FIN 317 Week 11 Final Exam – Strayer
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Chapters 7 Through 15
Part 1: Chapters 7 Through 11
Part 2: Chapters 12 Through 15
CHAPTER 7
TYPES
AND COSTS OF FINANCIAL CAPITAL
True-False
Questions
1. The accounting emphasis on accrued revenue
and expenses and depreciation is the same emphasis as that of finance managers.
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.
3. Formal historical accounting procedures
include explicit records of debt (interest and principal) and dividend capital
costs.
4. Public financial markets are markets for the
creation, sale and trade of illiquid securities having less standardized
negotiated features.
5. A venture’s “riskiness” in terms of poor
performance or failure is usually very high during the maturity stage of its
life cycle.
6. 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.
7. First-round financing during a venture’s
survival stage comes primarily from venture capitalists and investment banks.
8. Startup financing usually comes from
entrepreneurs, business angels, and investment bankers.
9.
Commercial banks provide liquidity-stage
financing for ventures in the rapid-growth stage of their life cycles.
10. 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.
11. A nominal interest rate is an observed or
stated interest rate.
12. 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.
13. The risk-free interest rate is the interest
rate on debt that is virtually free of inflation risk.
14. Inflation premium is the rising prices not
offset by increasing quality of goods being purchased.
15. “Default-risk” is the risk that a borrower
will not pay the interest and/or the principal on a loan.
16. The “prime rate” is the interest rate charged
by banks to their highest default risk business customers.
17. Bond ratings reflect the inflation risk of a firm’s
bonds.
18. The relationship between real interest rates
and time to maturity when default risk is constant is called the term structure
of interest rates.
19. The graph of the term structure of interest
rates, which plots interest rates to time to maturity is called the yield
curve.
20. Liquidity premiums reflect the risk
associated with firms that possess few liquid assets.
21. Subordinated debt is secured by a venture’s
assets, while senior debt has an inferior claim to a venture’s assets.
22. Early-stage ventures tend to have large
amounts of senior debt relative to more mature ventures.
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.
24. A venture with a higher expected return
relative to other ventures will necessarily have a higher standard deviation or
returns.
25. Historically, large-company stocks have
averaged higher long-term returns than small-company stocks.
26. The coefficient of variation measures the
standard deviation of a venture’s return relative to its expected return.
27. Closely held corporations are those companies
whose stock is traded over-the-counter.
28. Typically, the stocks of closely held
corporations aren’t publicly traded.
29. 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.
30. Market cap is determined by multiplying a
firm’s current stock price by the number of shares outstanding.
31. The excess average return of long-term
government bonds over common stock is called the market risk premium.
32. The weighted average cost of capital is simply
the blended, or weighted cost of raising equity and debt capital.
33. Venture capital holding period returns (all
stages) for the 10-year period ending in 2012 were about the same as the
returns on the S&P 500 stocks.
Multiple-Choice
Questions
1. 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
2. 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
3. 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
4. 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
5. 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
6. 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
7. 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
8. 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
9. 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
10. 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
11. 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
12. 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%
13. 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%
14. 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)
15.
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
16. 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%
17. 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
18. 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
19. 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
20. 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
21. 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%
22. 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%
23. 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
none of the above
24. 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
25. 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
26. 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
27. 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%
28. 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%
29. 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%
30. 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%
31. 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%
32. 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%
33. 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%
Supplemental Problems related to
Chapter 7 Appendix A (and Chapter 4 Appendix A)
1. Estimate a firm’s NOPAT based on: Net sales =
$2,000,000; EBIT = $600,000; Net income = $20,000; and Effective tax rate =
30%.
$600,00
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