Capital Structure and Funding Flashcards
7 cards from real CTP practice questions. Tap to flip, then mark Knew It or Still Learning — missed cards come back until you master them.
Read the first 7 Capital Structure and Funding flashcards as text
Which metric best measures a company's ability to service its debt obligations from operating cash flow?
Answer: Interest coverage ratio
The interest coverage ratio (EBIT divided by interest expense) directly measures how many times operating earnings can cover interest payments.
A company issues $500 million in convertible bonds at a 2% coupon versus 5% for straight debt. What is the primary reason investors accept the lower coupon?
Answer: The embedded equity conversion option has value
Investors accept a below-market coupon on convertible bonds because the option to convert to equity has intrinsic value, compensating for the yield sacrifice.
Under the pecking order theory of capital structure, what is a firm's FIRST preferred source of financing?
Answer: Internal retained earnings
Pecking order theory holds that firms prefer internal funds first because they avoid information asymmetry costs and flotation expenses associated with external financing.
A leveraged buyout (LBO) typically uses what financing structure?
Answer: Primarily debt secured by the target's assets and cash flows
LBOs are characterized by high leverage, using the target company's assets as collateral and its future cash flows to service debt, maximizing equity returns.
What is the primary purpose of a shelf registration (SEC Rule 415) in corporate finance?
Answer: To allow pre-registered securities to be issued quickly when market conditions are favorable
Shelf registration pre-approves securities with the SEC so companies can access capital markets rapidly without a full registration process each time.
Which of the following best describes 'financial distress costs' in capital structure theory?
Answer: Direct and indirect costs incurred when a firm cannot meet its debt obligations
Financial distress costs include direct costs like legal and restructuring fees, and indirect costs like lost customers and supplier credit, which offset the tax benefits of debt.
A company with a WACC of 8% evaluates a project returning 6%. What should the treasurer recommend?
Answer: Reject the project because it destroys shareholder value
A project returning less than the WACC destroys value because it earns less than the blended cost of capital provided by investors.