28 Lecture - Introduction to debt, efficient market & cost of capital

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28 Lecture

MGT201

Midterm & Final Term Short Notes

Introduction to debt, efficient market & cost of capital

Debt is a common financing tool for companies, but it comes with costs and risks. In an efficient market, investors are rational and have access to all relevant information, which affects a company's cost of capital. The cost of capital is the m


Important Mcq's
Midterm & Finalterm Prepration
Past papers included

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  1. Which of the following is a common financing tool for companies? a) Equity b) Debentures c) Warrants d) Options Answer: b) Debentures

  2. In an efficient market, what do investors have access to? a) All relevant information b) Only limited information c) Biased information d) No information Answer: a) All relevant information

  3. What is the cost of capital? a) The cost of borrowing b) The interest rate on a loan c) The minimum return a company must earn on its investments d) The amount of money a company needs to operate Answer: c) The minimum return a company must earn on its investments

  4. Which of the following is a risk associated with debt financing? a) Dilution of ownership b) Lower return on investment c) Bankruptcy d) No risk associated with debt financing Answer: c) Bankruptcy

  5. Which type of market is characterized by investors having access to all relevant information? a) Inefficient market b) Efficient market c) Biased market d) None of the above Answer: b) Efficient market

  6. What is the main advantage of debt financing? a) Increased ownership b) Lower cost of capital c) Higher return on investment d) None of the above Answer: b) Lower cost of capital

  7. What is the main disadvantage of debt financing? a) Increased risk of bankruptcy b) Higher cost of capital c) Lower return on investment d) None of the above Answer: a) Increased risk of bankruptcy

  8. Which of the following is not a factor affecting a company's cost of capital? a) Interest rates b) Inflation c) Government regulations d) Company's mission statement Answer: d) Company's mission statement

  9. Which type of financing involves selling ownership in a company? a) Debt financing b) Equity financing c) Warrant financing d) Option financing Answer: b) Equity financing

  10. What is the relationship between risk and return? a) Higher risk leads to lower return b) Lower risk leads to higher return c) No relationship between risk and return d) None of the above Answer: b) Lower risk leads to higher return.



Subjective Short Notes
Midterm & Finalterm Prepration
Past papers included

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  1. What is debt financing? Answer: Debt financing involves borrowing money from lenders in exchange for a promise to repay the borrowed amount with interest over a specific period.

  2. What is an efficient market? Answer: An efficient market is a financial market where all relevant information is publicly available and incorporated into the stock prices, making it difficult for investors to earn excess profits.

  3. What is the cost of debt? Answer: The cost of debt is the interest rate that a company must pay on the money it borrows through debt financing.

  4. What is the cost of equity? Answer: The cost of equity is the rate of return that a company must pay to its equity investors to compensate them for the risk they take by investing in the company.

  5. What is the cost of capital? Answer: The cost of capital is the weighted average cost of a company's debt and equity financing.

  6. What is the relationship between debt and risk? Answer: Debt increases a company's financial risk because the company has an obligation to pay back the borrowed amount with interest. If the company is unable to meet its debt obligations, it may face bankruptcy.

  7. What are the advantages of debt financing? Answer: The advantages of debt financing include lower cost of capital, tax-deductible interest payments, and greater control for the company's owners.

  8. What are the disadvantages of debt financing? Answer: The disadvantages of debt financing include increased financial risk, potential for bankruptcy, and reduced flexibility in the company's financial decisions.

  9. How does the efficient market hypothesis impact investors? Answer: The efficient market hypothesis suggests that it is difficult for investors to earn excess profits by trading in financial markets. Therefore, investors must rely on fundamental analysis to make informed investment decisions.

  10. How does the cost of capital impact a company's investment decisions? Answer: A company's cost of capital is the minimum return it must earn on its investments to satisfy investors' expectations and maintain its market value. If the company's cost of capital is high, it may be more selective in its investment decisions to ensure that its projects can generate sufficient returns to meet its cost of capital.

Debt financing is a common method of raising capital for businesses. It involves borrowing money from lenders with a promise to repay the borrowed amount along with interest over a specific period. The cost of debt is the interest rate that a company must pay on the borrowed amount. Debt financing provides the benefit of lower cost of capital compared to equity financing, which involves selling ownership in a company. Efficient market theory suggests that financial markets are highly efficient, and all relevant information is reflected in the stock prices. In an efficient market, investors are rational, and they have access to all relevant information that affects a company's stock price. This makes it difficult for investors to earn excess profits through trading in financial markets. The cost of capital is the weighted average cost of a company's debt and equity financing. It represents the minimum return that a company must earn on its investments to satisfy investors' expectations and maintain its market value. The cost of capital is impacted by factors such as interest rates, inflation, and government regulations. Debt financing carries risks, such as increased financial risk, potential for bankruptcy, and reduced flexibility in the company's financial decisions. On the other hand, equity financing has the benefit of providing more control to the company's owners. It also carries the risk of dilution of ownership and higher cost of capital compared to debt financing. Investors must consider the efficient market hypothesis when making investment decisions. The theory suggests that it is difficult to earn excess profits through trading in financial markets. Therefore, investors must rely on fundamental analysis to make informed investment decisions. The cost of capital impacts a company's investment decisions by determining the minimum return that the company must earn on its investments. If the company's cost of capital is high, it may be more selective in its investment decisions to ensure that its projects can generate sufficient returns to meet its cost of capital. Understanding these concepts is essential for businesses seeking to raise capital, manage their finances, and make sound investment decisions.

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