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Learning Objective: LO 1
Level of Difficulty: Easy
1.Most businesses are started when an entrepreneur is given a vision for a new business or
product by institutional investors.
A)
True
B)
False
Ans:
B
Format: True/False
Learning Objective: LO 1
Level of Difficulty: Easy
2.The process by which many entrepreneurs raise seed money and obtain other resources
necessary to start their businesses is often called bootstrapping.
A)
True
B)
False
Ans:
A
Format: True/False
Learning Objective: LO 1
Level of Difficulty: Easy
3.The initial seed money usually comes from the entrepreneur or other founders.
A)
True
B)
False
Ans:
A
Format: True/False
Learning Objective: LO 1
Level of Difficulty: Easy
4.The bootstrapping period usually lasts about five years.
A)
True
B)
False
Ans:
B
Format: True/False
Learning Objective: LO 2
Level of Difficulty: Easy
5.Venture capitalists are individuals or firms that help privately held businesses go public.
A)
True
B)
False
Ans:
B
Page 1
Format: True/False
Learning Objective: LO 2
Level of Difficulty: Easy
6.Angel investors are investors who come to the rescue of firms threatened by takeovers.
A)
True
B)
False
Ans:
B
Format: True/False
Learning Objective: LO 2
Level of Difficulty: Easy
7.A significant number of venture capital firms focus on high-technology investments.
A)
True
B)
False
Ans:
A
Format: True/False
Learning Objective: LO 2
Level of Difficulty: Easy
8.A significant number of venture capital firms focus on mature businesses.
A)
True
B)
False
Ans:
B
Format: True/False
Learning Objective: LO 2
Level of Difficulty: Easy
9.Traditional sources of funding work for new or emerging businesses despite the presence
of only intangible assets.
A)
True
B)
False
Ans:
B
Format: True/False
Learning Objective: LO 2
Level of Difficulty: Easy
10.The key idea behind staged funding is that each funding stage gives the venture capitalist
an opportunity to reassess the management team and the firm's financial performance.
A)
True
B)
False
Ans:
A
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Format: True/False
Learning Objective: LO 2
Level of Difficulty: Easy
11.A principal way for venture capitalists to exit is to sell part of the firm's equity back to
the entrepreneur.
A)
True
B)
False
Ans:
B
Format: True/False
Learning Objective: LO 2
Level of Difficulty: Easy
12.A venture capitalist may exit an investment by selling common stock in an initial public
offering.
A)
True
B)
False
Ans:
A
Format: True/False
Learning Objective: LO 3
Level of Difficulty: Easy
13.The amount of equity capital that can be raised in the public equity markets is typically
smaller than the amount that can be raised through private sources.
A)
True
B)
False
Ans:
B
Format: True/False
Learning Objective: LO 3
Level of Difficulty: Easy
14.Privately held firms find it easier to attract top management talent and to better motivate
current managers.
A)
True
B)
False
Ans:
B
Format: True/False
Learning Objective: LO 3
Level of Difficulty: Easy
15.To complete an IPO, a firm will need the services of investment bankers, who are experts
in bringing new securities to market.
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A)
B)
Ans:
True
False
A
Format: True/False
Learning Objective: LO 3
Level of Difficulty: Easy
16.To complete an IPO, a firm will need the services of angel investors, who are experts in
bringing new securities to market.
A)
True
B)
False
Ans:
B
Format: True/False
Learning Objective: LO 4
Level of Difficulty: Easy
17.Underwriting is the risk-bearing part of investment banking.
A)
True
B)
False
Ans:
A
Format: True/False
Learning Objective: LO 4
Level of Difficulty: Easy
18.In the firm-commitment underwriting, which is more typical, the investment banker
guarantees the issuer a fixed amount of money from the stock sale.
A)
True
B)
False
Ans:
A
Format: True/False
Learning Objective: LO 4
Level of Difficulty: Easy
19.With a firm-commitment underwriting, the investment banking firm makes no guarantee
to sell the securities at a particular price.
