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FIN 317 Week 5 Mid Term Exam

Chapters 1 Through 6

CHAPTER 1

INTRODUCTION TO FINANCE FOR ENTREPRENEURS

True-False Questions

1. Entrepreneurs provide the financing to individuals who think, reason, and act to convert ideas into commercial opportunities and create opportunities.

2. Entrepreneurship is the process of changing ideas into commercial opportunities and creating value.

3. An entrepreneur is an individual who thinks, reasons, and acts to convert ideas into commercial opportunities and to create value.

4. Mark Twain once said, “I was always able to see an opportunity before it became one.”

5. Small businesses, those with less than 500 employees, represent over 99 percent of all employers, and account for about one-half of the gross domestic product in the United States.

6. Small and growing enterprises are critical to the U.S. economy; small firms provide 20 to 30 percent of net new jobs.

7. Small high-technology firms are responsible for twice as many product innovations per employee and obtain more patents per sales dollar than large high-technology firms.

8. Phillips and Kirchhoff, using Dun & Bradstreet data, found that 24 percent of new firms were still in existence after two years of operation.

9. Nearly half of business failures are due to economic factors such as inadequate sales, insufficient profits, and industry weakness.

10. Although the risks associated with starting a new entrepreneurial venture are large, there is always room for one more success.

11. Studies by Phillips and Kirchhoff, and by Headd, found that about 38%-40% of new firms survived six years of operation.

12. One study of Inc. magazine’s 500 high-growth firms suggests that about 88 percent of founders feel their firms’ successes are due to extraordinary ideas, while the remaining 12 percent feel their firms’ successes are due to exceptional execution of ordinary ideas.

13. “Fads” are large societal, demographic, or technological trends or changes that are slow in forming but once in place continue for many years.

14. “Fads” are not predictable, have short lives, and do not involve macro changes.

15. Three major megatrends discussed in Chapter 1 include: societal trends or changes, demographic trends or changes, and technological trends or changes.

16. In 1982, Harry Dent identified several major or megatrends shaping U.S. society and the world.

17. The so-called “baby boom” generation applies to people born in the United States during the 1946-1964 time period.

18. Perhaps the most important invention shuttling us from an industrial society to an information society is the computer chip.

19. Environmental commerce, or e-commerce, involves the use of electronic means to conduct business online.

20. The Office of Advocacy of the U.S. Small Business Administration documents that “employer firm births” have exceeded 700,000 annually in recent years.

21. Reasonable estimates place nonemployer (e.g., single person or small family) business started each year at less than 100,000.

22. Bill Gates once said: “I was seldom able to see an opportunity, until it ceased to be one.”

23. A study by Phillips and Kirchhoff using Dun & Bradstreet data found that about three-fourths of new firms were still in existence after two years of operation.

24. Studies by Phillips and Kirchhoff, and by Headd, found that one-half of new firms or new employers were still in existence after four years of operation.

25. Nine principles of entrepreneurial finance are identified and explored in this entrepreneurial finance textbook,

26. The “time value of money” is an important component of the rent one pays for using someone else’s financial capital.

27. A venture’s financial objective is to survive.

28. Private financial markets are a place where standardized contracts or securities are traded on organized security exchanges with restrictions on how they can be transferred.

29. Free cash flow is the net income forecast to be available to the venture’s owners over time.

30. Free cash flows are adjusted for risk and the time value of money when used to calculate the value of a venture.

31. Free cash exists when cash exceeds that which is needed to operate, pay creditors, and invest in assets.

32. Free cash is all the cash available to cover operating expenses.

33. Owner-manager (agency) conflicts are differences between manager’s self-interest and that of the owners who hired the manager.

34. The owner-debtholder conflict is the divergence of the owners’ and lenders’ self-interest as the firm gets close to going “public.”

35. The financial objective of increasing value is inconsistent with developing positive character and reputation.

36. Entrepreneurial finance is the application and adaptation of financial tools and techniques to the planning, funding, operations, and valuation of an entrepreneurial venture.

37. Financial distress occurs when cash flow is insufficient to meet current debt obligations.

38. The second stage in a successful venture’s life cycle is the startup stage.

39. The rapid growth stage directly follows the startup stage.

40. Early-stage ventures include firms in their development, startup, or survival live cycle stages.

41. Business angels are wealthy individuals acting as informal or private investors, who provide venture financing for small businesses.

42. Mezzanine financing is temporary financing needed to keep the venture afloat until the next offering.

43. “Crises and bubbles” and “emerging economies and global change” are considered to be sources of entrepreneurial opportunities.

44. In Chapter I five mega-trend categories are identified as sources of entrepreneurial opportunities.

45. Entrepreneurial opportunities can occur only when there are societal changes in the world.

46. One principal of entrepreneurial finance is “risk and expected reward go hand in hand.

47. While cash is the language of business, accounting is the currency.

48. Venture character and reputation can be assets or liabilities.

Multiple-Choice Questions

1. Successful entrepreneurs exhibit which of the following traits?
a. recognize and seize commercial opportunities
b. economic pessimism
c. tend to be doggedly optimistic
d. both a and b
e. both a and c

2. While one must be careful to avoid too many generalizations about entrepreneurial traits or characteristics, which one of the following characteristics would not normally be associated with successful entrepreneurs?
a. being able to see and seize a commercial opportunity
b. planning for the venture’s future
c. only being able to see an opportunity after it ceases to be one
d. being optimistic about the venture’s success

3. About one-half of all newly created businesses in the U.S. are dissolved or cease operations within how many years after being started?
a. two years
b. four years
c. six years
d. eight years

4. About 60 percent of all newly created businesses in the U.S. are dissolved or cease operations within how many years after being started?
a. two years
b. four years
c. six years
d. eight years

5. “Fads” are:
a. not predictable
b. have short lives
c. do not involve macro changes
d. all of the above

6. Harry Dent documented major generation waves in the United States during the twentieth century in:
a. 1972
b. 1982
c. 1993
d. 2003

7. “E-commerce” refers to:
a. environmental commerce
b. electronic commerce
c. economic commerce
d. exploratory commerce

8. While entrepreneurial opportunities come from an almost unlimited number of sources, this textbook focuses on:
a. societal changes
b. demographic changes
c. technological changes
d. crises and bubbles
e. emerging economies and global changes
f. all of the above

9. Indicate the number of principles of entrepreneurial finance that are emphasized in this textbook:
a. one
b. three
c. five
d. seven
e. nine

10. Maximizing the value of the venture to its owners is the common financial goal of which of the following?
a. the entrepreneur
b. the debtholders
c. the venture equity investors
d. both a and b
e. both a and c

11. Which of the following is considered to be an “agency” conflict?
a. owner-manager conflict
b. stockholder-manager conflict
c. stockholder-debtholder conflict
d. manager-debtholder conflict

12. Which one of the following possible conflicts of interest is usually minimized through the use of equity incentives?
a. owner-manager conflicts
b. owner-employee conflicts
c. manager-employee conflicts
d. manager-debtholder conflicts

13. Which one of the following possible conflicts of interest increases in divergence at venture gets close to bankruptcy?
a. owner-manager conflict
b. owner-employee conflict
c. manager-employee conflict
d. manager-debtholder conflict

14. Which of the following is not a life cycle stage of a successful venture?
a. development stage
b. startup stage
c. survival stage
d. cash cow stage
e. early-maturity stage

15. Which of the following does not describe activity during the venture’s life cycle startup stage?
a. venture’s organization
b. venture’s development
c. operating cash flows are generated
d. initial revenue model is put in place

16. At which stage of the venture’s life cycle stage is best characterized by the period when revenues start to grow and when cash flows from operations begin covering cash outflows?
a. survival stage
b. startup stage
c. rapid growth stage
d. early-maturity stage

17. Which is not a major source of start-up financing for a venture’s startup stage?
a. entrepreneur’s assets
b. business operations
c. family and friends
d. business angels
e. venture capitalists

18. Obtaining bank loan, issuing bonds, and issuing stock is characteristic of which type of financing during the venture’s life cycle?
a. seed financing
b. second round financing
c. mezzanine financing
d. seasoned financing
e. liquidity stage financing

19. During a venture’s rapid growth stage, funds for plant expansion, marketing expenditures, working capital, and product or service improvements is obtained through?
a. seed financing
b. second round financing
c. mezzanine financing
d. seasoned financing
e. liquidity stage financing

20. Founder and venture investor shares are sold to the public after the initial offering to the public is called?
a. secondary market transaction
b. secondary stock offering
c. venture offering
d. bridge loan

21. Which of the following advise and assist corporations on the type, timing, and costs of issuing new debt and equity securities and facilitate the sale of firms?
a. brokerage firms
b. venture law firms
c. specialist firms
d. investment banking firms

22. Which stage in the venture life cycle is characterized by creating and building value, obtaining additional financing, and examining opportunities?
a. survival stage
b. startup stage
c. rapid growth stage
d. early-maturity stage

23. Which of these statements is correct?
a. The development stage occurs between the startup and survival stages of a venture’s life cycle
b. The early-maturity stage is the final stage of a new venture’s lifecycle
c. Firms typically begin to cover all expenses with internally-generated funds during the survival stage
d. During the startup stage, revenues grow much more rapidly than cash expenditures
e. None of the above

24. The last three stages of a successful venture’s life cycle occur in the following order:
a. startup, development, rapid growth
b. startup, survival, rapid growth
c. survival, rapid growth, early-maturity
d. development, startup, survival

25. The stage that precedes the middle stage in a successful venture’s life cycle is called the:
a. rapid growth stage
b. early-maturity stage
c. development stage
d. survival stage
e. startup stage

26. During the maturity stage of a venture’s life cycle, the primary source of funds is in the form of:
a. mezzanine financing
b. seed financing
c. startup financing
d. first round financing
e. seasoned financing

27. The type of financing that occurs during the development stage of a venture’s life cycle is typically referred to as:
a. seed financing
b. startup financing
c. first round financing
d. second round financing
e. mezzanine financing

28. Mezzanine financing is associated with which one of the following life cycle stages:
a. development stage
b. startup stage
c. survival stage
d. rapid growth stage
e. early-maturity stage

29. Entrepreneurial finance is the application and adaptation of financial tools and techniques to an entrepreneurial venture. Entrepreneurial finance involves:
a. planning
b. funding
c. operations
d. valuation
e. a and d above
f. all of the above

30. The first three stages of a successful venture’s life cycle occur in the following order:
a. development, rapid growth, survival
b. startup, development, rapid growth
c. startup, survival, rapid growth
d. survival, rapid growth, early-maturity
e. development, startup, survival

31. The last stage in a successful venture’s life cycle is called the:
a. rapid growth stage
b. early-maturity stage
c. development stage
d. survival stage
e. startup stage

32. The type of financing that occurs during the survival stage of a venture’s life cycle is typically referred to as the:
a. seed financing
b. startup financing
c. first round financing
d. second round financing
e. mezzanine financing

33. Which one of the following would not be considered a type of venture financing?
a. seed financing
b. startup financing
c. mezzanine financing
d. liquidity-stage financing
e. seasoned financing

34. One study of successful entrepreneurs indicated that a majority felt that the most important factor in the long-term success of their ventures was:
a. being greedy
b. having high ethical standards
c. working hard
d. taking frequent vacations

35. Financial markets where customized contracts or securities are negotiated, created, and held with restrictions on how they can be transferred are called:
a. private financial markets
b. public financial markets
c. domestic financial markets
d. international financial markets
e. all of the above

36. The time value of money concept is associated with which one of the following principles of entrepreneurial finance:
a. real, human, and financial capital must be rented from owners
b. risk and expected reward go hand in hand
c. while accounting is the language of business, cash is the currency
d. it is dangerous to assume that people act against their own self-interests

37. The goal of the entrepreneurial process is to:
a. develop opportunities
b. gather resources
c. manage and build operations
d. create value

38. Which of the following is not considered to be a mega-trend in this textbook?
a. societal, demographic, and technological changes
b. crises and bubbles
c. fads
d. emerging economies and global changes

Supplementary Questions (may require basic knowledge of probability and/or prior introductory accounting and business concepts)

1. You have the opportunity of making a $5,000 investmen The outcomes one year from now will be either $4,500 or $6,000 with an equal chance of either outcome occurring. What is the expected outcome?
a. $4,500
b. $6,000
c. $5,250
d. $5,750
e. $5,000

2. You have the opportunity of making a $5,000 investmen The outcomes one year from now will be either $5,000 or $6,000 with an equal chance of either outcome occurring. What is the expected rate of return?
a. 10%
b. 15%
c. 20%
d. 25%
e. 30%

3. A project requires an initial investment of $1,000,000. In one year, there is a 40% chance of a $950,000 return; a 50% chance of a $1,200,000 return; and a 10% chance of a $2,000,000 return. What is the project’s expected return one year from now?
a. 12.8%
b. 15.5%
c. 18.0%
d. 38.3%

4. Lindsey and Tobias have the opportunity to invest in a project that requires an investment of $3,000. There is a 35% chance of a $2,900 return; a 40% chance of a $3,400 return; and a 25% chance of a $4,500 return one year from now. Lindsey requires a 15% return on the project after the first year, but Tobias requires a return of only 12%. Using the expected rate of return:
a. Lindsey and Tobias should both invest in the project
b. Only Tobias should invest in the project
c. Only Lindsey should invest in the project
d. Lindsey and Tobias should both reject the project

5. You are considering investing in two independent projects “A” and “B”. Project A requires an initial investment of $12,000. In one year, there is a 30% chance of a $10,500 return; a 50% chance of a $12,500 return; and a 20% chance of a $14,500 return. Project B requires an initial investment of $1,000. In one year, there is a 25% chance of a $950 return; a 25% chance of a $1,000 return; and a 50% chance of a $1,200 return. If you require a 7% return on your investment after one year, you should:
a. Accept A and reject B
b. Accept B and reject A
c. Accept both projects
d. Reject both projects

6. Assume that you can sell a new product at $5.00 per uni Your variable costs are $3.00 per unit and you fixed costs are $20,000. What is your breakeven point in sales units?
a. 5,000
b. 7,500
c. 10,000
d. 12,500
e. 15,000

7. Assume that you can sell a new product at $5.00 per uni Your variable costs are $3.00 per unit and you fixed costs are $20,000. What will be your profit before taxes if you sell 12,000 units next year?
a. $0
b. $1,000
c. $2,000
d. $4,000
e. $8,000

CHAPTER 2

DEVELOPING THE BUSINESS IDEA

True-False Questions

1. For ventures that first get to market or create intellectual property rights, it’s common to price new products or services at high markups or profit margins.

2. Lifestyle firms are growth-driven in terms of revenues, profits, and cash flows and also performance-oriented as reflected in rapid value creation over time.

3. “Salary-replacement” firms provide their owners with income levels comparable to what they could have earned working for much larger firms.

4. An entrepreneur may start a number of different types of businesses, including salary-replacement firms, lifestyle firms, and entrepreneurial firms or ventures.

5. “Entrepreneurial ventures” are firms that allow owners to pursue specific lifestyles while being paid for doing what they like to do.

6. Entrepreneurial ventures emphasize survival and providing an acceptable living for their owners with growth being a secondary goal.

7. A sound business model is a plan to generate investor interest, make profits, and grow asset investments.

8. A sound business model should provide a plan to generate revenues, make profits, and produce free cash flows.

9. Mark Twain said: “Like I tell anybody, if you fail to plan, you’re planning to fail.”

10. Best practices of high-growth, high-performance firms applied in the marketing practices area include “developing new products or services that are considered to be the bes ”

11. Best practices of high-growth, high-performance firms applied in the marketing practices area include “preparing detailed monthly financial plans for the next year and annual financial plans for the next five years.

12. Best practices of high-growth, high-performance firms applied in the financial practices area include “preparing detailed monthly financial plans for the next year and annual financial plans for the next five years.

13. Best practices of high-growth, high-performance firms applied in the management practices area include “assembling a management team that is balanced in both functional area coverage and industry/market knowledge.”

14. Business opportunities, because they exist in real time, have a relatively narrow window of opportunity to become a successful business venture. However being the first to market does not guarantee success.

15. Ideas that are said to be “ahead of their time” are too early to become viable business opportunities for the inventor or innovator.

16. Once conceptualized, a new idea should be examined for its business feasibility.

17. A SWOT analysis is an examination of the strengths, weaknesses, opportunities, and threats to determine the business opportunity viability of an idea.

18. A SWOT analysis focuses on strengths (S), worries (W), opportunities (O), and treats (T).

19. A “venture opportunity screening” is the same thing as preparing a business plan.

20. A SWOT analysis should consider as potential strengths or weaknesses whether there are unfilled customer needs and the extent to which intellectual property rights exis

21. A SWOT analysis should consider the extent of existing competition and the likelihood of substitute products or services as potential strengths or opportunities.

22. Venture opportunity screening involves assessment of an idea’s commercial potential to produce revenue growth, financial performance, and value.

23. A venture with a low score on the VOS Indicator should always be abandoned.

24. The VOS Indicator is useful in assessing the commercial potential of a venture, but should not be used as the sole tool to determine a venture’s fate.

25. The VOS Indicator provides both qualitative and quantitative information about a venture’s commercial potential.

26. A venture opportunity-screening guide, called the VOS Indicator, is used to determine potential attractiveness of venture opportunities as business opportunities.

27. Asset intensity is the net after-tax profit divided by total assets.

28. One way to describe asset intensity is the dollar investment in assets needed to generate a dollar in sales.

29. Business changes resulting in higher net profit always increases ROA.

30. The compound rate of return that equates the present value of the cash inflows with the initial investment outlay is called the internal rate of return (IRR).

31. Bootstrapping refers to the process of minimizing resources such as the need for financial capital and finding unique sources for financing a new venture.

32. Free cash flow to equity is the cash flow from producing and selling a product or providing a service.

33. In a typical business plan, the section covering the management team does not need to disclose the expertise and experience of the managemen

34. The non-financial option available to managers as the venture progresses through its lifecycle is known as real options.

35. The process of moving from entrepreneurial opportunities to new businesses, products, or services begins with ideas, then moves to the preparation of a business plan, and finally ends with a feasibility study.

36. A well-designed entrepreneurial venture bins with an idea that survives an analysis of its feasibility and results in a business model/plan.

