CPFM Corporate Finance Structure 2

Question 1

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

Accepted Answer

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

Answer

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

Question 2

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

Accepted Answer

The present value of the debt tax shield

Answer

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

Question 3

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

Accepted Answer

Common equity

Answer

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

Question 4

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

Accepted Answer

A more conservative, equity-heavy structure

Answer

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

Question 5

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

Accepted Answer

Internal funds (retained earnings)

Answer

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

CPFM Practice Test