DCF Capital Structure

Question 1

What does 'capital structure' refer to in corporate finance?

Accepted Answer

The mix of debt and equity financing a company uses to fund its assets

Answer

The total market capitalization of a company

Answer

The company's allocation of capital among different business units

Answer

The amount of working capital available for operations

Question 2

According to the Modigliani-Miller theorem in a world with no taxes and perfect markets, what is true about capital structure?

Accepted Answer

It is irrelevant to firm value in a perfect market

Answer

Firms should maximize debt to lower WACC

Answer

Equity always costs less than debt on an after-tax basis

Answer

Capital structure is the primary driver of firm value

Question 3

What creates the 'debt tax shield' in capital structure analysis?

Accepted Answer

Interest payments on debt are tax-deductible, reducing taxable income

Answer

Debt holders receive preferential capital gains tax treatment

Answer

Equity dividends are tax-exempt for the issuing company

Answer

Debt reduces a firm's effective tax rate on revenues

Question 4

Which theory of capital structure states that firms balance the tax shield benefits of debt against the costs of financial distress?

Accepted Answer

The trade-off theory

Answer

The pecking order theory

Answer

The market timing theory

Answer

The signaling theory

Question 5

How is the debt-to-capital ratio calculated?

Accepted Answer

Total debt divided by (total debt plus total equity)

Answer

Total debt divided by total assets

Answer

Total equity divided by total debt

Answer

Net debt divided by EBITDA

Question 6

What happens to the cost of equity as a company takes on progressively more debt?

Accepted Answer

It increases because equity holders bear greater financial risk

Answer

It decreases as shareholders benefit directly from leverage

Answer

It remains constant regardless of the level of financial leverage

Answer

It converges toward the cost of debt at high leverage levels

Question 7

In a DCF valuation, why is WACC used as the discount rate for free cash flows to the firm (FCFF)?

Accepted Answer

It reflects the blended required return of all capital providers weighted by their market-value proportions

Answer

It is always lower than the cost of equity, producing a higher valuation

Answer

It eliminates the need to model interest payments in the cash flows

Answer

It is mandated by GAAP for enterprise valuations