37. A successful, sound business model does not have to ultimately produce free cash flows.

38. The first component of a sound business model is the need to generate revenues.

Multiple-Choice Questions

1. Firms that allow owners to pursue specific lifestyles while being paid for doing what they like to do are referred to as:
a. salary-replacement firms
b. lifestyle firms
c. entrepreneurial ventures
d. rapid value creation firms

2. U.S. small businesses are predominately:
a. salary-replacement or entrepreneurial firms
b. lifestyle or entrepreneurial firms
c. entrepreneurial ventures
d. salary-replacement or lifestyle firms

3. The definition of an entrepreneurial firm is:
a. survival, high growth
b. high growth, high performance
c. survival, average performance
d. high, growth, average performance

4. A sound business model provides a plan which includes all of the following except?
a. generates revenues
b. makes profits
c. retains all its earnings
d. produces free cash flows
e. all of the above are included

5. A sound business model includes a plan to:
a. generate revenues, make profits
b. make profits, produce free cash flows
c. produce free cash flows for the owners of the venture
d. generate revenues, make profits, and produce free cash flows

6. Which one of the following components is not a standard component of a sound business model?
a. produce low-cost products
b. generate revenues
c. make profits
d. produce free cash flows

7. Free cash flows, which can be paid back to investors occurs when cash generated from operations exceeds all of the following except?
a. borrowing costs
b. non-cash depreciation
c. taxes
d. investment in assets

8. A venture’s value is determined by
a. the size and timing of its future free cash flows
b. time value of money
c. its net income
d. a and b
e. a and c

9. Developing new and delivering high-quality products or services that command higher prices and margins best describes strong
a. marketing practices
b. financial practices
c. operating practices
d. management practices

10. Effective entrepreneurial management teams should include all of the following except?
a. provide expertise in the areas of marketing, finance, and operations
b. have successful experience in the venture’s industry and markets
c. work collaboratively with each other
d. share the entrepreneurial spirit
e. in-house accounting, auditing, and tax professionals

11. A viable venture opportunity is characterized by all of the following except?
a. creating or meeting a customer need
b. has perceived attraction to prospective investors
c. provides an initial competitive advantage
d. is timely in terms of time-to-market
e. offers the expectation of added value to investors

12. A SWOT analysis does not focus on which of the following components or areas?
a. strengths
b. weaknesses
c. new ideas
d. opportunities
e. threats

13. A SWOT analysis focuses on which of the following components or areas?
a. strengths
b. weaknesses
c. opportunities
d. threats
e. all of the above
a, b, and d

14. When conducting a SWOT analysis, “unfilled customer needs” are examined in terms of:
a. strengths
b. weaknesses
c. opportunities
d. threats
e. a or b
c or d

15. SWOT analysis should at the very least consider which of the following areas:
a. experience/expertise
b. reputation value
c. first mover
d. a and b
e. a, b, and c

16. Which one of the following is not a part of the VOS indicator?
a. industry/market considerations
b. pricing/profitability considerations
c. financial/harvest considerations
d. management team considerations
e. location/profitability considerations

17. The evaluation of “entry barriers” occurs under which one of the following parts of the VOS indicator?
a. industry/market considerations
b. pricing/profitability considerations
c. financial/harvest considerations
d. management team considerations

18. A VOS indicator stands for:
a. venture opportunity screening indicator
b. viable opportunity statement indicator
c. venture only success indicator
d. viable assessment screening indicator

19. The factor categories in a VOS indicator are:
a. industry/market considerations
b. pricing/profitability considerations
c. financial/harvest considerations
d. management team considerations
e. all of the above
a, b, and d

20. A “score” in the range of 2.34-3.00 using the VOS IndicatorTM ¬¬¬¬ ¬would be considered a:
a. a low score
b. an average score
c. a high score
d. a very, very high score

21. An average score on using the VOS Indicator¬TM would fall in the range:
a. 0.00-0.99
b. 1.00-1.66
c. 1.67-2.33
d. 2.34-3.00

22. At the end of a qualitative-based venture opportunity screening exercise, the interviewer prepares a subjective assessment and indicates one of the following except for:
a. natural commercial potential
b. high commercial potential
c. average commercial potential
d. low commercial potential

23. Direct costs of producing a product or providing a service is called
a. gross profit
b. gross profit margin
c. net profit
d. net profit margin
e. cost of goods sold

24. Revenues minus the cost of goods sold is called
a. gross profit
b. gross profit margin
c. net profit
d. net profit margin

25. Dollar profit left after all expenses, including financing costs and taxes have been deducted from the firm’s revenues is called
a. gross profit
b. gross profit margin
c. net profit
d. net profit margin
e. cost of goods sold

26. Return on assets can be stated as which of the following?
a. net after-tax profit divided by total assets
b. net profit margin times asset turnover
c. net cash flow divided by total assets
d. both a and b
e. both a and c

27. All else held constant, a higher asset turnover:
a. increases ROA
b. decreases ROA
c. has no effect on ROA
d. may raise or lower ROA, depending on how it affects revenues.

28. The return on assets (ROA) model measures:
a. revenues divided by net profit times the asset turnover
b. net profit margin times the equity multiplier
c. net profit margin times asset turnover
d. net profit divided by total assets multiplied by the asset turnover

29. Free cash flow to equity is the cash available to the entrepreneur and venture investors after all of the following except?
a. net cash flows
b. operating cash outflows
c. financing and tax cash flows
d. investment in assets needed to sustain the venture’s group
e. net increase in debt capital

30. The free cash flows to equity of an entrepreneurial firm includes cash flows to:
a. venture investors
b. creditors
c. the entrepreneur
d. a and b
e. a and c
f a, b, and c

31. Determine the cost of goods sold for a venture with the following financial information: revenues = $50,000; net profit margin = 20%;
gross profit margin = 70%
a. $40,000
b. $35,000
c. $15,000
d. $10,000

32. Determine gross profit of a venture with the following
financial information: cost of goods sold = $30,000; net profit = $17,000; asset turnover = 1.6; return on assets 32%
a. $85,000
b. $72,000
c. $55,000
d. $38,000
33. Determine the return on assets (ROA) for a venture with the following financial information: revenues = $500,000; net profit = $70,000; and asset turnover = 2.00 times.
a. 10%
b. 14%
c. 20%
d. 28%
e. 34%

34. Determine the dollar amount of total assets for a venture with the following financial information: revenues = $500,000; net profit = $70,000; and asset turnover = 2.00 times.
a. $100,000
b. $250,000
c. $375,000
d. $500,000
e. $650,000

35. Determine the dollar amount of net profit for a venture with the following financial information: revenues = $500,000; return on assets = 20%; and asset turnover = 2.00 times.
a. $10,000
b. $25,000
c. $50,000
d. $60,000
e. $75,000

36. Determine the dollar amount of revenues for a venture with the following financial information: net profit = $60,000; assets turnover = 1.5 times; and return on assets 30%.
a. $300,000
b. $500,000
c. $800,000
d. $1,000,000
e. $1,200,000

37. Determine the asset intensity of a venture with the following financial information: net profit = $22,000; revenues = $132,000; return on assets 30%. a. .05
b. .56
c. 1.8
d. 20

38. In the venture life cycle, moving from the development stage to the startup stage frequently begins with the preparation of a business plan. The business plan is a written document that describes the proposed venture in all of the following terms except:
a. the proposed product or service opportunity
b. the accounting data for the last five years
c. current resources available to the venture
d. financial projections

39. A typical business plan includes all of the following sections except:
a. executive summary
b. business description
c. marketing plan and strategy
d. disclosure of pending litigation
e. operations and support

40. When composing the financial plans and projections section of a business plan, all of the following should be included except:
a. income statements and balance sheets
b. statement of cash flows
c. past and present dividend per share information
d. breakeven analysis
e. funding needs and sources

41. A typical business plan includes all of the following except:
a. management team
b. financial plans and projections
c. risk and opportunities
d. timeline and milestones
e. initial public offering information

42. The first two requirements of a sound business model are:
a. generate revenues, make profits
b. make profits, produce free cash flows
c. produce free cash flows for creditors and owners of the venture
generate revenues and produce free cash flows

43. The process involving minimizing the need for financial capital and finding unique sources for financing a new venture is referred to as:
a. mezzanine financing
b. financial bootstrapping
c. seed financing
d. startup financing

44. A written document that describes the proposed venture in terms of the product or service opportunity, current resources, and financial projections is called a:
a. financial plan
b. business plan
c. entrepreneurial plan
d. survival plan

45. In the Kauffman Center study of best practices of high-growth, high-performance firms, which of the following practices was not included?
a. marketing practices
b. financial practices
c. management practices
d. production/operations practices

46. When moving from entrepreneurial opportunities to new businesses, products, or services, which one of the following is not considered a component?
a. ideas
b. feasibility
c. business plan
d. harvest of venture

47. A firm’s option to abandon a venture is an example of a:
a. bootstrapping option
b. financial option
c. survival option
d. real option

48. A venture’s value to its owners is determined by the:
a. size and timing of its future free cash flows (to equity)
b. level of its past revenues
c. prior losses and expenses
d. all of the above

49. A well-designed entrepreneurial venture typically includes:
a. generating ideas
b. analyzing the feasibility of ideas
c. producing business models/plans
d. only a and c above
e. a, b, and c above

50. Some venture investors like to draw analogies between baseball terms and venture performance. The baseball term used to reflect a total loss of an investment is:
a. home run
b. single
c. strikeout
d. double

CHAPTER 3

ORGANIZING AND FINANCING A NEW VENTURE

True-False Questions

1. The difference between a limited partnership and a general partnership is that the limited partnership has partners who actively manage the day-to-day operations but also has passive investors.

2. A limited partnership limits certain partners’ liabilities to pay the venture’s obligations to the amount each paid for their partnership interests.

3. In a corporate legal entity, the personal assets of the owners are separate from the business’ assets, but the personal liabilities of the owners are no

4. Limited liability in the corporate business structure means creditors can seize only some of the corporation’s assets.

5. The articles of incorporation are the basic legal declarations contained in the corporate charter.

6. Limited liability companies (LLCs) are owned by shareholders with limited liability and its earnings are taxed at the corporate rate.

7. Partnerships are treated with pass-through taxation. This means that profits and losses of the business pass directly through to investors on the basis specified in the partnership agreemen

8. An employment contract is an agreement between an employer and employee about the terms and conditions of employment including the employee’s agreement to keep confidential information secret and to assign ideas and inventions to the employer.

9. Financial bootstrapping maximizes the need for financial capital.

10. The income received by a proprietorship is taxed at personal tax rates.

11. The equity capital sources for a proprietorship are partners, families, and friends.

12. The maximum number of owners in a Subchapter S corporation is 150.

13. An S corporation provides unlimited liability for its shareholders.

14. Professional corporations (PCs) and service corporations (SCs) are corporate structures that “states” provide for professionals such as physicians, dentists, lawyers, and accountants.

15. The marginal tax rate for the first dollar of taxable income is higher for corporations than for individuals.

16. Based on 201209 tax laws, the highest possible marginal tax table rate is higher for corporations than for individuals.

17. The highest marginal income tax rate for taxable personal income is 45 percen

18. There are four types of “marks” that can be used to try to protect intellectual property.

19. Patents, trade secrets, trademarks, and copyrights are intangible assets.

20. “Certification marks” cover memberships in groups (e.g., a sorority or a labor union).

21. “Collective marks” cover memberships in groups (e.g., a sorority or a labor union).

22. Most trademarks take the form of names, words, or graphic designs.

23. A “color mark” is considered to be one four types of “marks” used to try to protect intellectual property.

24. A copyright must be registered with the U.S. Copyright Office in order for a work to be protected.

25. A work does not need to be registered to receive copyright protection; the work’s creation is enough to provide copyright protection.

26. There are four kinds of patents.

27. “Business method” is one kind of paten

28. An idea is enough to be patented.

29. “Design patents” cover most inventions pertaining to new products, services, and processes.

30. “Business method” patents protect a specific way of doing business and the underlying computer codes, programs, and technology.

31. “Patents” are intellectual property rights granted for inventions that are useful, novel, and obvious.

32. Nondisclosure agreements prohibit the creator of an idea or other form of intellectual property from sharing it with others once it has been presented the first time.

33. Confidential disclosure agreements are used to protect intellectual property when disclosure must be made to an outside individual or organization.

34. “Certification marks” are intellectual property rights in the form of inventions and information (e.g., formulas, processes, customer lists, etc.) not generally known to others.

35. “Trademarks” are intellectual property rights that allow firms to differentiate their products and services through the use of unique marks.

36. A trademark must be novel in order to receive protection.

37. Business angels are wealthy individuals who invest in early-stage ventures in exchange for the excitement of launching the business, as well as a share of the firm’s financial gains.

38. “Service marks” refer to services such as those provided by a sorority or a labor union.

39. “Certification marks” provide indications of quality.

40. Copyrights are intellectual property rights to writings in printed and electronically stored forms.

Multiple-Choice Questions

1. In which form of business organization are the owners not offered the protection of limited liability?
a. proprietorship
b. limited partnership
c. corporation
d. subchapter S corporation
e. limited liability corporation

2. In which form of business organization is the taxation effects characterized by the income flowing to shareholders taxed at personal tax rates?
a. proprietorship
b. limited partnership
c. corporation
d. subchapter S corporation
e. general partnership

3. Which form of business organization is characterized by having the shortest start-up time and lowest legal costs?
a. proprietorship
b. limited partnership
c. corporation
d. subchapter S corporation
e. limited liability corporation

4. Which form of business organization typically offers the easiest transfer of ownership?
a. proprietorship
b. limited partnership
c. corporation
d. subchapter S corporation
e. general partnership

5. Which form of business organization is characterized as having unlimited life?
a. proprietorship
b. limited partnership
c. limited liability corporation
d. subchapter S corporation
e. general partnership

6. Which of the following is not a right or a duty of general partners?
a. participation in profits and losses
b. some liability for partnership obligations
c. veto right on new partners
d. eventual return of capital
e. access to partnership books

7. The rules and procedures established to govern the corporation are called the
a. corporate charter
b. articles of incorporation
c. corporate bylaws
d. confidentiality disclosure agreements
e. partnership agreements

8. In a general partnership, legal action that treats all partners equally as a group is called:
a. joint and several liability
b. joint liability
c. limited liability
d. accrued liability
e. general liability

9. Which of the following business organizational forms provides the owners with limited investor liability and passes its income before taxes through to the owners?
a. partnership
b. subchapter S (or S) corporation
c. regular or (C ) corporation
d. limited liability company (LLC)
e. both a and b
f. both b and d

10. Which of the following numbers of shareholders is allowed in a Subchapter S (or S) corporation business form?
a. 74
b. 125
c. 130
d. 500

11. Based on 2012 tax schedules, the first dollar of personal taxable income is taxed at which of the following marginal tax rates:
a. 05.0%
b. 10.0%
c. 15.0%
d. 20.0%
e. 25.0%

12. Based on 2012 tax schedules, the first dollar of corporate income is taxed at which of the following marginal tax rates:
a. 05.0%
b. 10.0%
c. 15.0%
d. 20.0%
e. 25.0%

13. Based on 2012 tax schedules, the highest marginal tax rate on personal taxable income is:
a. 25.0%
b. 28.0%
c. 33.0%
d. 35.0%
e. 40.0%

14. Based on 2012 tax schedules, the highest marginal tax rate on corporate taxable income is:
a. 25.0%
b. 28.0%
c. 35.0%
d. 38.0%
e. 39.0%

Note: The following information should be used for multiple choice questions 15-19. Following is a partial 2012 personal income tax schedule for a single filer:
Taxable Income

Beginning Ending Bracket Marginal
Amount Amount Amount Tax Rate
$1 $8,700 $8,700 0.10
$8,700 $35,350 $26,650 0.15
$35,350 $85,650 $50,300 0.25

15. The dollar amount of income taxes paid by a single filer who has taxable income of $8,700 would be:
a. $150
b. $870
c. $3,840
d. $4,675
e. $10,385

16. The cumulative dollar amount of income taxes paid by a single filer who has taxable income of $35,350 would be:
a. $150
b. $835
c. $3,840
d. $4,867.50
e. $10,385

17. The maximum dollar amount of income taxes in the $35,350-$85,650 “bracket” paid by a single filer with taxable income of $85,650 would be:
a. $150
b. $870
c. $3,997.50
d. $4,675
e. $12,575

18. The average tax rate for a single filer with taxable income of $35,350 would be:
e. 10.0%
f. 13.8%
g. 15.0%
h. 16.7%
i. 20.0%

19. The average tax rate for a single filer with taxable income of $85,650 would be:
a. 14.7%
b. 16.7%
b. 20.0%
c. 20.4%
d. 25.0%

Note: The following information should be used for multiple choice questions 20-36. Following is a partial 2012 corporate income tax schedule:

Taxable Income
Beginning Ending Bracket Marginal
Amount Amount Amount Tax Rate
$1 $50,000 $50,000 0.15
$50,000 $75,000 $25,000 0.25
$75,000 $100,000 $25,000 0.34

20. The dollar amount of income taxes paid by a corporation with taxable income of $50,000 would be:
a. $1,500
b. $6,250
c. $7,500
d. $8,500
e. $10,850

21. The cumulative dollar amount of income taxes paid by a corporation with taxable income of $75,000 would be:
a. $6,250
b. $7,500
c. $8,500
d. $13,750
e. $22,250

22. The maximum dollar amount of income taxes in the $75,000-$100,000 bracket paid by a corporation with taxable income of $100,000 would be:
a. $6,250
b. $7,500
c. $8,500
d. $13,750
e. $22,250

23. The average tax rate for a corporation with taxable income of $75,000 would be:
a. 15.0%
b. 18.3%
c. 20.0%
d. 22.7%
e. 25.0%

24. The average tax rate for a corporation with taxable income of $100,000 would be:
a. 15.0%
b. 16.75%
c. 20.0%
d. 22.25%
e. 25.0%

25. Intellectual property can be protected by all of the following except:
a. patents
b. trademarks
c. legal disclaimers
d. copyrights
e. trade secrets

26. Which of the following are intellectual property rights granted for inventions that are useful, novel, and non-obvious?
a. patents
b. trademarks
c. legal disclaimers
d. copyrights
e. trade secrets

27. Which of the following are intellectual property rights in the form of inventions and information such as formulas, processes, and customer lists that are not generally known to others and which convey economic advantage to the holders?
a. patents
b. trademarks
c. legal disclaimers
d. copyrights
e. trade secrets

28. Which of the following are intellectual property rights that allow firms to differentiate their products and services through the use of unique marks which allow consumers to easily identify the source and quality of the products and services?
a. patents
b. trademarks
c. legal disclaimers
d. copyrights
e. trade secrets

29. Which of the following are intellectual property rights to writings in written and electronically stored forms?
a. patents
b. trademarks
c. legal disclaimers
d. copyrights
e. trade secrets

30. Which of the following are not sources of seed and start-up financing?
a. family and friends
b. the entrepreneur’s physical and financial assets
c. business angels
d. venture capitalists
e. stock and bond markets

31. Wealthy individuals who invest in early stage ventures in exchange for the excitement of launching a business and a share in any financial rewards are known as:
a. creditors
b. white knights
c. corporate raiders
d. business angels
e. stakeholders

32. Business angels typically initiate their investments during the:
a. early stages of a venture’s lifecycle
b. middle stages of a venture’s lifecycle
c. maturity stage of a venture’s lifecycle
d. all of the above

33. Which of the following forms of protecting intellectual property had its protection limit increased from 17 to 20 years?
a. copyrights
b. trademarks
c. patents
d. trade secrets

34. Patents are intellectual property rights granted for inventions that are:
a. not useful, novel, and non-obvious
b. not useful, not novel, and obvious
c. useful, novel, and non-obvious
d. useful, not novel, and obvious

35. Patents that cover most inventions pertaining to new products, services, and processes, are referred to as:
a. design patents
b. plant patents
c. utility patents
d. electrical patents
e. mechanical patents

36. Intellectual property rights to “writings” in written and electronically-stored forms are protected by:
a. Patents
b. copyrights
c. trade secrets
d. trademarks

37. Which of the following forms of protecting intellectual property currently has a protection limit of 20 years?
a. copyrights
b. patents
c. trade secrets
d. trademarks

38. Certification marks are typically used to:
a. indicate membership in a trade group
b. indicate a certain brand of service
c. indicate quality
d. are symbols used to associate products to a specific brand

39. Which of the following is not a “kind” of patent?
a. Utility
b. Design
c. Mark
d. Plant
e. Business method

40. Which of the following is not a “type” of mark?
a. Trademark
b. Service mark
c. Collective mark
d. Certification mark
e. Design mark

41. During the development stage, seed financing chiefly comprises:
a. funds from business angels and venture capitalists
b. the entrepreneur’s personal assets
c. funds from family and friends
d. a, b, and c
e. only b and c

42. The term that refers only to words, symbols, shapes, and similar items associated with products is:
a. trademarks
b. service marks
c. collective marks
d. certification marks

CHAPTER 4

PREPARING AND USING FINANCIAL STATEMENTS

True-False Questions

1. Assets are financial and physical items controlled or owned by the business.

2. GAAP stands for “General American Accounting Principles.”

3. GAAP stands for “Generally Accepted Accounting Principles.”

4. The practice of recording economic activity when realized is known as accrual accounting.

5. Accrual accounting is the practice of recording economic activity when recognized rather than waiting until realized.

6. The balance sheet equation is: Total Assets = Total Liabilities + Net Income.

7. On the balance sheet, Total Liabilities = Total Assets – Owners Equity.

8. How quickly an asset can be converted into cash is called liability.

9. Cash or other assets that are expected to be converted into cash in less than one year are known as current liabilities.

