Capital Structure Flashcards
Define a capital structure.
Capital structure is defined as the mix of debt and equity used by a firm. It is measured by the debt-equity ratio or the debt-firm value ratio. It directs how the firm’s operating cash flows are to be divided between the different classes of investors.
The fundamental source of a firm’s value is ___________.
Its future net operating cash flows (generated by the firm’s assets).
Differ between the two types of corporate risk.
Business risk is derived from the variability of future cash flows attributable to the business’ nature of the operation or the assets it holds. Financial risk is derived from the debt a business holds as a source of financing of a firm’s operations.
What is financial leverage?
Financial leverage refers to the use of borrowed debts to buy more asset. This is employed to increase return on equity. However, in bad economic conditions, the situation may be reversed.
Define RfO AND RoE.
Return from operations refers to the return to the company as a whole. Obtained by dividing net operating income divided by the value of the company’s assets.
Return on equity refers to the return to the shareholders. Obtained by dividing the net income by the value of the company’s equity.
Mention the relationship of RfO and RoE with respect to the debt interest rate.
