Capital Structure and Financing: Master the Basics for Financial Success

Question 1

Which of the following is NOT a capital structure theory that explains the optimal capital structure for a firm?

Accepted Answer

Efficient Market Hypothesis

Answer

Traditional Approach

Answer

Trade-Off Theory

Answer

Pecking Order Theory

Question 2

Which attribute is unique to debt financing?

Accepted Answer

Interest payments are tax-deductible.

Answer

Lenders have a residual claim on assets.

Answer

Equity holders have voting rights.

Answer

Dividend payments are typically fixed.

Question 3

What is the primary objective of optimizing a company's capital structure?

Accepted Answer

Minimize the cost of capital.

Answer

Maximize earnings per share.

Answer

Maintain stable leverage ratios.

Answer

Facilitate dividend payments.

Question 4

According to the pecking order theory, which type of financing do firms initially prefer?

Accepted Answer

Internal financing.

Answer

Debt financing.

Answer

Equity financing.

Answer

Hybrid financing.

Question 5

What is the primary function of a debt covenant?

Accepted Answer

Protect lenders' interests.

Answer

Limit a company's borrowing capacity.

Answer

Restrict dividend payments.

Answer

Impose financial performance standards.

Question 6

What is the identifying attribute of a secured loan compared to an unsecured loan?

Accepted Answer

Secured loans are backed by collateral.

Answer

Unsecured loans have lower interest rates.

Answer

Secured loans are easier to obtain.

Answer

Unsecured loans provide stronger protection for lenders.

Question 7

Which of the following is NOT a source of long-term financing for a company?

Accepted Answer

Trade credit

Answer

Debt

Answer

Equity

Answer

Retained earnings

Question 8

The cost of capital is best calculated as the:

Accepted Answer

Weighted average cost of debt and equity

Answer

Average cost of all sources of financing

Answer

Cost of the most expensive source of financing

Answer

Cost of the cheapest source of financing

Question 9

Which of the following is a primary benefit of debt financing?

Accepted Answer

Tax deductibility of interest payments

Answer

Increased financial flexibility

Answer

Ownership dilution

Answer

Lower cost of capital

Question 10

Which capital structure theory suggests that companies should balance debt and equity financing to minimize the weighted average cost of capital?

Accepted Answer

Trade-off theory

Answer

Traditional theory

Answer

Pecking order theory

Answer

Agency theory

Question 11

Which of the following is a potential disadvantage of equity financing?

Accepted Answer

Ownership dilution

Answer

Higher cost of capital

Answer

Increased risk of bankruptcy

Answer

Loss of tax benefits

Question 12

The process of raising capital by selling shares of a company to the public for the first time is known as:

Accepted Answer

Initial public offering (IPO)

Answer

Secondary public offering (SPO)

Answer

Private placement

Answer

Debt issuance

Question 13

Which capital structure type features a high proportion of debt financing and a low proportion of equity financing?

Accepted Answer

Aggressive

Answer

Conservative

Answer

Balanced

Answer

Flexible

Question 14

The primary function of capital structure management is to:

Accepted Answer

Maximize firm value

Answer

Minimize firm risk

Answer

Raise capital efficiently

Answer

Comply with regulatory requirements

Question 15

Which of the following is NOT a source of debt financing?

Accepted Answer

Shares

Answer

Loans

Answer

Bonds

Answer

Leases

Question 16

The weighted average cost of capital (WACC) is calculated by:

Accepted Answer

Multiplying the cost of debt by the weight of debt, then adding the cost of equity multiplied by the weight of equity

Answer

Adding the cost of debt and equity, then dividing by two

Answer

Multiplying the cost of debt and equity, then dividing by two

Answer

Dividing the cost of debt by the cost of equity, then adding one

Question 17

Which of the following factors does NOT affect a firm's optimal capital structure?

Accepted Answer

Inflation rate

Answer

Business risk

Answer

Tax environment

Answer

Investor preferences

Question 18

A key assumption of the Modigliani-Miller theorem is that:

Accepted Answer

There are no taxes

Answer

Capital markets are imperfect

Answer

Bankruptcy costs exist

Answer

There is asymmetric information

Question 19

A common financial ratio used to assess a firm's capital structure is the:

Accepted Answer

Debt-to-equity ratio

Answer

Times interest earned ratio

Answer

Current ratio

Answer

Return on equity

Question 20

The cost of debt is generally higher than the cost of equity primarily because:

Accepted Answer

Lenders demand a higher return to compensate them for taking on more risk.

Answer

Equity investors are more patient and willing to accept lower returns.

Answer

Debt financing is tax-deductible, unlike equity financing.

Answer

Equity financing is more adaptable than debt financing.

Question 21

One of the advantages of debt financing is:

Accepted Answer

Tax deductibility of interest payments

Answer

Increased financial risk for investors

Answer

Reduced flexibility in financial decision-making

Answer

Lower cost compared to equity financing

Question 22

The term 'capital structure' in the context of a company refers to:

Accepted Answer

The combination of debt and equity financing used by the company.

Answer

The total amount of capital raised by the company.

Answer

The value of the company's assets.

Answer

The profitability of the company.

Question 23

The weighted average cost of capital (WACC) is calculated by:

Accepted Answer

Multiplying the cost of each capital source by its proportion in the capital structure and then summing these values.

