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
Under Modigliani-Miller with taxes, the value of a levered firm equals the unlevered firm value plus:
Answer: The tax shield on debt (tax rate × debt)
MM with taxes shows that debt creates value through the interest tax shield, calculated as the corporate tax rate multiplied by the amount of debt outstanding.
Which credit metric is most commonly used by rating agencies to assess leverage for industrial companies?
Answer: Net debt / EBITDA
Net debt-to-EBITDA is the primary leverage metric because it measures how many years of operating earnings are needed to repay net debt, adjusted for non-cash charges.
A company wants to fund a long-term capital project but avoid balance sheet debt. Which off-balance sheet structure historically served this purpose?
Answer: Operating lease under old GAAP (pre-ASC 842)
Before ASC 842, operating leases were kept off-balance sheet, allowing companies to use assets without recording associated debt, though rating agencies typically adjusted for this.
What is the primary difference between investment-grade and high-yield (junk) bond markets in terms of investor base?
Answer: Investment-grade bonds attract more price-sensitive institutional buyers like pension funds and insurance companies
Investment-grade bonds are dominated by regulated institutions (pension funds, insurance companies) with mandated quality requirements, creating a deep, liquid market with tighter spreads.
A company's optimal capital structure is BEST described as the point where:
Answer: The marginal tax benefit of debt equals the marginal cost of financial distress
Trade-off theory identifies the optimal capital structure where the tax shield benefit from the last dollar of debt exactly offsets the incremental financial distress costs it creates.
Which of the following describes a 'rights offering' in equity capital markets?
Answer: An offer allowing existing shareholders to buy new shares at a discount before they are offered to the public
A rights offering gives existing shareholders pre-emptive rights to purchase new shares at a discount, allowing them to maintain their proportional ownership and prevent dilution.
What is 'negative leverage' in the context of real estate or corporate finance?
Answer: When the cost of debt exceeds the return on assets, making borrowing value-destructive
Negative leverage occurs when the after-tax cost of debt exceeds the return generated by the assets financed, meaning borrowing reduces rather than amplifies equity returns.