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Questions and Answers of
Corporate Finance
Complete the following table by marking an "X" next to each type of policy/risk in the column corresponding to the phase when it should be used.
From a legal standpoint, building a project finance deal requires: a) Specialized expertise in a wide variety of fields. b) A huge quantity of work which is spread out over a very long time horizon.
During the construction phase of the project, the independent technical advisor is usually called on to: a) Give an opinion on the technical feasibility of the project. b) Express a non-binding
When should insurance products be used in a project finance deal? a) Due to the contractual structure of project finance, there's no need for insurance because risks are allocated among various
"Investment Risk" policies: a) Cover the SPV against risks of currency inconvertibility, expropriation without compensation, war and other political upheavals. b) Cover the SPV against risks
Which of the following statements regarding insurance bonding is FALSE? a) Insurance bonding doesn't impact bank credit facilities. b) Insurance doesn't adversely affect the borrower's level of
Which of the following is NOT a factor that derives from an integrated package for developers and lenders? a) Disputes are minimized.
What variables have to be estimated to quantify future cash flows?
What are operating cash flows used for during each of the years of the operations phase of the project?
What are the fundamentals that a sponsor would use to value the profitability of a project finance deal? Would the same factors be used by banks?
Describe the key cover ratios and what they mean for a lender who participates in a project finance deal.
From the data in the table below, calculate DSCR, ADSCR, and LLCR for the project, if possible.
When calculating net operating cash flow (unlevered free cash flow), the following are NOT taken into account:a) Changes in net working capital b) Taxes c) Debt service and dividend payments
The underlying rationale of sensitivity analysis lies in: a) The creation of a large number of scenarios to show the level of depth attained by the advisor in designing the initiative. b) The
The pay-back period: a) Is the best criterion for valuing investment projects. b) Can be used as a complementary indicator to IRR. c) Is meaningless when analyzing project finance deals.
"Owners' costs" refer to: a) Costs which depend on the financial structure, specifically on the amount of equity contributed by sponsors. b) Costs which depend on the financial structure,
The funds set aside in the DSRA (debt service reserve account): a) Are a way creditors use to safeguard even more their rights toward the SPV. b) Are already included in the calculation of operating
With the maturity being equal, from the point of view of a bank lender the facility with a longer average life shows: a) A higher level of risk. b) A lower level of risk. c) The same level of risk
What condition must be respected for a project finance initiative to be financed with a given financing structure? a) Operating cash flow > debt service b) Operating cash flow < debt service c)
The SPV's cost of equity is: a) The weighted average of sponsors' WACC. b) The sponsors' weighted average cost of equity. c) Independent of the cost of the sponsors' sources of financing.
Cover ratios are: a) Indicators of financial sustainability for a project finance deal. b) Profitability indicators for a project finance deal. c) Profitability indicators for debt capital providers,
If the loan life cover ratio is greater than 1: a) It means there would be a cash surplus for sponsors if the investment were liquidated immediately. b) It means there would be a cash deficit for
Calculate the fees paid all players, keeping in mind their roles in the project financing deal and the return on funded capital:
Consider the data in the table below, and answer the following question: Can the use of mezzanine debt be advantageous for an initiative's senior lenders in case of default? Base your answer on the
Illustrate the concepts of the dividend trap and negative equity.
List the key features of the facilities included in the senior debt category in a project finance deal.
Beginning with the reasons why a sponsor might decide to refinance loans already granted, illustrate the two possible options: hard and soft refinancing.
Describe the various categories of project bonds.
Provide a series of assessment criteria for the use of project bonds.
Explain the roles of the advisor and the arranger in project finance initiatives. Also, list the other possible members of a loan syndicate.
What's the success fee and how is it calculated?
What's the purpose of the commitment fee?
In what ways are multilateral development agencies different from bilateral agencies?
Illustrate the fee structure in project finance.
On 1 Jan 20XX, Bank XYZ makes 100 million available to the ABC SPV at a 5% fixed rate with a commitment fee of 0.8%. On the same day, the company decides to use 45 million of the committed amount.
Give a numerical example of the positive effects of the use of mezzanine debt, based on these data:
Advisory services for project finance initiatives: a) Are inextricably related to the aspects of the financing b) Require huge amounts of capital c) Can be provided by parties other than financial
Mezzanine finance: a) Obliges sponsors to inject more capital. b) Allows senior lenders to benefit from a higher level of protection against bankruptcy of the SPV. c) Lowers the level of guarantees
The base facility: a) Can be used and repaid at the SPV's discretion. b) Is a revolving credit. c) Funds construction of the plant and facilities.