Answer

Taking the arithmetic mean of the costs of all capital sources.

Answer

Subtracting the cost of debt from the cost of equity.

Answer

Adding the cost of debt to the cost of equity.

Question 24

According to the Modigliani-Miller theorem:

Accepted Answer

A company's value is unaffected by its capital structure.

Answer

The cost of capital remains constant regardless of the capital structure.

Answer

Debt financing is always more expensive than equity financing.

Answer

The optimal capital structure consists entirely of equity.

Question 25

The debt-to-equity ratio is primarily used to:

Accepted Answer

Measure the proportion of debt in a company's capital structure.

Answer

Assess the liquidity of a company.

Answer

Determine the amount of financial leverage employed by the company.

Answer

Evaluate a company's creditworthiness.

Question 26

Which of the following is NOT a long-term financing source?

Accepted Answer

Operating revenue

Answer

Equity financing

Answer

Debt financing

Answer

Retained earnings

Question 27

What is the weighted average cost of capital (WACC)?

Accepted Answer

The average cost of all capital sources, weighted by their proportions

Answer

The cost of issuing new equity

Answer

The cost of debt financing

Answer

The return demanded by investors

Question 28

What is the trade-off theory of capital structure?

Accepted Answer

A theory that suggests companies should balance the advantages and disadvantages of debt and equity financing to minimize their cost of capital

Answer

A theory that suggests companies should always use debt financing because it is cheaper than equity financing

Answer

A theory that suggests companies should always use equity financing because it is less risky than debt financing

Answer

A theory that suggests companies should use a mixture of debt and equity financing regardless of cost

Question 29

What does the agency cost of debt refer to?

Accepted Answer

The cost of conflicts of interest between managers and creditors

Answer

The cost of conflicts of interest between managers and shareholders

Answer

The cost of bankruptcy

Answer

The cost of issuing new debt

Question 30

What is the pecking order theory of capital structure?

Accepted Answer

A theory that suggests companies prefer internal financing before external financing, and debt financing before equity financing

Answer

A theory that suggests companies should always use debt financing because it is less expensive than equity financing

Answer

A theory that suggests companies should always use equity financing because it is less risky than debt financing

Answer

A theory that suggests companies should use a mixture of debt and equity financing regardless of cost

Question 31

What is the formula for calculating the weighted average cost of capital (WACC)?

Accepted Answer

(Cost of equity * Equity weight) + (Cost of debt * Debt weight)

Answer

(Cost of equity / Cost of debt)

Answer

(Cost of equity + Cost of debt)

Answer

Cost of equity - Cost of debt

Question 32

According to the Pecking Order Theory of capital structure, which source of financing do firms prefer first?

Accepted Answer

Internal financing

Answer

Equity financing

Answer

Convertible financing

Answer

Debt financing

Question 33

Which of the following is a potential drawback of debt financing?

Accepted Answer

Higher financial risk

Answer

Lower cost of capital

Answer

More flexibility

Answer

Tax savings

Question 34

What is the key difference between senior debt and subordinated debt?

Accepted Answer

Senior debt has priority in repayment over subordinated debt.

Answer

Senior debt can only be issued by large corporations.

Answer

Subordinated debt always has a lower interest rate than senior debt.

Answer

Senior debt is always less risky than subordinated debt.

Question 35

Which of the following is a potential benefit of using convertible bonds?

Accepted Answer

Lower cost of capital

Answer

Higher financial risk

Answer

Less flexibility

Answer

No tax savings

Question 36

What is the primary responsibility of the underwriter in an equity offering?

Accepted Answer

To guarantee the sale of the shares

Answer

To provide financing for the issuer

Answer

To conduct due diligence on the issuer

Answer

To provide legal advice to the issuer

Question 37

Which of the following is NOT a factor to consider when determining the optimal capital structure for a company?

Accepted Answer

Analyst recommendations

Answer

Industry norms

Answer

Cost of capital

Answer

Business risk

Question 38

A company's capital structure refers to the mix of ________ and __________ used to finance its operations.

Accepted Answer

Debt, Equity

Answer

Assets, Liabilities

Answer

Cash Flow, Profitability

Answer

Revenue, Expenses

Question 39

Which of the following is NOT a typical source of debt financing for a company?

Accepted Answer

Issuing New Stock

Answer

Debentures

Answer

Bank Loans

Answer

Bonds

Question 40

The cost of capital is the __________ a company must earn on its investments to satisfy its investors.

Accepted Answer

Minimum Rate of Return

Answer

Maximum Rate of Return

Answer

Target Rate of Return

Answer

Average Rate of Return

Question 41

The primary advantage of debt financing is that it ________.

Accepted Answer

Provides Tax-Deductible Interest Payments

Answer

Reduces Financial Risk

Answer

Provides Flexibility in Repayment

Answer

Increases Shareholder Ownership

Question 42

The main disadvantage of equity financing is that it ________.

Accepted Answer

Dilutes Ownership for Existing Shareholders

Answer

Requires High Interest Payments

Answer

Limits Financial Flexibility

Answer

Increases Financial Risk

Question 43

A company's optimal capital structure is one that ________.

Accepted Answer

Maximizes the Firm's Value

Answer

Minimizes the Firm's Debt

Answer

Minimizes the Firm's Costs

Answer

Maximizes the Firm's Profits