Chapter 15

Financial Management: Core Concepts, 3e, GE (Brooks)
Chapter 15 Raising Capital
15.1 The Business Life Cycle
1) ________ employer businesses (businesses that employ others besides the owners) will close within the
first six years.
A) Two out of every five
B) One out of every two
C) Three out of every five
D) Seven out of every ten
Answer: C
Diff: 1
Topic: 15.1 The Business Life Cycle
AACSB: 3 Analytical Thinking
LO: 15.1 Describe the life cycle of a business.
2) In the life cycle of a business, a stable life cycle stage is most closely identified with ________.
A) old age
B) youth
C) maturity
D) infancy
Answer: C
Diff: 1
Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.
3) In the life cycle of a business, a business that has peaked and is now in decline is most closely identified
with ________.
A) old age
B) youth
C) maturity
D) infancy
Answer: A
Diff: 1
4) Firms move in an orderly fashion through each stage of the business life cycle without skipping any of
the steps.
Answer: FALSE
Explanation: Some businesses will move to the final stages very rapidly, even skipping the middle
stages.
Diff: 1
1
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5) List the five active phases of a business life cycle as identified by the textbook. Do all business go
through these five phases?
Answer:
1. The start-up phase of the business.
2. The growth phase of the business.
3. The maturity phase of the business.
4. The decline of the business.
5. The closing of the business.
All businesses do NOT go through all five phases; there can be overlap. Also, many businesses move
through the first two phases of startup and growth and then settle for a long time into the mature stage.
Others will start up and move rapidly to the final stage. The life-cycle approach provides a convenient
classification of the timeline of a business, but it is not rigid.
Diff: 2
15.2 Borrowing for a Start-up and Growing Business
1) Starting a business with ________ is by far the most common start-up financing.
A) bonds and equity
B) personal and family funds
C) bank loans
D) venture capital
Answer: B
Diff: 1
Topic: 15.2 Borrowing for a Start-up and Growing Business
LO: 15.2 Understand the different sources of capital available to a start-up business and to a growing business.
2) Which of the following statements is FALSE about sole proprietorships?

