Financial leases are basically a medium-term financing alternative referring to its basic characteristics indicated below:

• Financial leases do not provide for maintenance or service by the lessor.

• Financial leases are fully amortized.

• The lessee usually has a right to renew the lease on expiration.

• Generally, financial leases cannot be canceled. The lessee has the sole responsibility to make all payments.

The correct answer is B.

Capital expenditure refers to outlay of funds by the firm that is expected to produce benefits over a period of time longer than one year.

Project finance is the process of financing a specific economic unit that the sponsors create, in which creditors share much of the venture’s business risk and funding is obtained strictly for the project itself. Project finance creates value by reducing the costs of funding, maintaining the sponsor’s financial flexibility, increasing the leverage ratios, avoiding contamination risk, reducing corporate taxes, improving risk management, and reducing the costs associated with market imperfections. The correct answer is A.

Mixing debt and equity in building up the capital structure of the firm is essential for value maximization. Estimating the optimal capital structure requires a careful analysis with repetitions. The managers normally start with a trial capital structure and evaluate shareholders’ wealth. They continue the same practice until they identify a capital structure maximizing the firm value. At each trial, the cost of debt and equity are projected in order to quantify the WACC. Then the forecasted free cash flows are capitalized at the calculated WACC to determine the firm value. As a final step, debt is deducted from the value of the firm to measure the value of the equity and the stock price.

Agency theory suggests that agency problems may arise if managers (agents) pursue different objectives other than those of the shareholders (principals). Shareholders’ seek for wealth maximization which can be attained by the maximization of the value of the firm. However, managers often waste shareholders’ wealth by consuming perquisites or investing in pet projects. Hence, high debt levels can be a solution to prevent these agency problems, since higher borrowing costs discipline managers to funnel cash flows to interest payments.

There are three kinds of risk sources when we talk about the risk of an investment project. The first one is (IV) stand-alone risks that a project exhibits when evaluated alone rather than as part of a combination or portfolio of assets. The second one is (III) within-firm risks that a project has on the total overall riskiness of the company. The third one is (II) market risks that a project has and assessed from the standpoint of a stockholder who has a portfolio of assets. The correct answer is E.

Systematic risk is the uncertainty inherent to the entire market or entire market segment.

Firms raise equity funds from their shareholders, who own a direct share of the net income and the net worth of the company. As shareholders hold residual claims on both the earnings and the assets of the business, they bear more risk than the creditors. Therefore, equity financing becomes more expensive than debt financing. Furthermore, as more debt is raised, the risk borne by the shareholder’s increases, leading to a higher cost of equity. The correct answer is A.

The bond indenture is a legal document. It can run in several hundred pages it generally includes the following provisions:
1. The basic terms of the bonds.
2. The total amount of bonds issued.
3. A description of property used as security.
4. The repayment arrangements.
5. The call provisions.
6. Details of the protective covenants.