Corporate Finance Structure Flashcards

The trade-off theory of capital structure balances the tax benefits of debt against what cost?

Answer: Expected costs of financial distress and bankruptcy

Trade-off theory weighs the debt tax shield against rising distress and bankruptcy costs.

A firm's optimal capital structure is the mix of debt and equity that does what?

Answer: Minimizes WACC and maximizes firm value

The optimal structure minimizes the weighted average cost of capital, maximizing firm value.

Issuing new equity when management believes the stock is overvalued sends what signal to the market?

Answer: Often a negative signal that shares may be overpriced

Investors often interpret equity issuance as a sign management thinks shares are overvalued.

Preferred stock is best described as a hybrid security because it combines features of what?

Answer: Debt and common equity

Preferred stock pays fixed dividends like debt but represents ownership like equity.

If a company increases financial leverage, what generally happens to the cost of equity?

Answer: It rises because equity holders bear more financial risk

Higher leverage increases the financial risk borne by shareholders, raising their required return.

Which of the following is a direct cost of bankruptcy?

Answer: Legal and administrative court fees

Legal and administrative fees are direct, measurable costs of the bankruptcy process.

The financial structure of a firm differs from its capital structure because financial structure also includes what?

Answer: Short-term liabilities such as accounts payable

Financial structure covers all liabilities including short-term ones, while capital structure focuses on long-term financing.