A) They mix the assets of the company with the personal assets of the owner.
B) The owner receives some, but not all, of the profits.
C) The limitation of capital may constrain growth.
D) The owner makes all decisions.
Answer: B
Explanation: B) One advantage of a sole proprietorship is that the owner enjoys all the profits.
Diff: 1
2
3) Banks and other lending institutions ________.
A) frown upon family funding for start-up businesses
B) have lending models better fitted for start-up businesses compared with established businesses
C) are in competition with the Small Business Administration (SBA) for start-up loans
D) are often next sources of financing for businesses after personal and family contributions
Answer: D
Explanation: D) Banks tend to LOOK FAVORABLY upon family funding for start-up businesses; have
lending models better fitted for established businesses, and work with the Small Business Administration
(SBA) for start-up loans.
Diff: 1
4) Which of the following is NOT typically involved when a start-up business applies for a loan at a
commercial bank?
A) Collateral and owner's contribution
B) Evidence of management capability
C) A contract for partial ownership by the bank of the proposed firm
D) Evidence of good character
Answer: C
Diff: 2
5) Which of the following is NOT typically involved when a start-up business applies for a loan at a
commercial bank?
A) A viable business plan
B) Evidence of at least two months of projected sales already in inventory
C) A personal financial statement
D) Business financial statements, including projected cash flows
Answer: B
Diff: 1
6) The 7(a) Loan Guaranty Program of the Small Business Administration (SBA) delivers loans through
________ that are guaranteed by ________.
A) the SBA; commercial lenders
B) banks; the Federal Reserve System
C) commercial lenders; state government
D) commercial lenders; the SBA
Answer: D
Diff: 2
3
7) SBA guarantee loans have an interest rate that is on average ________.
A) the same as current market rates on business loans
B) lower than current market rates on business loans
C) higher than current market rates on business loans
D) the same as mortgage loans
Answer: A
Diff: 1
8) If the SBA makes a loan guarantee, the guarantee is only ________. If the original borrower defaults,
the government will repay the obligation up to the ________.
A) to the borrower; loan balance
B) to the public at large; percentage of the SBA guarantee
C) to the lending institution; percentage of the SBA guarantee
D) to the lending institution; loan balance
Answer: C
Diff: 2
9) The SBA only aids ________ when their applications would not be approved through normal
processes.
A) banks
B) the FRS
C) creditors
D) small business owners
Answer: D
Diff: 1
10) Typical SBA guaranty loans carry an interest rate equal to ________.
A) the prime rate
B) current market rates
C) the prime rate plus a 1.00% default risk premium
D) the prime rate less 1.00% due to the SBA guarantee
Answer: B
Diff: 2
4
11) Angel financing is ________.
A) rare
B) usually for medium-term loans
C) usually limited to the early development of a business
D) All of the above
Answer: D
Diff: 1
12) ________ is a general term applied to lenders who provide funding for new, high-risk ideas.
A) Angel investing
B) SBA loan agreement
C) Investment banking
D) None of the above
Answer: A
Diff: 1
13) Financing that will take ________ ten years for repayment is ________ to angel investors.
A) less than; not attractive
B) more than; attractive
C) more than; not attractive
D) None of the answer choices is accurate
Answer: C
Explanation: C) Angel investors prefer to be repaid in as short a time as possible.
Diff: 1
14) Which of the following answer choices is more characteristic of a venture capitalist than an angel
investor?
A) Usually individuals or groups; invest own money; early stages of the business
B) Usually corporate entities; often tied to individual or group expertise; early stages of the business
C) Usually individuals or groups; pooled money from range of investors; all stages of the business
D) Usually corporate entities; pooled money from range of investors; all stages of the business
Answer: D
Diff: 1
5
15) A major issue with venture capitalists and angel investors is the rate at which their funds will be used
up. This is called the ________.
A) consumption or constriction rate
B) burn rate or bleed rate
C) IV rate
D) depreciation rate
Answer: B
Diff: 1
16) Ventures that have low burn or bleed rates may require less ________ compared to a venture with a
high bleed rate.
A) time from the financier
B) monitoring by the venture capitalist
C) performance benchmarks
D) All of the above
Answer: D
Diff: 1
17) Which of the following characteristics of angel financiers are not important considerations for a firm
or entrepreneur seeking financing?
A) The financial strength of the angel or venture capitalist
B) Contacts of the angel or venture capitalist
C) The exit strategy of the angel or venture capitalist
D) All of the above are important considerations regarding an angel or venture capitalist.
Answer: D
Diff: 1
18) SBA loans are delivered directly to the small business and bypass the need for a commercial bank.
Answer: FALSE
Explanation: The SBA insures loans to small businesses made by commercial banks.
Diff: 1
19) Financing through angel investors is a fairly common way for funding a start-up.
Answer: FALSE
Explanation: Angel investors are rare for most start-up business ideas.
Diff: 1
6
20) Loans to start-ups without sufficient outside resources for collateral are the exception for commercial
banks. This type of lending is usually left to the SBA.
Answer: TRUE
Diff: 1
21) The venture capitalist's objective is to help small business owners qualify for loans when they may not
be able to qualify through the normal lending policies of a commercial lender.
Answer: FALSE
Explanation: The SMALL BUSINESS ADMINISTRATION'S objective is to help small business owners
qualify for loans when they may not be able to qualify through the normal lending policies of a
commercial lender.
Diff: 1
22) The most popular loan program provided by the Small Business Administration is the basic 7(a) Loan
Guaranty program. What is the 7(a) Loan Guaranty program? In your answer please address the
following points: who is eligible for the loans, how the loans are administered, typical requirements of
the applicant, who is responsible for the repayment of the loan, and what happens if there is a loan
default.
Answer: The 7(a) Loan Guaranty program administers business loans to individuals or firms that might
not be eligible for a loan through the normal lending agencies. The loans are delivered through
commercial lenders and guaranteed by the SBA. Common requirements of applicants include:
• evidence of good character
• evidence of management capability
• collateral and owner's contribution
• a viable business plan
• a personal financial statement
• business financial statements, including projected cash flows
The borrower is responsible for repayment of the loan, but the SBA does guarantee a certain percentage
of the loan in case of default.
Diff: 2
7
23) The terms angel investors and venture capitalists are often used interchangeably in the popular and
financial press, but the textbook highlights some differences between them. What are these differences?
Answer:
Angel Investors Venture Capitalists
Individual or groups of individuals Corporate entities
Invest pooled money from a range of
Invest their own money investors
Focus on early stages of business All stages of business
Investment often associated with a Often focuses on high-growth and/or
particular expertise technology and innovation
Diff: 2
15.3 Borrowing for a Stable and Mature Business: Bank Loans
1) If you go to your bank and it grants you a lump sum loan today that requires monthly payments for a
fixed period of time to repay the borrowed money, you have most likely received a ________.
A) discount loan
B) line of credit
C) straight loan with a preset payment schedule
D) compensating balance loan
Answer: C
Diff: 1
Topic: 15.3 Borrowing for a Stable and Mature Business: Bank Loans
LO: 15.3 Explain the funding available to a stable or mature business.
2) You have agreed to a $50,000 fixed-rate loan from First National Bank today and promise to repay the
loan with 36 equal monthly payments at an APR of 6.50%. How large are your monthly payments? Use a
financial calculator to determine your answer.
A) $1246.77
B) $1,458.21
C) $1,532.45
D) $1,650.71
Answer: C
Explanation: C) Via financial calculator: PV = -50,000, I% = 6.50/12, N = 36, FV = 0.
Solve for PMT = $1,532.45.
Diff: 3
8
3) You have agreed to a $25,000 fixed-rate loan from Valley State today and promise to repay the loan
with 24 equal monthly payments at an APR of 7.50%. How large are your monthly payments? Use a
A) $1,124.99
B) $1,218.17
C) $1,532.45
D) $1,602.71
Answer: A
Explanation: A) Via financial calculator: PV = -$25,000, I% = 7.50/12, N = 24, FV = 0.
Diff: 3
4) You have agreed to a $50,000 fixed-rate loan from First National Bank today and promise to repay the
loan with 36 equal monthly payments at an APR of 6.50%. What is the EAR of this loan?
A) 6.50%
B) 6.70%
C) 6.90%
D) 7.10%
Answer: B
Explanation: B) EAR = -1= - 1 = 6.70%.
Diff: 3
5) Your bank grants you a lump sum loan today equal to the face value of the loan less the interest.
Further you must repay the face value of the loan amount in a single lump sum at the end of one year.
These terms most closely resemble which of the following types of bank loan?
A) Straight loan with a pre-set payment schedule
B) Compensating balance loan
C) Line of credit
D) Discount loan
Answer: D
Diff: 1
9
6) Your bank has agreed to grant you a discount loan with an APR of 5.25%. If you need $5,000 today,
how large is the face value of the loan?
A) $4,751
B) $5,000
C) $5,263
D) $5,277
Answer: D
Explanation: D) To receive $5,000 the size of the discount loan must be net loan amount ÷ (1 - r)
= $5,000 ÷ (1 - .0525) = $5,277.
Diff: 3
7) Your bank has agreed to grant you a discount loan with an APR of 5.25%. If you need $5,000 today, the
loan is to be repaid in full in one year, and the total interest to be paid is $277, what is the EAR of the
loan?
A) 5.25%
B) 5.54%
C) 5.73%
D) 5.91%
Answer: B
Explanation: B) EAR = interest paid ÷ loan amount received = $277 ÷ $5,000 = 5.54%.
Diff: 3
8) "A company can borrow money at a preset rate from the bank at any time without seeking approval of
the loan each time it needs funds" is a description of what type of loan?
A) Discount loan
B) Compensating balance loan
C) Line of credit
D) Straight loan with preset payment schedule
Answer: C
Diff: 1
9) With a line of credit, the bank is compensated ________.

