Deck 7: Types and Costs of Financial Capital

Question 1

The accounting emphasis on accrued revenue and expenses and depreciation is the same emphasis as that of finance managers.

Answer 1

False

Question 2

The risk-free interest rate is the interest rate on debt that is virtually free of inflation risk.

Answer 2

False

Question 3

Startup financing usually comes from entrepreneurs, business angels, and investment bankers.

Answer 3

False

Question 4

A venture's "riskiness" in terms of poor performance or failure is usually high to moderate during the rapid-growth stage of its life cycle.

Question 5

The relationship between real interest rates and time to maturity when default risk is constant is called the term structure of interest rates.

Question 6

Bond ratings reflect the inflation risk of a firm's bonds.

Question 7

A nominal interest rate is an observed or stated interest rate.

Question 8

Formal historical accounting procedures include explicit records of debt interest and principal) and dividend capital costs.

Question 9

A venture's "riskiness" in terms of the likelihood of poor performance or failure decreases as it moves from its development stage through to its rapid-growth stage.

Question 10

"Default-risk" is the risk that a borrower will not pay the interest and/or the principal on a loan.

Question 11

First-round financing during a venture's survival stage comes primarily from venture capitalists and investment banks.

Question 12

The graph of the term structure of interest rates, which plots interest rates to time to maturity is called the yield curve.

Question 13

The "prime rate" is the interest rate charged by banks to their highest default risk business customers.

Question 14

Liquidity premiums reflect the risk associated with firms that possess few liquid assets.

Question 15

The "real interest rate" RR) is the interest one would face in the absence of inflation, risk, illiquidity, and any other factors determining the appropriate interest rate.

Question 16

Traditional accounting does not focus on the implicit cost of equity that is the required capital gains to complement dividends. However, evaluation methods exist to determine this value by financial managers.

Question 17

Inflation premium is the rising prices not offset by increasing quality of goods being purchased.

Question 18

Commercial banks provide liquidity-stage financing for ventures in the rapid-growth stage of their life cycles.

Question 19

Public financial markets are markets for the creation, sale and trade of illiquid securities having less standardized negotiated features.

Question 20

A venture's "riskiness" in terms of poor performance or failure is usually very high during the maturity stage of its life cycle.

Question 21

Which of the following describes the interest rate in addition to the inflation rate expected on a risk-free loan?

A) real rate
B) nominal rate
C) risk-free rate
D) prime rate
E) inflation rate

Question 22

Venture capital holding period returns all stages) for the 5-year and 10-year periods ending in 2014 were about the same as the returns on the S&P 500 stocks.

Question 23

The coefficient of variation measures the standard deviation of a venture's return relative to its expected return.

Question 24

Organized exchanges have physical locations where trading takes place, while the over-the-counter market is comprised of a network of brokers and dealers that interact electronically.

Question 25

A venture with a higher expected return relative to other ventures will necessarily have a higher standard deviation or returns.

Question 26

Subordinated debt is secured by a venture's assets, while senior debt has an inferior claim to a venture's assets.

Question 27

Early-stage ventures tend to have large amounts of senior debt relative to more mature ventures.T 23. Investment risk is the chance or probability of financial loss on one's venture investment, and can be assumed by debt, equity, and founding investors.

Question 28

Over the past 90 or so years in the U.S., average annual rates of return have been higher for government bonds than for corporate common stocks.

Question 29

Which one of the following markets involve liquid securities with standardized contract features such as stocks and bonds?

A) private financial market
B) derivatives market
C) commodities market
D) real estate market
E) public financial market

Question 30

The weighted average cost of capital is simply the blended, or weighted cost of raising equity and debt capital.

Question 31

Which of the following markets involve direct two-party negotiations over illiquid, non-standardized contracts such as bank loans and direct placement of debt?

A) primary market
B) secondary market
C) options market
D) private financial market
E) public financial market

Question 32

Historically, large-company stocks have averaged higher long-term returns than small-company stocks.