10. The reduction in value of a fixed asset over its expected life intended to reflect the usage or wearing out of the asset is called accumulated depreciation.

11. Amounts owed to another for purchase made on credit which come due in less than one year are known as receivables.

12. Long-term, non-cancelable leases whereby the owner receives payments that cover the cost of the equipment plus a return on investment in the equipment is known as a capital lease.

13. Operating income, or earnings before interest and taxes, reflects the firm’s profits after all operating expenses, excluding financing costs, have been deducted from net sales.

14. Net income, or profit, is the bottom line measure of what’s left from the firm’s net sales after operating expenses, financing costs, and taxes have been deducted.

15. Net cash burn occurs when the sum of cash flows from operations and investing is positive.

16. Net cash build occurs when the sum of cash flows from operations and investing is negative.

17. During the development stage in a new venture’s life cycle, the balance sheet reflects the acquisition of initial assets and the obtaining of seed financing.

18. During the development stage in a new venture’s life cycle, the income statement typically shows no sales but expenses such as rent, utilities, and a subsistence salary for the entrepreneur.

19. During the startup stage in a new venture’s life cycle, the income statement typically shows no sales but expenses including the production and market of products or services.

20. Production assets (e.g., inventories and equipment to produce products and give credit to customers) usually occurs during the development stage in a new venture’s life cycle.

21. Seed financing (e.g., financing from the entrepreneur’s assets, family, and friends) usually occurs during the development stage in a new venture’s life cycle.

22. Startup financing (e.g., financing from business angels and venture capitalists) usually occurs during the development stage in a new venture’s life cycle.

23. “Cost of goods sold” is the cost of materials, labor, and advertising incurred to produce the products that were sold.

24. “Variable expenses” are costs or expenses that vary directly with revenues.

25. “Variable expenses” are costs that are expected to remain constant over a range of revenues for a specific time period.

26. EBDAT is earnings before interest, taxes, depreciation, and amortization.

27. “Contribution profit margin” is the portion of the sale of a product that contributes to covering the cash fixed costs.

28. EBDAT stands for “Earnings Before Depreciation And Taxes”.

29. Cash fixed costs = survival revenues – variable cost revenue ratio × survival revenues.

True-false questions for Chapter 4, Appendix A:

1. “Economic value added” (EVA) measures a firm’s market value added over a specified time period.

2. Economic value added (EVA) is a measure of a firm’s economic profit over a specified time period.

3. NOPAT equals Net Sales multiplied by on minus the tax rate.

4. When EBIT is zero, a firm’s net operating profit after taxes (NOPAT) also is zero because no taxes are payable.

Multiple-Choice Questions

1. Financial statement that provides a snapshot of a business’ financial position as of a specific date is called the:
a. income statement
b. balance sheet
c. statement of retained earnings
d. statement of cash flows

2. Financial statement that reports the revenues generated and expenses incurred over an accounting period is called the
a. income statement
b. balance sheet
c. statement of retained earnings
d. statement of cash flows

3. Financial statement that shows how cash, as reflected in accrual accounting, flows into and out of a company during a specific period of operation is called the:
a. income statement
b. balance sheet
c. statement of retained earnings
d. statement of cash flows

4. The balance sheet equation states that total assets =
b. total liabilities + depreciation
c. total liabilities + owners’ equity
d. owners’ equity + net income
e. owners’ equity + current liabilities
f. total liabilities + net income

5. Which one of the following is not considered to be a current asset?
a. cash
b. receivables
c. inventories
d. fixed assets

6. “Retained earnings” is:
a. a corporate asset
b. part of owners’ equity
c. neither a or b
d. both a and b

7. Cash includes all of the following except:
a. coins
b. currency
c. checking accounts
d. certificates of deposit

8. Which of the following is not a characteristic of marketable securities?
a. short-term
b. illiquid
c. high-quality
d. interest-bearing

9. Which of the following is not a characteristic of inventories?
a. raw materials
b. finished products
c. goods sold but not yet shipped
d. work-in-process

10. Which of the following is not depreciated?
a. inventory
b. machinery
c. land
d. both a and b
e. both a and c

11. Which of the following is a use of cash?
a. a decrease in inventory
b. an increase in accrued liabilities
c. the sale of an asset for a gain
d. a drop in the amount owed on a bond
e. an increase in stock issued

12. Which of the following is a source of cash?
a. an increase in accounts receivable
b. a decrease in wages payable
c. the acquisition of land
d. an increase in the amount owed on a note payable
e. the repurchase of outstanding shares of stock

13. Which of the following is not a category on the statement of cash flows?
a. cash flow from operating activities
b. cash flow from equity activities
c. cash flow from investing activities
d. cash flow from financing activities

Note: Use the following data for the next three problems (14, 15, & 16).
Acme Pest Control has sales of $13,500, cost of goods sold of $4,000, selling expenses of $3,500, depreciation of $2,000, interest expense of $2,000, and a tax rate of 34%.

14. What is Acme’s operating income?
a. $4,000
b. $2,000
c. $9,500
d. $6,000
e. $1,320

15. What is Acme’s taxable income and tax expense?
a. $6,000; $2,040
b. $2,000; $1,320
c. $4,000; $1,360
d. $2,000; $680
e. $9,500; $3,230

16. What is Acme’s net income?
a. $2,720
b. $897.60
c. $6,460
d. $2,040
e. $1,320

17. Your venture has total assets of $690, net fixed assets of $500, long term debt of $80, and stockholders’ equity of $400. What is the amount of your venture’s current liabilities?
a. -$100
b. $100
c. $210
d. $290
e. $1,090

18. In breakeven analysis, solving for when EBITDA is equal to zero gives breakeven in terms of:
a. economic revenues
b. variable costs
c. survival revenues
d. fixed costs

19. A lease that provides maintenance in addition to financing and is also usually cancelable is called:
a. capital lease
b. liability lease
c. operating lease
d. asset lease
e. equity lease

20. Which one of the following is not considered to be an internal operating schedule?
a. income statement
b. cost of production schedule
c. cost of goods sold schedule
d. inventories schedule

21. “Net cash burn” occurs when the sum of which of the following items is negative?
a. cash flows from operations and financing
b. cash flows from investing and financing
c. cash flows from operations and investing
d. cash flows from net income and depreciation
e. cash flows from operations and net income

22. Expenses or costs that vary directly with revenues are said to be:
a. fixed expenses
b. semi-fixed expenses
c. semi-variable expenses
d. variable expenses

23. EBDAT is equal to:
a. revenues – variable costs – cash fixed costs
b. revenues + variable costs + cash fixed costs
c. revenues – variables costs – total fixed costs
d. revenues + variable costs – cash fixed costs

24. “Gross earnings” is equal to:
a. Revenue – After-Tax cost of financial capital used
b. net income ÷ sales
c. (net sales – the cost of production) × tax rate
d. net sales – the cost of production

25. According to Appendix A of Chapter 4, NOPAT is defined as:
a. revenues times (1 + tax rate)
b. revenues times (1 – tax rate)
c. EBITDA times (1 – tax rate)
d. EBIT times (1 – tax rate)
e. net income times (1 + tax rate)

26. Last year a firm had sales of $200,000. Its cost of goods sold was $75,000, and administrative and marketing expenses were $25,000 each. Depreciation expense was $10,000, while interest expense was $15,000. If the tax rate is 30%, what was the firm’s NOPAT last year?
a. $19,500
b. $35,000
c. $45,500
d. $52,500
e. $80,500

27. What is the survival revenues breakeven based on: cash fixed costs = $400,000 and a variable cost revenue ratio = .65?
a. $460,500
b. $615,385
c. $1,142,857
d. $2,000,334
e. $4,000,667

28. Use the following information to determine the cash fixed costs: Administrative expenses = $200,000; Marketing expenses = $180,000; Depreciation expenses = $100,000; and Interest expenses = $20,000.
e. $380,000
f. $400,000
g. $480,000
h. $500,000
i. $620,000

29. Find the “contribution profit margin” based on the following information: cash fixed costs = $60,000; variable costs = $70,000; and sales = $100,000.
a. 70%
b. 60%
c. 30%
d. 40%
e. 100%

30. Find the “survival revenues” (SR), also known as the EBDAT breakeven) based on the following information: cash fixed costs = $60,000; variable costs = $70,000; and sales = $100,000.
a. $85,714
b. $100,000
c. $116,667
d. $200,000
e. $300,000

31. What is the survival revenues breakeven based on the following: Administrative expenses = $200,000; Marketing expenses = $180,000; Depreciation expenses = $100,000; and Interest expenses = $20,000; and a variable cost revenue ratio = .50?
a. $400,000
b. $600,000
c. $800,000
d. $1,000,000
e. $1,200,000

32. A firm with constant variable costs has a survival revenue breakeven of $375,000. This year it had $250,000 in sales, $100,000 of which was a fixed cos What are the firm’s cash fixed costs?
a. $150,000
b. $225,000
c. $625,000
d. $937,500

33. Last year, Beth’s Baked Goods exactly broke even with cash fixed costs of $63,000. If its breakeven survival revenue level was $94,000, what was its variable cost revenue ratio (VCRR)?
a. .27
b. .30
c. .33
d. .67

34. In its first year, Joe’s Start-Up Company had revenues of $125,000 and cost of goods sold of $81,250, which was the only variable cos Depreciation was $20,000, and cash costs were $5,000 in financing costs, admin expenses of $50,000, and $45,000 in marketing expenses – all of which were fixed. What is the survival breakeven revenue?
a. $342,857
b. $285,714
c. $271,429
d. $184,615
e. $153,846

Multiple Choice Questions and Problems for Chapter 4, Appendix A:

1. Economic Value Added (EVA) is calculated as:
a. NOPAT plus after-tax dollar cost of financial capital used
b. ROE minus percentage cost of financial capital
c. NOPAT minus after-tax dollar cost of financial capital used
d. ROE plus the percentage cost of financial capital

2. A firm’s net operating profit after taxes (NOPAT) is calculated as:
a. net profit
b. EBIT times one minus the tax rate
c. EBT minus interest paid
d. EBIT times the tax rate

3. Total operating fixed costs (TOFC) equal:
a. cash operating fixed costs (excluding interest expenses)
b. noncash fixed costs (e.g., depreciation)
c. interest expenses
d. a plus b
e. a plus b plus c

4. Find the NOPAT given the following information: sales = $520,000, earnings before interest = $100,000; interest = $20,000; and the tax rate = 30%.
a. $70,000
b. $56,000
c. $30,000
d. $24,000
e. $10,000

5. Find the NOPAT breakeven revenues (NR) given the following information: total operating fixed costs = $75,000; variable costs = $150,000; and sales = $200,000.
a. $100,000
b. $240,000
c. $300,000
d. $400,000
e. $460,000

6. Determine the total operating fixed costs (TOFC) based on the following: Administrative expenses = $200,000; Marketing expenses = $180,000; Depreciation expenses = $100,000; and Interest expenses = $20,000.
a. $200,000
b. $380,000
c. $400,000
d. $480,000
e. $500,000

CHAPTER 5

EVALUATING OPERATING AND FINANCIAL PERFORMANCE

True-False Questions

1. Showing the relationships between two or more financial variable and/or time, financial ratios are useful means of summarizing large amounts of financial data for comparative purposes.

2. Second-round, mezzanine, and liquidity-stage financing generally occur during a venture’s survival stage.

3. Commercial banks are important users of financial ratios and measures during the development and startup stages of ventures.

4. Investment bankers are users of financial ratios and measures of ventures primarily during the rapid-growth stage relative to the development and startup stages.

5. Trend analysis is used to examine a venture’s performance over time.

6. Cross-sectional analysis is used to examine a venture’s performance over time.

7. “Cash burn” is the cash a venture expends on its operating, financing, and depreciation expenses.

8. “Net cash burn” occurs when cash burn exceeds cash build in a specified time period.

9. The “cash burn rate” is the cash burn for a fixed period of time, typically a month.

10. The term “cash build” as used in Chapter 5 is equal to net sales minus the change in receivables.

11. Liquidity ratios indicate the venture’s ability to pay short term assets from short-term liabilities.

12. Net working capital reflects current assets deducted from current liabilities.

13. “Net working capital” is calculated as fixed assets minus current liabilities.

14. A venture’s cash, marketable securities, and receivables comprise the venture’s “liquid assets”.

15. The current ratio and the quick ratio differ only because average inventories are subtracted in the numerator of the quick ratio.

16. For a venture with inventories, the quick ratio will always be greater than the current ratio.

17. Net working capital is a dollar amount measure of the cushion between current assets and current liabilities.

18. Leverage ratios indicate the extent to which the venture has used debt and its ability to meet debt obligations.

19. Total debt includes current liabilities, long-term debt, and retained earnings.

20. How efficiently a venture controls its expenses and uses its assets and debt is evaluated with profitability and efficiency ratios.

21. During the development and startup stages of a venture’s life cycle, important financial ratios and measures include cash burn rates and liquidity ratios.

22. During the development and startup stages of a venture’s life cycle, important users of financial ratios and measures include the entrepreneur, business angels, and venture capitalists (VCs).

23. Leverage ratios are generally considered to be more important during the survival and rapid-growth stages compared to the development and startup stages.

24. The equity multiplier is considered an efficiency ratio.

25. The extent to which a venture is in debt and in its ability to repay its debt obligations is indicated by leverage ratios.

26. The equity multiplier shows the extent by which assets are supported by equity and deb

27. Accounting rules require that the current maturities of long-term debt obligations be classified as short-term liabilities.

28. Profitability and efficiency ratios are generally considered to be more important during the development and startup stages compared to the survival and rapid-growth stages.

29. The part of a venture’s interest payment that is subsidized by the government because of the deductibility of interest is called the interest tax shield.

30. How efficiently a venture controls its expenses and uses its assets and debt is evaluated with profitability and efficiency ratios.

31. The Return on Assets model states: ROA = net profit margin × asset turnover × the equity multiplier.

32. If a firm has positive net income, a drop in a venture’s asset intensity ratio will increase its ROE.

Multiple-Choice Questions

1. Investment bankers and commercial banks are important users of financial ratios and measures during which of the following life cycle stages?
a. Development stage
b. Startup stage
c. Survival stage
d. Rapid-growth stage
e. All four stages

2. The entrepreneur, angels, and VCs are important users of financial ratios and measures during which of the following life cycle stages?
a. Development stage
b. Startup stage
c. Survival stage
d. Rapid-growth stage
e. All four stages

3. Which of the following is used to examine a venture’s performance over time?
a. qualitative analysis
b. trend analysis
c. cross sectional analysis
d. industry comparable analysis

4. Which of the following is used to compare a venture’s performance against another firm at the same point in time?
a. qualitative analysis
b. trend analysis
c. cross sectional analysis
d. industry comparable analysis

5. Which of the following is used to compare a venture’s performance against the average performance of other firms in the same industry?
a. qualitative analysis
b. trend analysis
c. cross sectional analysis
d. industry comparable analysis

6. Which one of the following is not a basic ratio techniques used to conduct financial analysis?
a. trend analysis
b. sensitivity analysis
c. cross-sectional analysis
d. industry comparables analysis

7. The term “cash build” is measured as:
a. net income plus depreciation
b. net sales minus expenses minus (plus) an increase (decrease) in inventories
c. net sales minus (plus) an increase (decrease) in receivables
d. net income plus depreciation minus (plus) an increase (decrease) in payables

8. “Net cash burn” is calculated as:
a. cash burn plus cash build
b. cash build minus cash burn
c. cash burn minus cash build
d. cash burn minus cash build squared

9. Using the following information, determine the average monthly net cash burn rate: annual net income = $20,000; annual interest = $10,000; annual cash build = $150,000; and annual cash burn = $186,000.
a. $1,000
b. $3,000
c. $4,000
d. $6,000
e. $7,000

10. Use the following information to determine a firm’s “cash build:” net sales = $150,000; net income = $15,000; beginning-of-period accounts receivable = $60,000; end-of-period accounts receivable = $90,000; and interest = $10,000.
a. $10,000
b. $15,000
c. $30,000
d. $60,000
e. $120,000

11. Average current assets minus average inventories when divided by average current liabilities is called which of the following ratios?
a. current ratio
b. quick ratio
c. net working capital ratio
d. current liabilities to total debt ratio

12. Dividing the average total assets by the average owners’ equity is called which of the following ratios?
a. equity multiplier
b. debt to equity ratio
c. current liabilities to total debt ratio
d. current ratio

13. Net sales minus cost of goods sold when divided by sales is called which of the following ratios?
a. gross profit margin
b. operating profit margin
c. net profit margin
d. net operating profit after taxes margin

14. Net income divided by net sales is called which of the following ratios?
a. net operating profit after taxes margin
b. net profit margin’
c. operating profit margin
d. gross profit margin

15. The difference between a venture’s ability to generate cash to pay interest and the amount of interest it has to pay is determined by which of the following ratios?
a. fixed charges coverage
b. debt to asset
c. equity multiplier
d. debt to equity
e. interest coverage

16. Which of the following is not a profitability and efficiency ratio?
a. sales-to-total-assets
b. return on equity
c. return on assets
d. inventory-to-total assets
e. NOPAT profit margin

17. Which of the following is true?
a. ROA is always greater than or equal to ROE
b. an increase in the asset turnover ratio implies a decrease in the asset
intensity ratio
c. a and b
d. none of the above

18. A firm has the following balance sheet information: total assets = $100,000; current assets = $30,000; inventories = $10,000; cash = $5,000; total liabilities = $30,000; current liabilities = $15,000; notes payable = $2,000. What are the firm’s quick and NWC-to-Total-Assets ratios?
a. 1.00 and .13
b. 1.33 and .13
c. 1.00 and .15
d. 1.33 and .15

19. Last year, Nemo’s Fish ‘n Chips recorded the following financial data: sales = $85,000; cost of goods sold = $45,000; selling and administrative expenses = $25,000; depreciation and amortization = $7,000; interest expense = $12,000. The tax rate was 30%. Find Nemo’s interest coverage for last year.
a. -.29 times
b. .66 times
c. .86 times
d. 1.25 times
e. 3.33 times

20. A venture has net sales of $400,000, cost of goods sold of $200,000, operating expenses (selling, general, and administrative) of $100,000, and interest expenses of $50,000. What is the operating profit margin?
a. 50.0%
b. 75%
c. 25%
d. 40%

21. Last year, Lenny’s Lemonade had $3,500 in sales, and cost of goods sold was $2,000. Depreciation expenses totaled $500 and interest expense was $700. If the tax rate is 25%, what is the net profit margin for Lenny’s Lemonade? What is its NOPAT margin?
a. 6.43% and 21.43%
b. 20.7% and 21.43%
c. 2.14% and 32.14%
d. 22.86% and 32.14%

Note: The following information should be used for the next eleven (22 through 32) problems.
In its closing financial statements for its first year in business, the Runs and Goses Company, had cash of $242, accounts receivable of $850, inventory of $820, net fixed assets of $3,408, accounts payable of $700, short-term notes payable of $740, long-term liabilities of $1,100, common stock of $1,160, retained earnings of $1,620, net sales of $2,768, cost of goods sold of $1,210, depreciation of $360, interest expense of $160, taxes of $312, addition to retained earnings of $508, and dividends paid of $218.