A) based on the outstanding balance of the loan
B) based on the principal value of the credit line
C) exclusively with a fixed annual payment
D) based on a fixed interest rate tied to the T-bill rate
Answer: A
Diff: 1
10
10) A ________ type of loan is similar to a line of credit. However, even though only a portion of the loan
is available to the borrower, interest is paid on the entire face value of the loan.
A) line of credit
B) compensating balance loan
C) straight loan with preset payment schedule
D) discount loan
Answer: B
Diff: 1
11) Pacific Automotive has a $250,000 compensating balance loan with its bank. The terms of the loan call
for Pacific to keep 10% of the loan as a compensating balance and pay interest at an annual rate of 6.50%
on the entire amount. If the firm borrows the maximum amount for one year, how much interest is due at
the end of the year?
A) $14,625
B) $16,250
C) $22,500
D) $25,000
Answer: B
Explanation: B) Interest due = rate × total loan amount = .065 × $250,000 = $16,250.
Diff: 3
12) Pacific Automotive has a $250,000 compensating balance loan with its bank. The terms of the loan call
for Pacific to keep 10% of the loan as a compensating balance and pay interest at an annual rate of 6.50%
on the entire amount. If the firm borrows the maximum amount for one year, what is the EAR on this
loan?
A) 6.50%
B) 6.87%
C) 7.22%
D) 7.39%
Answer: C
Explanation: C) Interest due = rate × total loan amount = .065 × $250,000 = $16,250. EAR = interest paid ÷
net amount available for borrowing = $16,250 ÷ ($250,000 × (1 - .10)) = 7.22%.
Diff: 3
11
13) Bestor Bookkeeping has a $150,000 compensating balance loan with its bank. The terms of the loan
call for Bestor to keep 8% of the loan as a compensating balance and pay interest at an annual rate of
7.50% on the entire amount. If the firm borrows the maximum amount for one year, how much interest is
due at the end of the year?
A) $10,650
B) $11,250
C) $12,375
D) $14,250
Answer: B
Explanation: B) Interest due = rate × total loan amount = .075 × $150,000 = $11,250.
Diff: 3
14) Bestor Bookkeeping has a $150,000 compensating balance loan with its bank. The terms of the loan
call for Bestor to keep 8% of the loan as a compensating balance and pay interest at an annual rate of
7.50% on the entire amount. If the firm borrows the maximum amount for one year, what is the EAR on
this loan?
A) 7.50%
B) 8.15%
C) 8.35%
D) 8.67%
Answer: B
Explanation: B) Interest due = rate × total loan amount = .075 × $150,000 = $11,250. EAR = interest paid ÷
net amount available for borrowing = $11,250 ÷ ($150,000 × (1 - .08)) = 8.15%.
Diff: 3
15) A letter of credit or line of credit is a preapproved borrowing amount that works much like a
________.
A) premium loan
B) discount loan
C) syndicated loan
D) credit card
Answer: D
Diff: 1
12
16) Syndicated loans are ________.
A) loans where multiple banks join together to make a loan to a single company
B) loans made to television stations to purchase re-runs
C) loans where one bank makes several loans to firms in the same industry as an effort to diversify the
bank's loan portfolio
D) loans bought by other banks that have unused funds available for loans
Answer: A
Diff: 1
17) You have agreed to a $50,000 fixed-rate loan from People's Bank today and promise to repay the loan
with 48 equal monthly payments at an APR of 5.50%. How large are your monthly payments? Use a
A) $1,124.99
B) $1,162.82
C) $1,532.45
D) $1,602.71
Answer: B
Explanation: B) Via financial calculator: PV = -$50,000, I% = 5.50/12, N = 48, FV = 0.
Diff: 3
18) You have agreed to a $30,000 fixed-rate loan from People's Bank today and promise to repay the loan
with 24 equal monthly payments at an APR of 4.50%. What is the EAR of this loan?
A) 4.71%
B) 4.63%
C) 4.59%
D) 4.50%
Answer: C
Explanation: C) EAR = - 1 = (1 + .045/12)12 - 1 = 4.59%
Diff: 3
13
how large is the face value of the loan?
A) $8,355
B) $8,000
C) $7,845
D) $7,641
Answer: A
Explanation: A) To receive $8,000, the size of the discount loan must be net loan amount ÷ (1 - r)
= $8,000 ÷ (1 - .0425) = $8,355.
Diff: 3
the loan is to be repaid in full in one year, and the total interest to be paid is $667, what is the EAR of the
loan?
A) 6.25%
B) 6.45%
C) 6.69%
D) 6.67%
Answer: D
Explanation: D) EAR = interest paid ÷ loan amount received = $667 ÷ $10,000 = 6.67%.
Diff: 3
21) A discount loan features a series of repayments to the bank.

