LIBOR is a benchmark rate that represents the interest rate at which banks offer to lend funds to one another in the international interbank market for short-term loans.

Preferred stockholders have higher claims on the earnings and the assets of the firm, though they have no voting rights.

In MM’s world, there are no bankruptcy costs whereas in real life companies face severe costs in case of bankruptcy. High legal costs related to customer, supplier and employee settlements are incurred. Furthermore, a bankrupt firm’s assets will most probably be liquidated at cheaper prices, lowering the worth of its assets. Not only bankruptcy, but the possibility of financial distress can also create problems leading to higher interest rates, contractions in credit purchases, employee jump ship and loss of customers. Therefore, financial distress or bankruptcy costs refrain firms from abundant debt financing. Especially firms with higher business risk should rely less on debt financing.

The main differences between debt and equity are the following:

• Debt is not an ownership interest in the firm. Creditors do not generally have voting power.

• The corporation’s payment of interest on debt is considered a cost of doing business and is fully tax deductible. Dividends paid to stockholders are not tax deductible.

• Unpaid debt is a liability of the firm. If it is not paid, the creditors can legally claim the assets of the firm. This action can result in liquidation or reorganization, two of the possible consequences of bankruptcy. Thus, one of the costs of issuing debt is the possibility of financial failure. This possibility does not arise when equity is issued. 

Therefore, the correct option is A.

With revolving credits, a limit of credit is set on the credit account of the borrower and both limits of credit and the due date are determined in a loan agreement.

A lease is a contractual agreement between a lessee and lessor establishing that the lessee has the right to use an asset and in return must make periodic payments to the lessor who is the owner of the asset. The lessor is either the asset’s manufacturer or an independent leasing company.

For funding investments and/or other cash uses by medium and long-term sources, the companies have four different alternatives. These are generally in the forms of bank borrowing, borrowing from special institutions, debt issuance and equity finance, securitization. Furthermore, depending on the peculiarities of the funding needs leasing can be another source of medium and long-term financing. Additionally, the internal sources such as Retained Earning and Depreciation provide financing to the corporate. As can also be understood from the information given “Retained Earning” and “Depreciation” are the internal sources which provide financing to the corporate, so the correct answer is B.

The debt and equity mix is called the capital structure of a firm.

The variance in the ROIC is an indicator of the business risk and a higher variance demonstrates a higher business risk.

The economic conditions in general impact the investment and financing decisions simultaneously. The economic policies of the country where the company is established to determine the market conditions shaping up both the forces of demand and supply. The political and economic stability affect the level of risk at the macro and micro levels. The inflation rate leads to the interest rate. Furthermore, the tax rates directly impel the level of investments and financing mechanisms. Risk escalates in an economic

Investment refers to all kinds of spendings made to acquire, sustain and increase production factors. The correct answer is A.

The CAPM (Capital Asset Pricing Model) estimates the required return of a stock investment in relation to its systematic risk which cannot be diversified away in a portfolio context.

The financial management of a company requires the management of funds’ uses as well as optimizing the funding of those uses.  The uses of cash flows are for net working capital and others and also for capital expenditures. In order to fund those uses, there exist two types of cash sources. Internal cash flow is generated from retained earnings and depreciation. External cash flow is generated from short-term borrowings and long-term debt and equity finance. The correct answer is C.

= 10 / 100 = 0.10

Financial risk is the additional risk borne by the stockholders when the company raises debt financing. As debt holders have prior claims in sharing the earnings and the assets of the firm, the use of debt capital (financial leverage) concentrates all of the business risks on the stockholders, putting equity capital to more risk than if the company were all equity financed. Therefore, financial leverage rises the cost of equity investments.

The bonds conventionally have fixed interest payments up to maturity as calculated based on the fixed par value. However, by the time the changing interest environment in the international financial markets, floating-rate bonds (floaters) began to be issued in which, the coupon payments are adjustable. The adjustments are tied to an interest rate index such as the Treasury bill interest rate or the 30-year Treasury bond rate and the value of a floating-rate bond depends on exactly how the coupon payment adjustments are defined.

The expected growth rate of ABC Corp. is:

PRS retains 40% of its net income, thus the expected growth rate is 6.40% when calculated from the retention growth model. Hence, the cost of equity is 11.32%. The correct answer is D.

The financial management of a company requires the management of funds’ uses as well as optimizing the funding of those uses. The uses of cash flows are for net working capital and others and also for capital expenditures. In order to fund those uses, there exist two types of cash sources. Internal cash flow is generated from retained earnings and depreciation. External cash flow is generated from short-term borrowings and long-term debt and equity finance. As can also be understood from the information given, “short-term borrowings” , “long-term debt” and “equity finance” are the cash sources which external cash flow is generated from, so the correct answer is E.