Corporate Finance Structure Flashcards

A firm's weighted average cost of capital (WACC) will most likely decrease when it does which of the following?

Answer: Adds a modest amount of tax-deductible debt to an all-equity structure

Adding tax-deductible debt lowers WACC because debt is cheaper than equity and interest provides a tax shield.

Under Modigliani-Miller with corporate taxes, the value of a levered firm equals the value of an unlearvered firm plus what?

Answer: The present value of the debt tax shield

MM with taxes adds the present value of the interest tax shield to the unlevered firm value.

Which capital component typically carries the highest required rate of return for investors?

Answer: Common equity

Common equity is the most junior claim and bears the most risk, so it demands the highest return.

A company with highly volatile, cyclical cash flows should generally maintain what type of capital structure?

Answer: A more conservative, equity-heavy structure

Volatile cash flows raise default risk, so lower leverage reduces the chance of distress.

The 'pecking order theory' of capital structure predicts that firms prefer to finance investments first with which source?

Answer: Internal funds (retained earnings)

Pecking order theory ranks internal funds first, then debt, then equity as a last resort.

Financial leverage refers to the use of what to finance a firm's assets?

Answer: Fixed-cost financing such as debt

Financial leverage is the use of fixed-cost debt financing to magnify returns to equity.

Which ratio best measures the proportion of a company's capital that comes from creditors?

Answer: Debt-to-total-capital ratio

The debt-to-total-capital ratio shows debt as a share of the firm's total financing.