A)
True
B)
False
Ans:
B
Format: True/False
Learning Objective: LO 4
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Format: True/False
Learning Objective: LO 6
Level of Difficulty: Easy
25.Bootstrapping and venture capital financing are part of the public market.
A)
True
B)
False
Ans:
B
Format: True/False
Learning Objective: LO 6
Level of Difficulty: Easy
26.Private placement occurs when a firm sells unregistered securities directly to investors
such as insurance companies, commercial banks, or wealthy individuals.
A)
True
B)
False
Ans:
A
Format: True/False
Learning Objective: LO 6
Level of Difficulty: Easy
27.The biggest drawback of private placements involves restrictions on the resale of the
securities.
A)
True
B)
False
Ans:
A
Format: True/False
Learning Objective: LO 6
Level of Difficulty: Easy
28.Transactions in which a public company sells unregistered stock to an investor are called
PIPE transactions.
A)
True
B)
False
Ans:
A
Format: True/False
Learning Objective: LO 6
Level of Difficulty: Easy
29.The major disadvantage of a PIPE transaction to issuers is that it slows the firm's access
to capital.
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A)
B)
Ans:
True
False
B
Format: True/False
Learning Objective: LO 7
Level of Difficulty: Easy
30.Term loans are defined as business loans with maturities greater than one month but less
than one year.
A)
True
B)
False
Ans:
B
Format: Multiple Choice
Learning Objective: LO 1
Level of Difficulty: Easy
31.The initial seed money comes from
A)
public investors.
B)
investment banks.
C)
the entrepreneur or other founders.
D)
commercial banks.
Ans:
C
Format: Multiple Choice
Learning Objective: LO 1
Level of Difficulty: Easy
32.Bootstrapping is the process by which
A)
many entrepreneurs raise seed money and obtain other resources necessary to
start their businesses.
B)
the entrepreneur often fleshes out his or her ideas and makes them operational.
C)
most businesses are started by an entrepreneur.
D)
none of the above.
Ans:
A
Format: Multiple Choice
Learning Objective: LO 1
Level of Difficulty: Easy
33.Which one of the following statements is NOT true?
A)
The process by which many entrepreneurs raise seed money and obtain other
resources necessary to start their businesses is often called bootstrapping.
B)
Most businesses are started by an entrepreneur who has a vision for a new business
or product and a passionate belief in the concept's viability.
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C)
D)
Ans:
The initial seed money usually comes from the entrepreneur or other founders.
The seed money is spent on developing an initial public offering.
D
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Ans:
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Learning Objective: LO 2
Level of Difficulty: Easy
40.Which ONE of the following statements is true?
A)
A typical venture capital fund may generate annual returns of 15 to 25 percent on
the money that it invests, compared with an average annual return for the S&P 500
of almost 12 percent.
B)
A typical venture capital fund may generate annual returns of 12 percent on the
money that it invests, compared with an average annual return for the S&P 500 of
about 20 percent.
C)
A typical venture capital fund may generate annual returns of 12 percent on the
money that it invests, compared with an average annual return for the S&P 500 of
about 25 percent.
D)
None of the above
Ans:
A
Format: Multiple Choice
Learning Objective: LO 3
Level of Difficulty: Easy
41.Advantages of going public include all EXCEPT
A)
Larger amount of capital can be raised this way than the amount that can be raised
through private sources.
B)
Publicly traded firms find it harder to attract top management talent.
C)
Going public can enable an entrepreneur to fund a growing business without
giving up control.
D)
Additional equity capital can usually be raised through follow-on seasoned public
offerings at a low cost.
Ans:
B
Format: Multiple Choice
Learning Objective: LO 3
Level of Difficulty: Easy
42.Which ONE of the following statements is true?
A)
After the IPO, there is a less active secondary market for the firm's shares.
B)
Only smaller amounts of capital can be raised through an IPO than the amount that
can be raised through private sources.
C)
Publicly traded firms find it easier to attract top management talent.
D)
Going public can enable an entrepreneur to fund a growing business but not
without giving up control.
Ans:
C
Format: Multiple Choice
Learning Objective: LO 3
Level of Difficulty: Medium
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B)
C)
D)
Ans:
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D)
Ans:
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Learning Objective: LO 6
Level of Difficulty: Medium
57.Which one of the following statements is NOT true?