22. What is the return on equity for Runs and Goses?
a. 26.1%
b. 44.7%
c. 62.6%
d. 18.4%
e. 7.9%

23. What is Runs and Goses’ return on total assets?
a. 9.6%
b. 13.6%
c. 19.1%
d. 37.9%
e. 22.5%

24. What is the net profit margin for Runs and Goses?
a. 60.0%
b. 22.7%
c. 7.9%
d. 18.4%
e. 26.2%

25. Runs and Goses operating profit margin is?
a. 26.2%
b. 56.3%
c. 43.3%
d. 30.3%
e. 60.0%

26. The gross profit margin for Runs and Goses is?
a. 26.2%
b. 30.3%
c. 43.3%
d. 56.3%
e. 60.0%

27. What is Runs and Goses’ sales to total asset ratio?
a. 1.91
b. 0.25
c. 0.52
d. 0.23
e. 0.57

28. What is the current ratio for Runs and Goses?
a. 1.46
b. 1.33
c. 1.23
d. 1.21
e. 1.13

29. The total-debt-total-asset ratio for Runs and Goses is?
a. 0.48
b. 0.71
c. 0.27
d. 0.53
e. 0.82

30. What is Runs and Goses’ debt-to-equity ratio?
a. 0.91
b. 2.15
c. 0.48
d. 1.12
e. 2.32

31. What is the equity multiplier for Runs and Goses?
a. 4.59 times
b. 2.35 times
c. 0.48 times
d. 1.12 times
e. 1.91 times

32. The interest coverage ratio for Runs and Goses is:
a. 6.5 times
b. 4.5 times
c. 9.7 times
d. 3.5 times
e. 1.5 times

CHAPTER 6

MANAGING CASH FLOW

True-False Questions

1. The actions of screening business ideas, preparing a business model/plan, and obtaining seed financing occurs during a venture’s development stage.

2. The actions of monitoring financial performance, determining project cash needs, and obtaining first-round financing occurs during a venture’s survival stage.

3. “First-round financing” usually occurs during a venture’s rapid-growth life cycle stage.

4. Short-term financial planning is critical during the survival stage because operations not yet turning a profit and the associated cash burn often lead to a venture’s inability to pay its maturing liabilities.

5. Cash shortages during the rapid growth stage frequently derive from the lack of operating profits to fund working capital and fixed asset investments needed to support sales growth.

6. Due to the difficulty of projecting financial statements for a young firm, short-term financial forecasts are never required of early-stage ventures.

7. Early-stage ventures are defined as firms that are only operating in either their development or startup stages.

8. Even in a young, successful venture, restricted access to bank credit and with little to no access to short-term lending markets can hinder operations until the next round of financing.

9. “First-round financing” usually occurs during a venture’s rapid-growth life cycle stage.

10. Short-term cash planning tools include preparation of a: sales schedule, a purchases schedule, a wages and commissions schedule, and a cash budge

11. Short-term financial planning typically involves preparing monthly financial statements and focuses on identifying and planning for net income demands on the business.

12. A venture’s operating schedules typically include a: sales schedule, purchases schedule, and wages and commissions schedule.

13. A cash budget shows a venture’s projected revenues and expenses over a forecast period.

14. Preparing monthly cash budgets for a full year allows the entrepreneur to determine whether there will be a cash need, the maximum size of the cash need, and whether the need can be repaid during the year.

15. Conversion period ratios show the average time in days it takes to convert certain current assets and current liabilities into cash.

16. A venture’s operating cycle is the same as its cash conversion cycle.

17. The sum of the inventory-to-sale conversion period and the purchase-to-payment conversion period minus the sale-to-cash conversion period is called the cash conversion cycle.

18. The cash conversion cycle refers to the time it takes to convert a sale into net income.

19. The “cash conversion cycle” measures the time it takes to pay off the principal on a loan.

20. The sale-to-cash conversion period is calculated by dividing average revenues by net sales per day.

21. A venture’s cash conversion cycle will decrease if the purchase-to-payment conversion period increases.

Multiple-Choice Questions

1. A firm is said to be an early stage venture when it is in which of the following except?
a. rapid growth stage
b. startup stage
c. development stage
d. survival stage
e. early-maturity stage

2. Seed financing is generally associated with which one of the following life cycle stages:
a. development stage
b. startup stage
c. survival stage
d. rapid-growth stage
e. early-maturity stage

3. First-round financing is generally associated with which one of the following life cycle stages:
a. development stage
b. startup stage
c. survival stage
d. rapid-growth stage
e. early-maturity stage

4. Which of the following is not part of the operating cycle?
a. time it takes to purchase products
b. time it takes to produce products
c. time it takes to sell the products
d. time it takes to pay suppliers
e. time it takes to collect receivables

5. Which one of the following “measures” the average days of sales committed to the extension of trade credit?
a. sale-to-cash conversion period
b. inventory-to-sale conversion period
c. purchase-to-payment conversion period
d. cash conversion cycle period

6. Which of the following is measured by dividing the average daily cost of goods sold into the average inventory?
a. sale-to-cash conversion period
b. inventory-to-sale conversion period
c. purchase-to-payment conversion period
d. cash conversion cycle

7. Which of the following measures the average time from purchase of materials and labor to actual cash payment?
a. sale-to-cash conversion period
b. inventory-to-sale conversion period
c. purchase-to-payment conversion period
d. cash conversion cycle

8. Which of the following measures the average time it takes a firm to complete its operating cycle after deducting the days supported by trade credit and delayed payroll financing?
a. sale-to-cash conversion period
b. inventory-to-sale conversion period
c. purchase-to-payment conversion period
d. cash conversion cycle

9. Which one of the following conversion periods operates to reduce the length of the cash conversion cycle?
a. inventory-to-sale conversion period
b. sale-to-cash conversion period
c. purchase-to-payment conversion period
d. fixed assets-to-usage conversion period

10. Which one of the following conversion periods is not a component in the cash conversion cycle?
a. inventory-to-sale conversion period
b. sale-to-cash conversion period
c. purchase-to-payment conversion period
d. fixed assets-to-usage conversion period

11. Calculate the inventory-to-sale conversion period based on the following information: average inventories = $120,000; average receivables = $90,000; average payables = $40,000; cost of goods sold = $182,500; and net sales = $365,000.
a. 240.0 days
b. 180.0 days
c. 90.0 days
d. 60.0 days
e. 45.0 days

12. Calculate the sale-to-cash conversion period based on the following information: average inventories = $120,000; average receivables = $90,000; average payables = $40,000; cost of goods sold = $182,500; and net sales = $365,000.
a. 240.0 days
b. 180.0 days
c. 90.0 days
d. 60.0 days
e. 45.0 days

13. Based on the following information, determine the venture’s cash conversion cycle: Inventory-to-sale conversion period = 112.9 days; Sale-to-cash conversion period= 57.1 days; and Purchase-to-payment conversion period = 76.8 days.
a. 170.0 days
b. 189.7 days
c. 93.2 days
d. 246.8 days
e. 133.9 days

14. Determine the cash conversion cycle based on the following information: inventory-to-sale conversion period = 112.9 days; sale-to-cash conversion period = 57.1 days; and purchase-to-payment conversion period = 76.8 days.
a. 93.2 days
b. 132.6 days
c. 170.0 days
d. 246.8 days
e. 365.0 days

15. Based on the following information, determine the average receivables (rounded to thousands of dollars) that were outstanding: Net sales = $575,000; Sale-to-cash conversion period = 57.1 days; Purchase-to-payment conversion period = 76.8 days; and Cost of goods sold = $380,000.
a. $90,000
b. $180,000
c. $121,000
d. $31,000
e. $41,000

16. Based on the following information, determine the venture’s inventory-to-sale conversion period: cash conversion cycle = 250 days; sale-to-cash conversion period = 60 days; and purchase-to-payment conversion period = 70 days.
a. 70 days
b. 140 days
c. 240 days
d. 260 days
e. 330 days

FIN 317 Week 11 Final Exam

Chapters 7 Through 15

CHAPTER 7

TYPES AND COSTS OF FINANCIAL CAPITAL

True-False Questions

1. The accounting emphasis on accrued revenue and expenses and depreciation is the same emphasis as that of finance managers.

2. Traditional accounting does not focus on the implicit cost of equity that is the required capital gains to complement dividends. However, evaluation methods exist to determine this value by financial managers.

3. Formal historical accounting procedures include explicit records of debt (interest and principal) and dividend capital costs.

4. Public financial markets are markets for the creation, sale and trade of illiquid securities having less standardized negotiated features.

5. A venture’s “riskiness” in terms of poor performance or failure is usually very high during the maturity stage of its life cycle.

6. A venture’s “riskiness” in terms of poor performance or failure is usually high to moderate during the rapid-growth stage of its life cycle.

7. First-round financing during a venture’s survival stage comes primarily from venture capitalists and investment banks.

8. Startup financing usually comes from entrepreneurs, business angels, and investment bankers.

9. Commercial banks provide liquidity-stage financing for ventures in the rapid-growth stage of their life cycles.

10. A venture’s “riskiness” in terms of the likelihood of poor performance or failure decreases as it moves from its development stage through to its rapid-growth stage.

11. A nominal interest rate is an observed or stated interest rate.

12. The “real interest rate” (RR) is the interest one would face in the absence of inflation, risk, illiquidity, and any other factors determining the appropriate interest rate.

13. The risk-free interest rate is the interest rate on debt that is virtually free of inflation risk.

14. Inflation premium is the rising prices not offset by increasing quality of goods being purchased.

15. “Default-risk” is the risk that a borrower will not pay the interest and/or the principal on a loan.

16. The “prime rate” is the interest rate charged by banks to their highest default risk business customers.

17. Bond ratings reflect the inflation risk of a firm’s bonds.

18. The relationship between real interest rates and time to maturity when default risk is constant is called the term structure of interest rates.

19. The graph of the term structure of interest rates, which plots interest rates to time to maturity is called the yield curve.

20. Liquidity premiums reflect the risk associated with firms that possess few liquid assets.

21. Subordinated debt is secured by a venture’s assets, while senior debt has an inferior claim to a venture’s assets.

22. Early-stage ventures tend to have large amounts of senior debt relative to more mature ventures.

23. Investment risk is the chance or probability of financial loss on one’s venture investment, and can be assumed by debt, equity, and founding investors.

24. A venture with a higher expected return relative to other ventures will necessarily have a higher standard deviation or returns.

25. Historically, large-company stocks have averaged higher long-term returns than small-company stocks.

26. The coefficient of variation measures the standard deviation of a venture’s return relative to its expected return.

27. Closely held corporations are those companies whose stock is traded over-the-counter.

28. Typically, the stocks of closely held corporations aren’t publicly traded.

29. Organized exchanges have physical locations where trading takes place, while the over-the-counter market is comprised of a network of brokers and dealers that interact electronically.

30. Market cap is determined by multiplying a firm’s current stock price by the number of shares outstanding.

31. The excess average return of long-term government bonds over common stock is called the market risk premium.

32. The weighted average cost of capital is simply the blended, or weighted cost of raising equity and debt capital.

33. Venture capital holding period returns (all stages) for the 10-year period ending in 2012 were about the same as the returns on the S&P 500 stocks.

Multiple-Choice Questions

1. Which one of the following markets involve liquid securities with standardized contract features such as stocks and bonds?
a. private financial market
b. derivatives market
c. commodities market
d. real estate market
e. public financial market

2. Which of the following markets involve direct two-party negotiations over illiquid, non-standardized contracts such as bank loans and direct placement of debt?
a. primary market
b. secondary market
c. options market
d. private financial market
e. public financial market

3. Which of the following is an example of rent on financial capital?
a. interest on debt
b. dividends on stock
c. collateral on equity
d. a and b
e. a, b, and c

4. Which of the following describes the observed or stated interest rate?
a. real rate
b. nominal rate
c. risk-free rate
d. prime rate
e. inflation rate

5. Which of the following describes the interest rate in addition to the inflation rate expected on a risk-free loan?
a. real rate
b. nominal rate
c. risk-free rate
d. prime rate
e. inflation rate

6. Which of the following describes the interest rate on debt that is virtually free of default risk?
a. real rate
b. nominal rate
c. risk-free rate
d. prime rate
e. inflation rate

7. Which of the following describes the interest rate charged by banks to their highest quality customers?
a. real rate
b. nominal rate
c. risk-free rate
d. prime rate
e. inflation rate

8. Which of the following is not a component in determining the cost of debt?
a. inflation premium
b. default risk premium
c. liquidity premium
d. maturity premium
e. interest rate premium

9. The additional interest rate premium required to compensate the lender for the probability that a borrower will not be able to repay interest and principal on a loan is known as?
a. inflation premium
b. default risk premium
c. liquidity premium
d. maturity premium
e. investment risk premium

10. The additional premium added to the real interest rate by lenders to compensate them for a debt instrument which cannot be converted to cash quickly at its existing value is called?
a. inflation premium
b. default risk premium
c. liquidity premium
d. maturity premium
e. investment risk premium

11. The added interest rate charged due to the inherent increased risk in long-term debt is called?
a. inflation premium
b. default risk premium
c. liquidity premium
d. maturity premium
e. investment risk premium

12. Suppose the real risk free rate of interest is 4%, maturity risk premium is 2%, inflation premium is 6%, the default risk on similar debt is 3%, and the liquidity premium is 2%. What is the nominal interest rate on this venture’s debt capital?
a. 13%
b. 14%
c. 15%
d. 16%
e. 17%

13. A venture has raised $4,000 of debt and $6,000 of equity to finance its firm. Its cost of borrowing is 6%, its tax rate is 40%, and its cost of equity capital is 8%. What is the venture’s weighted average cost of capital?
a. 8.0%
b. 7.2%
c. 7.0%
d. 6.2%
e. 6.0%

14. Your venture has net income of $600, taxable income of $1,000, operating profit of $1,200, total financial capital including both debt and equity of $9,000, a tax rate of 40%, and a WACC of 10%. What is your venture’s EVA?
a. $400,000
b. $200,000
c. $ 0
d. ($180,000)
e. ($300,000)

15. The “risk-free” interest rate is the sum of:
a. a real rate of interest and an inflation premium
b. a real rate of interest and a default risk premium
c. an inflation premium and a default risk premium
d. a default risk premium and a liquidity premium
e. a liquidity premium and a maturity premium

16. Venture investors generally use which one of the following target rates to discount the projected cash flows of ventures in the “startup” stage of their life cycles:
a. 20%
b. 25%
c. 40%
d. 50%

17. Which one of the following components is not used when estimating the cost of risky debt capital?
a. real interest rate
b. inflation premium
c. default risk premium
d. market risk premium
e. liquidity premium

18. Which of the following components is not typically included in the rate on short-term U.S. treasuries?
a. liquidity premium
b. default risk premium
c. market risk premium
d. b and c
e. a, b, and c

19. The word “risk” developed from the early Italian word “risicare” and means:
a. don’t care
b. take a chance
c. to dare
d. to gamble

20. The difference between average annual returns on common stocks and returns on long-term government bonds is called a:
a. default risk premium
b. maturity premium
c. risk-free premium
d. liquidity premium
e. market risk premium

21. What has been the approximate average annual rate of return on publicly traded small company stocks since the mid-1920s?
a. 10%
b. 16%
c. 25%
d. 30%
e. 40%

22. Venture investors generally use which one of the following target rates to discount the projected cash flows of ventures in the “development” stage of their life cycles:
a. 15%
b. 20%
c. 25%
d. 40%
e. 50%

23. Corporate bonds might involve which of the following types of “premiums.”
a. inflation premium
b. default risk premium
c. liquidity premium
d. maturity premium
e. all of the above
none of the above

24. Which of the following venture life cycle stages would involve seasoned financing rather than venture financing?
a. Development stage
b. Startup stage
c. Survival stage
d. Rapid-growth stage
e. Maturity stage

25. A venture’s “riskiness” in terms of possible poor performance or failure would be considered to be “very high” in which of the following life cycle stages:
a. Startup stage
b. Survival stage
c. Rapid-growth stage
d. Maturity stage

26. Which of the following types of financing would be associated with the highest target compound rate of return?
a. public and seasoned financing
b. second-round and mezzanine financing
c. first-round financing
d. startup financing
e. seed financing

27. The cost of equity for a firm is 20%. If the real interest rate is 5%, the inflation premium is 3%, and the market risk premium is 2%, what is the investment risk premium for the firm?
a. 10%
b. 12%
c. 13%
d. 15%

28. Use the SML model to calculate the cost of equity for a firm based on the following information: the firm’s beta is 1.5; the risk free rate is 5%; the market risk premium is 2%.
a. 4.5%
b. 8.0%
c. 9.5%
d. 10.5%

29. Calculate the weighted average cost of capital (WACC) based on the following information: the capital structure weights are 50% debt and 50% equity; the interest rate on debt is 10%; the required return to equity holders is 20%; and the tax rate is 30%.
a. 7%
b. 10%
c. 13.5%
d. 17.5%
e. 20%

30. Calculate the weighted average cost of capital (WACC) based on the following information: the equity multiplier is 1.66; the interest rate on debt is 13%; the required return to equity holders is 22%; and the tax rate is 35%.
a. 11.5%
b. 13.9%
c. 15.0%
d. 16.6%

31. Calculate the after-tax WACC based on the following information: nominal interest rate on debt = 16%; cost of common equity = 30%; equity to value = 60%; debt to value = 40%; and a tax rate = 25%.
a. 10%
b. 16%
c. 19.8%
d. 22.8%
e. 30%

32. Calculate the after-tax WACC based on the following information: nominal interest rate on debt = 12%; cost of common equity = 25%; common equity = $700,000; interest-bearing debt = $300,000; and a tax rate = 25%.
a. 15%
b. 16.4%
c. 20.2%
d. 22.8%
e. 30%

33. Venture capital holding period returns (all stages) for the 20-year period ending in 2012, had a compound average return of approximately:
a. 35%
b. 28%
c. 21%
d. 14%
e. 7%

Supplemental Problems related to Chapter 7 Appendix A (and Chapter 4 Appendix A)

1. Estimate a firm’s NOPAT based on: Net sales = $2,000,000; EBIT = $600,000; Net income = $20,000; and Effective tax rate = 30%.
a. $600,000
b. $420,000
c. $150,000
d. $70,000
e. $40,000

2. Estimate a firm’s economic value added (EVA) based on: NOPAT = $400,000; amount of financial capital used = $1,600,000; and WACC = 19%.
a. $26,000
b. $36,000
c. $96,000
d. $54,000
e. $64,000

3. Find a venture’s “economic value added” (EVA) based on the following information: EBIT = $200,000; financial capital used = $500,000; WACC = 20%; effective tax rate = 30%.
a. $20,000
b. $25,000
c. $30,000
d. $40,000
e. $50,000

CHAPTER 8

SECURITIES LAW CONSIDERATIONS WHEN OBTAINING VENTURE FINANCING

True-False Questions

1. The securities Exchange act of 1934 provides for the regulation of securities exchanges and over-the-counter markets.

2. The Investment Company Act of 1940 defines investment companies and excludes them from using some of the registration exemptions originating in the 1933 Ac

3. The Investment Advisers Act of 1940 provides a definition of an investment company.

4. According to the Investment Advisers Act of 1940, a bank would not be classified as an “investment advisor”.

5. The Securities Act of 1933 is the main body of federal law governing the creation and sale of securities in the U.S.

6. The Securities Exchange Act was passed in 1933 and the Securities Act was passed in 1934.

7. The trading of securities is regulated under the Securities and Exchange Act of 1954.

8. Regulation of investment companies (including professional venture capital firms) is carried out under the Investment Company Act of 1940.

9. State laws designed to protect high net-worth investors from investing in fraudulent security offerings are known as blue-sky laws.

10. Offerings and sales of securities are regulated under the Securities Act of 1933 and state blue-sky laws.

11. Blue-sky laws are federal laws designed to protect individuals from investing in fraudulent security offerings.

12. The typical business organization for a venture in its rapid-growth stage is a partnership or LLC.

13. Investor liability in a limited liability company (LLC) is limited to the owners’ investments.

14. Investor liability in a proprietorship or corporation is unlimited.

15. The life of a proprietorship is determined by the owner.

16. It is usually easier to transfer ownership in a proprietorship relative to a corporation.

17. The two basic types of exemptions from having to register securities with the SEC are security and transaction exemptions.

