaining assets in a project with a beta of 1.8. What is the beta of the company?&#10;A) 0.96.&#10;B) 1.24.&#10;C) 1.28.&#10;D) None of the above.

Accepted Answer

The beta of the company is calculated as a weighted average of the betas of its investments. For the first project, the weight is 40% (or 0.4) and its beta is 0.4, contributing 0.4 * 0.4 = 0.16 to the overall beta. For the second project, the weight is 60% (or 0.6, since it's the remainder of the assets) and its beta is 1.8, contributing 0.6 * 1.8 = 1.08 to the overall beta. Adding these contributions together, 0.16 + 1.08 = 1.24, which is the company's beta.

Question 4

Which of the following statements is correct?&#10;A) The WACC is the appropriate discount rate to use for cash flows similar in risk to the firm.&#10;B) The WACC for a firm reflects the risk and the target capital structure to finance the firm's existing assets as a whole.&#10;C) The WACC is the weighted average of the costs of the different types of capital (debt and equity) that have been used to finance a company; the cost of each type of capital is weighted by the proportion of the total capital that it represents.&#10;D) All of the above.

Accepted Answer

All the statements are true.

Question 5

Which of the following statement is false?&#10;A) The market value of debt is used in the calculation of WACC.&#10;B) Historical costs do not belong in WACC calculations.&#10;C) The current cost of long-term debt is what matters when calculating WACC.&#10;D) None of the above.

Accepted Answer

All of them are true.

Question 6

Which of the following is not used as a capital base in the WACC calculation?&#10;A) Debentures.&#10;B) Bank overdraft.&#10;C) Preference shares.&#10;D) Accounts receivables.

Accepted Answer

Only debts and equity are used as capital base.

Question 7

Which of the following is most likely to account for business failure in Australia?&#10;A) Civil disturbance.&#10;B) Uninsured cyclone damage.&#10;C) Insufficient working capital.&#10;D) Loss of funds due to failure of local bank.

Accepted Answer

Cyclones only affect a small part of Australia. Australia is noted for its political stability: arguably there have been no major civil disturbances since the Eureka Stockade. No Australian bank has failed since federation.

Question 8

In managing the level of working capital, which of the following is generally not a concern:&#10;A) the need to maintain liquidity.&#10;B) the need to earn the required rate of return on the assets.&#10;C) the cost and risk of long-term funding.&#10;D) none of the above.

Accepted Answer

It is the cost and risk of short-term funding which is of concern.

Question 9

To maintain liquidity, firms may:&#10;A) use cash budgeting.&#10;B) use a bank overdraft.&#10;C) keep an overestimate of cash required on hand at all times.&#10;D) all of the above.

Accepted Answer

All the options mentioned are strategies firms can use to maintain liquidity. Cash budgeting helps in planning inflows and outflows of cash, a bank overdraft provides immediate funds when needed, and keeping an overestimate of cash ensures that there are always funds available for unexpected expenses.

Question 10

Which of the following statements relates to the matching principle?&#10;A) Permanent assets should be financed with short-term sources of funding.&#10;B) Permanent assets should be sourced with permanent sources of funding.&#10;C) Temporary assets should be sourced with permanent sources of funding.&#10;D) None of the above.

Accepted Answer

The matching principle in finance suggests that permanent assets should be financed with permanent sources of funding to ensure stability and alignment of asset and liability durations.

Question 11

Factoring businesses normally require client firms to satisfy which of the following?&#10;A) Have a spread of debtors.&#10;B) Have efficient debtors' ledgers.&#10;C) Sell goods on normal, credit terms.&#10;D) All of the above.

Accepted Answer

The answer of Factoring businesses normally require client firms to...

Deck 7: Cost of Capital and Working Capital Management