Finance for Non-Finance Managers Business Finance and Funding 1 — Questions and Answers
Question 1: What is equity financing?
- Borrowing money from a bank and repaying with interest
- Raising capital by selling ownership shares in the business (Correct answer)
- Issuing bonds to the public
- Leasing assets instead of purchasing them
Correct answer: Raising capital by selling ownership shares in the business
Equity financing involves selling shares (ownership stakes) in the company to raise capital without incurring debt.
Question 2: What is the key advantage of debt financing over equity financing?
- Debt does not need to be repaid
- Interest payments are tax-deductible, reducing the effective cost (Correct answer)
- Debt does not affect the company's credit rating
- Debt holders share in the company's upside profits
Correct answer: Interest payments are tax-deductible, reducing the effective cost
Interest on debt is typically tax-deductible, lowering the after-tax cost of borrowing compared to paying dividends on equity.
Question 3: A company's debt-to-equity ratio measures:
- How profitable the company is relative to its assets
- The proportion of financing from debt versus equity (Correct answer)
- How quickly the company generates cash from sales
- The percentage of equity owned by management
Correct answer: The proportion of financing from debt versus equity
The debt-to-equity ratio = Total Debt ÷ Total Equity, showing the relative proportion of debt and equity used to finance assets.
Question 4: Retained earnings are best described as:
- Loans retained by the bank for reinvestment
- Profits kept in the business rather than paid out as dividends (Correct answer)
- Cash reserves held in a special account
- Government grants retained by the company
Correct answer: Profits kept in the business rather than paid out as dividends
Retained earnings are cumulative profits that the company has kept rather than distributing to shareholders as dividends.
Question 5: Venture capital is typically provided to:
- Large, established public companies needing expansion funds
- Early-stage or high-growth companies with significant risk and potential (Correct answer)
- Government agencies for infrastructure projects
- Retirees seeking low-risk investment returns
Correct answer: Early-stage or high-growth companies with significant risk and potential
Venture capital firms invest in early-stage, high-potential startups in exchange for equity, accepting high risk for potentially high returns.
Question 6: What does 'leverage' mean in a financial context?
- Using physical machinery to increase production efficiency
- Using borrowed funds to amplify potential returns (and losses) (Correct answer)
- Negotiating lower interest rates with lenders
- Increasing the company's equity base through share issuance
Correct answer: Using borrowed funds to amplify potential returns (and losses)
Financial leverage means using debt to increase the potential return on equity, but it also magnifies potential losses.
Finance for Non-Finance Managers Business Finance and Funding 1
What is equity financing?