Answer: FALSE
Explanation: A discount loan has a lump sum up front (principal borrowed) and a lump-sum payment at
maturity (principal and interest).
Diff: 1
22) With a line of credit, a company can borrow money at a preset rate from the bank at any time, without
seeking additional approval of the loan each time funds are needed.
Answer: TRUE
Diff: 1
14
23) Syndicated loans are generally reserved for large and mature businesses, and are for the long term
rather than the short term.
Answer: TRUE
Diff: 1
24) Citizens' Bank of Business commercial loans are currently posted as having an 8.50% APR, with
monthly payments due over a three-year period. If your firm takes out a $25,000 loan, what is the
monthly payment, and what is the EAR? Use a financial calculator to determine your answer.
Answer:
Mode: P/Y=12, C/Y=12
Input: 36 8.5 -25,000 ? 0
Key: N I/Y PV PMT FV
CPT: 789.19
and the effective annual rate of this 8.5% APR is:
EAR = (1 + 0.085/12)12 - 1 = 8.84%
Diff: 3
25) Your bank offers discount loans at a discount rate of 7.50%. If you borrowed $50,000 as a discount
loan from the bank today at this rate (you receive less than the face value today and repay the face value
in one year), how much money would you receive today? What is the EAR of this loan?
Answer: Loan amount = FV × (1 - discount rate) = $50,000 × (1 - 0.075) = $46,250.
EAR = Interest paid/Net loan amount = $3,750/$46,250 = 8.11%.
Diff: 3
15.4 Borrowing for a Stable and Mature Business: Selling Bonds
1) Bonds may be issued through either a ________ or a ________.