18. The Securities Act of 1933 provides a very narrow definition as to what constitutes a security.

19. SEC Rule 147 provides guidance on the issuer’s diligent responsibilities in assuring that offerees are in-state and that securities don’t move across state lines.

20. A private placement, or transactions by an issuer not involving any public offering, is exempt from registering the security.

21. Accredited investors are specifically protected by the Securities Act of 1933 from investing in unregistered securities issues.

22. The typical business organization for a venture in its rapid-growth stage is a partnership or LLC.

23. In SEC v. Ralston Purina (1953), the U.S. Supreme Court took an important step toward defining a public offering for the purposes of Section 4(2) of the Securities Act of 1933.

24. SEC Regulation D requires the registration of securities with the SEC.

25. An early stage venture that is not an investment company and has written compensation agreements can structure compensation-related securities issues so they are exempt from SEC registration requirements.

26. SEC Regulation D took effect in 1932 and provides the basis for “safe harbor” as a private placemen

27. Rule 504 under Regulation D has a $2 million financing limit (i.e., applies to sales of securities not exceeding $2 million).

28. A Rule 504 exemption under Regulation D has no limit in terms of the number and qualifications of investors.

29. A Regulation D Rule 505 offering cannot exceed $5 million in a twelve-month period.

30. A Regulation D Rule 505 offering is limited to 35 accredited investors.

31. A Regulation D Rule 506 offering has no limit in terms of the dollar amount of the offering but is limited to 35 unaccredited investors.

32. Regulation A, while technically considered an exemption from registration, is a public offering rather than a private placemen

33. Regulation A allows for registration exemptions on private security offerings so long as all investors are considered to be financially sophisticated.

34. Regulation A issuers are allowed to “test the waters” before preparing the offering circular (unlike almost all other security offerings).

35. Regulation A offerings are allowed up $10 million and do not have limitations on the number or sophistication of offerees.

36. The objective of the Jumpstart Our Business Startups Act of 2012 is to stimulate the initiation, growth, and development of small business companies.

37. Title II of the JOBS Act of 2012 eliminates the general solicitation and advertising restriction for Regulation D 506 offerings.

Note: Following are true-false questions relating to materials presented in Appendix B of Chapter 8.

1. The definition of an “accredited investor,” initially defined in the Securities Act of 1933, was expanded in Rule 501 of Reg D.

2. One of the monetary requirements for individuals or natural persons as accredited investors as defined in Regulation D Rule 501 is a net worth greater than $1,000,000.

3. One of the monetary requirements for individuals or natural persons as accredited investors as defined in Regulation D Rule 501 is individual annual income greater than $500,000.

4. Regulation D Rule 502 focuses, in part, on resale restrictions imposed on privately-placed securities.

5. Rule 503 of Regulation D states that a Form D should be filed with the SEC within six months after the first sale of securities.

Multiple-Choice Questions

1. Which of the following is not true regarding the Securities Act of 1933?
a. it was passed in response to abuses thought to have contributed to the financial catastrophes of the Great Depression
b. it covers securities fraud
c. it requires securities to be registered formally with the federal government
d. it set of the nature and authority of the Securities and Exchange Commission
e. it focuses on those who provide investment advice

2. The U.S. federal law that impacts the creation and sales of securities is:
a. Securities Exchange Act of 1934
b. Securities Act of 1933
c. Investment Company Act of 1940
d. Investment Advisers Act of 1940

3. The efforts to regulate the trading of securities takes place under which of the following securities laws?
a. Securities Act of 1933
b. state “blue-sky” laws
c. Securities and Exchange Act of 1934
d. Investment Company Act of 1940
e. Investment Advisers Act of 1940

4. Efforts to regulate the offerings and sales of securities take place under which of the following securities laws?
a. Securities Act of 1933
b. state “blue-sky” laws
c. Securities and Exchange Act of 1934
d. Investment Company Act of 1940
e. Investment Advisers Act of 1940
Both a and b
g. Both a and c

5. In securities law, which of the following is (are) true?
a. ignorance is no defense
b. security regulators may alter your investment agreement to the benefit of the investors
c. Securities Act of 1933 gives the SEC broad civil procedures to use in enforcement
d. Securities Act of 1933 gives the SEC some criminal procedures to use in enforcement
e. a, b, and c above
a, b, c, and d above

6. Which of the following is not a security?
a. treasury stock
b. debenture
c. put option
d. real property
e. call option

7. State securities regulations are referred to as:
a. Regulation A legislation
b. “stormy day” laws
c. “blue sky” laws
d. SEC oversight legislation

8. Which of the following is not true about registering securities with the SEC?
a. it is a time consuming process
b. it required the disclosure of accounting information
c. it is usually done with the help of an investment bank
d. it is an inexpensive process
e. it provides information to prospective investors

9. All of the following do not create any securities registration responsibilities except?
a. Treasury securities
b. Municipal bonds
c. securities issued by publicly held companies
d. securities issued by banks
e. securities issued by the government

10. Ventures that reach their survival stage of their life cycles and seek first-round financing are typically organized as:
a. proprietorships or partnerships
b. LLCs or corporations
c. corporations
d. partnerships or LLCs
e. proprietorships or corporations

11. Investor liability is “unlimited” under which of the following types of business organizational forms?
a. proprietorship
b. limited liability company (LLC)
c. corporation
d. S corporation
e. S limited liability company (SLLC)

12. Which one of the following is not a requirement for registration of securities with the SEC?
a. the name under which the issuer is doing business
b. the name of the state where the issuer is organized
c. the names of all products sold by the issuer
d. the names and addresses of the directors
e. the names of the underwriters

13. The returning of all funds to equity investors as a common “remedy” for a “fouled up” securities offering is called:
a. just action
b. fraud
c. second round financing
d. a rescission
e. mezzanine financing

14. “Security” exemptions from registration with the SEC include which of the following:
a. securities issued by banks and thrift institutions
b. government securities
c. intrastate offerings
d. securities issued by large, high quality corporations
e. a, b, and c above
f. a, b, c, and d above

15. The basic types of “transaction” exemptions for registration with the SEC are:
a. private placement exemption
b. “too big to fail” exemption
c. accredited investor exemption
d. intrastate offering exemption
e. a and c above
b and d above

16. In the Ninth Circuit Court of Appeals decision on SEC v. Murphy, all of the following were considerations in determining an offering to be a private placement except:
a. there must be an arm’s length relationship between the issuer of the security and the prospective purchaser
b. the number of offerees must be limited
c. the size and the manner of the offering must not indicate widespread solicitation
d. the offerees must be sophisticated
e. some relationship between the offerees and the issuer must be present

17. Which SEC Regulation took effect in 1982 and provides the basis for “safe harbor” as a private placement?
a. Regulation A
b. Regulation B
c. Regulation C
d. Regulation D
e. Regulation E

18. Unless your security is exempted, what Section of the Securities Act of 1933 requires you to file a registration statement with the SEC?
a. Section 1
b. Section 2
c. Section 3
d. Section 4
e. Section 5

19. Which one of the following is not an exemption method for making an offering exempt from SEC registration?
a. 4(2) private offering
b. accredited investor
c. Regulation D
d. Regulation A
e. Regulation Z

20. Exemptions for private placement offerings and sales of securities in the amount of $2 million are handled under which one of the follow rules under Regulation D?
a. Rule 501
b. Rule 502
c. Rule 503
d. Rule 504
e. Rule 505

21. Which one of the following SEC registration exemptions has a financing limit in a 12-month period and permits a maximum of 35 unaccredited investors?
j. Section 4(2)
k. Reg D: Rule 504
l. Reg D: Rule 505
m. Reg D: Rule 506
n. Regulation A

22. Rule 504 of Regulation D limits the total number of investors to:
a. 35
b. 100
c. 35 unaccredited investors and any number of accredited investors
d. there is no limit on the number of accredited or unaccredited
investors

23. Offerings exempted from registration under rule 505 of Regulation D may raise up to $5 million in a:
a. 6-month period
b. 9-month period
c. 12-month period
d. 18-month period
e. 24-month period

24. Rule 506 of Regulation D is limited in terms of the number of unaccredited investors to:
a. 20
b. 25
c. 30
d. 35
e. 40

25. Which one of the following “rules” under Regulation D has a $5 million financing limit?
a. Rule 504
b. Rule 505
c. Rule 506
d. Rule 507
e. Rule 508

26. While Section 4(2) does not limit the dollar amount of an offering, the interpretation of the law has stipulated that:
a. the investors must be sophisticated
b the number of investors must be limited to 35
c. the funds must be raised within a 12-month period
d. the offering must be extended to the public, and not only investors
who have a relationship with the issuer

27. An offering that raises $2,500,000 over a 12-month period, involving 35 unaccredited investors and 5 accredited investors, might be exempt from registration under:
a. Section 4(6)
b. Regulation D: Rule 504
c. Regulation D: Rule 505
d. none of the above

28. Which one of the following is not a characteristic of Regulation A?
a. An offering is limited to $5 million
b. the number offerees or investors is limited to 35
c. the offering is a public offering
d. the securities issued can generally be freely resold

29. Of the following, which is not true about Regulation A?
a. it is shorter and simpler than the full registration
b. it does not have limitations on the number or sophistication of offerees.
c. it is a public offering rather than a private placement
d. it can generally be freely sold
e. it requires no offering statement be filed with the SEC

30. Which of the following exemptions involves a public, and not a private, offering?
a. Section 4(2)
b. Rule 501
c. Rule 505
d. Rule 506
e. Regulation A

31. Under Regulation A, which one of the following is not true?
a. issuers are allowed to test the waters prior to preparing the offering circular
b. after filing a SEC statement, the issuer can communicate with perspective investors orally, in writing, by advertising in newspapers, radio, television, or via the mail to determine investor interest
c. issuers can take commitments or funds
d. there is a formal delay of 20 calendar days before sales are made
e. if the interest level is insufficient, the issuer can drop Regulation A filing

32. The JOBS Act of 2012 provides for which of the following:
a. establishes a new business classification called “Emerging Growth Company”
b. lifts restrictions on general solicitation and advertising for Reg D 506 accredited investor offerings
c. establishes a small offering registration exemption and calls for SEC rules relating to the sales of securities to an Internet :crowd” (security crowd funding)
d. a and b above
e. a, b, and c

Note: Following are multiple-choice questions relating to materials presented in Appendix B of Chapter 8.

1. Rule 501 of Regulation D expands the categories of accredited investors. Which is not one of the categories?
a. any organization formed for the specific purpose of acquiring securities with assets in excess of $5 million
b. any director or executive officer of the issuer of securities being sold
c. any individual whose net worth exceeds $1 million
d. any partnership
e. any trust with total assets greater the $5 million

2. Which of the following is not a condition of a Regulation D offering under Rule 502?
a. integration
b. offering
c. information
d. solicitation
e. resale

3. Which of the following are requirements of natural persons to be accredited investors under Regulation D Rule 501?
a. net worth greater than $5 million
b. total assets greater than $1 million
c. individual (single) annual income greater than $200,000
d. stock market portfolio greater than $2 million
e. all of the above

4. Rule 502 of Regulation D deals with:
a. integration
f. information
g. solicitation
h. resale
i. a and b above
e. a, b, c, and d above

5. Rule 503 dictates that for all Reg D exemptions, a Form D should be filed within how many days after the first sale of securities?
a. 1 day
b. 15 days
c. 30 days
d. six months
e. one year

6. The primary exemption from the prohibition of resale of unregistered securities (including, but not limited to, securities safely harbored in Rules 505 and 506 offerings) is:
a. Rule 111
b. Rule 122
c. Rule 133
d. Rule 144
e. Rule 147

CHAPTER 9

PROJECTING FINANCIAL STATEMENTS

True-False Questions

1. Long-term financial planning begins with a forecast of annual working capital needs.

2. In a typical venture’s life cycle, the rapid-growth stage involves creating and building value, obtaining additional financing, and examining exit opportunities.

3. Forecasting for firms with operating histories is generally much easier than forecasting for early-stage ventures.

4. Sales forecasts usually are based on either a single specific scenario or weighted averages of several possible realizations.

5. The weighted average of a set of possible outcomes or scenarios is known as expected values.

6. A customer-driven or “bottom-up” approach to forecasting sales is used primarily to forecast industry sales growth rates.

7. Sales forecasting accuracy is usually highest during a venture’s startup stage in its life cycle.

5. “Public or seasoned financing” typically occurs during the survival stage of a venture’s life cycle.

8. The volatility of a firm’s cash balance will steadily decreases as the firm progresses from the survival stage to the rapid-growth stage.

9. “First-round financing” usually occurs during a venture’s rapid-growth life cycle stage.

10. Sales forecasting accuracy is usually lowest during a venture’s development stage in its life cycle.

11. “Internally generated funds” is the cash produced from operating a firm over a specified time period.

12. The rate at which a firm can grow sales based on the retention of business profits is known as sustainable sales growth rate.

13. A firm’s maximum sustainable sales growth rate occurs at a retention ratio of 100%.

14. When using the beginning of period equity base, the sustainable sales growth rate is equal to ROE times the retention ratio.

15. The sustainable sales growth rate is equal to ROA times the retention ratio.

16. “Financial capital needed” (FCN) is the amount of funds needed to acquire assets necessary to support a firm’s sales growth.

17. The cost of obtaining additional funds, such as additional interest expenses from borrowing funds, may be explicit and impact AFN.

18. The added costs associated with obtaining equity capital are based on investor expected rates of return and are explicit costs which affect AFN.

19. “Additional funds needed” (AFN) is the gap remaining between the financial capital needed and that funded by spontaneously generated funds and retained earnings.

20. Increases in accounts receivable and accounts payable that accompany sales increases are called “spontaneously generated funds”.

21. “Spontaneously generated funds” are increases in accounts receivable and accounts payable that accompany sales increases.

22. Increases in accounts payable and notes payable are examples of spontaneously generated funds.

23. A firm with a positive growth rate in sales will require some additional funds, assuming the existing ratios will not be changed.

24. An increase in accounts receivable will require additional financing unless the increase is offset by an equal decrease in another asset accoun

25. The percent of sales forecasting method must project all cost and balance sheet items at the same growth rate as sales.

26. The “constant-ratio forecasting method” is a variant of the “percent-of- sales forecasting method.”

27. The constant ratio forecasting method makes projections based on the assumption that certain costs and some balance sheet items are best expressed as a percentage of sales.

Multiple-Choice Questions

1. Which of the following is not a step in forecasting sales for a seasoned firm?
a. forecast future growth rates based on possible scenarios and the probabilities of those scenarios.
b. attempt to corroborate the projected sales growth rates analyzing both industry growth rates and the firm’s own past market share.
c. refine the sales forecast by using the sales force as a direct contact with both existing and potential customers.
d. take into consideration the likely impact of major operating changes within the firm on the sales forecas
e. consider the effects of changes in the firm’s debt/equity blend on the sales forecasts.

2. Which of the following statements is incorrect?
a. forecasting sales is the first step in creating projected financial
statements
b. financial forecasting tends to be more accurate for mature ventures
than for early-stage ventures
c. forecasting is relatively unimportant for early-stage ventures with
little historical financial data
d. a and b
e. a and c

3. During which round of financing is a venture typically most accurate in forecasting sales?
a. seasoned financing
b. mezzanine financing
c. first round financing
d. startup financing
e. seed financing

4. During which life cycle stage is a venture typically most accurate in forecasting sales?
a. rapid growth stage
b. startup stage
c. development stage
d. early-maturity stage
e. survival stage
5. Public or seasoned financing is generally associated with which one of the following life cycle stages:
a. development stage
b. startup stage
c. survival stage
d. rapid-growth stage
e. early-maturity stage

6. A “new” venture usually begins its sales forecast by first:
a. forecasting industry sales and expressing the venture’s sales as a percent of industry sales
b. using a “bottom-up” market-driven approach
c. extrapolating past sales
d. working with existing and potential customers

7. An “expected value” is:
a. a simple average of a set of scenarios or possible outcomes
b. a weighted average of a set of scenarios or possible outcomes
c. the highest scenario value or outcome
d. the lowest scenario value or outcome

8. Lola is in the process of forecasting the sales growth rate for an early-stage venture specializing in the production of durable running shoes. Lola predicts a .2 probability of an 80% growth in sales, a .3 probability of a 60% growth in sales, a .4 probability of a 40% growth in sales, and a .1 probability of a 10% decrease in sales. What is the expected sales growth rate of the venture?
a. 47%
b. 49%
c. 51%
d. 53%

9. Which one of the following life cycle stages would generally be associated with the second lowest sales forecasting accuracy?
a. early-maturity
b. rapid-growth
c. survival
d. start-up
e. development

10. Internally generated funds which are available for distribution to owners of for reinvestment back into the business to support future growth can be characterized by which of the following?
a. operating income
b. operating cash flow
c. net income
d. net cash flow
e. pre-tax income

11. Which of the following is not part of the financial forecasting process used to project financial statements?
a. forecast sales
b. forecast tax rates
c. project the income statement
d. project the balance sheet
e project the statement of cash flows

12. A firm projects net income to be $500,000, intends to pay out $125,000 in dividends, and had $2 million of equity at the beginning of the year. The firm’s sustainable growth rate is:
a. 5%
b. 18.75%
c. 6.25%
d. 4.69%
e. none of the above

13. A firm has net income of $320,000 on sales of $3,200,000. Its assets total $2,000,000; the equity at the beginning of the year was $1,600,000 and dividends paid were $80,000. What is the sustainable growth rate?
a. 5%
b. 15%
c. 6.25%
d. 4.69%
e. none of the above

14. A sales growth rate based on the retention of profits is referred to as the:
a. real sales growth rate
b. sustainable sales growth rate
c. spontaneous sales growth rate
d. nominal sales growth rate
e. weighted average sales growth rate

15. Which one of the following ratios is not part of the “standard” return on equity (ROE) model?
a. net profit margin
b. asset turnover
c. equity multiplier
d. retention rate

16. If beginning of period common equity is $200,000 and end of period common equity is $300,000, the sustainable growth rate is:
a. 33%
b. 40%
c. 50%
d. 67%
e. 75%

17. Use the following information to estimate a venture’s sustainable growth rate: Net income = $200,000; Total assets = $1,000,000; equity multiple based on beginning common equity = 2.0 times; and Retention rate = 25%.
a. 50%
b. 25%
c. 20%
d. 10%
e. 5%

18. If a venture has a return on assets (ROA) = 10%, an equity multiplier based on beginning equity = 3.5 times, and a retention rate = 50%, the sustainable growth rate would be:
a. 10%
b. 17.5%
c. 35%
d. 40%
e. 20.5%

19. If a venture has a return on assets (ROA) = 10%, an equity multiplier based on beginning equity = 4.0 times, and a dividend payout ratio of 60%, the sustainable growth rate would be:
a. 10%
b. 16%
c. 20%
d. 24%
e. 40%

20. If a venture has a return on assets (ROA) = 12%, an equity multiplier based on beginning equity = 3.0 times, and a sustainable growth rate of 18%, the retention rate would be:
a. 10%
b. 20%
c. 30%
d. 40%
e. 50%

21. A venture’s common equity was $50,000 at the end of last year. If the venture’s common equity at the end of this year was $60,000, what was its sustainable sales growth rate?
a. 5%
b. 10%
c. 15%
d. 20%
e. 25%

22. A venture’s common equity account increased by $100,000 the past year and ended the year at $500,000. What was its sustainable sales growth rate?
a. 5%
b. 10%
c. 15%
d. 20%
e. 25%

23. Determine a venture’s sustainable growth rate based on the following information: sales = $1,000,000; net income = $100,000; common equity at the beginning of the year = $500,000; and the retention rate = 50%.
a. 10%
b. 15%
c. 20%
d. 25%
e. 30%

24. Determine a venture’s sustainable growth rate based on the following information: sales = $1,000,000; net income = $150,000; common equity at the end of last year = $520,000; and the dividend payout percentage = 20%.
a. 10%
b. 16%
c. 20%
d. 24%
e. 30%

25. Determine a firm’s “financial policy” multiplier based on the following information: sustainable growth rate = 20%; net profit margin = 10%; and asset turnover = 2 times.
a. 1.00
b. 1.25
c. 1.50
d. 1.75
e. 2.00

26. Determine a firm’s “return on assets” percentage based on the following information: sustainable growth rate = 20%; total assets $500,000; beginning of year common equity $200,000; and dividend payout percentage = 60%.
a. 10.0%
b. 12.5%
c. 15.0%
d. 17.5%
e. 20.0%

27. The financial funds needed to acquire assets necessary to support a firm’s sales growth is called: a. spontaneously generated funds
b. additional funds needed
c. addition in retained earnings
d. financial capital needed

28. The increase in accounts payables and accruals that occur with a sales increase is called:
a. spontaneously generated funds
b. additional funds needed
c. addition in retained earnings
d. financial capital needed

29. The financial funds still needed to finance asset growth after using spontaneously generated funds and any increase in retained earnings is called:
a. spontaneously generated funds
b. additional funds needed
c. addition in retained earnings
d. financial capital needed

30. Which one of the following would increase a firm’s need for additional funds?
a. an increasing profit margin
b. a decreasing expected sales growth rate
c. an increase in accruals
d. an increasing dividend payout rate
e. a decrease in assets

31. Your firm recorded sales for the most recent year of $10 million generated from an asset base of $7 million, producing a $500,000 net income. Sales are projected to grow at 20%, causing spontaneous liabilities to increase by $200,000. In the most recent year, $200,000 was paid out as dividends, and the current payout ratio will continue in the upcoming years. What is your firm’s AFN?
a. $200,000
b. $600,000
c. $840,000
d. $960,000
e. $1,400,000

32. Which of the following is a forecasting method used to project financial statements?
a. percent-of-sales method
b. percent-of-expenses method
c. GNP-ratio method
d. a and b
e. a, b, and c

33. When projecting financial statements, one would first , and then proceed to :
a. project of the balance sheet, forecast sales.
b. forecast sales, project the income statement
c. forecast sales, project the balance sheet
d. forecast sales, project the statement of cash flows

CHAPTER 10

VALUING EARLY-STAGE VENTURES

True–False Questions

1. The valuation approach involving discounting present value cash flows for risk and delay is called discounted cash flow (DCF).

