FIN 101 CHP 14 & 15

Y Corporation needs to raise capital to purchase new equipment for its research laboratory. Use the following information to compute the WACC for Y Corporation. Equity financing = $200,000 Cost of equity = 10% Debt financing = $400,000 Cost of debt = 5% Tax rate = 30%

5.6%

Company A's creditors are so worried about the company's ability to repay them that they file with the court to demand that Company A sell off all the assets it owns in order to pay off its debts. Company A is in Chapter _____ bankruptcy.

7

Payback Analysis

A formula that allows you to figure out how long it will take an investment to pay for itself.

Which of the following statements best describes bankruptcy?

A legal process by which an individual or a company can get rid of debts and repay creditors.

Modified Accelerated Cost Recovery System (MACRS)

A system that provides information about how items that will last for over a year will depreciate.

Which of the following is a benefit to a company in choosing to raise funds through bonds instead of spending cash on hand?

Bonds allow a company to maintain cash in reserve.

Which of the following are considered debt?

Bonds and loans

Stocks: Marketing

Businesses use this process to try to raise the number of bond sales. This process requires businesses to spend money.

Capital structure is comprised of which of the following?

Cash, debt, and equity

Stocks: Advantages

Companies may choose to issue these instead of bonds because they don't always require the company to pay out dividends.

Jane's company is considering investing in a new expansion project. To figure out if it is viable, Jane calculates what the project will have to return based on the risk and returns of her company at large. What is Jane calculating?

Cost of capital

An estimate of the minimum a project will have to return in order for it to be a good investment is called the:

Cost of capital.

The percentage return that individuals who purchase a company's stock expect to receive is called _____.

Cost of equity

A jam company sends each of its shareholders a jar of jam. What kind of dividend is this?

Dividend in kind

A retailer has a weighted average cost of capital of 7%. It wants to build out two new retail stores. How much must the stores return to go ahead with the project?

Greater than 7%

Choose the BEST answer to explain the correlation between risk and return.

High risk investors require a higher return.

Cost of Capital

How much money you lose by not investing your money somewhere.

Investing: Beta

In investing, this term is used when discussing the risk an investment offers as it relates to some type of benchmark.

Payback Analysis: Formula

Initial investment / annual net cash flow = payback period. Find out what your initial investment should be by using the equation: payback period x annual net cash flow.

Common Stock

Investors who own this kind of stock are given voting rights and a percentage of company ownership. They don't get a guarantee on dividend payouts.

Which of the following is true with regard to the earnings per share of a company that issues a bond?

Issuing a bond leads to lower earnings per share.

Which of the following is a form of debt financing?

Issuing bonds

Which of the following is true of homemade leverage?

It only works if the investor can borrow at the same rate as the company.

Jennifer is the CEO of a company that has many debts. Why does she decide to file a Chapter 11 bankruptcy with the court?

It would allow her to restructure the company in an effort to pay off its debts.

In financing with debt, who are the two main creditors?

Lenders and Bondholders

Which of the following statements is true of leverage?

Leverage can result in magnified gains and losses.

Which typically have the lowest costs associated with it?

Loans

Which of the following is NOT an example of a direct cost associated with bankruptcy?

Lost sales

The Tire Factory wants to issue a bond, in addition to the cost of interest, what are additional costs associated with bonds?

Marketing, underwriting, and SEC registration and reporting

Georgio's company has three divisions. He wants to invest in new equipment to help one of his divisions be more productive. When looking at what return he'll need on his investment to make it worthwhile, Georgio estimates what his company as a whole will need to bring in. Is he using divisional cost of capital? Why or why not?

No, because he is looking at the company as a whole.

Typically, the cost of equity exceeds the cost of debt; however, there are disadvantages in securing financing using debt. How are debt bonds less beneficial than issuing stock?

Obtaining debt requires a contractual obligation and repayment is required at maturity.

Bonds: Advantages

Offering these instead of stocks allows businesses to maintain voting rights. Additionally, companies don't have to offer repayment for several years with these.

Ed is considering investing in a new asset for his company. Before doing that, he wants to calculate the company's cost of capital. Which of the following should Ed take into consideration?

Overall risk to the company

Preferred Stock

Owning this kind of stock guarantees that you will earn dividends and gives you a percentage of ownership in a company. However, you can't vote on company changes.

Which of the following is a major advantage in issuing stock?

Payment of dividends are not required.

How do preferred stocks differ from common stocks?

Preferred stock investors do not have voting rights.

Lorenzo's publishing company has several divisions, including one that is dedicated to children's picture books. When considering a new project for that division, Lorenzo looks at the cost of capital for several publishing companies that only put out children's picture books. What is Lorenzo using?

Pure play approach

Sarah is the CEO of a fashion company that only makes sweaters. What type of company does she have?

Pure play company

Systematic Risk

The inherent risk of investing in the stock market. This risk does not indicate anything about a specific stock, but reflects the entire market as a whole.

Why does the term (1 - t) appear in the WACC formula?

The interest paid on debt is tax deductible.

Which of the following should NOT be taken into consideration when calculating the divisional cost of capital?

The purpose of the division.

Kendi built his business from the ground up, and it produces a unique type of product. As he is examining a new product line, he is using the subjective approach. Why would he use this approach?

There are no pure play businesses, and he is comfortable with going on 'gut instinct.'

Stock

These are shares of ownership in a company. There are two types: common and preferred. Both are considered to be equity.

Securities and Exchange Commission (SEC): Protection

This organization looks at the financial health of companies that offer stocks and bonds. This helps build investor confidence.

Securities and Exchange Commission (SEC)

This regulatory body requires companies to register before they can publically offer their stock. Businesses must pay a registration fee as part of this process.

Louisa is the CEO of a company that operates in several different countries. If the risk of doing business in a specific country is very high, then the divisional cost of capital will be:

Very high.

weighted average cost of capital (WACC): FORMULA

WACC = Wd (KD (1 - t)) + We (Ke)

When is divisional cost of capital a better guide for decision making than the cost of capital for the company as a whole?

When the division's risk is higher or lower than that of the company as a whole.

Accounting Rate of Return / Simple Rate of Return / Average Accounting Return

You can look at this to estimate how much profit you'll earn off of an investment.

The last date that the buyer of a stock is eligible to receive a dividend is the _____.

cum-dividend date

The _____ is the date that the company puts together a list of shareholders who will receive dividends and how much each shareholder will receive.

date of record

Which of the following is NOT one of the three most common types of dividends?

forced dividends

Roberto's company is facing bankruptcy. In the days before the company files, Roberto invests some of the company's money into a stock that is very risky, but the investment may provide the company with an influx of cash if the investment goes well. This is an example of a(n) _____ cost of bankruptcy.

indirect

How can companies increase their leverage by raising funds?

Bonds

Capital

Another term for money. In order to raise this, companies may sell stocks or offer bonds to investors.

Accounting Rate of Return / Simple Rate of Return / Average Accounting Return: Formula

Average profit / average investment x 100. The answer is written as a percent.

Ali receives a dividend check in the mail. Why would we call this a cash dividend?

Because as a shareholder, Ali is receiving money from the company.

Suzie wants to raise capital to buy a new piece of equipment that will generate increased revenue. Suzie is the sole owner of the company and she likes it that way. How can she raise capital for the equipment?

Take out a loan