Chapter 8 questions:
8.1. The two primary factors that affect interest rates on debt securities are risk and inflation. Explain the role of each factor. I will explain the first factor.
First, the risk inherent in a business, and hence its ability to repay debt capital, affects the return lenders would require; the higher the perceived risk, the higher the interest rate. Investors would be unwilling to lend to high-risk businesses unless the interest rate was higher than on loans to low-risk businesses.
Second factor (you answer)
8.2. Briefly describe the features of the following types of debt ( I will explain the first one, term loan):
a. Term loan
A term loan is a contract under where a borrower agrees to make a series of interest and principal payments, on specified dates, to a lender. Investment bankers are generally not involved. The word ‘term’ means a specific period of time. Term loans are negotiated between a borrowing business and the lender. Typically, the lender is a financial institution such as a bank, a mutual fund, an insurance company, or a pension fund, but it can also be a wealthy private investor. Most term loans have maturities of 3 to 15 years for businesses borrowing the money. Term loans are typically amortized in equal installments over the life of the loan, so part of the principal of the loan is retired (i.e. paid down) with each payment. The interest rate on a term loan either can be fixed for the life of the loan or variable. If it is fixed, the rate used will be close to the rate on equivalent maturity bonds issued by businesses of comparable risk. If the rate is variable, it is usually set at a certain number of percentage points over an index rate (the LIBOR rate is used in the U.S. as the index rate) such as the prime rate. When the index rate goes up or down, so does the interest rate that must be paid on the outstanding balance of the loan.
b. Bond
c. Line of credit
d. Municipal bond
8.3. Briefly explain the following debt features:
a. Loan agreement
b. Restrictive covenant
c. Trustee
DO NOT ANSWER D IN THE TEXT
8.4.
a. What do bond ratings measure? (I will answer this one) Bond ratings rate the probability of default; the higher the rating, the lower the probability of the issue going into default.
b. How do investors interpret bond ratings?
c. Why are bond ratings important?
Do not answer d in the book.
8.5. Critique this statement: The use of debt financing lowers the profits of the firm, and hence debt financing should be used only as a last resort.
Chapter 8 problems:
8.3. St. Vincent’s Hospital has a target capital structure of 35 percent debt and 65 percent equity. Its cost of equity estimate is 13.5 percent and its cost of tax- exempt debt estimate is 7 percent. What is the hospital’s corporate cost of capital?
8.5. Morningside Nursing Home, a not-for-profit corporation, is estimating its corporate cost of capital. Its tax-exempt debt currently requires an interest rate of 6.2 percent, and its target capital structure calls for 60 percent debt financing and 40 percent equity (fund capital) financing. Its estimated cost of equity is 16.4 percent. What is Morningside’s corporate cost of capital?
Chapter 9 questions:
9.1
a. What is capital investment analysis? Why are capital investment decisions so important to businesses? ( I will answer this first one)
Decisions regarding the acquisition of new land, buildings, and equipment are called capital investment, or capital budgeting, decisions. Thus, capital investment analysis is the process by which an organization’s capital is allocated to specific uses. Capital investment decisions are of fundamental importance to the success or failure of any business, for these decisions, more than anything else, shape a business’s future.
b. What is the purpose of placing capital investments into categories, such as mandatory replacement, or expansion of existing products, services, or markets?
c. Should financial analysis play the dominant role in capital investment decisions? Explain your answer.
d. What are the four steps of capital investment financial analysis?
9.2
a. What is the opportunity cost of capital?
b. How is this rate, the opportunity cost of capital, used in discounted cash flow (DCF) analysis?
c. Is this rate, the opportunity cost of capital, a single number that is used in all situations?
9.3 Describe the following project breakeven and profitability measures. Be sure to include each measure’s economic interpretation.
a. Payback
b. Net present value (NPV)
c. Internal rate of return (IRR)
Chapter 9 problems:
9.2 Consider the following net cash flows:
What is the net present value if the opportunity cost of capital (discount rate) is 10 percent? ANSWER: $1,715.87 ( I will provide the first solution =)
Add an outflow (or cost) of $1,000 at Year 0. Now, what is the net present value? REMEMBER TO SHOW YOU WORK AS I HAVE ABOVE=)
9.6 Assume that you are the chief financial officer at Porter Memorial Hospital. The CEO has asked you to analyze two proposed capital investments—Project X and Project Y. Each project requires a net investment outlay of $10,000, and the opportunity cost of capital for each project is 12 percent. The projects’ expected net cash flows are as follows:
Calculate each project’s payback, NPV, and IRR. I will provide the solution here for you to answer b.
b. Which project (or projects) is financially acceptable? Explain your answer.
Rubric
Lab Assignments Rubric
Lab Assignments Rubric
Criteria Ratings Pts
This criterion is linked to a Learning OutcomeAccuracy
Key to demonstrating understanding is the accuracy of calculated answers.
40 pts
Full Marks
32 pts
80%
28 pts
70%
5 pts
Needs Substantial Improvement
40 pts
This criterion is linked to a Learning OutcomeOrganization/Communication
Key to demonstrating the mastery of communication in a clear and organized manner. **This is an all or no points condition.
10 pts
Full Marks
0 pts
No Marks
10 pts
Total Points: 50