If a bank facility is not completely paid back at the end of its tenor and the borrower is not able to refinance the loan, the SPV is forced into bankruptcy. Which is the repayment method underlying
Why might a sponsor find it economically convenient to refinance loans once the construction phase for the project in question has been successfully completed?a) To cut down on the length of the
Which of the following factors is not typical of a private placement with respect to a public placement? g) Strict regulatory constraints h) Speed of structuring the deal i) Lower cost of funding
Municipal bonds: j) Are not structured in the same way as project bonds. k) Can only be sold by private placement. l) Are issued by a public body.3
Assessing the risks inherent to a given project, and assistance in drawing up the business plan and various contracts are typical responsibilities of: a) The advisor. b) The sponsor. c) The arranger.
The arranger's job is to: a) Manage default risk for the project. b) Structure and manage the financing contract. c) Express an opinion on the financial feasibility of the project.
The commitment fee: a) Is paid only if the SPV uses the funds made available to it. b) Is linked to the total value of funds made available. c) Compensates the undrawn portion of funds made
Which statement referring to the role of multilateral financial institutions is false? a) In accordance with their policies, they don't take on financial commitments in countries with high political
Not included among bilateral agencies are: a) Development agencies. b) Export credit agencies (ECAs). c) Banks.
By means of the mechanism establishing pro-rata equity payments: a) Sponsors make resources available before drawdown's on the loan are made. b) Sponsors make resources available after the entire
Fill in the following table marking with an X the column which defines the clause included in each row.
What is a "materiality test" and why is the definition of materiality so important for project sponsors?
How can lenders get full control of the project in case of default with sufficient rapidity?
Can the sponsors be one of the parties which subscribe an intercreditor agreement with other lenders?
Why can we say that there are defensive reasons for the creation of a SPV? a) Because project lenders can avoid the sharing of project cash flows with the sponsoring firm's creditors. b) Because
What is a due diligence report? a) It is a document containing information and a description of the legislative and/or regulatory framework in a given sector. b) It is a two-part document which
The credit agreement is a project document which can be classified into the category of: a) The security documents b) The project agreements c) The finance documents
In a project finance credit agreement, lenders have included a clause which authorizes the SPV to withdraw funds for the payment of the first tranche of works to the contractor only after
Is it possible for the SPV to repay the loan in advance with respect to to the original final loan maturity? a) Yes, but the project company must demonstrate that it has sufficient funds to
In legal terms, a declaration made by the borrower regarding the validity of security interests granted to its creditors and included in the credit agreement is defined as: a) Condition precedent b)
Suppose that a transfer of shares in the project company takes place which is not allowed by the credit agreement. How would you define such event? a) Negative covenant b) Event of default c)
When does the enforcement of security interests by lenders normally takes place? a) When a condition precedent has been fulfilled b) When an event of default occurs c) Immediately after the
Mark an X next to the variables that can be linked to the 5 criteria in the columns of the table below.
According to provisions set down by the Basel Committee, if a bank adopts the standard method, are the following statements true or false? • There are cases which provide for the same capital
The Basel Committee established certain grades to associate with every single factor that impacts risk and rating of project finance initiatives. Referring to the variable "financial strength", if
Which one of these statements is NOT a factor in classifying a deal as specialized lending: a) The primary source of loan repayment is the repayment capacity of an up-and-running company. b) The
The VaR approach makes it possible to quantify: a) The maximum potential loss within a certain time interval and level of probability; "a" is normally used to signify VaR. b) The maximum potential
Object finance is: a) A transaction which isn't classified as specialized lending. b) A type of transaction involving the purchase of large plants and machinery; repayment of this type of financing
According to Basel rules, the banks that adopt an IRB foundation system for project finance transactions have to: a) Use the same formulae as for corporate loans. b) Use weights relating to the 5
Expected loss is: a) The average amount which isn't paid by the borrower to the lender; it depends on counterparty risk, the transaction amount, and the possibility to recover the loan. b) The loss
In project finance deals, normally:a) There's no correlation between PD and LGD values.b) There's a positive correlation between PD and LGD.c) There's a negative correlation between PD and LGD
If a bank were to adopt the standard approach, as provided by the Basel Committee, the project finance solution would be economically convenient: a) In every case.b) Only for rating categories below
Graphically demonstrate the Fisher separation theorem for the case where an individual ends up lending in financial markets. Label the following points on the graph: initial wealth, W0; optimal
Graphically analyze the effect of an exogenous decrease in the interest rate on (a) The utility of borrowers and lenders (b) The present wealth of borrowers and lenders (c) The investment in real
The interest rate cannot fall below the net rate from storage. True or false? Why?