2. The stepping stone year is the first year before the explicit forecast period.

3. The terminal or horizon value is the value of a venture at the end of its explicit forecast period.

4. The “stepping stone” year is the second year after the explicit forecast period when valuing a venture.

5. The explicit forecast period is the two to ten year period in which the venture’s financial statements are explicitly forecas

6. The maximum dividend valuation method involves explicitly forecasted dividends to provide surplus cash which is positive.

7. The easiest way to value a venture is to discount the projected maximum dividend/issue stream.

8. The pseudo dividend method treats surplus cash as a free cash flow to equity.

9. The reversion value of a venture is the present value of the venture’s terminal value.

10. A venture’s reversion value is the present value of ongoing expenses.

11. The “reversion value” is the future value of the terminal value.

12. The “terminal” value is the value of the venture at the beginning of the explicit forecast period.

13. As used in this textbook, the “terminal” value is the same as the “horizon” value.

14. Finding the present value of the horizon value produces the venture’s reversion value.

15. Surplus cash is the cash remaining after required cash, all operating expenses, and reinvestments are made.

16. Surplus cash is the cash remaining after required cash, all operating expenses, reinvestments, and dividends payouts are made.

17. Required cash is the amount of cash required to operate a venture through its day-to-day business.

18. Surplus cash is the amount of cash required to pay scheduled dividends for next quarter.

19. The capitalization or “cap” rate is the spread between the discount rate and the growth rate of cash flow in the terminal value period.

20. Pre-money valuation is the present value of a venture prior to a new money investmen

21. Post-money valuation is the pre-money valuation of a venture plus all monies previously contributed by the venture’s founders.

22. “Net operating working capital” is current assets other than surplus cash less non-interest-bearing current liabilities.

23. “Equity valuation cash flow” is defined as: net sales + depreciation and amortization expense – change in net operating working capital (excluding surplus cash) – capital expenditures + net debt issues.

24. The “pseudo dividend method” (PDM) is a valuation method involving zero explicitly forecasted dividends and an adjustment to working capital to strip surplus cash.

25. A “post-money” valuation differs from a “pre-money” valuation by the cost of financial capital.

26. Applying the “maximum dividend method” (MDM) and the “pseudo dividend method” (PDM) result in different valuation estimates.

27. The “maximum dividend method” assumes that all surplus cash will be paid out as dividends.

28. A pseudo dividend involves excess cash that does not need to be invested in a venture’s assets or operations, and may be invested elsewhere for a period of time.

29. The pseudo dividend method treats equity infusions and withdrawals in a “just in time” fashion.

30. The pseudo dividend method treats surplus cash either as stripped out while not in use or as employed outside the venture and stored in a zero NPV investmen

31. The wider the capitalization or “cap” rate (i.e., the discount rate minus the growth rate in the terminal period), the higher the terminal value.

Multiple-Choice Questions

1. The present value of the venture’s expected future cash flows is called?
a. going-concern value
b. present value
c. terminal value
d. reversion value
e. net present value

2. The value today of all future cash flows discounted to the present at the investor’s required rate of return is called?
a. going-concern value
b. present value
c. terminal value
d. reversion value
e. net present value

3. The value of the venture at the end of the explicit forecast period is called the horizon value, or what?
a. going-concern value
b. present value
c. terminal value
d. reversion value
e. net present value

4. The present value of the terminal value is called?
a. going-concern value
b. present value
c. terminal value
d. reversion value
e. net present value

5. The present value of a set of future flows plus the current undiscounted flow is called?
a. going-concern value
b. present value
c. terminal value
d. reversion value
e. net present value

6. The calculation of equity valuation cash flows nets the cash impact of all other balance sheet and income accounts to focus on the ______ account as the repository of any remaining cash flow.
a. cash
b. debt
c. equity
d. non-interest-bearing liabilities
e. net income

7. Equity valuation cash flow = Net income plus
a. Depreciation and amortization expense minus the change in net operating working capital plus capital expenditures plus net debt issues
b. Depreciation and amortization expense plus the change in net operating working capital plus minus capital expenditures plus net debt issues
c. Depreciation and amortization expense minus the change in net operating working capital plus capital expenditures minus net debt issues
d. Depreciation and amortization expense minus the change in net operating working capital plus minus capital expenditures plus net debt issues
e. Depreciation and amortization expense minus the change in net operating working capital plus capital expenditures plus net debt issues

8. In a wildly successful first year in business that started and ended with no required cash, your firm has operating income of $989,000, net income of $637,000, current assets of $900,000, current liabilities of $659,000, net capital expenditures were $690,000, and depreciation was $460,000. The firm has never financed itself with deb What is your equity valuation cash flow?
a. $648,000
b. $900,000
c. $2,028,000
d. $166,000

9. Your firm has been in business for two years. In its first year, the firm ended with $227,000 of current assets, long-term assets of $143,000, $70,000 in surplus cash, current liabilities of $52,000, and long-term assets of $68,000. At the end of the second year, current assets were $279,000, long-term assets of $195,000, surplus cash of $90,000, current liabilities of $62,000, and long-term assets of $78,000. What is your firm’s change in net operating working capital?
a. $22,000
b. $62,000
c. $42,000
d. $244,000
e. $32,000

10. The equity valuation method involving explicitly forecasted dividends to provide surplus cash of zero is called?
a. maximum dividend method
b. pseudo dividend method
c. sustainable growth method
d. dividend payout method

11. The equity valuation method involving zero explicitly forecasted dividends and an adjustment to working capital to strip surplus cash is called?
a. maximum dividend method
b. pseudo dividend method
c. sustainable growth method
d. dividend payout method

12. “Just in time” capital injections by equity investors is a reference to
a. sustainable growth
b. the present value of the terminal value
c. equity investors’ providing money only when needed
d. dividend payout

13. The maximum dividend method is
a. the cleanest for valuing assets, but creates problems valuing surplus cash
b. the cleanest for valuation purposes but its dividend-laden financial statements can dramatically understate the firm’s cash position
c. the cleanest for cash planning, but creates problems valuing the venture by discounting the dividends
d. calculated by directly discounting the cash flow statement’s projected dividend flow to investors, but ignores risks associated with periodic gluts of surplus cash

14. The pseudo dividend method is
a. the cleanest for valuing assets, but creates problems valuing surplus cash
b. the cleanest for valuation purposes but its dividend-laden financial statements can dramatically understate the firm’s cash position
c. the cleanest for cash planning, but creates problems valuing the venture by discounting the dividends
d. calculated by directly discounting the cash flow statement’s projected dividend flow to investors, but ignores risks associated with periodic gluts of surplus cash

15. “Required cash” is?
a. the cash needed to pay interest expense
b. a valuation method for early stage ventures
c. cash needed to cover a venture’s day-to-day operations
d. cash available to pay as a dividend

16. Most discounted cash flow valuations involve using cash flows from an:
a. historical period, an explicit forecast period, and a terminal value
b. historical period and a terminal value
c. historical period and an explicit forecast period
d. explicit forecast period and a terminal value

17. Which one of the following equity valuation methods records surplus cash on the balance sheet but assumes that the surplus cash is paid out over time for valuation purposes?
a. maximum dividend method
b. pseudo dividend method
c. sustainable growth method
d. return on equity method

18. When estimating the terminal value of a venture using an equity valuation method, a perpetuity growth equation is often applied that uses the capitalization rate for discounting purposes. This “cap” rate is measured as the:
a. equity discount rate minus the perpetuity growth rate
b. equity discount rate plus the perpetuity growth rate
c. risk-free rate plus the perpetuity growth rate
d. risk-free rate minus the perpetuity growth rate

19. A venture’s going-concern value is the:
a. present value of the expected future cash flows
b. net present value of the current and expected future cash flows
c. future value of the expected cash flows
d. net future value of the current and expected cash flows

20. The purpose of the stepping stone year is?
a. to assure that there is sufficient required cash
b. to assure that future dividends are constant
c. to assure that investment flows are consistent with terminal growth rates
d. to allow for a final year of higher-than-sustainable growth

21. When estimating the terminal value of a cash flow perpetuity, which one of the following is not a component?
a. the next period’s cash flow
b. a constant discount rate
c. a constant growth rate
d. the payback period

22. Which one of the following components is not a component of the equity valuation cash flow?
a. NOPAT
b. depreciation and amortization expense
c. change in net operating working capital (without surplus cash)
d. capital expenditures
e. net debt issues

23. What is the difference between pre-money valuation and post-money valuation?
a. size of the capitalization rate
b. amount of money injected by new investors
c. revision value
d. amount of money previously contributed by founders
e. amount of money previously contributed by venture investors

24. To calculate a terminal value, one divides the next period’s cash flow by the:
a. constant discount rate plus a constant growth rate
b. constant discount rate plus a variable growth rate
c. constant discount rate minus a constant growth rate
d. constant growth rate minus constant discount rate
e. constant growth rate plus a variable discount rate

25. The MDM equity valuation method is an abbreviation for:
a. minimum dividend method
b. maximum discount method
c. maximum dividend method
d. minimum discount method
e. Montgomery design method

26. The PDM equity valuation method is an abbreviation for:
a. pseudo dividend method
b. proximate dividend method
c. pseudo discount method
d. proximate discount method
e. pre-money discount method

27. Estimate a venture’s equity valuation cash flow based on the following information: net income = $6,372; depreciation = $4,600; change in net operating working capital = $2,415; capital expenditures = $6,900; and new debt issues = $1,000.
a. $6,487
b. $5,487
c. $4,487
d. $3,787
e. $5,787

28. Estimate a venture’s terminal value based on the following information: current year’s net income = $20,000; next year’s expected cash flow = $26,000; constant future growth rate = 7%; and venture investors’ required rate of return = 20%.
a. $156,846
b. $285,714
c. $200,000
d. $150,000
e. $428,571

29. Estimate a venture’s required rate of return based on the following information: terminal value = $400,000; current year’s net income = $20,000; next year’s expected cash flow = $25,000; and a constant growth rate = 7%.
a. 6%
b. 7%
c. 8%
d. 9%
e. 10%

30. Estimate a venture’s constant growth rate (g) based on the following information: terminal value = $400,000; current year’s net income = $20,000; next year’s expected cash flow = $25,000; and a required rate of return of 20%.
a. 2%
b. 4%
c. 6%
d. 8%
e. 10%

31. Which one of the following components is not a component of the equity valuation cash flow calculation?
a. net income
b. depreciation and amortization expense
c. change in net operating working capital (without surplus cash)
d. capital expenditures
e. net equity repurchases

32. Estimate a venture’s terminal value based on the following information: current year’s net sales = $500,000; next year’s expected cash flow = $16,000; constant future growth rate = 10%; and venture investors’ required rate of return = 20%.
a. $156,846
b. $285,714
c. $200,000
d. $150,000
e. $160,000

33. Estimate a venture’s cash flow expected next year based on the following information: current year’s net sales = $400,000; terminal value = $500,000; constant future growth rate = 10%; and venture investors’ required rate of return = 20%.
a. $20,000
b. $40,000
c. $50,000
d. $60,000
e. $80,000

CHAPTER 11

VENTURE CAPITAL VALUATION METHODS

True–False Questions

1. The venture capital valuation method estimates the venture’s value by projecting both intermediate and terminal/exit flows to investors.

2. Venture investors returns depend on the venture’s ability to generate cash flows or to find an acquirer for the venture.

3. The value of the venture’s equity is equal to the value the financing contributed in the first venture capital round.

4. A direct application of the earnings-per-share ratio to venture earnings is known as the direct comparison valuation method.

5. The venture capital valuation method which capitalizes earnings using a cap rate implied by a comparable ratio is known as direct capitalization.

6. Failure to account for any additional rounds of financing and its accompanying dilution in order to meet projected earnings will result in the investor’s not receiving an adequate number of shares to ensure the required percent ownership at the time of exi

7. Almost without exception, professional venture investors demand that some equity or deferred equity compensation be structured into any valuation.

8. If a venture issues debt prior to the exit period, the initial equity investors will still receive first claims on the venture’s net worth at exit time.

9. The utopia discount process allows the venture investors to value their investment using only the business plan’s explicit forecasts, discounting it at a bank loan interest factor.

10. The internal rate of return is the simple (non-compounded) interest rate that equates the present value of the cash inflows received with the initial investmen

11. The basic venture capital method estimates a venture’s value using only terminal/exit flows to all the venture’s owners.

12. The basic venture capital method estimates a venture’s value using only terminal/exit flows to founders.

13. Post-money valuation of a venture is the pre-money valuation plus money injected by new investors.

14. Staged financing is financing provided in sequences of rounds rather than all at one time.

15. In staged financing, the expected effect of future dilution is borne by both founders and the investors currently seeking to inves

16. The capitalization rate is the sum of the discount rate and the growth rate of the cash flow in the terminal value period.

17. The internal rate of return (IRR) is the compound rate of return that equates the present value of the cash inflows received with the initial investmen

18. The discount rate that one applies in a multiple scenario valuation will usually be lower than the discount rate that would be applied to the business plan cash flows.

19. All of the scenarios in a multiple scenario analysis must have exit cash flows in the same year.

20. The discount rate applied in an Expected PV approach should be the same rate across scenarios.

21. The expected present value method incorporates the present values of different scenarios, as well as their probabilities, into the valuation process.

Note: The following TF questions relate to Learning Supplements 11A and 11B:

1. The return on book equity equals the sustainable growth rate when all earnings are paid out in the form of dividends.

2. A price-earnings ratio is related to the level and growth of earnings.

3. The Venture Capital ShortCut (VCSC) method is a post-money version of the Delayed Dividend Approximation (DDA).

4. The VSCS and DDA methods are “just-in-time” capital methods which do not assess capital charges for idle cash.

5. For the typical business plan having current and early cash outflows and later-stage cash inflows, the VCSC and DDA methods will typically give lower valuations than the MDM and PDM.

6. The VSCS is like a post-money version of the DDA.

7. For the typical business plan having current and early cash outflows and later-stage cash inflows, the VSCS will give a higher valuation than the DDA.

8. The DDA and VCSC methods give the same valuation.

Multiple-Choice Questions

1. The return to venture investors directly depends on which of the following?
a. venture’s ability to generate cash flows
b. ability to convince an acquirer to buy the firm
c. the amount of its short-term liabilities
d. both a and b
e. all of the above

2. To obtain the percent ownership to be sold in order to expect to provide the venture investor’s target return, one must consider the:
a. cash investment today and the cash return at exit multiplied by the venture investor’s target return, then divide today’s cash investment by the venture’s NPV
b. cash investment today and the cash return at exit discounted by the venture investor’s target return, then divide today’s cash investment by the venture’s NPV
c. cash investment today and the cash return at exit multiplied by the venture investor’s target return, then divide today’s cash investment by the venture’s NPV
d. cash investment today and the cash return at exit discounted by the venture investor’s target return, then multiply today’s cash investment by the venture’s NPV

3. The value of the existing venture without the proceeds from the potential new equity issue is known as?
a. pre-money valuation
b. post money valuation
c. staged financing
d. the capitalization rate

4. The value of the existing venture plus the proceeds from the potential new equity issue is known as?
a. pre-money valuation
b. post money valuation
c. staged financing
d . the capitalization rate

5. Financing provided in sequences of rounds rather than all at one time is
known as?
a. pre-money valuation
b. post money valuation
c. staged financing
d. the capitalization rate

[Note: Use the following information for Problems 6 through 11.]

A potential investor is seeking to invest $500,000 in a venture, which currently has 1,000,000 million shares held by its founders, and is targeting a 50% return five years from now. The venture is expected to produce half a million dollars in income per year at year 5. It is known that a similar venture recently produced $1,000,000 in income and sold shares to the public for $10,000,000.

