Cost of Capital

MANAGEMENT ADVISORY SERVICES

COST OF CAPITAL

THEORY

1. All of the following statements are correct except:

a. The matching of asset and liability maturities is considered desirable because this strategy minimizes interest rate risk.

b. Default risk refers to the inability of the firm to pay off its maturing obligations.

c. The matching of assets and liability maturities lowers default risk.

d. An increase in the payables deferral period will lead to a reduction in the need to non-spontaneous funding.

2. Which of the following would increase risk?

a. Increase the level of working capital.

b. Change the composition of working capital to include more liquid assets.

c. Increase the amount of short-term borrowing.

d. Increase the amount of equity financing.

3. A firm’s financial risk is a function of how it manages and maintains its debt. Which one of the following sets of ratios characterizes the firm with the greatest amount of financial risk?

A. High debt-to-equity ratio, high interest coverage ratio, stable return on equity.

B. Low debt-to-equity ratio, low interest coverage ratio, volatile return on equity.

C. High debt-to-equity ratio, low interest coverage ratio, volatile return on equity.

D. Low debt-to-equity ratio, high interest coverage ratio, stable return on equity.

4. Which of the following classes of securities are listed in order from lowest risk/opportunity for return to highest risk/opportunity for return? (E)

A. U.S. Treasury bonds; corporate first mortgage bonds; corporate income bonds; preferred stock.

B. Corporate income bonds; corporate mortgage bonds; convertible preferred stock; subordinated debentures.

C. Common stock; corporate first mortgage bonds; corporate second mortgage bonds; corporate income bonds.

D. Preferred stock; common stock; corporate mortgage bonds; corporate debentures.

5. If the return on the market portfolio is 10% and the risk-free...