Question 33

Venture capital holding period returns all stages) for the 20-year period ending in 2014 were more than three times the returns on the S&P 500 stocks.

Question 34

Which of the following describes the observed or stated interest rate?

A) real rate
B) nominal rate
C) risk-free rate
D) prime rate
E) inflation rate

Question 35

Over the past 90 or so years in the U.S., average annual rates of return have been higher for small-company stocks relative to large-company stocks.

Question 36

Market cap is determined by multiplying a firm's current stock price by the number of shares outstanding.

Question 37

The excess average return of long-term government bonds over common stock is called the market risk premium.

Question 38

Typically, the stocks of closely held corporations aren't publicly traded.

Question 39

Closely held corporations are those companies whose stock is traded over-the-counter.

Question 40

Which of the following is an example of rent on financial capital?

A) interest on debt
B) dividends on stock
C) collateral on equity
D) a and b
E) a, b, and c

Question 41

Venture investors generally use which one of the following target rates to discount the projected cash flows of ventures in the "startup" stage of their life cycles:

A) 20%
B) 25%
C) 40%
D) 50%

Question 42

Which of the following types of financing would be associated with the highest target compound rate of return?

A) public and seasoned financing
B) second-round and mezzanine financing
C) first-round financing
D) startup financing
E) seed financing

Question 43

The additional interest rate premium required to compensate the lender for the probability that a borrower will not be able to repay interest and principal on a loan is known as?

A) inflation premium
B) default risk premium
C) liquidity premium
D) maturity premium
E) investment risk premium

Question 44

Which of the following is not a component in determining the cost of debt?

A) inflation premium
B) default risk premium
C) liquidity premium
D) maturity premium
E) interest rate premium

Question 45

Venture investors generally use which one of the following target rates to discount the projected cash flows of ventures in the "development" stage of their life cycles:

A) 15%
B) 20%
C) 25%
D) 40%
E) 50%

Question 46

Which of the following components is not typically included in the rate on short-term U.S. treasuries?

A) liquidity premium
B) default risk premium
C) market risk premium
D) b and c
E) a, b, and c

Question 47

The difference between average annual returns on common stocks and returns on long-term government bonds is called a:

A) default risk premium
B) maturity premium
C) risk-free premium
D) liquidity premium
E) market risk premium

Question 48

Which of the following describes the interest rate charged by banks to their highest quality customers?

A) real rate
B) nominal rate
C) risk-free rate
D) prime rate
E) inflation rate

Question 49

The added interest rate charged due to the inherent increased risk in long-term debt is called?

A) inflation premium
B) default risk premium
C) liquidity premium
D) maturity premium
E) investment risk premium

Question 50

Which of the following describes the interest rate on debt that is virtually free of default risk?

A) real rate
B) nominal rate
C) risk-free rate
D) prime rate
E) inflation rate

Question 51

A venture has raised $4,000 of debt and $6,000 of equity to finance its firm. Its cost of borrowing is 6%, its tax rate is 40%, and its cost of equity capital is 8%. What is the venture's weighted average cost of capital?

A) 8.0%
B) 7.2%
C) 7.0%
D) 6.2%
E) 6.0%

Question 52

Your venture has net income of $600, taxable income of $1,000, operating profit of $1,200, total financial capital including both debt and equity of $9,000, a tax rate of 40%, and a WACC of 10%. What is your venture's EVA?

A) $400,000
B) $200,000
C) $ 0
D) $180,000)
E) $300,000)

Question 53

The "risk-free" interest rate is the sum of:

A) a real rate of interest and an inflation premium
B) a real rate of interest and a default risk premium
C) an inflation premium and a default risk premium
D) a default risk premium and a liquidity premium
E) a liquidity premium and a maturity premium

Question 54

Which one of the following components is not used when estimating the cost of risky debt capital?