6. What is the percent ownership of our venture that must be sold in order to provide the venture investor’s target return?
a. 33.33%
b. 75.94%
c. 12.76%
d. 15.00%

7. What is the number of shares that must be issued to the new investor in order for the investor to earn his target return?
a. 3,156,276
b. 1,578,138
c. 4,156,276
d. 2,578,138

8. What is the issue price per share?
a. $0.1939
b. $0.1203
c. $0.3168
d. $0.1584

9. What is the pre-money valuation?
a. $120,300
b. $316,800
c. $158,400
d. $193,900

10. What is the post-money valuation?
a. $658,354
b. $499,954
c. $408,377
d. $249,977

11. What is the value of the venture in year five using direct capitalization?
a. $500,000
b. $5,000,000
c. $1,000,000
d. $100,000

12. For early stage ventures, which of the following is a strong reason for having an equity component in employee compensation?
a. the expected deferred and tax-preferred compensation allows the venture to pay a lower current compensation to employees
b. as a way to motivate employees to strive for the same goal of high equity value
c. because any dividends received as part of the equity compensation reduces taxable income
d. both a and b
e. all of the above

13. During the exit period, which of the following will have last crack at the venture’s wealth?
a. banks giving loans to the venture
b. convertible debt holders of the venture
c. initial equity investors of the venture
d. participating preferred equity holders

14. Suppose your venture’s expected mean cash flows are $(85,000) initially, followed by expected mean cash flows at the end of the first, second, and third years of $40,000, $40,000, and $35,000. What is the internal rate of return?
a. 13.9%
b. 14.7%
c. 16.2%
d. 17.2%
e. 19.2%

15. A P/E multiple refers to:
a. price/expectations multiple
b. price/earnings multiple
c. profit/EBIT multiple
d. profit/earnings multiple
e. price/EBITDA multiple

16. Estimate the value of a privately-held firm based on the following information: stock price of a comparable firm = $20.00; net income of a comparable firm = $20,000; number of shares outstanding for the comparable firm = 10,000; and earnings per share for the target firm = $3.00.
a. $10.00
b. $20.00
c. $30.00
d. $40.00
e. $50.00

17. Estimate the value of a privately-held firm based on the following information: total market value (or capitalization value) of a comparable firm = $200,000; net income of a comparable firm = $40,000; number of shares outstanding for the comparable firm = 20,000; net income for the target firm = $15,000; and number of shares outstanding for the target firm = 10,000.
a. $5.00
b. $7.50
c. $10.00
d. $12.50
e. $15.00

18. Determine the market value of a “comparable” firm based on the following information: value of target firm = $4,000,000; net income of target firm = $200,000; and net income of “comparable” firm = $500,000.
a. $4 million
b. $7.5 million
c. $10 million
d. $12.5 million
e. $15 million

19. Determine the net income of a “comparable” firm based on the following information: value of target firm = $4,000,000; net income of target firm = $200,000; stock price of “comparable” firm = $30.00; and 300,000 shares of stock outstanding for the comparable firm.
a. $450,000
b. $500,000
c. $550,000
d. $600,000
e. $700,000

20. Determine the future value of a target venture which has net income expected to be $40,000 at the end of four years from now. A comparable firm currently has a stock price of $20.00 per shares; 100,000 shares outstanding; and net income of $50,000.
a. $1.0 million
b. $1.4 million
c. $1.6 million
d. $2.0 million

21. Which of the following financing rounds dilutes the ownership founders?
a. first-round
b. second-round
c. incentive ownership round
d. a and b
e. a, b, and c

22. The utopian approach to valuation ignores which of the following venture scenarios:
a. black hole scenarios
b. living dead scenarios
c. both a and b
d. neither a or b

23. Which of the following is not a variation of the venture capital valuation method?
a. venture capital method
b. expected present value
c. utopian discount process
d. none of the above

Following are MC questions relating to Learning Supplements 11A and 11B:

1. When a firm has growth that only meets, rather than exceeds, the cost of capital, we would expect its price-earnings multiple to be approximately equal to:
a. the reciprocal of its required return on equity
b. its earnings per share
c. its book-to-market ratio
d. its debt-to-value ratio

2. The two “just-in-time” capital methods are:
a. DDA and VCSC
b. DDA and PDM
c. VSCS and MDM
d. MDM and PDM

3. For the typical venture investing project, the valuation will be highest under:
a. DDA
b. PDM and MDM
c. VCSC
d. initial book value of equity

CHAPTER 12

PROFESSIONAL VENTURE CAPITAL

True–False Questions

1. In addition to having personal financial stakes in their portfolio of investments, professional venture capitalists have raised funds from other investors to invest in the portfolio.

2. The establishment of the Small Business Administration was the first major government foray into venture investing.

3. Created by the Small Business Administration, Small Business Investment Companies possess important tax advantages and were eligible to borrow amounts up to four times their equity base from the governmen

4. Initially, Small business Investment Companies access to borrowed funds appeared attractive. This was because venture investing and debt service commitments are an ideal mixture of financing for start-ups.

5. Professional venture capital, as we know it today, did not exist before World War II.

6. Most venture investing came from wealthy individuals and families prior to World War II.

7. The beginning of professional venture capitalists began with the formation of American Research and Development in 1966.

8. In 1958 the Small Business Administration created Small Business Investment Companies.

9. The first major government foray into venture investing came with the formation of the Small Business Administration (SBA) in 1947.

10. The American Research and Development (ARD) company was formed in 1946.

11. Internet financing led the record level of venture investing in the 1999-2000 time period.

12. The phrase “two and twenty shops” refers to investment management firms having a contract that gives them two percent carried interest and 20 percent of assets annual management fee.

13. When the venture fund calls upon the investors to deliver their investment funds, it reflects the deal flow.

14. The deal flow reflects the flow of business plans and term sheets involved in the venture capital investing process.

15. In the venture investing context, due diligence describes the process of investigating a potentially worthy concept or plan.

16. The summary of the investment terms and conditions accompanying an investment proposed by the venture capitalist is known as the statement of strengths and weaknesses.

17. “Carried interest” is the portion of profits paid to the professional venture capitalist as incentive compensation.

18. The term “capital call” refers to the flow of business plans and term sheets involved in the venture capital investing process.

19. Pension funds are the dominant source of funds for venture investing.

20. Individuals and families are more important suppliers of venture capital relative to finance and insurance firms.

21. Endowments and foundations are more important suppliers of venture capital relative to individuals and families.

22. “Due diligence,” in venture investing context, is the process of ascertaining the viability of a business plan.

23. When a syndicate of VCs invests in a venture, the investor in charge of organizing the due diligence process is known as the “lead investor.”

24. SLOR stands for “standard letter of recognition.”

25. SLOR stands for “standard letter of rejection.”

26. A “term sheet” is a summary of the investment terms and conditions accompanying an investment by venture capitalists.

27. Term sheets consist of the terms and conditions accompanying an investment, as stipulated by the founders of the venture.

28. Two typical issues addressed in a term sheet are valuation and the size and staging of financing.

29. Term sheets may contain demands regarding the voting rights of shares issued to venture investors.

30. Once the venture capital firm has received exit proceeds from a venture in the form of cash or securities, some method of returning the proceeds (less the carried interest) must be determined.

31. Annual VC investments, as indicated in Figure 12.1, reached an all-time high in the year 2000.

32. According to Figure 12.4, individuals and families were the largest supplier of venture capital in 2009.

Multiple-Choice Questions

1. The beginning of professional venture capitalists is considered to have occurred:
a. prior to World War II
b. 1946
c. 1956
d. 1966
e. after the Vietnam War

2. The beginning of professional venture capitalists is considered to have begun with the establishment or formation of:
a. Small Business Administration
b. Small Business Investment Companies
c. American Research and Development organization
d. Professional Venture Capitalists organization

3. Which of the following was the largest source of venture capital funds in 2009 (as reported in Figure 12.4)?
a. pension funds and corporations
b. individuals and families
c. endowments and foundations
d. finance and insurance

4. Venture Capital firms tend to specialize in publicly identified niches because of the potential for value-added investing by venture capitalists. Which is not one of these niches?
a. industry type
b. venture stage
c. size of investment
d. management style
e. geographic area

5. As venture firms attract money from investors, it is placed in a fund. Important issues that must be put in place with the establishment of the fund include all of the following except:
a. determine the general partners
b. establishing a fee structure
c. a profit sharing arrangement
d. establish its governance
e. the management team assigned to each borrower

6. All of the following are typically part of a venture fund’s typical compensation and incentive structure except:
a. some percent annual fee on invested capital
b. a percent share of any profits to the managing general partner
c. carried interest
d. salary for the general partners

7. When evaluating the prospects of a new venture, venture capital firms consider which of the following?
a. characteristics of the proposal
b. characteristics of the entrepreneur/team
c. nature of the proposed industry
d. both b and c
e. all of the above

8. When screening prospective new ventures, venture capital firms consider their own funds’ requirements. Which of the following is not one of the venture firm’s requirements relating to its own funds?
a. investor control
b. rate of return
c. size of investment
d. probable stock listing exchange for the mature venture
e. financial provisions for investors

9. When evaluating the prospects of a new venture, venture capital firms consider the characteristics of the entrepreneur and its team. Which of the following is not part of the review of the entrepreneur/team?
a. its background and experience
b. its managerial capabilities
c. management’s stake in the firm
d. the VC firms’ ability to cash out
e. the capability to sustain an effort

10. When screening prospective new ventures, venture capital firms must consider the nature of the proposed industry. Which of the following is not part of the screening of the proposed industry?
a. market attractiveness
b. managerial references
c. potential size
d. technology
e. threat resistance

11. Professional venture investing usually involves setting up a venture capital firm as a:
a. proprietorship
b. corporation
c. partnership
d. S corporation

12. After a new professional venture capital fund is organized, the fund managers:
a. conduct due diligence and actively invest
b. solicit investments and obtain commitments
c. arrange harvest or liquidation
d. identify prospective venture investments and then solicit investments

13. After determining the next fund’s objectives and policies, the “professional venture investing cycle’s” next step is:
a. solicit investments in new fund
b. organize the new fund
c. obtain commitments for a series of capital calls
d. conduct due diligence and actively invest
e. arrange harvest or liquidation

14. The term “carried interest” refers to:
a. interest not currently paid but which must be paid in the future by a professional venture capitalist
b. interest transported directly to a bank
c. interest owed on a loan in default
d. the portion of profits paid to the professional venture capitalist as incentive compensation

15. If an investment management firm is known to be a “two and twenty shop”, this implies that the firm:
a. receives an annual 2% fee on invested capital, and a 20% carried interest
b. receives an annual 20% fee on invested capital, and a 2% carried interest
c. receives an annual 2% fee on gross operating profits, and a 20% carried interest
d. receives an annual 20% fee on gross operating profits, and a 2% carried interest

16. A venture fund calls upon its investors to deliver their investment funds. This is known as:
a. due diligence
b. deal flow
c. a capital call
d. carried interest
e. a SLOR

17. All of the following are typical issues addressed in a term sheet except?
a. valuation
b. board structure
c. registration rights
d. management fees
e. employment contracts

18. Term sheets are usually drafted by:
a. the mangers of the venture seeking VC funding
b. the VC fund seeking to fund the venture
c. management and founders
d. it is usually done by an third party, in order to
ensure the fair treatment of both parties

19. In a syndicate of venture investors, the investor who is responsible for governing the process of due diligence is:
a. the primary investor
b. the lead investor
c. a small group of secondary investors
d. the investor in charge of issuing SLORs for the syndicate
e. it is a democratic process that is shared by all investors in the group

20. A summary of the investment terms and conditions accompanying an investment is referred to as a:
a. term sheet
b. business plan
c. fund created by professional venture capitalists
d. due diligence in venture investing
e. capital call

21. When screening possible investments, a venture capital firm might issue an SLOR which stands for:
a. standard letter of rejection
b. standing letter of reconciliation
c. standard letter of reassessment
d. senior letter of reference

22. Which of the following is not one of the four likely outcomes of the venture firm’s screening process?
a. seek the lead investor position
b. seek a non-lead investor position
c. close the capital fund
d. refer the venture to more appropriate financial market participants
e. issue a standard letter of rejection

Note: The following MC questions relate to Figure 12.3 Elements of a Venture Capital Fund Placement Memorandum

1. In a Venture Capital Fund Placement Memorandum, which of the following is not a front matter declaration?
a. description of limited manner of the offering
b. targeted fund size
c. imposition of confidentiality
d. notice of lack of SEC registration
e. declaration of the highly risky nature of investment

2. In a Venture Capital Fund Placement Memorandum, which of the following is not part of the offering summary?
a. objective of formation
b. declaration of general partner
c. management fee
d. minimum capital restrictions
e. targeted fund size

3. In a Venture Capital Fund Placement Memorandum, which of the following is not part of the fund overview?
a. fund size
b. investment focus
c. fund management
d. portfolio size
e. general partners’ capital contributions

4. In a Venture Capital Fund Placement Memorandum, all of the following are part of the executive summary except?
a. special limited partners
b. general partners’ capital contributions
c. limitation of liability
d. allocation of gains and losses
e. imposition of confidentiality

5. In a Venture Capital Fund Placement Memorandum, all of the following are included in the summary of terms except?
a. indemnification
b. objective
c. liquidation
d. valuation
e. expenses

CHAPTER 13

OTHER FINANCING ALTERNATIVES

True–False Questions

1. Despite the high risk and costs of using a facilitator or up-front fee solicitor to obtain financing, many start-ups never-the-less seek them as a source of funds due to the length of time it takes to raise new funds.

2. Collateral plays an important role in determining the willingness to lend and the amount and terms of the loan, making it the most important factor in the lending process.

3. Commercial loan officers have the expertise to project new venture’s business successes, and thus are as willing to make funds available to entrepreneurs on the same basis as other businesses.

4. Because investors and commercial lenders both seek returns on the funds given to start-up firms, entrepreneurs can obtain financing as easily from either source.

5. Because of loan restrictions, obtaining funding from commercial lenders is prohibitive for entrepreneurs.

6. Unlike traditional commercial banks, venture banks typically provide debt to start-ups that have already received equity financing from professional venture capital firms.

7. Among start-ups, it is widely understood that bank debt (outside of Small Business Administration loans), is not a very realistic source of financing for ventures with less than two years operating results.

8. Compensation received by commercial loan officers makes them more likely to finance early-stage ventures.

9. Warrants allow lenders to buy equity at a specified price.

10. Warrants are a debt instrument frequently used by commercial banks when financing entrepreneurial ventures.

11. Credit cards issued to start-ups have proven to be an alternative source of start-up financing.

12. The returns to venture bank lenders are generated solely from interest payments made by borrowers plus the return of the loan principal.

13. Commercial banks receive a portion of their returns from warrants in addition to the receipt of interest and the repayment of the principal that was len

14. By an act of Congress, the Small Business Administration (SBA) was created for the purpose of fostering the initiation and growth of small businesses.

15. The Small Business Administration was created by an Act of Congress in 2003.

16. Microloans in the SBA credit program are intended for very small businesses with a maximum amount of $35,000 to be used for general purposes.

17. The SBA’s role in its microloan credit program is to approve the loans and guarantee up to 85% of the loan value.

18. Microloans in the SBA credit program are made by not-for-profit or government-affiliated Community Development Financial Institutions (CDFIs).

19. The SBA’s venture capital credit program works through Community Development Financial Institutions (CDFIs).

20. The 7(a) loan traditionally has been the SBA’s primary loan program

21. SBA 7(a) loans are made usually for 1 to 3 years in amounts up to $5,000,000, require collateral, and can be used for most business purposes.

22. The SBA approves the standard 7(a) loan and guarantees up to 85% of the loan value.

23. For the 504 loan, the SBA approves and guarantees the development company’s portion of the debt but does not guaranteed the debt of the participating commercial bank.

24. Factoring is the sale of payables to a third party at a discount to their face value.

25. In a factoring arrangement, the third party makes its money by purchasing the receivables at a discount from the total amount due on the receivables.

26. With venture leasing, one component of the return to the lessor is the opportunity to take an equity interest in the venture.

27. Receivables lending is the use of receivables as collateral for an equity issue.

28. Factoring is the selling of receivables to a third party at a discount from their face value.

29. Direct public offerings have recently become a serious challenge to traditional venture capital firms.

30. The Immigration and Nationality Act (INA) of 1990 provided an opportunity for foreign nationals to obtain a “green card” through the EB-5 immigrant visas program.

31. A foreign national may seek Lawful Permanent Resident (LPR) status by investing $1 million in the U.S. that will preserve or create at least 100 jobs for U.S. workers.

Multiple-Choice Questions

1. When assessing the creditworthiness of new entrepreneurs, lending institutions review the “Five C’s”. The ability of the entrepreneur to repay borrowed funds is known as:
a. capacity
b. capital
c. collateral
d. conditions
e. character

2. When assessing the creditworthiness of new entrepreneurs, lending institutions review the “Five C’s”. The money the entrepreneur has invested in the business, which is an indication how much is at risk if the business should fail is known as:
a. capacity
b. capital
c. collateral
d. conditions
e. character

3. When assessing the creditworthiness of new entrepreneurs, lending institutions review the “Five C’s”. The guarantees, or additional forms of security (such as assets), the entrepreneur can provide the lender is known as:
a. capacity
b. capital
c. collateral
d. conditions
e. character

4. When assessing the creditworthiness of new entrepreneurs, lending institutions review the “Five C’s”. The focus on the intended purpose of the loan is known as:
a. capacity
b. capital
c. collateral
d. conditions
e. character

5. When assessing the creditworthiness of new entrepreneurs, lending institutions review the “Five C’s”. The general impression the entrepreneur makes on the potential lender or investor is known as:
a. capacity
b. capital
c. collateral
d. conditions
e. character

6. All of the following are common loan restrictions except?
a. limits on total debt
b. limits on total equity
c. restrictions on dividends or other payments to owners and/or investors
d. restrictions on additional capital expenditures
e. performance standards on financial ratios

7. Unlike traditional commercial banks, venture banks typically provide debt to start-ups that have already received equity financing from professional venture capital firms. In return for providing additional debt financing, these venture banks receive in return all of the following except?
a. interest payments
b. repayment of principal
c. implementation of loan restrictions
d. tax breaks on the interest
e. right to buy equity at a specific price

8. Bank debt is not a realistic source of financing for start-ups due to all of the following reasons except?
a. a large portion of the assets are intangible and provide no collateral
b. payables either don’t yet exist or its history is inadequate
c. the start-up’s dependence on a small number of irreplaceable people is not a good match to demand deposits or other bank liabilities
d. receivables collection track record is incomplete
e. in the event of a default, it is now plausible for the bank to install a management team to help right the operations

9. A provision that allows lenders to acquire equity at a specific price is known as a(n):
a. factor
b. warrant
c. venture lease
d. equity carve-out

10. Personal credit cards have proven to be a source of financing for start-up firms for all of the following reasons except?
a. credit card debt is not based on the firm’s ability to repay, but rather the individual card holder’s ability to repay
b. teaser rates afford initial low cost borrowing
c. balance transfer at below-prime rates
d. credit card debt can create problems if the firm doesn’t generate cash flows to cover credit card payments once low introductory rates expire

11. In the context of new ventures, what does SBA stand for?
a. Standard Business Arrangement
b. Small Business Association
c. Small Business Administration

12. By an act of Congress, the Small Business Administration (SBA) was created in which one of the following years?
a. 1953
b. 1968
c. 1973
d. 1985
e. 1993

13. Which is not a duty of the Small Business Administration?
a. provide capital and credit to entrepreneurial start-ups
b. guaranteeing general business loans
c. provide equity financing for start-ups
d. help create new jobs in small businesses
e. help small firms obtain Federal contracts

14. Which of the following is not a Small Business Administration program?
a. loan guaranty programs
b. certified and preferred lender programs
c. low documentation loan programs
d. energy and conservation loan programs
e. certified financial planner funding programs

15. Which of the following is not a source of debt funding for a start-up firm?
a. accounts payable
b. vendor financing
c. factoring
d. trade notes
e. leasing

16. Venture banks seek loan returns from:
a. interest received
b. principal repayments
c. warrants being exercised
d. all of the above
e. none of the above

17. Which one of the following is not a current Small Business Administration (SBA) credit program?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

18. In which of the following credit programs does the SBA approve and guarantee a not-for-profit Certified Development Company’s portion of the debt?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

19. In which of the following credit programs does the SBA approve a loan and guarantees up to 85% of loan value?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

20. In which of the following credit programs is the SBA role in the loan one of providing a direct loan to a community organization, which reloans the funds in small amounts?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

21. In which of the following credit programs does the SBA borrow money to be lent Small Business Investment Companies (SBICs) and guarantees payment to investors?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

22. Commercial banks, credit unions, and/or financial services firms are lenders in which of the following SBA credit programs?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

23. Commercial banks, jointly with not-for-profit Certified Development Companies, are lenders in which of the following SBA credit programs?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

24. Not-for-profit or government-affiliated Community Development Financial Institutions (CDFIs) are lenders in which of the following SBA credit programs?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

25. Small Business Investment Companies (SBICs) are lenders in which of the following SBA credit programs?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

26. Concerning factoring, all of the following are true except:
a. factors prefer business over consumer accounts
b. factoring is done at a discount to the third party purchaser
c. factoring discounts are often a function of the riskiness of the receivables
d. factoring speeds the inflow of cash to the seller of the receivables
e. receivable lending is the process of factoring

27. The use of receivables as collateral for a loan is known as:
a. capital leasing
b. warehouse financing
c. receivables lending
d. a microloan
e. venture leasing

28. Selling receivables to a third party at a discount from their face value is referred to as:
a. factoring
b. receivables lending
c. venture banking
d. vendor financing
e. mortgage lending

29. Which of the following is/are not a type of leasing arrangement?
a. factoring
b. capital lease
c. venture lease
d. mortgage lease
e. both a and d

30. Arranging for partial ownership as a component of the expected return to a lessor is known as:
a. venture leasing
b. capital leasing
c. investment leasing
d. none of the above

CHAPTER 14

SECURITY STRUCTURES AND DETERMINING ENTERPRISE VALUES

True–False Questions

1. Preferred stock is the equity claim senior to common stock providing preference on dividends but not liquidation proceeds.

