Certified Treasury Professional Capital Structure and Funding Questions and Answers

Question 1

According to the pecking order theory of capital structure, which of the following funding sources would a company's management prefer to use first when financing a new investment?

Accepted Answer

Using retained earnings

Answer

Issuing new long-term debt

Answer

Issuing new common stock

Answer

Issuing preferred stock

Question 2

In a world with corporate taxes but no personal taxes or bankruptcy costs, what is the key implication of the Modigliani-Miller (M&M) Proposition I with taxes?

Accepted Answer

The value of a levered firm exceeds the value of an unlevered firm by the present value of the interest tax shield.

Answer

A firm's weighted average cost of capital (WACC) is constant regardless of leverage.

Answer

The value of a firm is unaffected by its capital structure.

Answer

A firm's value is maximized at 100% equity financing.

Question 3

A manufacturing company is undergoing a review by a major credit rating agency. Which of the following events would most likely lead to a downgrade of the company's credit rating?

Accepted Answer

A significant increase in its debt-to-EBITDA ratio beyond industry norms.

Answer

A sustained increase in free cash flow.

Answer

The strategic acquisition of a competitor financed entirely with new equity.

Answer

A successful refinancing of existing debt at a lower interest rate.

Question 4

Which of the following statements best describes the primary effect of increasing a company's financial leverage?

Accepted Answer

It magnifies the impact of changes in EBIT on earnings per share (EPS).

Answer

It decreases the company's business risk.

Answer

It reduces the cost of equity due to tax shield benefits.

Answer

It decreases the volatility of net income.

Question 5

A company's CFO is evaluating a new project that has a similar risk profile to the company's existing operations. The company intends to maintain its target capital structure to fund the project. What is the most appropriate discount rate to use when calculating the Net Present Value (NPV) of this project?

Accepted Answer

The company's Weighted Average Cost of Capital (WACC)

Answer

The company's after-tax cost of debt

Answer

The company's cost of equity

Answer

The current risk-free rate of return

Question 6

A mature company with stable cash flows and limited growth opportunities is reviewing its dividend policy. Management and the board believe that investors value the certainty of receiving cash returns now over the possibility of future capital gains. This belief is most consistent with which dividend theory?

Accepted Answer

Bird-in-the-Hand Theory

Answer

Dividend Irrelevance Theory

Answer

Residual Theory of Dividends

Answer

Signaling Theory