A)
Private equity firms pool money from wealthy investors, pension funds, insurance
companies, and other sources to make investments.
B)
Private equity firms invest in more mature companies.
C)
Private equity firms invest in new companies.
D)
Private equity investors focus on firms that have stable cash flows because they
use a lot of debt to finance their acquisitions.
Ans:
C
Format: Multiple Choice
Learning Objective: LO 7
Level of Difficulty: Medium
58.Private equity firms improve the performance of firms in which they invest by:
A)
making sure that the firms have the best possible management teams.
B)
closely monitoring each firm's performance and providing advice and counsel to
the firm's management team.
C)
facilitating mergers and acquisitions that help improve the competitive positions of
the companies in which they invest.
D)
All of the above.
Ans:
D
Format: Multiple Choice
Learning Objective: LO 6
Level of Difficulty: Medium
59.Which one of the following statements is NOT true?
A)
PIPE transactions are registered with the SEC.
B)
PIPE transactions are not registered with the SEC.
C)
In a PIPE transaction, investors purchase securities (equity or debt) directly from a
publicly traded company in a private placement.
D)
The securities are virtually always sold to the investors at a discount to the price at
which they would sell in the public markets.
Ans:
A
Format: Multiple Choice
Learning Objective: LO 6
Level of Difficulty: Medium
60.Which ONE of the following statements is true?
A)
Under federal securities law, they can be resold to investors in the public markets
immediately even if they are not registered.
B)
As part of the PIPE contract, the company often agrees to register the restricted
securities with the SEC, usually within 90 days of the PIPE closing.
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C)
D)
Ans:
As part of the PIPE contract, the company often agrees to register the restricted
securities with the SEC after 90 days of the PIPE closing.
PIPE transactions involving a healthy firm can also be executed without the use of
an investment bank but result in a cost increase of 7 to 8 percent of the proceeds.
B
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Ans:
A
Feedback:
Underwriter's gross spread ($19.30 $12.50) =$6.80 per share.
Number of shares outstanding = ($38.6 million/$19.30 per share) = 2 million.
Underwriting cost = ($6.80 per share x 2.0 million shares) = $13.6 million
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A)
B)
C)
D)
Ans:
investment bank demands a spread of 20 percent. Five million shares are issued.
However, the bank was overly optimistic and could not sell at the offer price of $31. If
the net proceeds to the issuer is $110 million, how much did the investment bank
receive?
$22.0 million
$27.5 million
$31.0 million
None of the above
B
Feedback:
Number of shares issued = 5 million
Net proceeds to issuer = $110 million
Underwriting spread = 20%
Gross proceeds from offer = $110,000,000 / 0.80 = $137.5 million
Proceeds to underwriter = $137.5 million 0.20 = $27.5 million
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D)
Ans:
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c. $8,500,000
d. $9,100,000
Ans:D
Feedback:
Stock price at end of first day = $61.00
First-day underpricing = ($61.00 $50.00) = $11.00 per share.
Total underpricing = ($11.00 per share x 500,000 shares of stock) = $5,500,000
Underwriter's gross spread ($50.00 x .12) =$6.00 per share.
Underwriting cost = ($6.00 per share x 500,000 shares) = $3 million
Total cost to the firm of selling the = $3,000,000 + $600,000 + $5,500,000
IPO
= $9,100,000
Format: Multiple Choice
Learning Objective: LO 7
Level of Difficulty: Medium
78. Castle Co. needs to borrow $10 million for process improvement upgrades. Management
decides to sell 20-year bonds. They determine that the 3-month Treasury bill rate is 2.75
percent, the firm's credit rating is A, and the yield on 20-year Treasury bonds is 1.80 percent
higher than that for 3-month Treasury bills. Bonds with an A rating are selling for 50 basis
points above the 20-year Treasury bond rate. What is the borrowing cost to do this
transaction?
a. 4.55%
b. 5.05%
c. 7.75%
d. 9.55%
Ans:B
Feedback:
kl = 2.75 + 1.80 + 0.50 = 5.05%
Format: Multiple Choice
Learning Objective: LO 5
Level of Difficulty: Medium
79. Why is the total cost of bringing a general cash offer to the market lower than issuing an
IPO?
a. They do not include a large underpricing
b. Underwriting spreads are smaller
c. There is less risk involved with a general cash offer than an IPO
d. all of the above
Ans:D
Format: Essay
Learning Objective: LO 1
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80.Why do traditional sources of funding not work for new or emerging businesses?