Graphically illustrate the decision-making process faced by an individual in a Robinson Crusoe economy where (a) storage is the only investment opportunity and (b) there are no capital markets.
Suppose that the investment opportunity set has N projects, all of which have the same rate of return, R*. Graph the investment opportunity set.
Suppose your production opportunity set in a world of perfect certainty consists of the following possibilities'.(a) Graph the production opportunity set in a C0, Q framework.(b) If the market rate
Basic capital budgeting problem with straight-line depreciation. The Roberts Company has cash inflows of $140,000 per year on project A and cash outflows of $100,000 per year. The investment outlay
The cash flows for projects A, B, and C are given below. Calculate the payback period and net present value for each project (assume a 10% discount rate). If A and B are mutually exclusive and C is
Calculate the internal rate of return on the following set of cash flows, according to the economic interpretation of internal rate of return near the end of Section F.3. Assume that the
Basic capital budgeting problem with accelerated depreciation. Assume the same facts as in Problem 2.1 except that the earnings before depreciation, interest, and taxes is $22,000 per year.(a)
Basic replacement problem. The Virginia Company is considering replacing a riveting machine with a new design that will increase earnings before depreciation from $20,000 per year to $51,000 per
Replacement problem when old machine has a positive book value. Assume the same facts as in Problem 2.3 except that the new machine will have a salvage value of $12,000. Assume further that the old
Cash flows. The Cary Company is considering a new investment that costs $10,000. It will last five years and has no salvage value. The project would save $3,000 in salaries and wages each year and
Calculate the internal rate of return for the following set of cash flows: t1: ..............................400 t2: ..............................400 t3:............................-1,000 If the
Calculate the internal rate of return on the following set of cash flows: t0: ............................-1,000 t1: ............................100 t2: ............................900 t3:
The Ambergast Corporation is considering a project that has a three-year life and costs $ 1,200. It would save $360 per year in operating costs and increase revenue by $200 per year. It would be
The treasurer of United Southern Capital Co. has submitted a proposal to the board of directors that, he argues, will increase profits for the all-equity company by a whopping 55%. It costs $900 and
State in your own words the minimum set of necessary conditions needed to obtain mean variance indifference curves like those graphed in Fig. Q3.1.Figure 3.1
Consider a lottery that pays $2 if n consecutive heads turn up in (n + 1) tosses of a fair coin (i.e., the sequence of coin flips ends with the first tail). If you have a logarithmic utility
(Our thanks to David Pyle, University of California, Berkeley, for providing this problem.) Mr. Casadesus's current wealth consists of his home, which is worth $50,000, and $20,000 in savings, which
Assume that security returns are normally distributed. Compare portfolios A and B, using both first- and second-order stochastic dominance:
Given the following probability distributions for risky assets Z and Y:(a) If the only available choice is 100% of your wealth in X or 100% in Y and you choose on the basis of mean and variance,
You have estimated the following probabilities for earnings per share of companies A and B:(a) Calculate the mean and variance of the earnings per share for each company.(b) Explain how some
Answer the following questions either true or false:(a) If asset A is stochastically dominant over asset B according to the second-order criterion, it is also dominant according to the first-order
Consider the following risky scenarios for future cash flows for a firm:Given that the firm has fixed debt payments of $8,000 and limited liability, which scenario will shareholders choose and why?
(Our thanks to Nils Hakansson, University of California, Berkeley, for providing this problem.) Two widows, each with $10,000 to invest, have been advised by a trusted friend to put their money into
(a) Reorder the six real estate trusts in Problem 3.17, using the mean-variance criterion,(b) Is the mean-variance ranking the same as that achieved by second-order stochastic dominance?In problem
Figure 3.6(a) shows the utility of a risk lover. What does the indifference curve of a risk lover look like?Figure 3.6 (a)
You have a logarithmic utility function U(W) = In W, and your current level of wealth is $5,000. (a) Suppose you are exposed to a situation that results in a 50/50 chance of winning or losing $1,000.
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