Test Bank for Entrepreneurial Finance, 7th Edition, J. Chris Leach Ronald W.

Melicher

Test Bank for Entrepreneurial Finance, 7th Edition, J.

Chris Leach Ronald W. Melicher

To download the complete and accurate content document, go to:

https://testbankbell.com/download/test-bank-for-entrepreneurial-finance-7th-edition-j-c
hris-leach-ronald-w-melicher/

Visit TestBankBell.com to get complete for all chapters

Name: Class: Date:

Chapter 07: Types and Costs of Financial Capital

True / False

1. The accounting emphasis on accrued revenue and expenses and depreciation is the same emphasis as that of finance
managers.
a. True
b. False
ANSWER: False

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.
a. True
b. False
ANSWER: True

3. Formal historical accounting procedures include explicit records of debt (interest and principal) and dividend capital
costs.
a. True
b. False
ANSWER: True

4. Public financial markets are markets for the creation, sale, and trade of illiquid securities having less standardized
negotiated features.
a. True
b. False
ANSWER: False

5. A venture's riskiness in terms of poor performance or failure is usually very high during the maturity stage of its life
cycle.
a. True
b. False
ANSWER: False

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.
a. True
b. False
ANSWER: True

7. First-round financing during a venture's survival stage comes primarily from venture capitalists and investment banks.
a. True
b. False
ANSWER: True

8. Startup financing usually comes from entrepreneurs, business angels, and investment bankers.
a. True
b. False
Copyright Cengage Learning. Powered by Cognero. Page 1
Name: Class: Date:

Chapter 07: Types and Costs of Financial Capital

ANSWER: False

9. Commercial banks provide liquidity-stage financing for ventures in the rapid-growth stage of their life cycles.
a. True
b. False
ANSWER: True

10. A venture's riskiness in terms of the likelihood of poor performance or failure decreases as it moves from its
development stage to its rapid-growth stage.
a. True
b. False
ANSWER: True

11. A nominal interest rate is an observed or stated interest rate.

a. True
b. False
ANSWER: True

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.
a. True
b. False
ANSWER: True

13. The risk-free interest rate is the interest rate on debt that is virtually free of inflation risk.
a. True
b. False
ANSWER: False

14. Inflation premium is the rising prices not offset by increasing quality of goods being purchased.
a. True
b. False
ANSWER: False

15. Default risk is the risk that a borrower will not pay the interest and/or the principal on a loan.
a. True
b. False
ANSWER: True

16. The prime rate is the interest rate charged by banks to their highest default-risk business customers.
a. True
b. False
ANSWER: False

17. Bond ratings reflect the inflation risk of a firm's bonds.

Copyright Cengage Learning. Powered by Cognero. Page 2
Name: Class: Date:

Chapter 07: Types and Costs of Financial Capital

a. True
b. False
ANSWER: False

18. The relationship between real interest rates and time to maturity when default risk is constant is called the term
structure of interest rates.
a. True
b. False
ANSWER: False

19. The graph of the term structure of interest rates, which plots interest rates to time to maturity, is called the yield curve.
a. True
b. False
ANSWER: True

20. Liquidity premiums reflect the risk associated with firms that possess few liquid assets.
a. True
b. False
ANSWER: False

21. Subordinated debt is secured by a venture's assets, while senior debt has an inferior claim to a venture's assets.
a. True
b. False
ANSWER: False

22. Early-stage ventures tend to have large amounts of senior debt relative to more mature ventures.
a. True
b. False
ANSWER: False

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.
a. True
b. False
ANSWER: True

24. A venture with a higher expected return relative to other ventures will necessarily have a higher standard deviation or
returns.
a. True
b. False
ANSWER: False

25. Historically, large-company stocks have averaged higher long-term returns than small-company stocks.
a. True
b. False
Copyright Cengage Learning. Powered by Cognero. Page 3
Name: Class: Date:

Chapter 07: Types and Costs of Financial Capital

ANSWER: False

26. The coefficient of variation measures the standard deviation of a venture's return relative to its expected return.
a. True
b. False
ANSWER: True

27. Closely held corporations are those companies whose stock is traded over the counter.
a. True
b. False
ANSWER: False

28. Typically, the stocks of closely held corporations aren't publicly traded.
a. True
b. False
ANSWER: True

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.
a. True
b. False
ANSWER: True

