CH 7 Types and costs of Financial capital

27. 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

B 600,000 *(1-.30)

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

C. RISK FREE RATE

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

D. NOPAT=[200,000*(1-.30)]=140,000 500,000 * (.20)=100,000 140,000-100,000=40,000

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

D. 40,000 NOPAT=[EBIT * (1-TAX RATE)] 200,000*(1-.30)=140,000 500,000 *.20=100,000 140,000-100,000=40,000

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

D. private financial market

Which 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

E. public financial market

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

F

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

F

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

F

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

F

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

F

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

F

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

F

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

F

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

F interest rate on debt that in virtually free of default risk excludes inflation

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

F subordinated debt is with an inferior claim (relative to senior debt) to venture assets senior debt is secured by ventures assets

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

F that is inflation it is average expected inflation rate over the risk of loan

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)

NPOAT=1,200,000 - (1,200,000*40%) EVA= 720,000 - (9,000,000*10%) = 720,000- 900,000 = - 180000 that is (180000)

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

T

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

T

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

T

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

T

18. 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.

T

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

T

2. 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.

T

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

T

22. 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.

T

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

T

24. 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.

T

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

T

7. 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.

T

9. 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.

T

An observed or stated interest rate is said to be a: a. nominal interest rate b. real interest rate c. risk-free interest rate d. pure interest rate e. guaranteed interest rate

a

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

a. a real rate of interest and an inflation premium

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

a. real rate

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

a. startup stage

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

b

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

b. default risk premium

What has been the approximate average annual rate of return on publicly traded small company stocks since the mid-1920s? a. 10% b. 17% c. 25% d. 30% e. 40%

b.17%

Venture capital holding period returns (all stages) for the 20-year period ending in 2012, had a compound average return of approximately: a. 35% b. 28% c. 21% d. 14% e. 7%

b.28%

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

b.420,000 NOPAT=EBIT (1-TAXRATE) 600,000 (1-.30)

. 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

c

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

c

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%

c

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

c 1,600,000 * .19=304,000 400,000-304,000=96,000

26. 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%

c. (.50)(.10)(1-.30)+(.50)(.20)

The risk that a borrower will not pay the interest and /or principal on a loan is called? a. interest rate risk b. re-investment rate risk c. default risk d. inflation risk e. risk-free rate

c. default risk

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

c. liquidity premium

Calculate the after-tax WACC based on the following information: nominal interest rate on debt = 12%; cost of common equity = 25%; common equity = $700,000; interest-bearing debt = $300,000; and a tax rate = 25%. a. 15% b. 16.4% c. 20.2% d. 22.8% e. 30%

c.22.8 (300,000/1,000,000)(.12)(1-.25)+(700,000/1,000,000)(.25)

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

d

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%

d (1-.25)(.16)(.40)+(.30)(.60)

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

d. market risk premium

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

d. maturity premium

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

d. prime rate

13. 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%

e

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%

e. 50%

Corporate bonds might involve which of the following types of "premiums." a. inflation premium b. default risk premium c. liquidity premium d. maturity premium e. all of the above f. none of the above

e. all above

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 risk premium e. interest rate premium

e. interest rate premium

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

e. maturity stage

. 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

e. seed financing

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

e.market risk premium