CFC Capital Structure & Funding 5

Question 1

Which of the following is the MOST accurate description of economic value added (EVA) in the context of capital structure decisions?

Accepted Answer

After-tax operating profit minus the cost of all capital employed

Answer

EVA equals Net Operating Profit After Tax (NOPAT) minus the product of WACC and invested capital, measuring true economic profit after charging for all capital costs.

Question 2

A company in financial distress considering debt restructuring would most likely pursue which option FIRST?

Accepted Answer

Out-of-court debt workout or exchange offer

Answer

Out-of-court workouts are typically pursued first as they are faster, cheaper, and less disruptive than formal bankruptcy while still restructuring unmanageable debt burdens.

Question 3

Preferred stock is classified as equity on the balance sheet, but for cost of capital analysis it behaves similarly to debt because:

Accepted Answer

Preferred dividends are fixed obligations that rank above common equity

Answer

Preferred dividends are fixed (like debt interest) and must be paid before common dividends, making preferred stock behave like a hybrid instrument in capital cost analysis.

Question 4

A company plans to issue $50M in bonds to retire $50M in equity. Assuming a 25% tax rate and 5% cost of debt, what is the annual after-tax cost savings from this recapitalization?

Accepted Answer

$625,000

Answer

Annual interest = $50M × 5% = $2,500,000; tax shield = $2,500,000 × 25% = $625,000 annual after-tax benefit from replacing equity with debt.

Question 5

Under the market timing theory of capital structure, firms issue equity when:

Accepted Answer

Management believes equity is overvalued relative to intrinsic value

Answer

Market timing theory posits that managers issue equity opportunistically when they perceive their stock price to be overvalued, thereby raising capital cheaply.

(CFC) Certified Financial Controller Practice Test

(CFC) Certified Financial Controller Practice Test

CFC Capital Structure & Funding 5