45
CHAPTER 7
TYPES AND COSTS OF FINANCIAL CAPITAL
True-False Questions
depreciation is the same emphasis as that of finance managers.
the required capital gains to complement dividends. However, evaluation
methods exist to determine this value by financial managers.
(interest and principal) and dividend capital costs.
illiquid securities having less standardized negotiated features.
very high during the maturity stage of its life cycle.
high to moderate during the rapid-growth stage of its life cycle.
from venture capitalists and investment banks.
investment bankers.
rapid-growth stage of their life cycles.
failure decreases as it moves from its development stage through to its rapid-
growth stage.
of inflation, risk, illiquidity, and any other factors determining the appropriate
interest rate.
Chapter 7: Types and Costs of Financial Capital
46
inflation risk.
goods being purchased.
the principal on a loan.
default risk business customers.
default risk is constant is called the term structure of interest rates.
to time to maturity is called the yield curve.
liquid assets.
an inferior claim to a venture’s assets.
more mature ventures.
venture investment, and can be assumed by debt, equity, and founding
investors.
necessarily have a higher standard deviation or returns.
than small-company stocks.
return relative to its expected return.
the-counter.
Chapter 7: Types and Costs of Financial Capital
47
while the over-the-counter market is comprised of a network of brokers and
dealers that interact electronically.
the number of shares outstanding.
stock is called the market risk premium.
cost of raising equity and debt capital.
ending in 2012 were about the same as the returns on the S&P 500 stocks.
Multiple-Choice Questions
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
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
a. interest on debt
b. dividends on stock
c. collateral on equity
d. a and b
e. a, b, and c
Chapter 7: Types and Costs of Financial Capital
48
a. real rate
b. nominal rate
c. risk-free rate
d. prime rate
e. inflation rate
rate expected on a risk-free loan?
a. real rate
b. nominal rate
c. risk-free rate
d. prime rate
e. inflation rate
free of default risk?
a. real rate
b. nominal rate
c. risk-free rate
d. prime rate
e. inflation rate
highest quality customers?
a. real rate
b. nominal rate
c. risk-free rate
d. prime rate
e. inflation rate
a. inflation premium
b. default risk premium
c. liquidity premium
d. maturity k premium
e. interest rate premium
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
Chapter 7: Types and Costs of Financial Capital
49
d. maturity premium
e. investment risk premium
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
term debt is called?
a. inflation premium
b. default risk premium
c. liquidity premium
d. maturity premium
e. investment risk premium
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%
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%
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
Chapter 7: Types and Costs of Financial Capital
50
d. ($180,000)
e. ($300,000)
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
discount the projected cash flows of ventures in the “startup” stage of their life
cycles: a. 20%
b. 25%
c. 40%
d. 50%
cost of risky debt capital?
a. real interest rate
b. inflation premium
c. default risk premium
d. market risk premium
e. liquidity premium
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
means:
a. don’t care
b. take a chance
c. to dare
d. to gamble
returns on long-term government bonds is called a:
a. default risk premium
b. maturity premium
Chapter 7: Types and Costs of Financial Capital
51
c. risk-free premium
d. liquidity premium
e. market risk premium
traded small company stocks since the mid-1920s?
a. 10%
b. 16%
c. 25%
d. 30%
e. 40%
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%
“premiums.”
a. inflation premium
b. default risk premium
c. liquidity premium
d. maturity premium
e. all of the above
f. none of the above
financing rather than venture financing?
a. Development stage
b. Startup stage
c. Survival stage
d. Rapid-growth stage
e. Maturity stage
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
Chapter 7: Types and Costs of Financial Capital
52
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
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%
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%
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%
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%
Chapter 7: Types and Costs of Financial Capital
53
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%
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%
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)
$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
$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
Chapter 7: Types and Costs of Financial Capital
54
e. $64,000
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