Ans:
New firms cannot resort to traditional sources of funding for three main reasons.
First, starting a new business is a risky proposition. The fact is that most new
businesses fail, and it is difficult to identify which firms will be successful. Most
suppliers of capital, such as banks, pension funds, and insurance companies, are
averse to undertaking high-risk investments, and much of their risk-averse
behavior is mandated in regulations that restrict their conduct. Second, most new
firms do not have real or tangible assets against which they can borrow. Most
commercial loans are made to firms that have tangible assets, such as machines,
equipment, and physical inventory. Lenders understand the operations of these
traditional firms and their inherent risks; thus, they are comfortable making
loans to them. The third reason is the information gap that exists between the
entrepreneur and potential investors. An entrepreneur knows more about his or her
company's prospects than a lender does. When dealing with highly specialized
technologies or companies emerging in new business areas, most investors do not
have the expertise to distinguish between competent and incompetent
entrepreneurs. As a result, they are reluctant to invest in these firms.
For these reasons, many investorssuch as pension funds, insurance companies,
endowment funds, and university foundationsfind it difficult to participate
directly in the venture capital market. Instead, they invest in venture capital funds
that specialize in identifying attractive investments in new businesses, managing
those investments, and selling (exiting) them at the appropriate time.
Format: Essay
Learning Objective: LO 3
81.What are the advantages and disadvantages of going public?
Ans:
Going public has a number of potential advantages.
The amount of equity capital that can be raised in the public equity markets is
typically larger than the amount that can be raised through private sources.
Once an IPO has been completed, additional equity capital can usually be raised
through follow-on seasoned public offerings at a low cost.
Going public can enable an entrepreneur to fund a growing business without giving
up control.
After the IPO, there is an active secondary market in which stockholders can buy and
sell its shares.
Publicly traded firms find it easier to attract top management talent and to better
motivate current managers if a firm's stock is publicly traded.
There are also several disadvantages to going public.
One disadvantage of going public is the high cost of the IPO itself.
The costs of complying with ongoing SEC disclosure requirements also represent a
disadvantage of going public.
The transparency that results from this compliance can be costly for some firms.
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Finally, some investors argue that the SEC's requirement of quarterly earnings
forecasts and quarterly financial statements encourages managers to focus on shortterm profits rather than long-term wealth maximization.
Format: Essay
Learning Objective: LO 6
82.What are PIPE transactions and how do they help firms raise capital?
Ans:
Private investment in public equity (PIPE) transactions are transactions in which a
public company sells unregistered stock to an investor. In a PIPE transaction,
investors purchase securities (equity or debt) directly from a publicly traded
company in a private placement.
The securities are virtually always sold to the investors at a discount to the price at
which they would sell in the public markets to compensate the buyer for limits on
the liquidity associated with these securities and, often, for being able to provide
capital quickly. Because the securities sold in a PIPE transaction are not registered
with the SEC, they are restricted securities. As part of the PIPE contract, the
company often agrees to register the restricted securities with the SEC, usually
within 90 days of the PIPE closing. If the registration is delayed past a deadline
date, the issuer might be required to pay the investor liquidity damages, usually 1
or 1.5 percent per month, as compensation for the loss of liquidity.
The major advantage of a PIPE transaction to issuers is that it gives them faster
access to capital and a lower funding cost than a registered public offering. PIPE
transactions involving a healthy firm can also be executed without the use of an
investment bank, resulting in a cost saving of 7 to 8 percent of the proceeds. A
PIPE transaction can be the only way for a small financially distressed company to
raise equity capital.
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