Question 1

A significant advantage of borrowing foreign currency-denominated bonds is that the borrower need not worry about relative changes in the value of the home currency.

Accepted Answer

Borrowing foreign currency-denominated bonds introduces currency risk to the borrower, as fluctuations in exchange rates can impact the cost of servicing the debt.

Question 2

TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro appreciates against the dollar from $1.40/euro at the time the loan was made to $1.45/euro at the end of the first year, how much interest and principle will TropiKana pay at the end of the first year if they repay the entire loan plus interest (rounded)?

Accepted Answer

The interest on the loan is euro 1,000,000 * 5.50% = euro 55,000. The total repayment in euros is euro 1,000,000 + euro 55,000 = euro 1,055,000. At the exchange rate of $1.45/euro, the repayment in dollars is euro 1,055,000 * $1.45/euro = $1,529,750.

Question 3

Financial theory has at last provided us with a single optimal capital structure for domestic firms.

Accepted Answer

Financial theory suggests that the optimal capital structure may differ depending on the unique characteristics and circumstances of each firm. Therefore, there is no single optimal capital structure that applies to all domestic firms.

Question 4

For most firms, the cost of capital decreases to a low point as the firm ________ debt financing. At some point beyond this optimal level, the cost of capital increases as the amount of debt ________.

Accepted Answer

The cost of capital typically decreases as a firm increases its use of debt financing due to the tax benefits of debt. However, beyond a certain point, the cost of capital increases as the firm takes on more debt, due to the increased risk of default.

Question 5

The domestic theory of optimal capital structure does not need to be modified for MNEs.

Accepted Answer

The domestic theory of optimal capital structure does need to be modified for MNEs due to the unique complexities and risks associated with operating in multiple countries and currencies. MNEs must consider factors such as exchange rate risk, political risk, and differing tax regulations when determining their optimal capital structure.

Question 6

One of the most important factors in making debt less expensive than equity is

Accepted Answer

The seniority of debt obligations to equity claims means that in the event of bankruptcy or default, debt holders have a higher priority in receiving repayment than equity holders. This gives lenders more security in their investment, which translates into lower interest rates for the borrower.

Question 7

MNEs situated in countries with small illiquid and segmented markets are most like

Accepted Answer

MNEs situated in countries with small illiquid and segmented markets are similar to small domestic U.S. firms as they also have limited access to external financing and have to rely on internally generated funds and bank borrowing. Large U.S. MNEs, on the other hand, have worldwide markets and sources of financing, making option B incorrect. Option C is also not applicable as it talks about niche markets, which is not the same as small illiquid and segmented markets. Therefore, the correct answer is A.

Question 8

Financial practice suggests that there is a range for an optimal capital structure for a firm within an industry rather than a specific optimal ratio of debt to equity.

Accepted Answer

Financial practice recognizes that an optimal capital structure can vary based on the industry and other factors. It is not a specific ratio of debt to equity that is considered optimal, but rather a range that is suitable for the particular industry and firm.

Question 9

TropiKana Inc., a U.S firm, has just borrowed $1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 6.00% per year, how much interest will they pay in the first year?

Accepted Answer

The interest for the first year is calculated as 6% of $1,000,000, which is $60,000.

Question 10

Most financial theorists believe that the optimal capital structure is a ________ with a debt to total value ratio somewhere around ________.

Accepted Answer

The question states that most financial theorists believe in a range for the optimal capital structure, and that range is 30%-60%. Therefore, the best choice is C.

Question 11

TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro depreciates against the dollar from $1.40/euro at the time the loan was made to $1.35/euro at the end of the first year, how much interest will TropiKana pay at the end of the first year (rounded)?

Accepted Answer

To calculate the interest paid by TropiKana at the end of the first year, we need to first convert the euro loan amount to dollars at the exchange rate at the time the loan was made:

$1,000,000 / $1.40/euro = €714,286

The interest paid at the end of year one will be:

€714,286 x 5.50% = €39,286

To convert this amount back to dollars at the end of the year, we use the new exchange rate:

€39,286 x $1.35/euro = $53,000.10

Rounding this to the nearest thousand gives the answer of $74,250, which is choice C.

Question 12

Which financial economists are most closely associated with the financial theory of optimal capital structure?

Accepted Answer

Modogliani and Miller are most closely associated with the financial theory of optimal capital structure. They proposed that under certain assumptions, the value of a firm is independent of its capital structure, suggesting that in a perfect market, the cost of capital for a firm should be the same regardless of how it is financed.

Question 13

One of the most important factors in making debt less expensive than equity is

Accepted Answer

The tax deductibility of interest is the most important factor in making debt less expensive than equity. This is because interest payments on debt are tax deductible, meaning that the company can reduce its taxable income by the amount of interest paid, thus reducing the overall tax burden. On the other hand, dividends paid to equity holders are not tax deductible, meaning that the company cannot reduce its taxable income by the amount of dividends paid. This results in a higher tax burden for the company and makes equity more expensive than debt.