A) private auction; federal auction
B) state agency; federal agency
C) public auction; private placement
Answer: C
Diff: 2
Topic: 15.4 Borrowing for a Stable and Mature Business: Selling Bonds
LO: 15.4 Explain how companies sell bonds in a capital market.
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2) ________ is a government-authorized agency created to enforce the 1933 Securities Act.
A) The Securities and Exchange Commission (SEC)
B) The Federal Reserve System (FRS)
C) The Federal Deposit Insurance Corporation (FDIC)
D) The Stock Exchange Commission (SEC)
Answer: A
Diff: 2
3) ________ provides financial advice, helps design bond terms, makes sure that new bonds meet listing
requirements, and then markets new bond issues.
A) The Securities and Exchange Commission
B) An investment banker
C) The Federal Reserve
D) A stock broker
Answer: B
Diff: 1
4) The ________ is the formal contract for the bond between the issuing company and the buyer.
A) debenture
B) sinking fund
C) indenture
D) prospectus
Answer: C
Diff: 1
5) The bond ________ contains much of the information filed in the bond registration and is used to
inform potential buyers about the bond.
A) debenture
B) sinking fund
C) indenture
D) prospectus
Answer: D
Diff: 1
16
6) The bond indenture contains ALL BUT WHICH of the following?
A) The coupon rate
B) The yield-to-maturity
C) The maturity date
D) The par value
Answer: B
Explanation: B) The YM is a market-determined interest rate.
Diff: 2
7) Southern Communications will issue 30-year, semiannual bonds with an 8.0% coupon rate and a $1,000
par value. Bonds of similar risk and maturity are currently selling to yield 7.0% in the market place. What
is the market price of one of the firm's new bonds? Use a financial calculator to determine your answer.
A) $1,000.00
B) $1,124.72
C) $886.88
D) $1,124.09
Answer: B
Explanation: B)
Mode: PY = 2; C/Y = 2
Input: 60 7.0 ? -40 -1,000
CPT: 1,124.72
Diff: 3
8) Fairfield Pharmaceutical Inc. plans to sell 20,000 bonds each with a face value of $1,000. If all of the
bonds eventually sell for $950 each and the firm's investment banker receives a commission of 2.00% for
every bond sold, what are the net proceeds to the firm from the sale of the bond issue?
A) $19,600,000
B) $19,000,000
C) $18,780,000
D) $18,620,000
Answer: D
Explanation: D) Net proceeds = (P) × (Q) × (1 - commission rate) = $950 × 20,000 × (1 - 0.02) = $18,620,000.
Diff: 3
17
9) Austin Power Company will issue 20-year, semiannual bonds with an 7.0% coupon rate and a $1,000
par value. Bonds of similar risk and maturity are currently selling to yield 8.0% in the market place. What
is the market price of one of the firm's new bonds? Use a financial calculator to determine your answer.
A) $1,000.00
B) $953.16
C) $901.04
D) $879.36
Answer: C
Explanation: C)
Mode: PY = 2; C/Y = 2
Input: 40 8 ? -35 -1,000
CPT: 901.04
Diff: 3
10) Hopewell Drugstore plans to sell 50,000 bonds each with a face value of $1,000. If all of the bonds
eventually sell for $975 each and the firm's investment banker receives a commission of 1.50% for every
bond sold, what are the net proceeds to the firm from the sale of the bond issue?
A) $48,018,750
B) $43,415,250
C) $41,500,000
D) $40,875,750
Answer: A
Explanation: A) Net proceeds = (P) × (Q) × (1 - commission rate) = $975 × 50,000 × (1 - 0.015) = $48,018,750.
Diff: 3
11) The public auction of bonds in the United States is regulated by the Federal Reserve System.
Answer: FALSE
Explanation: The public auction of bonds in the United States is regulated by the Securities and
Exchange Commission.
Diff: 1
12) For a bond auction, a company selects a commercial banker to help design and market the bond.
Answer: FALSE
Explanation: For a bond auction, a company selects an investment banker to help design and market the
bond.
Diff: 1
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13) The prospectus is the formal contract for the bond.
Answer: FALSE
Explanation: The indenture is the formal contract for the bond.
Diff: 1
14) An investment bank is an agent that works with the firm to meet all the listing requirements of the
bond issue, the design of the bond terms, the marketing of the bond, and the auction of the bond.
Answer: TRUE
Diff: 1
15) Wilderness Adventure Vacation Company will issue 20-year, semiannual bonds with a 9.0% coupon
rate and a $1,000 par value. Bonds of similar risk and maturity are currently selling to yield 10.0% in the
marketplace. What is the market price of one of the firm's new bonds? If the investment banking firm
working with the firm receives a best-efforts commission of 2.0% per bond sold, how much money will it
make if the issue sells only 80% of the 5,000 bonds offered? Use a financial calculator to determine your
answer.
Answer:
Mode: P/Y = 2, C/Y = 2
Input: 40 10.0 ? -45 -1000
CPT: 914.20
Commission = (P) × (Q) × (commission rate) = $914.20 × 5,000 × 0.02 = $73,136.
Diff: 3
15.5 Borrowing for a Stable and Mature Business: Selling Stock
1) The process for selling stock for the very first time is known as ________.
A) an initial public offering
B) a primary market
C) first refusal rights
D) a rookie offering
Answer: A
Diff: 1
Topic: 15.5 Borrowing for a Stable and Mature Business: Selling Stock
LO: 15.5 Explain how companies sell stocks in a capital market.
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2) For your firm's initial public offering of stock, your investment banker has guaranteed a specific
amount of funds your firm will receive. This is an example of what type of investment banker
compensation?
A) Due diligence
B) Firm commitment
C) IPO
D) Best efforts
Answer: B
Diff: 1
3) By making a/an ________, the investment banker agrees to buy an entire issue of new securities from a
firm and then attempt to sell the securities to the public.
A) firm commitment
B) best effort
C) IPO
D) due diligence
Answer: A
Diff: 1
4) Houston Investments (HI), a Texas-based investment banking firm, has proposed two types of
payment plans for the IPO being considered by Anderson Exploration. The first is a firm commitment of
$10,000,000. The second is a best efforts arrangement in which Houston Investments will receive $3.00 for
every share sold up to a maximum of $1,200,000 for the 400,000 shares being offered. How much money
will HI earn under the firm commitment method if it is able to sell only 90% of the offering at a price of
$30.00 per share?
A) $800,000
B) $1,080,000
C) $1,200,000
D) $2,000,000
Answer: A
Explanation: A) Firm commitment compensation = Total dollars raised - firm commitment
= 400,000 × $30 × 0.90 - $10,000,000 = $800,000.
Diff: 3
20
5) Houston Investments (HI), an investment banking firm, has proposed two types of payment plans for
the IPO being considered by Anderson Exploration. The first is a firm commitment of $10,000,000. The
second is a best efforts arrangement in which HI will receive $3.00 for every share sold up to a maximum
of $1,200,000 for the 400,000 shares being offered. How much money will HI earn under the best efforts
method if it is able to sell only 90% of the offering at a price of $30.00 per share?
A) $800,000
B) $1,080,000
C) $1,200,000
D) $2,000,000
Answer: B
Explanation: B) Best efforts cash flow = # of shares offered × percent sold × commission per share sold
= 400,000 × 0.90 × $3.00 = $1,080,000.
Diff: 3
6) Great Plains Investment Inc. (GPI), an investment banking firm, has proposed two types of payment
plans for the IPO being considered by Ashford Community Hospital. The first is a firm commitment of
$5,000,000. The second is a best efforts arrangement in which GPI will receive $4.00 for every share sold
up to a maximum of $2,000,000 for the 500,000 shares being offered. How much money will GPI earn
under the best efforts method if it is able to sell only 80% of the offering at a price of $30.00 per share?
A) $2,000,000
B) $1,800,000
C) $1,600,000
D) $1,400,000
Answer: C
Explanation: C) Best efforts cash flow = # of shares offered × percent sold × commission per share sold
= 500,000 × 0.80 × $4.00 = $1,600,000.
Diff: 3
7) The process to register an equity security with the SEC, provide a prospectus for the sale, and advertise
for the sale takes, on average, ________.
A) 15-20 days
B) 30-60 days
C) 61-120 days
D) 121-180 days
Answer: D
Diff: 2
21
8) A preliminary prospectus is called a/an ________.
A) indenture
B) tombstone
C) red herring
D) letter of comment
Answer: C
Diff: 1
9) What is the street name for the advertisement issued during the period of time when a firm is waiting
for approval from the SEC to issue new securities? This advertisement typically contains the name of the
issuing firm and the list of investment bankers involved in underwriting and marketing the new issue.
A) Indenture
B) Tombstone
C) Red herring
D) Letter of comment
Answer: B
Diff: 1
10) A ________ allows an investment banker to purchase up to 15% of additional shares in an equity
offering beyond what is offered to the public.
A) green-shoe provision
B) lock-up agreement
C) letter of commitment
D) red herring
Answer: A
Diff: 1
11) A ________ requires that the original owners of the firm maintain ownership of their stock for at least
180 days following an IPO.
A) green-shoe provision
B) lock-up agreement
C) letter of commitment
D) red herring
Answer: B
Diff: 1
22
12) New York Investments (NYI), an investment banking firm, has proposed two types of payment plans
for the IPO being considered by Albany Exploration. The first is a firm commitment of $40,000,000. The
second is a best efforts arrangement in which NYI will receive $2.00 for every share sold up to a
maximum of $3,600,000 for the 1,800,000 shares being offered. How much money will NYI earn under the
firm commitment method if it is able to sell only 95% of the offering at a price of $25.00 per share?
A) $800,000
B) $1,080,000
C) $2,200,000
D) $2,750,000
Answer: D
Explanation: D) Firm commitment compensation = Total dollars raised - firm commitment
= 1,800,000 × $25 × 0.95 - $40,000,000 = $2,750,000.
Diff: 3
13) New York Investments (NYI), an investment banking firm, has proposed two types of payment plans
for the IPO being considered by Albany Exploration. The first is a firm commitment of $40,000,000. The
second is a best efforts arrangement in which NYI will receive $2.00 for every share sold up to a
maximum of $3,600,000 for the 1,800,000 shares being offered. How much money will NYI earn under the
best efforts method if it is able to sell only 95% of the offering at a price of $25.00 per share?
A) $3,420,000
B) $3,600,000
C) $3,200,000
D) $2,800,000
Answer: A
Explanation: A) Best efforts cash flow = # of shares offered × percent sold × commission per share sold
= 1,800,000 × 0.95 × $2.00 = $3,420,000.
Diff: 3
14) The firm commitment method of compensation for investment bankers is always more risky
financially for issuing firms than the best efforts method.
Answer: FALSE
Explanation: Compensation depends upon the contract and the success of the issue. Sometimes a firm
commitment is more expensive for the issuing firm, and at other times, the best efforts method is more
expensive.
Diff: 1
23
15) During the so-called cooling-off period while an issuing company is waiting for SEC approval of its
IPO, advertising and promotion of the stock usually begins.
Answer: FALSE
Explanation: During this time, promotional activity is banned.
Diff: 1
16) Regulation A is an exemption from filing with the SEC for an IPO issue of less than $5 million;
instead, it requires only a brief offering statement.
Answer: TRUE
Diff: 1
17) If the auction of an IPO is oversubscribed, shares of the IPO are allocated pro-rata to all bidders.
Answer: TRUE
Diff: 1
18) In a best efforts arrangement, the investment bank pledges to use its best efforts to sell all the
authorized shares and takes a cut on each individual share that it sells, but provides no guarantee as to
how many shares it will sell.
Answer: TRUE
Diff: 1
19) If there is missing information in the prospectus, the investment banker issues a letter of comment to
the company and the public.
Answer: FALSE
Explanation: If there is missing information in the prospectus, the SEC issues a letter of comment to the
company and the investment bank.
Diff: 1
24
20) Investment bankers are commonly compensated for their services through a best efforts or a firm
commitment method. Explain how the two compensation methods work.
Answer: IBs are compensated in one of two ways. With a best efforts arrangement, the IB pledges its best
efforts to sell the firm's securities and takes a commission on each sale. However, there is no guarantee
that the issue will be fully subscribed. With a firm commitment arrangement, the IB guarantees a payout
to the firm. A profit is made on the difference between the actual proceeds from the sale and the
guaranteed payoff to the firm.
Diff: 3
21) Extreme Adventures Inc. needs to raise capital and has hired Solomon Sisters to be its investment
banker (IB). Solomon recommends a sale of common stock and estimate the firm could raise a gross
amount of $7,500,000 if they could sell 300,000 shares of stock at $25 per share. Solomon has offered two
compensation methods for its work on the sale of these securities. The first is a best efforts arrangement
where Extreme will pay Solomon $1.00 for every share issued. The second is a firm-commitment of
$7,000,000. If Solomon is able to sell the entire issue at the recommended price, how much money will it
make under each arrangement? What is the break-even point in sales percent between firm commitment
and best efforts for Extreme Adventures?
Answer:
Firm commitment = P × Q - Commitment = $25 × 300,000 - $7,000,000 = $500,000.
Best Effort = Commission per share × Q = $1.00 × 300,000 = $300,000.
Break-even = Firm commitment = Net price per share × q × % sold
= $7,000,000 = $24 × 300,000 × % sold. Solve for % sold = 97.22%.
Diff: 3
15.6 Other Borrowing Options for a Mature Business
1) Commercial paper and banker's acceptances are two forms of corporate financing typically undertaken
by ________.
A) start-up firms
B) mature firms
C) sole proprietorships
D) All of the above
Answer: B
Diff: 1
Topic: 15.6 Other Borrowing Options for a Mature Business
LO: 15.6 Examine some special forms of financing: commercial paper and banker's acceptances.
25
2) Commercial paper has a maturity of ________.
A) less than 270 days
B) nine to eighteen months
C) greater than one year
D) three to five years
Answer: A
Diff: 1
3) Commercial paper has a minimum denomination of ________.

