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Questions and Answers
What is capital structure?
What is capital structure?
- The legal structure of a business
- The mix of external funds used to finance a business (correct)
- The management structure of a business
- The physical structure of a business
What is financial leverage?
What is financial leverage?
- The use of debt to finance a business (correct)
- The use of internal funds to finance a business
- The use of equity to finance a business
- The use of preferred stock to finance a business
What are leverage or gearing ratios used for?
What are leverage or gearing ratios used for?
- To assess the amount of preferred stock in a company's capital structure
- To assess the amount of debt in a company's capital structure (correct)
- To assess the amount of internal funds in a company's capital structure
- To assess the amount of equity in a company's capital structure
What is an optimal capital structure?
What is an optimal capital structure?
What is the seniority of the capital structure?
What is the seniority of the capital structure?
What does the Modigliani-Miller theorem argue?
What does the Modigliani-Miller theorem argue?
What does the trade-off theory of capital structure allow?
What does the trade-off theory of capital structure allow?
What does the pecking order theory state?
What does the pecking order theory state?
What do capital structure arbitrageurs seek to profit from?
What do capital structure arbitrageurs seek to profit from?
Flashcards
Capital Structure
Capital Structure
The combination of debt and equity a company uses to finance its operations.
Financial Leverage
Financial Leverage
The use of debt to finance a business, increasing financial risk but potentially boosting returns.
Leverage/Gearing Ratios
Leverage/Gearing Ratios
Ratios used to analyze a company's debt levels and its ability to meet obligations.
Optimal Capital Structure
Optimal Capital Structure
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Seniority of Capital Structure
Seniority of Capital Structure
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Modigliani-Miller Theorem
Modigliani-Miller Theorem
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Trade-off Theory of Capital Structure
Trade-off Theory of Capital Structure
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Pecking Order Theory
Pecking Order Theory
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Capital Structure Arbitrageurs
Capital Structure Arbitrageurs
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Study Notes
Capital structure determines the mix of external funds (capital) used to finance a business, including shareholders' equity, debt, and preferred stock, and is detailed in the company's balance sheet.
Too much debt in relation to other sources of capital increases financial leverage, which can increase the risk of the company and reduce its financial flexibility, resulting in a greater cost of capital.
Various leverage or gearing ratios are closely watched by financial analysts to assess the amount of debt in a company's capital structure.
An optimal capital structure is one that is consistent with minimizing the cost of debt and equity financing and maximizing the value of the firm.
Once management has decided how much debt should be used in the capital structure, decisions must be made as to the appropriate mix of short-term and long-term debt.
In the event of bankruptcy, the seniority of the capital structure comes into play, with senior debt being paid first.
The Modigliani-Miller theorem argues that, in a perfect market, how a firm is financed is irrelevant to its value.
Trade-off theory of capital structure allows bankruptcy costs to exist as an offset to the benefit of using debt as a tax shield.
Pecking order theory states that companies prioritize their sources of financing, preferring to raise equity as a financing means "of last resort".
Capital structure arbitrageurs seek to profit from differential pricing of various instruments issued by one corporation.
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Description
How much do you know about capital structure? Test your knowledge with this quiz! From the optimal mix of debt and equity financing to the different theories and ratios used to assess a company's capital structure, this quiz will challenge your understanding of this important aspect of corporate finance. Keywords: capital structure, debt, equity financing, financial leverage, Modigliani-Miller theorem, bankruptcy, trade-off theory, pecking order theory, capital structure arbitrageurs.