Ch. 8
The cost of debt capital to a business is measured by the: a) Maturity date b) Interest rate c) Amount borrowed d) Cost of equity e) None of the above
B
Generic Health Services has a target capital structure of 30 percent debt and 70 percent equity. Its cost of debt estimate is 10 percent and its cost of equity estimate is 16 percent. It pays federal, state, and local taxes at a 40 percent marginal rate. What is the firm's corporate cost of capital? a) 6.0% b) 10.0% c) 13.0% d) 14.2% e) 16.0%
C
Which of the following statements regarding the cost of equity is most correct? a) The cost of debt is the interest rate set on debt financing, while the cost of equity is defined similarly; it is the rate of return required by equity investors. b) The debt cost plus risk premium method is one way to estimate the cost of equity. c) The cost of equity for a not-for-profit business is zero. d) Both a. and b. above are correct. e) a., b., and c. above are correct.
D
Which of the following are basic sources (forms) of capital? a) Debt b) Equity c) Leases d) Convertible bonds e) Both a. and b. above
E
Long-term debt is defined as having a maturity of more than six months. a) True b) False
False
Although many factors influence the interest rate set on a loan, the two most important are risk and inflation. a) True b) False
True
What is the present value of a 100 dollar lump sum to be received in 5 years if the opportunity cost rate is 10 percent? a) $ 62.09 b) $ 90.91 c) $100.00 d) $110.00 e) $161.05
A
Which of the following statements about debt ratings is most correct? a) The ratings reflect the probability of default. b) The ratings on outstanding debt are automatically reviewed and updated annually. c) The ratings are important to investors, but unimportant to issuers. d) The ratings are based solely on a quantitative analysis of the issuer's financial condition. e) The ratings run from A (for the best) to F (for the worst).
A
Which of the following statements about short-term debt is most correct? a) Short-term debt has higher issuance costs than long-term debt. b) Short-term debt has more restrictions (restrictive covenants) than long-term debt. c) Short-term debt generally has a lower cost than long-term debt. d) Most short term debt is obtained by issuing bonds to individuals. e) All of the above statements are correct.
C
Which of the following statements about the use of debt financing (financial leverage) is incorrect? a) In most situations, the use of debt financing increases the return to owners (say, as measured by ROE). b) In all situations, the use of debt financing increases the riskiness to owners. c) Capital structure theory allows managers to precisely determine the optimal capital structure for any for-profit business. d) Debt financing allows more of a business's operating income to flow through to investors. e) Because debt financing "levers up" (increases) owners' returns, its use is called financial leverage.
C
Which of the following statements about debt contracts is most correct? a) Debt contracts have several different names. b) Debt contracts typically contain restrictive covenants. c) All debt contracts name a trustee. d) Both a. and b. above are correct. e) a., b., and c. above are all correct.
D
Which of the following statements about project classifications is most correct? a) Projects are classified by purpose, such as replacement projects. b) Projects are classified by size, such as less than $1 million. c) Projects are classified by life, such as less than 5 years. d) Both a. and b. above are correct. e) a., b., and c. above are correct.
D
Which of the following are steps in a capital investment financial analysis? a) Estimate the project's cash flows. b) Assess the project's riskiness. c) Estimate the project cost of capital (discount rate). d) Measure the financial impact. e) All of the above.
E
Which of the following factors influence the estimate of a business's optimal capital structure? a) The amount of business (inherent) risk b) Lender/rating agency attitudes c) Industry averages d) The need to maintain financial flexibility (reserve borrowing capacity) e) All of the above factors influence the estimate
E
Which of the following statements about cost of capital estimation is most correct? a) In general, at least five methods will be used to estimate the cost of debt. b) The corporate cost of capital is the higher of either the cost of equity or the cost of debt. c) The corporate cost of capital is used as the hurdle (discount) rate for all projects being evaluated in the organization. d) Because there is no tax savings associated with debt issued by not-for-profit organizations, it is theoretically wrong to recognize the savings for investor-owned businesses. e) None of the above statements are correct.
E
Which of the following statements about payback (payback period) is most correct? a) Payback is a measure of time breakeven. b) Payback is a rough measure of risk. c) Payback is a rough measure of liquidity. d) Both a. and b. above are correct. e) a., b., and c. above are correct.
E
The corporate cost of capital is a blend (weighted average) of the costs of all of a business's financing sources (excluding equity). a) True b) False
False
Although the use of financial leverage (debt financing) can increase the return to the owners of a business, it also increases the riskiness of their equity investment. a) True b) False
True
The corporate cost of capital provides a benchmark for determining a project's cost of capital. In general, projects that are riskier than average must have a cost of capital that is higher than the corporate cost of capital, while projects that are less risky than average must have a cost of capital that is less than the corporate cost of capital. a) True b) False
True
To minimize the risk associated with debt financing, permanent assets (land, buildings, and equipment) should be financed with long-term debt while temporary assets (such as a seasonal buildup in inventories) should be financed with short-term debt. a) True b) False
True
