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Capital Structure & Funding Flashcards

7 cards from real CFC 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 & Funding flashcards as text

  1. A company has a debt-to-equity ratio of 1.5 and a tax rate of 30%. If the cost of debt is 6%, what is the tax shield benefit per dollar of debt?

    Answer: $0.018

    The tax shield per dollar of debt equals the interest rate multiplied by the tax rate: 0.06 × 0.30 = $0.018.

  2. Which capital structure theory argues that in the absence of taxes and bankruptcy costs, capital structure is irrelevant to firm value?

    Answer: Modigliani-Miller theorem

    The Modigliani-Miller theorem (1958) proposes that under perfect market conditions without taxes or bankruptcy costs, capital structure does not affect firm value.

  3. A company's EBIT is $500,000 and it has $2,000,000 in debt at 8% interest. What is the degree of financial leverage (DFL)?

    Answer: 1.47

    DFL = EBIT / (EBIT - Interest) = $500,000 / ($500,000 - $160,000) = $500,000 / $340,000 ≈ 1.47.

  4. Under the pecking order theory, which funding source do firms prefer LAST?

    Answer: Equity issuance

    Pecking order theory holds that firms prefer internal funds first, then debt, and finally external equity as a last resort due to information asymmetry costs.

  5. A mezzanine financing instrument that converts to equity if not repaid by maturity is best described as:

    Answer: Convertible subordinated debenture

    A convertible subordinated debenture is a mezzanine instrument that starts as debt but can convert to equity, blending characteristics of both.

  6. When a company issues new common stock to fund operations, the primary cost that existing shareholders bear is:

    Answer: Dilution of ownership and earnings per share

    Issuing new common stock dilutes existing shareholders' ownership percentage and reduces earnings per share by spreading earnings over more shares.

  7. The weighted average cost of capital (WACC) is minimized at the point where:

    Answer: The marginal benefit of tax shields equals the marginal cost of financial distress

    According to trade-off theory, optimal capital structure occurs where the tax shield benefit of additional debt exactly equals the increasing cost of financial distress.