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44 Cards in this Set

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What is capital structure?
The firm's mix of debt and equity.
Name the three types of debt.
1. private debt
2. public debt
3. Eurobonds
Name the two forms of private debt.
1. long-term loans from financial institutions
2. private placement of unregistered bonds sold directly to accredited investors
Is private or public debt more expensive?
Public debt is typically more expensive than public debt.
Describe public debt.
Offerings of SEC registered bonds directly to investors.
Describe a Eurobond.
A bond payable in the borrower's currency but sold outside the borrower's country.
How does the cost of issuance of Eurobonds compare to other forms of debt?
The cost of issuance is less because the registration and disclosure requirements are less stringent.
What is the effect of a debt covenant?
It restricts the actions of management.
Name the five security provisions that come with debt.
1. mortgage bonds
2. ollateral trust bonds
3. debentures
4. subordinated debentures
5. income bonds
How is a mortgage bond secured?
It is secured with the pledge of property.
How is a collateral trust bond secured?
It is secured by financial assets.
How is a debenture secured?
It is unsecured.
How is a subordinated debenture secured?
It is unsecured with subordinated claims.
Describe an income bond.
Interest payments contingent on earnings.
Name the five methods of payment for bonds.
1. serial payments
2. sinking fund provisions
3. conversion
4. redeemable
5. call feature
Describe serial payment of bonds.
Paid in installments.
Describe sinking fund provisions of bonds.
Firm makes payments to sinking fund to liquidate bonds.
Describe conversion of bonds.
Convertible to common stock.
Describe redeemable bonds.
May be redeemed at the holder's option.
Describe a call feature of bonds.
Firm may force redemption.
Name the three types of bond yields.
1. coupon rate
2. current yield
3. yield to maturity
What is the coupon rate?
The stated interest rate that the bond pays.
What is the current yield?
The stated interest payment divided by the current price of the bond.
What is the yield to maturity?
The interest rate that equates the future interest payments and maturity payment into the current market price.
Name six advantages of debt financing.
1. interest is tax-deductible
2. fixed obligation
3. in periods of inflation, debt is paid back in dollars with less purchasing power
4. owners do not give up control
5. debtors do not participate in excess earnings
6. debt is less costly than equity
Name three disadvantages of debt financing.
1. interest and principal obligations must be paid regardless of the financial position of the firm
2. debt covenants restrict management's actions
3. excessive debt increases the risk of equity
Name six advantages of leasing.
1. a firm may be able to lease when it does not have the ability to purchase
2. less stringent provisions
3. no down payment may be required
4. creditor claims of certain types of leases are restricted in bankruptcy
5. the cost of a lease may be reduced if the lessor retains the tax benefits
6. operating leases do not require recognition of the liability
Name two advantages of common stock.
1. the firm has no fixed obligations
2. increased equity reduces the risk of debt which reduces the firm's cost of borrowing
Name five advantages of common stock.
1. issuance costs are greater than for debt
2. ownership and control is given up
3. dividends are not tax-deductible
4. shareholders demand a higher rate of return
5. issuance of too much common stock increases the cost of capital
Name four advantages of preferred stock.
1. No fixed obligation to pay dividends.
2. Increased equity reduces the cost of debt.
3. Common stockholders do not give up control.
4. Preferred stockholders do not generally participate in superior earnings.
Name three disadvantages of preferred stock.
1. Issuance of costs are greater than for debt.
2. Dividends are not tax deductible.
3. Dividends in arrears accumulated over time may create a burden on the firm.
How does a firm decide whether to go public?
Balance the additional compliance costs with the advantage of creating a liquid investment for its owners.
What does operating leverage measure?
The degree to which a firm builds fixed costs into its operations.
What does financial leverage measure?
The extent to which the firm uses debt financing.
What is the cost of debt?
The interest of the loan adjusted for the fact that interest is deductible.
What is the cost of preferred equity?
The preferred dividend amount divided by the issue price of the stock.
What is the value is the cost of common equity?
It is greater than that of debt or preferred equity.
Name the two ways in which common equity is raised.
1. retained earnings
2. issuing new common stock
Which is the more expensive way to raise equity?
By issuing new stock because of floatation costs (costs of issuance).
Name four methods for estimating the cost of common equity.
1. capital asset pricing model (CAPM)
2. arbitrage pricing model
3. bond-yield-plus approach
4. dividend-yield-plus-growth-rate approach
Describe the arbitrage pricing model.
Similar to the CAPM but the arbitrage pricing model uses a series of systematic risk factors instead of only one.
Describe the bond-yield-plus approach.
Involves adding a risk premium of 3 to 5% to the interest rate on the firm's long-term debt.
Describe the dividend-yield-plus-growth-rate approach.
Estimates the cost of equity by considering investors' expected yield on their investment.
Describe the weighted-average cost of capital (WACC).
Calculated by weighting each component of capital by its percentage of the total.