CFM Capital Structure & Debt Modeling 2

Question 1

The interest coverage ratio is calculated as:

Accepted Answer

EBIT / Interest Expense

Answer

Total Debt / Annual Interest Expense

Answer

Net Income / Total Debt

Answer

EBITDA / Total Liabilities

Question 2

The trade-off theory of capital structure argues that firms balance:

Accepted Answer

Tax benefits of debt against financial distress costs

Answer

Revenue growth against operating costs when setting leverage

Answer

Dividend payments against retained earnings to optimize capital

Answer

Short-term debt against long-term debt to manage liquidity

Question 3

Which source of capital is generally the least expensive for a corporation on an after-tax basis?

Accepted Answer

Debt (after-tax cost)

Answer

Common equity

Answer

Preferred equity

Answer

Mezzanine financing

Question 4

A revolving credit facility (revolver) is best described as:

Accepted Answer

A flexible credit line that can be drawn, repaid, and redrawn repeatedly

Answer

A long-term bond with a fixed maturity date and fixed amortization

Answer

A hybrid form of equity financing convertible into debt at maturity

Answer

A fixed amortizing loan with equal scheduled principal payments

Question 5

In the presence of corporate taxes, how does adding moderate debt typically affect a firm's WACC?

Accepted Answer

WACC initially decreases due to the interest tax shield on debt

Answer

WACC increases due to higher financial risk from leverage

Answer

WACC remains unchanged per MM Proposition I

Answer

WACC increases because equity becomes more expensive with no offsetting benefit

Question 6

What does a Debt Service Coverage Ratio (DSCR) of 1.2x indicate?

Accepted Answer

Net operating income is 20% higher than total debt service obligations

Answer

The company has $1.20 in total debt for every $1.00 of equity

Answer

The company pays 1.2 times its interest expense in income taxes

Answer

Total assets are 1.2 times greater than total liabilities

Question 7

In a corporate liquidation waterfall, which claim is satisfied first?

Accepted Answer

Senior secured debt holders

Answer

Common equity shareholders

Answer

Preferred equity shareholders

Answer

Subordinated (junior) debt holders