Question 1

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:

Accepted Answer

The answer of Venture investors generally use which one of...

Question 2

Which of the following types of financing would be associated with the highest target compound rate of return?

Accepted Answer

Seed financing is typically associated with the highest target compound rate of return due to the high risk involved in investing in very early-stage companies.

Question 3

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?

Accepted Answer

The default risk premium is 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.

Question 4

Which of the following is not a component in determining the cost of debt?

Accepted Answer

Interest rate premium is not a standard term used in determining the cost of debt, whereas the other options are recognized components.

Question 5

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:

Accepted Answer

The answer of Venture investors generally use which one of...

Question 6

Which of the following components is not typically included in the rate on short-term U.S. treasuries?

Accepted Answer

The rate on short-term U.S. treasuries typically includes a liquidity premium but does not include a default risk premium or a market risk premium.

Question 7

The difference between average annual returns on common stocks and returns on long-term government bonds is called a:

Accepted Answer

The market risk premium is the difference between the expected return on a market portfolio and the risk-free rate, which is often represented by long-term government bonds.

Question 8

Which of the following describes the interest rate charged by banks to their highest quality customers?

Accepted Answer

The prime rate is the interest rate that banks charge their most creditworthy customers, typically large corporations.

Question 9

The added interest rate charged due to the inherent increased risk in long-term debt is called?

Accepted Answer

The maturity premium is the additional interest rate charged to compensate for the increased risk associated with the longer time horizon of long-term debt.

Question 10

Which of the following describes the interest rate on debt that is virtually free of default risk?

Accepted Answer

The risk-free rate is the interest rate on debt that is considered free of default risk, typically represented by government securities like U.S. Treasury bonds.

Question 11

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?

Accepted Answer

The weighted average cost of capital (WACC) is calculated as: WACC = (E/V * Re) + (D/V * Rd * (1-Tc)), where E is equity, V is total value (equity + debt), Re is cost of equity, D is debt, Rd is cost of debt, and Tc is tax rate. Plugging in the values: WACC = ($6,000/$10,000 * 8%) + ($4,000/$10,000 * 6% * (1-0.40)) = 4.8% + 1.44% = 6.24%, which rounds to 6.2%.

Question 12

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?

Accepted Answer

EVA = (NOPAT - WACC * TC) = (1200 - 0.1 * 9000) = 300

Question 13

The "risk-free" interest rate is the sum of:

Accepted Answer

The "risk-free" interest rate is typically considered to be the sum of a real rate of interest and an inflation premium, as it assumes no default risk or other premiums.

Question 14

Which one of the following components is not used when estimating the cost of risky debt capital?

Accepted Answer

The market risk premium is associated with equity investments, not debt.

Question 15

What has been the approximate average annual rate of return on publicly traded small company stocks since the mid-1920s?

Accepted Answer

The approximate average annual rate of return on publicly traded small company stocks since the mid-1920s has been around 16%. This figure is based on historical data and reflects the higher risk and potential reward associated with small company stocks compared to larger, more established companies.

Question 16

The word "risk" developed from the early Italian word "risicare" and means:

Accepted Answer

The word "risk" developed from the early Italian word "risicare" which means "to dare" or "to take a chance." Therefore, the best choice is C.

Question 17

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?

Accepted Answer

The nominal interest rate is calculated by summing all the given premiums and the real risk-free rate: 4% (real risk-free rate) + 2% (maturity risk premium) + 6% (inflation premium) + 3% (default risk premium) + 2% (liquidity premium) = 17%.

Question 18

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:

Accepted Answer

The startup stage is typically the most risky phase for a venture due to high uncertainty, lack of established market presence, and limited resources.

Question 19

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?

Accepted Answer

The liquidity premium is the additional premium added to the real interest rate to compensate lenders for the risk associated with a debt instrument that cannot be easily converted to cash at its existing value.

Question 20

Which of the following venture life cycle stages would involve seasoned financing rather than venture financing?

Accepted Answer

Seasoned financing typically occurs in the maturity stage, where established companies seek additional funding through public markets or other means, unlike venture financing which is common in earlier stages.

Quiz 7: Types and Costs of Financial Capital