Capital Structure Questions PDF

Let me transcribe and answer the questions for you. 1. The optimal capital structure is that capital structure which strikes a balance between risk and return such that the firm's stock price is maximized. Answer: True Explanation: The optimal capital structure achieves a balance between risk and...

Let me transcribe and answer the questions for you. 1. The optimal capital structure is that capital structure which strikes a balance between risk and return such that the firm's stock price is maximized. Answer: True Explanation: The optimal capital structure achieves a balance between risk and return, maximizing shareholder wealth by minimizing the cost of capital. 2. Business risk will not affect a firm's beta, because beta is determined by the market and thus is outside the control of the firm. Answer: False Explanation: Business risk does affect a firm's beta since beta reflects both market risk and the firm’s sensitivity to market conditions, which includes business operations. 3. If a firm uses no debt, the uncertainty inherent in projections of future returns on equity can be described as business risk. Answer: True Explanation: Business risk pertains to operational uncertainty and is independent of financial leverage (debt). 4. The ability of a firm to raise sufficient capital on competitive terms under adverse conditions in order to sustain steady operations is referred to as financial flexibility. Answer: True Explanation: Financial flexibility is the ability to maintain operations and respond to unexpected events through access to capital. 5. As long as a firm is near its target capital structure it will not have to concern itself with financial flexibility. Answer: False Explanation: Financial flexibility remains important regardless of a firm’s target capital structure since unforeseen events may require additional capital. 6. The degree of financial risk is the single most important determinant of a firm’s capital structure. Answer: False Explanation: While financial risk is important, capital structure decisions also depend on business risk, market conditions, and other factors. 7. Other things held constant, an increase in financial leverage will increase a firm’s market (or systematic) risk as measured by its beta coefficient. Answer: True Explanation: Financial leverage amplifies returns, thereby increasing the firm’s beta and exposure to systematic risk. 8. Financial leverage affects both EPS and EBIT, while operating leverage only affects EBIT. Answer: False Explanation: Financial leverage affects EPS, but operating leverage affects EBIT and, indirectly, EPS as well. 9. The management of a firm can control the degree of total leverage to some extent. Answer: True Explanation: Management can influence total leverage by managing financial leverage (debt levels) and operating leverage (fixed versus variable costs). 10. The trade-off theory of capital structure recognizes the tax-shield benefit of debt financing but also recognizes that the benefit is offset by costs associated with debt financing. Answer: True Explanation: The trade-off theory balances the tax benefits of debt with potential bankruptcy and financial distress costs. Let me know if you need further clarifications!