Ques 1: How does leverage affect a company's capital structure?
(a) When income tax rates are high, companies will borrow more for the tax deduction.
(b) When a company uses owner equity rather than borrowing, it has less financial flexibility.
(c) When a company has leverage, it can demand lower prices from its vendors.
(d) When a company borrows money, it can use that money to purchase more assets.
Answer: Option(D): When a company borrows money, it can use that money to purchase more assets.
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This is the "leverage" in a financial capital structure that uses other people's money to increase profits for your company.
Ques 2: You are a lender and two companies approach you for a loan. One is a trucking company and the other is an internet service provider. Which company are you most likely to provide a loan to?
(a) The company that has the most efficient and profitable business model.
(b) The trucking company, because it has more physical assets you can seize if it does not repay the loan.
(c) The internet service company, because it has more physical assets you can take if it does not repay the loan.
(d) The company that has the highest cash flows in the most recent accounting year.
Answer: Option(B): The trucking company, because it has more physical assets you can seize if it does not repay the loan.
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The trucking company has the higher-quality collateral that a lender can go after to recover more of the money it loaned.
Ques 3: ABC Corp can raise $1 million with half-debt and half-equity. Which concept would be working if the debt was at a lower-than-usual interest rate, and the equity financing at a higher-than-usual required rate of return?
(a) time value of money
(b) cost of capital
(c) equity cushion
(d) shared risk
Answer: Option(C): equity cushion
Ques 4: ABC Corp. is considering its capital structure options. Which option is most likely to result in increased productivity for ABC's existing workforce?
(a) financing for the long-term
(b) borrowing money
(c) using owner equity
Answer: Option(B): borrowing money
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In order to make loan and interest payments, the company must run efficiently and get the most out of its workforce
Ques 5: What does the weighted-average cost of capital (WACC) tell you about a business?
(a) how much money a business can raise
(b) how rates of return on borrowing and equity should be set
(c) how much it costs the business to acquire money
(d) how good a business's financing mix is
Answer: Option(C): how much it costs the business to acquire money
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By averaging the cost of borrowing and the cost of equity, WACC gives you the cost of acquiring money.
Ques 6: Why do businesses engage in split debt-equity financing?
(a) It places the lenders in the residual claimant position, and ensures returns for owners if the company fails.
(b) They can take the tax advantages of borrowing, while also offsetting the cost of capital required by owners equity.
(c) Investors want to see the company matching the equity they put in with borrowing.
(d) Split debt-equity financing provides owners and future investors with an equity cushion.
Answer: Option(B): They can take the tax advantages of borrowing, while also offsetting the cost of capital required by owners equity.
Ques 7: You are considering buying your first house. You have a large income. How should you purchase the house, putting risk aside?
(a) Carry a large mortgage on the house.
(b) Carry a small mortgage on the house.
(c) Pay the full price of the house in cash.
Answer: Option(A): Carry a large mortgage on the house.
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The mortgage payments you make reduce your taxable income.
Ques 8: Why should finance managers understand the cost of capital?
(a) The cost of capital determines the number of new projects that can be undertaken.
(b) Once new projects are undertaken, the cost of the capital involved must be monitored.
(c) If the cost of capital is below the expected return, the new project should not be undertaken.
(d) Lenders require a higher rate of return than investors.
Answer: Option(C): If the cost of capital is below the expected return, the new project should not be undertaken.
Ques 9: Purchasing stocks and purchasing a new car are not all that different. When purchasing a new car, what question might you ask yourself that you might also consider when puchasing stock?
(a) Is the car popular enough that I can sell it in a couple years?
(b) Can I get the full value of the car if I sell it in a couple years?
(c) Is the car popular enough that I will have to pay a premium price?
Answer: Option(A): Is the car popular enough that I can sell it in a couple years?
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When you buy a car, you should consider what you can get back if you decide to sell it in a couple years, just as you do with a stock.
Ques 10: What is "over-the-counter" trading in corporate bonds?
(a) Over-the-counter trading is the same as a corporation's private debt.
(b) Bonds trades are arranged privately between a corporation and a purchaser.
(c) Purchasers go to a physical bond market to purchase a corporate bond "over-the-counter."
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Over-the-counter bond trading means the trades are arranged individually, between dealers, or through brokers and purchasers.
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