CCA Corporate Finance & Capital Structure Flashcards

What is the Weighted Average Cost of Capital (WACC) used for in corporate finance?

Answer: As a discount rate to evaluate investment projects and determine firm value

WACC represents the minimum return a company must earn on its assets to satisfy all capital providers, and it is used as the discount rate in NPV analysis.

According to the Modigliani-Miller theorem (with taxes), what happens to firm value as debt increases?

Answer: Firm value increases due to the tax shield on interest

In the MM framework with corporate taxes, interest is tax-deductible, creating a tax shield that increases firm value as leverage rises.

Which capital budgeting method accounts for the time value of money AND expresses the return as a percentage?

Answer: Internal rate of return (IRR)

IRR is the discount rate at which NPV equals zero; it considers the time value of money and expresses investment returns as a percentage.

A project has a positive NPV. What does this indicate?

Answer: The project creates value by earning more than the required rate of return

A positive NPV means the present value of cash inflows exceeds the present value of outflows, indicating the project generates returns above the cost of capital.

What is financial leverage, and what is its primary effect on earnings?

Answer: Using debt financing to amplify returns; it magnifies both gains and losses

Financial leverage uses debt to fund assets; because interest is a fixed cost, leverage amplifies EPS changes relative to operating income changes.

Which of the following best describes the pecking order theory of capital structure?

Answer: Firms prefer internal financing first, then debt, and issue equity only as a last resort

The pecking order theory holds that firms minimize information asymmetry costs by preferring retained earnings, then debt, and finally equity issuance.