A) real interest rate
B) inflation premium
C) default risk premium
D) market risk premium
E) liquidity premium

Question 55

What has been the approximate average annual rate of return on publicly traded small company stocks since the mid-1920s?

A) 10%
B) 16%
C) 25%
D) 30%
E) 40%

Question 56

The word "risk" developed from the early Italian word "risicare" and means:

A) don't care
B) take a chance
C) to dare
D) to gamble

Question 57

Suppose the real risk free rate of interest is 4%, maturity risk premium is 2%, inflation premium is 6%, the default risk on similar debt is 3%, and the liquidity premium is 2%. What is the nominal interest rate on this venture's debt capital?

A) 13%
B) 14%
C) 15%
D) 16%
E) 17%

Question 58

A venture's "riskiness" in terms of possible poor performance or failure would be considered to be "very high" in which of the following life cycle stages:

A) Startup stage
B) Survival stage
C) Rapid-growth stage
D) Maturity stage

Question 59

The additional premium added to the real interest rate by lenders to compensate them for a debt instrument which cannot be converted to cash quickly at its existing value is called?

A) inflation premium
B) default risk premium
C) liquidity premium
D) maturity premium
E) investment risk premium

Question 60

Which of the following venture life cycle stages would involve seasoned financing rather than venture financing?

A) Development stage
B) Startup stage
C) Survival stage
D) Rapid-growth stage
E) Maturity stage

Question 61

Calculate the weighted average cost of capital WACC) based on the following information: the capital structure weights are 50% debt and 50% equity; the interest rate on debt is 10%; the required return to equity holders is 20%; and the tax rate is 30%.

A) 7%
B) 10%
C) 13.5%
D) 17.5%
E) 20%

Question 62

Use the SML model to calculate the cost of equity for a firm based on the following information: the firm's beta is 1.5; the risk free rate is 5%; the market risk premium is 2%.

A) 4.5%
B) 8.0%
C) 9.5%
D) 10.5%

Question 63

Venture capital holding period returns all stages) for the 10-year period ending in 2014, were approximately:

A) 20%
B) 15%
C) 10%
D) 5%Supplemental Problems related to Chapter 7 Appendix A and Chapter 4 Appendix A)

Question 64

Find a venture's "economic value added" EVA) based on the following information: EBIT = $200,000; financial capital used = $500,000; WACC = 20%; effective tax rate = 30%.

A) $20,000
B) $25,000
C) $30,000
D) $40,000
E) $50,000

Question 65

The cost of equity for a firm is 20%. If the real interest rate is 5%, the inflation premium is 3%, and the market risk premium is 2%, what is the investment risk premium for the firm?

A) 10%
B) 12%
C) 13%
D) 15%

Question 66

Estimate a firm's NOPAT based on: Net sales = $2,000,000; EBIT = $600,000; Net income = $20,000; and Effective tax rate = 30%.

A) $600,000
B) $420,000
C) $150,000
D) $70,000
E) $40,000

Question 67

Estimate a firm's economic value added EVA) based on: NOPAT = $400,000; amount of financial capital used = $1,600,000; and WACC = 19%.

A) $26,000
B) $36,000
C) $96,000
D) $54,000
E) $64,000

Question 68

Venture capital holding period returns all stages) for the 20-year period ending in 2014, were approximately:

A) 34%
B) 25%
C) 14%
D) 7%

Question 69

Calculate the after-tax WACC based on the following information: nominal interest rate on debt = 16%; cost of common equity = 30%; equity to value = 60%; debt to value = 40%; and a tax rate = 25%.

A) 10%
B) 16%
C) 19.8%
D) 22.8%
E) 30%

Question 70

Calculate the weighted average cost of capital WACC) based on the following information: the equity multiplier is 1.66; the interest rate on debt is 13%; the required return to equity holders is 22%; and the tax rate is 35%.

A) 11.5%
B) 13.9%
C) 15.0%
D) 16.6%