2. For preferred noncumulative stock, all previously unpaid preferred dividends must be paid before any common stock dividend is paid.

3. Convertible preferred stockholders have the right to convert a preferred share into a specified number of common shares at any time after the expiration date.

4. If a share of preferred stock has a $10 par value, and the stock has a 2:1 conversion ratio, then the conversion price would be $5.

5. By issuing preferred stock, and thus forfeiting bankruptcy rights from the use of debt, the venture and its investors can benefit by committing to an internal reorganization as opposed to bankruptcy reorganization.

6. A call option is the obligation to purchase a specific asset at a pre-determined price.

7. Options generally have no effect on the value of a venture capital investmen

8. For American and Bermudan embedded options, the exercise price can change over time as specified in the security agreemen

9. An American-style option is an option that can be exercised only at the expiration date

10. A European-Style Option may only be exercised on a specific date.

11. A warrant is a call option issued by a company granting the holder the right to buy common stock at a specific price at a specific time.

12. An option granting the right to sell a stock at $10 when that stock currently has a market price $8 is “in the money.”

13. If a call option can be bought for $12 and the stock’s market value is $12, it’s said to be “at the money”.

14. As the underlying stock price increases in value, a put option to sell it becomes more valuable.

15. The value of a warrant can be directly derived from the value of a call option.

16. A preemptive right is a right for existing owners to buy sufficient shares to preserve their ownership share.

17. Convertible debt is debt that converts into preferred stock.

18. An option is a right to buy or sell additional shares of stock.

19. A warrant is a type of call option.

20. An option not currently worth exercising is said to be an out of the money option.

21. Owning a put option on a stock is the same as selling a call option on that same stock.

22. The enterprise method of valuation can be executed with either an after-tax or before-tax weighted cost of capital as long as the rate is applied to the appropriate enterprise cash flows.

23. Entity valuation allows us to answer the question of how much debt a venture needs to issue to achieve a target capital structure (D/V).

24. The concept of an enterprise value is that it is the combined value of all of venture’s financing, typically equity plus all of the deb

25. The enterprise value includes the value of the debt, equity, and warrant pieces of a venture.

Note: The following TF questions relate to Learning Supplements 14A and 14B:

1. An alternative approach to the Enterprise Valuation method adds the tax shield from paying interest back into the flows and discounts at a before-tax weighted average cost of capital.

2. Warrant valuation (as presented in this text) is similar to option valuation except that one applies a dilution factor to the option value to arrive at a warrant value.

3. The unadjusted Black and Scholes model is a model for determining the value of a warrant to buy a new share.

4. The Black and Scholes model requires the stock price as an inpu

5. The Black and Scholes model requires the inflation rate as an inpu

6. The Black and Scholes model requires an exercise price as an inpu

Multiple-Choice Questions

1. Which of the following have the least senior claim on a venture’s asset?
a. common Stock
b. preferred stock
c. convertible preferred stock
d. convertible debt
e. American-style option

2. The right for existing owners to maintain their ownership share by purchasing sufficient shares to keep their percentage share of the firm is called:
a. stock option
b. stock warrant
c. preemptive right
d. participating stock
e. paid-in-kind preferred stock

3. Which of the following stock can be structured to assure the shareholder that they will share in the payment of any dividends to common stockholders?
a. paid in kind preferred stock
b. cumulative preferred stock
c. participating preferred stock
d. convertible preferred stock
e. non-cumulative preferred stock

4. Which of the following provides the option to transform preferred stock into common stock?
a. paid in kind preferred stock
b. cumulative preferred stock
c. participating preferred stock
d. convertible preferred stock
e. non-cumulative preferred stock

5. Which of the following offers the option where the dividend obligation can be satisfied in cash or by issuing additional par amounts of the preferred security?
a. paid in kind preferred stock
b. cumulative preferred stock
c. participating preferred stock
d. convertible preferred stock
e. non-cumulative preferred stock

6. Which of the following requires that all previously unpaid preferred dividends must be paid prior to any common dividend?
a. paid in kind preferred stock
b. cumulative preferred stock
c. participating preferred stock
d. convertible preferred stock
e. non-cumulative preferred stock

7. Which of the following is never a component of a preferred stock’s security structure?
a. the right to participate in any dividends paid to common stock shareholders
b. payment of dividends in the form of additional shares of preferred stock
c. the option for the holder to convert preferred stock into common stock
d. the option for the venture to call outstanding preferred stock
e. none of the above; all of these may be included in the structure of
preferred stock

8. A round of financing where shares sell for a lower price than previous rounds is known as a:
a. down round
b. recessive round
c. reset round
d. a and c

9. Which of the following are components of common equity?
a. common stock
b. preferred stock
c. a and b
d. none of the above

10. Convertible debt has all of the following except:
a. bankruptcy rights
b. regular dividend payments
c. it can be structured to provide senior interest in specific assets
d. a tax shield due to interest expense
e. a security interest in the firms’ assets

11. Which of the following is not a type of option?
a. call option
b. put option
c. warrant
d. LBO

12. The right to buy a specified asset at a specified price on a specified date is called:
a. a forward contract
b. an American-style put option
c. an American-style call option
d. a European-style call option
e. a European style put option

13. The right to sell a specified asset at a specified price up until a specified date is called:
a. a forward contract
b. an American-style put option
c. an American-style call option
d. a European-style call option
e. a European style put option

14. An option that can be exercised at any time until its expiration is called a:
a. forward contract
b. lookback option
c. American-style option
d. European-style option
e. Bermuda-style option

15. An option that can be exercised only at its expiration date is called a:
a. forward contract
b. lookback option
c. American-Style option
d. European-Style option
e. Bermuda-Style option

16. An option that can be exercised only at a specific set of dates is called a:
a. forward contract
b. lookback option
c. American-Style option
d. European-Style option
e. Bermuda-Style option

17. Which of the following is an example of a call option which is out of the money?
a. The option to sell at $11, the stock is worth $12.
b. The option to buy at $13, the stock is worth $12.
c. The option to buy at $12, the stock is worth $12.
d. The option to sell at $13, the stock is worth $12.
e. The option to buy at $11, the stock is worth $12.

18. Which of the following is an example of a call option which is in the money?
a. The option to sell at $11, the stock is worth $12.
b. The option to buy at $13, the stock is worth $12.
c. The option to buy at $12, the stock is worth $12.
d. The option to sell at $13, the stock is worth $12.
e. The option to buy at $11, the stock is worth $12.

19. Which of the following is an example of a put option which is out of the money?
a. The option to sell at $11, the stock is worth $12.
b. The option to buy at $13, the stock is worth $12.
c. The option to buy at $12, the stock is worth $12.
d. The option to sell at $13, the stock is worth $12.
e. The option to buy at $11, the stock is worth $12.

20. Which of the following is an example of a put option which is in the money?
a. The option to sell at $11, the stock is worth $12.
b. The option to buy at $13, the stock is worth $12.
c. The option to buy at $12, the stock is worth $12.
d. The option to sell at $13, the stock is worth $12.
e. The option to buy at $11, the stock is worth $12.

21. Which of the following is an example of a put option which is at the money?
a. The option to sell at $11, the stock is worth $12.
b. The option to buy at $13, the stock is worth $12.
c. The option to sell at $12, the stock is worth $12.
d. The option to sell at $13, the stock is worth $12.
e. The option to buy at $11, the stock is worth $12

22. Generally speaking, warrants are call options that allow the holder to purchase what type of security at a specific price?
a. common stock
b. preferred stock
c. convertible debt
d. none of the above

23. To calculate the enterprise valuation cash flow, one begins with which of the following items from the income statement?
a. net sales
b. operating profit
c. (earnings before interest and taxes) × (1 – enterprise tax rate)
d. net income
e. net income times the enterprise tax rate

24. When consistent assumptions are used, we
a. get the same value for equity under the enterprise and equity methods of valuation
b. we get a higher value of equity under the equity method of valuation
c. we get a lower value of equity under the equity method of valuation
d. we get equity values that cannot be compared across the equity and enterprise methods of valuation

Note: The following MC questions relate to Learning Supplement 14B:

1. The Black and Scholes model is intended to be used to value
a. stocks
b. bonds
c. options
d. futures contracts

2. Which of the following is not an input to the Black and Scholes model?
a. earnings per share
b. stock price
c. risk free rate
d. volatility

3. N(h) in the Black and Scholes model involves the use of
a. the number of shares issued
b. the next time that a venture capitalist will invest money
c. the normal distribution cumulative density function
d. the number of times that the venture will have to raise money

CHAPTER 15

HARVESTING THE BUSINESS VENTURE INVESTMENT

True–False Questions

1. The process of exiting the privately held business venture to unlock the owners’ investment value is known as harvesting.

2. When harvesting a venture, the methodical distribution of assets directly to the owners is known as a systematic liquidation.

3. When harvesting a venture, the outright purchase of the going concern by managers, employees, or external buyers is known as going public.

4. When harvesting a venture, the two-step public equity registration and sale is known as an outright sale.

5. When an initial business plan is prepared, attention should be paid to the investors’ and founders’ desire for eventual liquidity by anticipating a harvest for the venture investors.

6. An advantage of an exit strategy that pays out the venture’s investment value over several years can make it more difficult for entrepreneurs to start a new venture because adequate capital has not been released from the existing venture.

7. When an industry is in decline, systematic liquidation is typically the most attractive harvest strategy.

8. Exit values for many mature ventures are usually determined by (1) discounted cash flow (DCF) methods or (2) relative valuation models based on some form of multiples analysis.

9. In determining a harvest value, non-monetary items such as culture, managerial succession, and employee retention are not factored in.

10. Harvesting is the process of exiting the privately held business venture to unlock the owners’ investment value.

11. Valuation methods that estimate a firm’s worth using value-related multiples of comparable firms are sometimes known as “relative value methods.”

12. The two discounted cash flow (DCF) methods covered in this text are the enterprise method and the debt funds method.

13. One method of harvesting a venture is through systematic distribution of assets directly to the owners.

14. One method of harvesting a successful venture is through systematic distribution of assets directly to lenders.

15. Other than when the venture is operating in a declining industry, it is difficult to think of cases where the disadvantages of liquidation outweigh the advantages.

16. A special type of harvesting process where the firm’s top management continues to run the firm and has a substantial equity position in the reorganized firm is known as a leveraged buyou

17. A leveraged buyout (LBO) takes place when the purchase price of a firm is financed largely with debt financial capital.

18. Ultimately for harvesting purposes, we need to decide on the venture’s value at exit and how that exit value pie will be divided up among investors.

19. An “initial public offering” is the only method used by entrepreneurs when exiting a venture.

20. A management buyout (MBO) is a special type of leveraged buyout (LBO).

21. A leveraged buyout (LBO) is a special type of management buyout (MBO).

22. ESOP stands for “employee stock ownership plan.”

23. An obligatory disclaimer disavowing any intent to act as an offer to sell, or solicit an offer to buy securities is known as a red herring.

24. The sale of new shares of common stock is a secondary offering.

25. The sale of used shares of common stock is a secondary market offering.

26. Most companies choose “best efforts” agreements in order to minimize the inherent risks of going public.

27. IPO underpricing results in a direct loss to the venture’s owners.

28. While not a direct loss to a venture, underpricing can represent a significant opportunity cost to the venture’s owners.

29. A “lockup provision” prohibits insiders from selling their existing shares for a specified period of time.

30. In a typical venture’s life cycle, the rapid-growth stage involves managing ongoing operations, maintaining and adding value, and obtaining seasoned financing.

31. In a typical venture’s life cycle, the examining of exit opportunities often occur during the rapid-growth stage.

Multiple-Choice Questions

1. Which of the following is not a way to harvest a venture?
a. systematic liquidation
b. outright sale
c. chapter 11 bankruptcy
d. going public

2. When registering equity and selling it via an IPO of new shares followed by a secondary offering of existing shares, this venture harvesting process is known as:
a. systematic liquidation
b. outright sale
c. chapter 11 bankruptcy
d. going public

3. The acquisition of the venture by family members, managers, or outside buyers is a venture harvesting process known as:
a. systematic liquidation
b. outright sale
c. chapter 11 bankruptcy
d. going public

4. The distribution of the venture’s cash flows directly to the owners is a venture harvesting process known as:
a. systematic liquidation
b. outright sale
c. chapter 11 bankruptcy
d. going public

5. Which of the following is not an advantage of a systematic liquidation?
a. maintaining control throughout the harvest period
b. harvesting of the investment value can be spread out over a number of years
c. the taxation treatment of liquidation proceeds as ordinary income
d. the time, effort, and costs of finding a buyer for the venture can be avoided

6. Which of the following is not a disadvantage of a systematic liquidation?
a. the treatment and taxation of liquidation proceeds as ordinary income rather than capital gains
b. the commitment of the entrepreneur’s resources and focus on a dying venture rather than on other more lucrative ventures
c. the harvesting of the investment gets spread out over a number of years
d. the acceleration of the venture’s rate of decline as other industry participants respond to the reduction in investment

7. A venture can be harvested in which of the following ways?
a.. systematic liquidation, outright sale, going public
b. outright sale, going public, acquisition
c. going public, acquisition
d. acquisition, systematic liquidation

8. Which of the following is not a candidate for a leveraged buyout?
a. a venture with stable and adequate operating cash flows
b. a venture with a high amount of equity relative to debt
c. a venture with the ability to protect market share
d. a venture with a high debt ratio

9. Which of the following is the premium that would be applied to venture valuation due to an investor’s majority ownership of a venture?
a. proxy premium
b. control premium
c. influence premium
d. liquidity premium
e. illiquidity premium

10. Shares registered with the Securities and Exchange Commission and state securities regulators and sold to the public are known as:
a. primary offering
b. secondary offering
c. initial public offering
d. shelf offering

11. In an outright sale of a venture, the venture can be sold to:
a. family members
b. managers
c. employees
d. outside (external) buyers
e. all of the above

12. The sale of new securities is known as:
a. primary offering
b. secondary offering
c. initial public offering
d. shelf offering

13. The sale of used shares is known as:
a. primary offering
b. secondary offering
c. initial public offering
d. shelf offering

14. The NYSE participates in:
a. the sale of new securities to private investors
b. primary offerings
c. secondary offerings
d. b and c

15. In the investment banking process, which of the following is a duty of the investment bank?
a. to be the targeted investors for a firm’s securities
b. to provide banking services such as checking accounts to firms
c. to find buyers for a firm’s securities
d. both a and b
e. all of the above

16. Based on the following information, estimate the percentage appreciation on stock bought by the venture investors: founders’ purchase price $.50; venture investors’ purchase price $2.00; current stock price $10.00; founders holding period = 5 years; venture investors holding period = 3 years.
a. 100%
b. 400%
c. 600%
d. 800%

17. Based on the following information, estimate the percentage appreciation on stock bought by the founders: founders’ purchase price $1.00; venture investors’ purchase price $2.00; current stock price $10.00; founders holding period = 5 years; venture investors holding period = 3 years.
a. 100%
b. 400%
c. 600%
d. 900%

18. Assume that a venture is expected to have an EBITDA of $1,500,000 at the end of five years from now. If the venture’s value is expected to be $12,000,000, what “valuation multiple” was being assumed?
a. 1 time
b. 4 times
c. 8 times
d. 10 times
e. 12 times

19. A venture is expected to have an exit value of $10,000,000 two years from now. If venture investors invest $2,000,000 now, and expect a 20% compounded rate of return on their investment, what portion of the exit value would they need?
a. 10%
b. 20.2%
c. 25%
d. 28.8%
e. 32%

20. A venture is expected to have an exit value of $10,000,000 five years from now. If venture investors invest $1,000,000 now, and expect a 20% compounded rate of return on their investment, what portion of the exit value would they need?
a. 10.5%
b. 20.1%
c. 24.9%
d. 28.8%
e. 32.5%

21. If venture investors invest $1,000,000 now, will receive 50% of the exit value, and expect a 20% compounded rate of return on their investment, what will be the amount of the exit value at the end of two years?
a. $1,000,000
b. $1,440,000
c. $2,880,000
d. $5,000,000
e. $5,760,000

22. If venture investors invest $1,000,000 now, will receive 25% of the exit value, and expect a 20% compounded rate of return on their investment, what is the approximate expected exit value at the end of five years?
a. $1,000,000
b. $2,490,000
c. $4,980,000
d. $7,470,000
e. $9,950,000

23. If venture investors invest $6,750,000 now, will receive 32% of the exit value, and expect a 22% compounded rate of return on their investment, what is the exit value at the end of seven years?
a. $27,153,298
b. $39,931,321
c. $69,552,505
d. $84,854,057
e. $103,521,949

24. The difference between what the investment bank gets from selling securities to public investors and what they pay to the issuing firm is known as:
a. IPO underpricing
b. due diligence
c. firm commitment
d. best efforts
e. underwriting spread

25. A type of agreement with an investment bank employing only marketing and distribution efforts without the actual transfer of securities ownership to the investment banking syndicate is called:
a. IPO underpricing
b. due diligence
c. firm commitment
d. best efforts
e. underwriting spread

26. An agreement with an investment bank that involves the purchase and distribution of new securities is known as:
a. IPO underpricing
b. due diligence
c. firm commitment
d. best efforts
e. underwriting spread

27. The investment banks process of ascertaining, to the extent possible, an issuing firm’s financial condition and investment intent is known as:
a. IPO underpricing
b. due diligence
c. firm commitment
d. best efforts
e. underwriting spread

28. The arrangement where an underwriter has the option of selling additional shares when the issue is heavily oversubscribed is known as
a. green shoe
b. red herring
c. best efforts
d. lockup

29. Which of the following describes when a syndicate’s offering price is less than the market price immediately following the offering?
a. IPO underpricing
b. due diligence
c. firm commitment
d. best efforts
e. underwriting spread

30. In the aftermarket trading for the venture’s securities, an order that is to be executed as soon as possible at the prevailing market price is known as a:
a. put order
b. market order
c. limit order
d. stop order

31. In the aftermarket trading for the venture’s securities, an order that converts to a market order once a certain price is achieved is known as a:
a. put order
b. market order
c. limit order
d. stop order

32. An order to purchase stock that can be executed only at a specified price or better is called a:
a. market order
b. limit order
c. stop order
d. stock order
e. private order

33. Which of the following is not a type of trading order?
a. market order
b. limit order
c. stop order
d. none of the above

34. The letters IPO stand for:
a. investment pricing organization
b. initial public offering
c. institutional pricing overhead
d. immediate pricing opportunity

35. The negotiated period around an equity securities offering during which insiders are prohibited from selling their existing shares is called:
a. a seasoned offering
b. an unseasoned offering
c. underpricing
d. an underwriting spread
e. a lockup provision

36. An initial public offering (IPO) involves:
a. sale of new securities to private investors
b. sale of used securities to the public
c. a venture’s first offering of SEC-registered securities to the public
d. all of the above
e. none of the above

37. The type of agreement with an investment bank involving the investment bank’s underwritten purchase and resale of securities is called:
a. firm commitment
b. best efforts commitment
c. due diligence
d. making a red herring disclaimer
e. a private placement