Ch9 Finance

what four steps are involved in the financial analysis of capital investment proposals

-cash flow estimation -project risk assessment -cost of capital estimation -financial impact assessment

what are the two deficiencies with payback

-it ignores all cash flows occurring after payback period -it ignores the time value of money

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?

13 percent

Which of the following statements about common stock is incorrect? A. The claim of shareholders on the cash flows of the firm is limited to the dividends they receive-that is, they have no claim on a business's residual earnings. B. In the event of bankruptcy and liquidation, shareholders often receive nothing. C. The preemptive right gives current stockholders the right to purchase any new shares issued by the company. D. Stockholders exercise control over the company by voting for board members. E. Common stockholders are the owners of for-profit corporations.

A

Which of the following statements about the trade-off theory of capital structure is most correct? A. The trade-off theory tells us that businesses should use almost 100 percent debt financing. B. The trade-off theory has no applicability to not-for-profit businesses. C. The trade-off theory tells us that businesses should use some debt financing but not too much. D. The trade-off theory can be used to set a precise optimal structure for any given business. E. The trade-off theory tells us that businesses should use almost no debt financing.

C

Which of the following statements about the use of debt financing (financial leverage) is incorrect? A. Debt financing allows more of a business's operating income to flow through to investors. 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. Because debt financing "levers up" (increases) owners' returns, its use is called "financial leverage." E. In most situations, the use of debt financing increases the return to owners (say, as measured by return on equity).

C

Which of the following statements about debt contracts is(are) most correct? A. Debt contracts have several different names. B. Debt contracts typically contain restrictive covenants. C. All debt contracts name a trustee. D. Answers (a) and (b) are correct. E. Answers (a), (b), and (c) are correct.

D

Which regarding 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. Answers (a) and (b) are correct. E. Answers (a), (b), and (c) are correct.

D

Which of the following factors influence(s) 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

E

Which of the following statements about cost of capital estimation is most correct? A. In general, at least five methods are 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 is correct.

E

True or False: The corporate cost of capital is a blend (weighted average) of the costs of all of a business's financing sources.

False

what are the most critical decisions health services managers must make; they involve large sums of money and the results generally affect the business's operations and financial condition for a long time

capital investment (budgeting) decision

what are business decisions involving which long-term assets to buy

capital investment decisions

the process of moving from today's value to a future value is called; the best starting point for learning DCF concepts

compounding

municipal bonds are essentially the same as __________ Thus, the coupon rate set on a not-for-profit hospital bond will be the same as the rate set on a similar for-profit hospital bond

corporate bonds

The ____________ provides a benchmark for determining a project's cost of capital.

corporate cost of capital

payback occurs when the ______ turns positive

cumulative cash flow

the best way to calculate payback is to examine the project's

cumulative cash flow

____ and ______ are two basic forms of capital

debt and equity

the use of time-value-of-money techniques to estimate the value of an investment is known as

discounted cash flow analysis

what is the process of assigning appropriate values to cash flows that occur at different points in time and then summarizing this info in a single value

discounted cash flow analysis

the process of finding the present value of a future cash flow

discounting

what provides managers with the relevant information about a capital investment's financial impact and helps them make better decisions

financial analysis

In general, projects that are riskier than average must have a cost of capital that is _______ than the corporate cost of capital

greater

the shorter the payback, the _____ the liquidity

higher

the cost of debt capital to a business is measured by

interest rate

Projects that are less risky than average must have a cost of capital that is _______ than the corporate cost of capital.

less

To minimize the risk associated with debt financing, businesses should finance permanent assets with __________ and temporary assets with ________

long term debt; short term debt

short term debt generally has a ______ than long term debt

lower cost

the sum of the present values of all cash flows when discounted at the opportunity cost of capital -- measures a project's expected dollar profitability

net present value (NPV)

the two most commonly used ROI measures are

net present value and internal rate of return

how is project liquidity measured

payback

what is the ability of a project to pay for itself from the cash flows that it generates

project liquidity

role of financial analysis in capital investment in regards to investor-owned businesses is

projects that contribute to owners' wealth should be undertaken while those that don't should be ignored

the goal of not-for-profit businesses when considering the financial analysis in capital investment decisions is to provide

quality, cost-effective services

project profitability is assessed by _______

return on investment measures

the higher the NPV, the _______ the project

the more profitable

debt ratings reflect

the probability of default

principle based on the fact that a dollar to be received in the future is worth less than a current dollar

time value of money

True or False: although the use of financial leverage can increase the return to the owners of a business, it also increases the riskiness of their equity investment

true