CPFM - Certified Professional in Financial Management Corporate Finance Structure Questions and Answers

Question 1

According to the static trade-off theory of capital structure, how does a firm determine its optimal level of debt?

Accepted Answer

By balancing the value-enhancing effects of the interest tax shield against the value-reducing effects of potential financial distress costs.

Answer

By issuing debt up to the point where the costs of financial distress are equal to the agency costs of equity.

Answer

By minimizing the weighted average cost of capital (WACC) through the exclusive use of the lowest-cost financing source.

Answer

By following a strict hierarchy, first using internal funds, then debt, and finally issuing new equity as a last resort.

Question 2

A company's management team believes its stock is currently undervalued by the market. According to the pecking order theory, which source of financing would the company most likely prefer for its new investment projects?

Accepted Answer

Using its accumulated retained earnings.

Answer

Issuing new common stock to the public.

Answer

Securing a long-term bank loan.

Answer

Issuing convertible bonds.

Question 3

Which of the following statements accurately describes the conclusion of the Modigliani-Miller (M&M) Proposition I in a world with no corporate taxes?

Accepted Answer

The market value of a company is unaffected by its capital structure.

Answer

The value of a firm increases as it takes on more debt due to the interest tax shield.

Answer

A firm's cost of equity is a linear function of its debt-to-equity ratio.

Answer

The weighted average cost of capital (WACC) is minimized at a 100% debt-financed capital structure.

Question 4

A financial manager is calculating the Weighted Average Cost of Capital (WACC) for a firm with the following characteristics: Market value of equity = $120 million, Market value of debt = $80 million, Cost of equity = 12%, Pre-tax cost of debt = 7%, Corporate tax rate = 25%. What is the firm's WACC?

Accepted Answer

9.30%

Answer

9.50%

Answer

8.95%

Answer

10.05%

Question 5

A surprise announcement by a mature, stable company that it is significantly increasing its regular quarterly dividend is most likely to be interpreted by the market as a:

Accepted Answer

Positive signal that management is confident about the firm's future earnings prospects.

Answer

Negative signal that the company is running out of profitable investment opportunities.

Answer

Neutral signal, as dividend policy is irrelevant to firm value.

Answer

Negative signal that the company needs to attract new investors to support its stock price.

Question 6

A firm is considering a major expansion and needs to raise capital. Which of the following scenarios would most likely lead to an increase in the firm's cost of equity (Re), according to capital structure theory?

Accepted Answer

The firm issues new debt, increasing its debt-to-equity ratio, while its cost of debt and business risk remain unchanged.

Answer

The firm issues new equity, diluting the ownership of existing shareholders but lowering the debt-to-equity ratio.

Answer

The central bank lowers interest rates, causing the firm's pre-tax cost of debt (Rd) to fall.

Answer

The firm uses retained earnings to finance the project, keeping its capital structure constant.