Unit 6: Cost of Capital

Question 1

What is a rights offer?

Answer 1

A public issue of securities in which securities are first offered to existing shareholders. Also called a rights offering.

Question 2

What is a general cash offer?

Answer 2

An issue of securities offered for sale to the general public on a cash basis

Question 3

What does OSC stand for?

Answer 3

Ontario Securities Commission

Question 4

On the most basic level, if a firm’s WACC is 12 %, what does this mean?

Answer 4

It is the minimum rate of return the firm must earn overall on its existing assets. If it earns more than this, value is created.

Theoretically, this would be same as a $0 NPV or the IRR

Question 5

What does WACC stand for?

Answer 5

Weighted Average Cost of Capital (WACC)

Question 6

True or false

Building a prototype is part of the first-stage financing of venture capital

Answer 6

True

Question 7

True or false

Whether a firm raises capital by debt or requity depends on the size of the firm, its life cycle stage and its growth prospects

Answer 7

True

Question 8

What is cost of debt?

Answer 8

The return that lenders require on the firm’s debt.

Question 9

What is Weighted Average Cost of Capital (WACC)?

Answer 9

The weighted average of the ocsts of debt and equity.

Question 10

What does TSX stand for?

Answer 10

Toronto Stock Exchange

Question 11

What is a prospectus?

Answer 11

Legal document describing details of the issuing corporation and the proposed offering to potential investors

Question 12

What is a red herring?

Answer 12

A preliminary prospectus distributed to prospective investors in a new issue of securities.

Question 13

Selling a portion of the firm is called _____ financing.

Answer 13

Equity

Question 14

_______ _______ refers to financing for new, often high risk ventures.

Answer 14

Venture capital

Question 15

True or false

If you can borrow all the money you need for a project at 6% then your cost of capital is 6%

Answer 15

False.

Cost of capital depends on risk of the project not the source of the money.

Question 16

True or false

The cost of capital for an investment depends primarily on how and where the capital is raised

Answer 16

False

Question 17

What is Venture Capital?

Answer 17

Financing for new, often high-risk ventures.

Question 18

The cost of capital for an investment depends on the ____ of that investment.

Answer 18

risk

Question 19

True or false

The terms below can all be used interchangably

• required return
• appropriate discount rate
• cost of capital

Answer 19

True

Question 20

Which is consider the industry best practice for estimating cost of equity?

• Dividend Growth model approach
• Security Market Line (SML) approach

Answer 20

SML approach

Question 21

True or false

Private equity firms provide financing for start-up firms which otherwise will have difficulty raising capital

Answer 21

True

Question 22

What is a public issue?

Answer 22

The creation and sale of securities on public markets

Question 23

What is the Securities Act?

Answer 23

Ontario legislation that sets forth the regulations for all new securities isses in the province including the Toronto Stock Exchange (TSX).

Question 24

What are the 5 key considerations when choosing a venture capitalist.

Answer 24

1. Financial Strength of the venture capitalist
2. Style of the venture capitalist
3. References of the venture capitalist (reputation)
4. Contacts of the venture capitalist (network)
5. Exit Strategy

Question 25

The cost of capital depends on the (use / source) of the funds

Answer 25

Use

Question 26

If you had to choose between using book values for either debt or equity when calculating WACC, which would you choose and why?

Answer 26

Debt, because debt book values are more likely to be closer to market values.

Question 27

What is cost of equity?

Answer 27

The return the equity investors require on their investment in the firm.

Question 28

Borrowing money to finance a firm is called ____ financing.

Answer 28

Debt