CCA Corporate Finance & Capital Structure Flashcards

What is the 'trade-off theory' of capital structure?

Answer: Firms balance the tax benefits of debt against the costs of financial distress to find an optimal leverage ratio

The trade-off theory says firms choose leverage by balancing the tax shield from debt against the increasing probability and cost of financial distress.

A bond is trading at a discount. What does this mean about its coupon rate relative to the market yield?

Answer: Coupon rate is lower than the market yield

When a bond trades at a discount (below face value), its coupon rate is lower than the prevailing market yield, making it less attractive at par.

What is the purpose of a dividend discount model (DDM)?

Answer: To estimate the intrinsic value of a stock based on expected future dividends discounted to present value

The DDM values a stock as the present value of all expected future dividend payments, using the required rate of return as the discount rate.

Which of the following is considered a spontaneous source of financing?

Answer: Accounts payable arising from credit purchases

Accounts payable arise automatically (spontaneously) from normal business operations without requiring formal financing arrangements.

What does a company's degree of combined leverage (DCL) measure?

Answer: The sensitivity of EPS to a percentage change in sales, combining operating and financial leverage

DCL = DOL × DFL, measuring the total amplification effect of both operating leverage (fixed operating costs) and financial leverage (fixed financing costs) on EPS.

Under the efficient market hypothesis (EMH) in its semi-strong form, which information is fully reflected in stock prices?

Answer: All publicly available information

The semi-strong form of EMH holds that current stock prices reflect all publicly available information, making fundamental analysis unable to consistently earn abnormal returns.