30. The excess average return of long-term government bonds over common stock is called the market risk premium.
a. True
b. False
ANSWER: False

31. Over the long run (90 or so years) in the United States, average annual rates of return have been higher for
government bonds than for corporate common stocks.
a. True
b. False
ANSWER: False

32. Over the long run (90 or so years) in the United States, average annual rates of return have been higher for small-
company stocks relative to large-company stocks.
a. True
b. False
ANSWER: True

33. Private equity investors are owners of proprietorships, partners in partnerships, and owners in closely held
corporations.
a. True
b. False
ANSWER: True

Copyright Cengage Learning. Powered by Cognero. Page 4

Name: Class: Date:

Chapter 07: Types and Costs of Financial Capital

34. Closely held corporations are corporations whose stock is publicly traded.
a. True
b. False
ANSWER: False

35. Market cap is determined by multiplying a firm's current stock price by the number of shares outstanding.
a. True
b. False
ANSWER: True

36. Late- and expansion-stage U.S. venture capital for most holding periods have lower returns than early-stage U.S.
venture capital.
a. True
b. False
ANSWER: True

37. Venture capital holding period returns (multistages) for the 20-year period ending in 2018 were more than three times
the returns on the Dow Jones Industrial Average Index.
a. True
b. False
ANSWER: False

38. The weighted average cost of capital is simply the blended, or weighted, cost of raising equity and debt capital.
a. True
b. False
ANSWER: True

39. Components used to calculate the after-tax WACC do not include an equity rate.
a. True
b. False
ANSWER: False

True/False Questions for Appendix A

40. EVA is a financial assessment of a venture's environmental value analysis.
a. True
b. False
ANSWER: False

41. EVA equals net operating profit after taxes minus after-tax dollar cost of financial capital used.
a. True
b. False
ANSWER: True

Multiple Choice

Copyright Cengage Learning. Powered by Cognero. Page 5

Name: Class: Date:

Chapter 07: Types and Costs of Financial Capital

42. Which of the following markets involve liquid securities with standardized contract features such as stocks and bonds?
a. private financial market
b. commodities market
c. real estate market
d. public financial market
ANSWER: d

43. Which of the following markets involve direct two-party negotiations over illiquid, nonstandardized contracts such as
bank loans and direct placement of debt?
a. secondary market
b. options market
c. private financial market
d. public financial market
ANSWER: c

44. Which of the following venture life cycle stages would involve seasoned financing rather than venture financing?
a. development stage
b. startup stage
c. rapid-growth stage
d. early-maturity stage
ANSWER: d

45. 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. early-maturity stage
ANSWER: a

46. Which of the following describes the observed or stated interest rate?
a. real rate
b. nominal rate
c. risk-free rate
d. prime rate
ANSWER: b

47. 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
ANSWER: a

Copyright Cengage Learning. Powered by Cognero. Page 6

Name: Class: Date:

Chapter 07: Types and Costs of Financial Capital

48. 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 liquidity premium and a maturity premium
ANSWER: a

49. 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. inflation rate
ANSWER: c

50. 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
ANSWER: d

51. Which of the following is not a component in determining the cost of debt?
a. inflation premium
b. default risk premium
c. maturity premium
d. interest rate premium
ANSWER: d

52. 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(n):
a. inflation premium
b. default risk premium
c. liquidity premium
d. maturity premium
ANSWER: b

53. 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(n):
a. inflation premium
b. default risk premium
c. liquidity premium
d. maturity premium
ANSWER: c

Copyright Cengage Learning. Powered by Cognero. Page 7

Name: Class: Date:

Chapter 07: Types and Costs of Financial Capital

54. The added interest rate charged due to the inherent increased risk in long-term debt is called a(n):
a. inflation premium
b. default risk premium
c. liquidity premium
d. maturity premium
ANSWER: d

55. Which 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
ANSWER: d

56. Which of the following "premiums" is not typically included in the rate on U.S. Treasury securities?
a. liquidity premium
b. default risk premium
c. market risk premium
d. inflation premium
ANSWER: b

57. Suppose the real risk-free rate of interest is 4%, the maturity risk premium is 2%, the 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. 14%
b. 15%
c. 16%
d. 17%
ANSWER: d