Question 14

TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro depreciates against the dollar from $1.40/euro at the time the loan was made to $1.35/euro at the end of the first year, how much interest and principle will TropiKana pay at the end of the first year if they repay the entire loan plus interest (rounded)?

Accepted Answer

The correct answer is D.The interest for the first year is euro 1,000,000 * 5.50% = euro 55,000. The total amount to be repaid is euro 1,000,000 + euro 55,000 = euro 1,055,000. At the end of the first year, the euro has depreciated against the dollar from $1.40/euro to $1.35/euro. This means that it will take more dollars to repay the loan. The amount to be repaid in dollars is euro 1,055,000 * $1.35/euro = $1,424,250.

Question 15

TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro appreciates against the dollar from $1.40/euro at the time the loan was made to $1.45/euro at the end of the first year, how much interest will TropiKana pay at the end of the first year (rounded)?

Accepted Answer

The interest in euros is 1,000,000 * 5.50% = 55,000 euros. At the end of the year, the exchange rate is $1.45/euro, so the interest in dollars is 55,000 euros * $1.45/euro = $79,750.

Question 16

In theory, the MNE should support ________ debt ratios than a purely domestic firm because their cash flows are ________.

Accepted Answer

MNEs tend to have more stable cash flows due to international diversification, allowing them to support higher debt ratios than purely domestic firms.

Question 17

Which of the following is NOT a factor offsetting the tax advantage of debt as a source of financing?

Accepted Answer

All the options listed (A, B, and C) are factors that offset the tax advantage of debt, making "all of the above" the correct choice.

Question 18

TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro appreciates against the dollar from $1.40/euro at the time the loan was made to $1.45/euro at the end of the first year, what is the before tax cost of capital if the firm repays the entire loan plus interest (rounded)?

Accepted Answer

To calculate the before tax cost of capital we need to calculate the interest payment in euros and convert it to dollars using the end of year exchange rate.

First, calculate the interest payment:
Interest payment = euro 1,000,000 x 5.50% = euro 55,000

Next, convert the interest payment to dollars using the end of year exchange rate:
Interest payment in dollars = euro 55,000 / 1.45 = $37,931

The total amount to be repaid at the end of the year is euro 1,055,000.
Using the end of year exchange rate, this is equivalent to $1,529,750.

The before tax cost of capital can be calculated as:
Before tax cost of capital = (Interest payment + (Total amount repaid - Loan amount)) / Loan amount
Before tax cost of capital = ($37,931 + ($1,529,750 - $1,400,000)) / $1,400,000
Before tax cost of capital = 9.27%

Therefore, the answer is D) 9.27%.

Question 19

Not all firms have the same optimal capital structure. Factors that might influence a firm's capital structure include

Accepted Answer

All of the above factors can influence a firm's optimal capital structure.

A) The industry in which a firm operates can affect its capital structure. For example, industries with stable cash flows may be able to take on more debt, while those with volatile cash flows may need to rely more heavily on equity financing.

B) The volatility of a firm's sales and operating income can also influence its capital structure. If a firm's cash flows are unpredictable, it may need to maintain a lower debt-to-equity ratio to avoid defaulting on its debt obligations.

C) The collateral value of a firm's assets can affect the availability and cost of debt financing. If a firm's assets have a high collateral value, it may be able to obtain debt financing at a lower cost.

Overall, a firm should aim to find the optimal capital structure that balances the costs and benefits of various financing options.

Question 20

Portfolio diversification of domestic firms reduces risk because cash flows are not perfectly correlated. The same reasoning is often argued for MNEs diversifying into international markets.

Accepted Answer

Portfolio diversification reduces risk for both domestic firms and multinational enterprises because it allows for cash flows to come from different sources that are not perfectly correlated. This helps to mitigate the impact of adverse events in any one market or region.

Quiz 14: Financial Structure and International Debt

A significant advantage of borrowing foreign currency-denominated bonds is that the borrower need not worry about relative changes in the value of the home currency.

Financial theory has at last provided us with a single optimal capital structure for domestic firms.

For most firms, the cost of capital decreases to a low point as the firm debt financing. At some point beyond this optimal level, the cost of capital increases as the amount of debt .

The domestic theory of optimal capital structure does not need to be modified for MNEs.

One of the most important factors in making debt less expensive than equity is

MNEs situated in countries with small illiquid and segmented markets are most like

Financial practice suggests that there is a range for an optimal capital structure for a firm within an industry rather than a specific optimal ratio of debt to equity.

TropiKana Inc., a U.S firm, has just borrowed $1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 6.00% per year, how much interest will they pay in the first year?

Most financial theorists believe that the optimal capital structure is a with a debt to total value ratio somewhere around .

Which financial economists are most closely associated with the financial theory of optimal capital structure?

One of the most important factors in making debt less expensive than equity is

In theory, the MNE should support debt ratios than a purely domestic firm because their cash flows are .

Which of the following is NOT a factor offsetting the tax advantage of debt as a source of financing?

Not all firms have the same optimal capital structure. Factors that might influence a firm's capital structure include

Portfolio diversification of domestic firms reduces risk because cash flows are not perfectly correlated. The same reasoning is often argued for MNEs diversifying into international markets.