A) $10,000
B) $50,000
C) $100,000
D) $500,000
Answer: C
Diff: 1
4) Pacific Motors Inc. plans to issue $3,000,000 of commercial paper with a 6-month maturity at 98% of
par value. What is the 6-month interest rate?
A) 2.00%
B) 4.00%
C) 2.04%
D) 4.08%
Answer: C
Explanation: C) Rate = Interest due ÷ Discounted amount = ($3,000,000 × (1 - 0.98))/ ($3,000,000 × 0.98) =
2.04%.
Diff: 2
5) Fruit Flavors Online Inc. plans to issue $5,000,000 of commercial paper with a 6-month maturity at 97%
of par value. What is the 6-month interest rate?
A) 1.50%
B) 3.00%
C) 3.09%
D) 6.18%
Answer: C
Explanation: C) Rate = Interest due ÷ Discounted amount = ($5,000,000 × (1 - 0.97))/ ($5,000,000 × 0.97) =
3.09%.
Diff: 2
26
par value. What is the EAR?
A) 4.12%
B) 4.08%
C) 4.00%
D) 2.00%
Answer: A
Explanation: A) EAR = (1 + periodic rate)m - 1 = (1.0204)2 - 1 = 4.12%.
Diff: 2
par value. What is the discounted selling price of the firm's commercial paper?
A) $3,000,000
B) $2,940,000
C) $2,700,000
D) $2,666,667
Answer: B
Explanation: B) Discounted selling price = Face Value × % of par = $3,000,000 × 0.98 = $2,940,000.
Diff: 2
8) Amalgamated Appliance Inc. has planned a 3-month issue of commercial paper with a face value of
$25,000,000. The paper is set to sell at 98.5% of face value. What is the EAR?
A) 6.08%
B) 6.23%
C) 3.04%
D) 3.12%
Answer: B
Explanation: B) FV(Face Value) = 100; PV(after the 1.5% discount) = 98.5; N = 1.
EAR = (1 + periodic rate)m - 1 = (1.015228)4 - 1 = 6.23%.
Diff: 2
27
$25,000,000. The paper is set to sell at 98.5% of face value. What is the discounted selling price of the
firm's commercial paper?
A) $25,000,000
B) $25,325,000
C) $24,625,000
D) $24,300,000
Answer: C
Explanation: C) Discounted selling price = Face Value × % of par = $25,000,000 × 0.985 = $24,625,000.
Diff: 2
$25,000,000. The paper is set to sell at 98.5% of face value. What is the 3-month interest rate?
A) 3.04%
B) 6.08%
C) 2.17%
D) 1.52%
Answer: D
Explanation: D) Rate = Interest due ÷ Discounted amount
= ($25,000,000 × (1 - 0.985))/ ($25,000,000 × 0.985) = 1.52%.
Diff: 2
11) Bacon Signs Inc. has planned a 3-month issue of commercial paper with a face value of $15,000,000.
The paper is set to sell at 99.5% of face value. What is the EAR?
A) 2.025%
B) 2.250%
C) 2.500%
D) 2.512%
Answer: A
Explanation: A) FV(Face Value) = 100; PV(after the 0.5% discount) = 99.5; N = 1.
EAR = (1 + periodic rate)m - 1 = (1.005025)4 - 1 = 2.025%.
Diff: 2
28
The paper is set to sell at 99.5% of face value. What is the discounted selling price of the firm's commercial
paper?
A) $14,925,000
B) $14,995,000
C) $15,000,000
D) $15,300,000
Answer: A
Explanation: A) Discounted selling price = Face Value × % of par = $15,000,000 × 0.995 = $14,925,000.
Diff: 2
The paper is set to sell at 99.5% of face value. What is the 3-month interest rate?
A) 0.5000%
B) 0.5025%
C) 0.5035%
D) 0.5050%
Answer: B
Explanation: B) Rate = Interest due ÷ Discounted amount
= ($15,000,000 × (1 - 0.995))/ ($15,000,000 × 0.995) = 0.5025%.
Diff: 2
14) Commercial paper sells at a discount and repays the face value with interest within 270 days.
Answer: TRUE
Diff: 1
15) Commercial paper sells in minimum denominations of $1,000,000.

