Week 16

Question 1

referred as the degree of debts in the financing or capital of a business firm

Answer 1

CAPITAL STRUCTURE

Question 2

refers to a systematic approach to financing business
activities through a combination of equities and liabilities.

Answer 2

CAPITAL STRUCTURE THEORY

Question 3

is the amount of debt that an entity uses to buy more assets.

Answer 3

FINANCIAL LEVERAGE

Question 4

Financial leverage has two primary advantages

Answer 4

Enhanced earnings.
Favorable tax treatment.

Question 5

Financial leverage may allow an entity to
earn a disproportionate amount on its assets

Answer 5

Enhanced earnings

Question 6

In many tax jurisdictions, interest
expense is tax deductible, which reduces its net cost to the
borrower.

Answer 6

Favorable tax treatment.

Question 7

Financial leverage formula

Answer 7

Total debt/share holders equity

Question 8

is a measurement of the degree to which a firm or project
incurs a combination of fixed and variable costs.

Answer 8

OPERATING LEVERAGE

Question 9

A business that makes more sales, with each sale providing a very high gross margin, is
said to be highly leveraged. TRUE OR FALSE

Answer 9

FALSE

Question 10

A business that makes many sales, with each sale
contributing a very slight margin is said to be less leveraged. TRUE OR FALSE

Answer 10

TRUE

Question 11

A business that has a less proportion of fixed costs and a lower proportion of variable costs is said to have used more operating leverage. TRUE OR FALSE

Answer 11

FALSE

Question 12

Those businesses with lower fixed costs and higher
variable costs are said to employ less operating leverage. TRUE OR FALSE

Answer 12

TRUE

Question 13

It consists of the equity and debt capital.

Answer 13

Capital Mix

Question 14

preference either for payment of interest or payment of dividends

Answer 14

Terms and Conditions

Question 15

the most important consideration in the selection of the appropriate currency in which such
international loans are granted and accepted is the exchange risk factor.

Answer 15

Selection of Currency of the Debt

Question 16

The profile of the instruments used in the capital mix may differ from each other. In the
same manner the priorities of the instruments also differ

Answer 16

Profile and Priority

Question 17

Financial innovative instruments are used to attract investors and they are
normally associated with reduction in capital cost

Answer 17

Various Financial Instruments

Question 18

The different target groups in any financial market could be individual investor, institutional
investors, private companies and corporates, public companies and corporates etc.

Answer 18

Various Target Groups in Financial Market

Question 19

A financial capital structure frame work can be structured and evaluated from various
perspectives

Answer 19

Capital Structure Frame Work

Question 20

It is used to help answer a firm’s financing choices.

Answer 20

FRICT Analysis

Question 21

The FRICT frame work consists of the following

Answer 21

Flexibility
Risk
Income
Control
Timing

Question 22

maximize the owners’ (share
holders’) wealth and value.

Answer 22

financial management

Question 23

Capital structure can be not changed by a company without incurring
transaction costs with ease and comfort and instantaneously. TRUE OR FALSE

Answer 23

FALSE

Question 24

High growth companies may prefer to take debts with lower maturities to keep interest rates down and to retain the financial flexibility since their performance can change unexpectedly at any point in time. They would also prefer unsecured debt to have flexibility

Answer 24

Growth Potential

Question 25

Tangible unencumbered fixed assets serve as a collateral security to debt. In the event of any unforeseen financial distress, the creditors can have recourse to these assets and they may be able to recover their debt by foreclosing such asset

Answer 25

Assets

Question 26

The tax provisions provide for deduction of interest paid on debt and therefore the debt capital can increase the company’s after tax free cash flows. Therefore this interest shield increases the value of the company.

Answer 26

Non debt and debt tax shields

Question 27

It is therefore prudent for the companies to maintain financial flexibility as this will enable the companies to adjust to any change in the future events

Answer 27

Financial flexibility

Question 28

The creditors providing the debt capital would insist for restrictive covenants in the long term loan agreements to protect their interest

Answer 28

Loan Agreements

Question 29

In designing a suitable capital structure, the management of the companies may decide and desire to continue control over the companies and this is true, particularly in the case of first-generation entrepreneurs.

Answer 29

Control

Question 30

It is therefore prudent for the companies to maintain financial flexibility as this will enable the companies to adjust to any change in the future events.

Answer 30

Issue Costs

Question 31

Capital Structure Determinants in Practice

Answer 31

Growth potential Assets Non debt and debt tax shields Financial flexibility Issue cost Control Loan agreements