DCF Capital Structure 1

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

Capital structure refers to the proportion of debt and equity a company uses to finance its operations and assets, determining how the firm is funded on the liability and equity side of the balance sheet.

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

MM Proposition I states that in a world without taxes, transaction costs, or information asymmetry, a firm's value is unaffected by how it is financed.

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

Since interest expense is deductible for corporate tax purposes, debt financing generates a tax shield equal to the interest payment multiplied by the corporate tax rate.

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 trade-off theory posits that firms choose debt levels where the marginal benefit of the debt tax shield equals the marginal cost of financial distress, yielding an optimal capital structure.

Question 5

How is the debt-to-capital ratio calculated?

Accepted Answer

Total debt divided by (total debt plus total equity)

Answer

The debt-to-capital ratio equals total debt divided by the sum of total debt and total equity, expressing debt as a share of the total capitalization of the firm.

DCF - Discounted Cash Flow Practice Test

DCF - Discounted Cash Flow Practice Test

DCF Capital Structure 1