CFM Capital Structure & Debt Modeling 1

Question 1

What does the Weighted Average Cost of Capital (WACC) represent?

Accepted Answer

The blended cost of all capital sources, weighted by their proportion in the capital structure

Answer

WACC blends the after-tax cost of debt and the cost of equity, each weighted by its proportion in the capital structure, reflecting the overall return required by all capital providers.

Question 2

According to the Modigliani-Miller theorem in a world with no taxes, which statement is true?

Accepted Answer

A firm's total value is unaffected by its capital structure

Answer

MM Proposition I (no taxes) states that capital structure is irrelevant because investors can replicate any leverage on their own, leaving total firm value unchanged.

Question 3

In a leveraged buyout (LBO) model, which tranche of debt typically carries the highest interest rate?

Accepted Answer

Mezzanine debt

Answer

Mezzanine debt is subordinated to all senior debt and carries greater default risk, so lenders demand a higher interest rate as compensation.

Question 4

A company has $600M in total debt and $300M in total equity. What is its debt-to-equity ratio?

Accepted Answer

2.0x

Answer

Debt-to-equity ratio = Total Debt / Total Equity = $600M / $300M = 2.0x.

Question 5

Which metric is most commonly used to assess a company's ability to cover interest payments from operating earnings?

Accepted Answer

Interest coverage ratio

Answer

The interest coverage ratio (EBIT / Interest Expense) shows how many times operating earnings can cover interest obligations, indicating debt serviceability.

CFM - Certified Financial Modeler Practice Test

CFM - Certified Financial Modeler Practice Test

CFM Capital Structure & Debt Modeling 1