M1-Capital Structure: Part 1 Flashcards Preview

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Flashcards in M1-Capital Structure: Part 1 Deck (15):

The benefits of debt financing over equity financing are likely to be highest if marginal tax rates are high (because interest on debt is deductible for tax purposes) and if there are few noninterest tax benefits (because there is little or no reason to depart from debt financing).(True or false)



Weighted Average Cost of Capital Formula:

Cost of Equity X %Equity in Capital Structure
+ Weight Average cost of debt X %Debt in Capital Struc.


The net cost of debt is computed as the effective interest rate net of tax. (true or false)


Actual interest rates minus tax savings is the most frequently used measure for cost of debt (kdt). After-tax interest fully considers both the costs and tax shield advantages of financing charges which reduce the cost of debt to its most relevant amount.


The weighted-average cost of capital is frequently used as the hurdle rate within capital budgeting techniques. Investments that provide a return that exceeds the weighted-average cost of capital should continuously add to the value of the firm. (true or false)



Discounted Cash Flow Method Formula:

Dividend Per Share Expected at end of year
Current Market Value or Price of outstanding Stock

Take that total and + with the constant rate of growth

That will = the cost of retained earnings or the cost of equity capital.


Debt is generally the least expensive component of a company's capital structure. Debt typically commands a lower return than equity since debt contemplates a full return of principal over a specific period compared to equity that has no such guarantee and exposes the investor/creditor to lower risks. (true or false)


In addition, interest payments on debt are tax deductible, creating a tax shield for the debtor company. Lower rates reduced further by a tax shield give debt an advantage over equity financing.

Because debt is a cheaper source of financing than equity, bonds will be the cheapest form of financing. In addition, the company issuing bonds receives a tax deduction for interest paid. This further reduces the cost of bond financing.


The optimal capitalization for an organization usually can be determined by the lowest total weighted average cost of capital (WACC). Capitalization at WACC serves to maximize shareholder's equity. (true or false)



A capital investment whose rate of return exceeds the rate of return associated with the firm's beta factor will increase the value of the firm. (true or false)



The market rate of interest on a one year US Treasury Bill is comprised of the risk free rate of return and an inflation premium. (true or false)



The beta coefficient represents the measure of a particular stock's percentage change compared to the percentage change in the market over the same period. The equation for the beta coefficient is as follows:

% change in stock price
% change in market price


When managing cash and short-term investments, a corporate treasurer is primarily concerned with liquidity and safety. (true or false)



Although commercial paper has a secondary market available, it is generally not an active secondary market. Commercial paper is usually sold to the money markets by highly creditworthy companies. (true or false)


The maturity dates are generally less than 270 days.
The interest rate on commercial paper is below the prime rate, but generally above the Treasury bill rate.

There are restrictions as to the type of corporation that can enter into the commercial paper market for short-term financing, since the use of the open market is restricted to a comparatively small number of the most credit-worthy large corporations.


The commercial paper market:

-Avoids the expense of maintaining a compensating balance with a commercial bank
-Provides a broad distribution for borrowing.
-Accrues a benefit to the borrower because its name becomes widely known.


Default risk is the risk that the security will not be repaid because the issuing entity is insolvent or illiquid. US Treasury securities are issued by the Treasury Department, which has virtually no risk of being insolvent or illiquid. (true or false)



The bond will sell at a premium when the stated coupon rate on the bond is greater than the market interest rate on the bond at a given date. (true or false)