58. 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"
ANSWER: c

59. Over the long run (90 or so years), the average annual rates of return in the United States have been highest for which
of the following securities?
a. five-year government bonds
b. twenty-year corporate bonds
c. large-company stocks
d. small-company stocks
ANSWER: d
Copyright Cengage Learning. Powered by Cognero. Page 8
Name: Class: Date:

Chapter 07: Types and Costs of Financial Capital

60. Over the long run (90 or so years), the variability (standard deviation) of average annual rates of return in the United
States have been lowest for which of the following securities?
a. five-year government bonds
b. twenty-year corporate bonds
c. large-company stocks
d. small-company stocks
ANSWER: a

61. What has been the approximate long-run (90 or so years) average annual rate of return on publicly traded small-
company stocks?
a. 10%
b. 17%
c. 25%
d. 30%
ANSWER: b

62. Which of the following types of "premiums" would not be associated with corporate bonds?
a. investment risk premium
b. default risk premium
c. liquidity premium
d. maturity premium
ANSWER: a

63. 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. market risk premium
ANSWER: d

64. Venture investors generally use which of the following target rate ranges to discount the projected cash flows of
ventures in the development stage of their life cycles:
a. 12%–15%
b. 20%–30%
c. 25%–35%
d. 40%–60%
ANSWER: d

65. Venture investors generally use which of the following target rate ranges to discount the projected cash flows of
ventures in the startup stage of their life cycles:
a. 20%–30%
b. 25%–35%
c. 30%–50%
d. 40%–60%
Copyright Cengage Learning. Powered by Cognero. Page 9
Name: Class: Date:

Chapter 07: Types and Costs of Financial Capital

ANSWER: c

66. Which of the following types of financing would be associated with the highest target compound rate of return on
venture equity capital?
a. public and seasoned financing
b. second-round and mezzanine financing
c. first-round financing
d. seed financing
ANSWER: d

67. 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%
ANSWER: b

68. 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%; and the market risk premium is 2%.
a. 8.0%
b. 9.5%
c. 10.0%
d. 12.0%
ANSWER: a

69. Venture capital holding period returns (all stages) for the 20-year period ending in 2018 were approximately:
a. 99%
b. 21%
c. 10%
d. 7%
ANSWER: b

70. Venture capital holding period returns (all stages) for the 10-year period ending in 2018 were approximately:
a. 25%
b. 18%
c. 13%
d. 8%
ANSWER: c

71. 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. 7.2%
b. 7.0%
c. 6.2%
Copyright Cengage Learning. Powered by Cognero. Page 10
Name: Class: Date:

Chapter 07: Types and Costs of Financial Capital

d. 6.0%
ANSWER: c

72. 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. 7.0%
b. 10.0%
c. 13.5%
d. 17.5%
ANSWER: c

73. 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%
ANSWER: d

74. 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 tax rate = 25%.
a. 10.0%
b. 16.0%
c. 19.8%
d. 22.8%
ANSWER: d

75. 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 tax rate = 25%.
a. 15.0%
b. 16.4%
c. 20.2%
d. 22.8%
ANSWER: c

Multiple-Choice Questions for Appendix A

76. Estimate a firm's NOPAT based on the following information: net sales = $2,000,000; EBIT = $600,000; net income =
$20,000; and effective tax rate = 30%.
a. $600,000
b. $420,000
c. $150,000
d. $70,000
ANSWER: b
Copyright Cengage Learning. Powered by Cognero. Page 11
Test Bank for Entrepreneurial Finance, 7th Edition, J. Chris Leach Ronald W. Melicher

Name: Class: Date:

Chapter 07: Types and Costs of Financial Capital

77. Estimate a firm's economic value added (EVA) based on the following information: NOPAT = $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
ANSWER: c

78. Find a venture's economic value added (EVA) based on the following information: EBIT = $200,000; financial capital
used = $500,000; WACC = 20%; and effective tax rate = 30%.
a. $20,000
b. $30,000
c. $40,000
d. $50,000
ANSWER: c

79. 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. –$20,000
d. –$180,000
ANSWER: d

Copyright Cengage Learning. Powered by Cognero. Page 12

Visit TestBankBell.com to get complete for all chapters