Answer: FALSE
Explanation: Commercial paper sells in minimum denominations of $100,000.
Diff: 1
16) Commercial paper is a short-term security issued by corporations for commercial purposes.
Answer: TRUE
Diff: 1
29
17) Commercial paper is often issued by large high-quality corporations because the market interest rate
they pay on this borrowed money is lower than what they would pay at a commercial bank.
Answer: TRUE
Diff: 1
18) Banker's acceptances are frequently used to facilitate trade between firms in the United States and
other countries.
Answer: TRUE
Diff: 1
19) A typical banker's acceptance would involve two firms and their commercial banks.
Answer: TRUE
Diff: 1
20) What is commercial paper? What is its maximum maturity? Why? Does it sell at a discount at face
value plus interest? Extract Electrical Motors has issued $3,000,000 of commercial paper with a 30-day
maturity date. If the paper sells at 99% of par value, what are the net proceeds to the firm? What is the
EAR for this issue of commercial paper?
Answer: Commercial paper is a short-term (less than 270 days) corporate IOU designed to meet short-
term cash flow needs. It is typically issued by only the most credit worthy firms. Commercial paper is
issued at a discount and repays the par value with interest at maturity.
Net proceeds = (1 - discount %) × par value = (1 - .01) × $3,000,000 = $2,970,000.

