DCF Capital Structure 3

Question 1

In DCF analysis, what is the relationship between enterprise value (EV) and equity value?

Accepted Answer

Equity Value = Enterprise Value − Net Debt (total debt minus cash)

Answer

Equity value is derived by subtracting net debt (debt minus cash) from enterprise value, because EV represents the total value to all capital providers while equity value belongs only to shareholders.

Question 2

In the WACC formula, what weights should be used for the debt and equity components?

Accepted Answer

Market values of debt and equity, not book values

Answer

WACC should use market-value weights because market values reflect current economic reality and the actual cost of capital today, whereas book values reflect historical accounting entries.

Question 3

According to the trade-off theory, which types of firms would be expected to carry less debt in their capital structure?

Accepted Answer

High-growth firms with predominantly intangible assets

Answer

High-growth firms with intangible assets face higher financial distress costs (growth options and brand value evaporate in bankruptcy) and smaller immediate tax shields, making lower leverage optimal.

Question 4

What is the Adjusted Present Value (APV) method, and when is it preferred over the WACC approach?

Accepted Answer

APV values the unlevered firm and adds financing side effects separately; preferred when capital structure changes over time

Answer

APV separates the base-case value of the unlevered firm from the present value of financing side effects (e.g., debt tax shields), making it ideal for LBOs or project finance where leverage ratios shift significantly.

Question 5

What is the Hamada equation used for in DCF and capital structure analysis?

Accepted Answer

Re-levering an unlevered (asset) beta to reflect a specific capital structure: β_L = β_U × [1 + (1 − T) × (D/E)]

Answer

The Hamada equation re-levers an unlevered beta for a target capital structure, incorporating the tax shield benefit: β_L = β_U × [1 + (1 − Tax Rate) × (D/E)].

DCF - Discounted Cash Flow Practice Test

DCF - Discounted Cash Flow Practice Test

DCF Capital Structure 3