EAR = (1 + rate) m -1 where the rate = interest/amount received = $30,000/$2,970,000 = 1.010101010%.
EAR = (1.010101)12 -1 = 12.82%.
Diff: 3
30
15.7 The Final Phase: Closing the Business
1) The two chapters for commercial businesses to handle financial difficulties under the Bankruptcy
Reform Act of 1978 are ________.
A) chapters 7 and 11
B) chapters 7 and 13
C) chapters 9 and 11
D) chapters 11 and 13
Answer: A
Diff: 1
Topic: 15.7 The Final Phase: Closing the Business
LO: 15.7 Describe the options and regulations for closing a business.
2) ________ bankruptcy calls for a company to cease business, sell remaining assets, and distribute the
proceeds as governed by a bankruptcy court.
A) Reorganization
B) Chapter 11
C) Chapter 7
Answer: C
Diff: 1
3) ________ bankruptcy allows a company to attempt reorganization under court supervision without
claimants taking action.
A) Chapter 7
B) Chapter 11
C) Liquidation
Answer: B
Diff: 1
4) Under a court-supervised corporate reorganization plan, the business may be run by ________.
A) a court-appointed trustee
B) current managers
C) A or B
Answer: C
Diff: 1
31
5) Chapter 7 bankruptcy is a liquidation of assets, and chapter 11 bankruptcy is a reorganization of assets.
Answer: TRUE
Diff: 1
6) Often, in bankruptcy, the current managers continue to run the business while it operates under the
reorganization plan, but the court may also appoint a trustee to oversee the operations and protect the
rights of the claimants during this period of time.
Answer: TRUE
Diff: 1
7) Explain the difference between chapter 7 and chapter 11 bankruptcy. Which group of claimants
generally stands last in a chapter 7 filing?
Answer:
Chapter 7 bankruptcies are designed to liquidate remaining assets under the supervision of a court-
appointed trustee. These bankruptcy proceedings are designed to terminate the life of a business and to
satisfy creditors to the best of the firm's ability, following a specific set of guidelines.
Chapter 11 bankruptcies are a form of court-supervised reorganization for corporations. Here, with the
help of a court-appointed trustee, a business is sheltered from creditor claims and given time to work out
financial difficulties. Eventually, the firm may emerge from bankruptcy with a newly agreed-to set of
claims from creditors and may continue in business in some form.
In chapter 7 bankruptcy, stockholders are residual claimants and stand last in line for compensation.
Diff: 2
32

Chapter 15

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Financial Management: Core Concepts, 3e, GE (Brooks)

Chapter 15 Raising Capital

15.1 The Business Life Cycle

15.2 Borrowing for a Start-up and Growing Business

2) Which of the following statements is FALSE about sole proprietorships?

15.3 Borrowing for a Stable and Mature Business: Bank Loans

Explanation: B) EAR = -1= - 1 = 6.70%.

9) With a line of credit, the bank is compensated ________.

Explanation: C) EAR = - 1 = (1 + .045/12)12 - 1 = 4.59%

21) A discount loan features a series of repayments to the bank.

15.4 Borrowing for a Stable and Mature Business: Selling Bonds

1) Bonds may be issued through either a or a .

15.5 Borrowing for a Stable and Mature Business: Selling Stock

15.6 Other Borrowing Options for a Mature Business

3) Commercial paper has a minimum denomination of ________.

15) Commercial paper sells in minimum denominations of $1,000,000.

Net proceeds = (1 - discount %) × par value = (1 - .01) × $3,000,000 = $2,970,000.

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