Capital Structure & Debt Modeling Flashcards
7 cards from real CFM practice questions. Tap to flip, then mark Knew It or Still Learning — missed cards come back until you master them.
Read the first 7 Capital Structure & Debt Modeling flashcards as text
The interest coverage ratio is calculated as:
Answer: EBIT / Interest Expense
Interest coverage ratio = EBIT / Interest Expense, measuring how many times operating income covers interest obligations in a given period.
The trade-off theory of capital structure argues that firms balance:
Answer: Tax benefits of debt against financial distress costs
The trade-off theory states firms optimize capital structure by weighing the tax shield from interest deductibility against the expected costs of financial distress and potential bankruptcy.
Which source of capital is generally the least expensive for a corporation on an after-tax basis?
Answer: Debt (after-tax cost)
After-tax debt is typically the cheapest capital source because interest payments are tax-deductible, reducing the effective cost, and debt holders bear less risk than equity holders.
A revolving credit facility (revolver) is best described as:
Answer: A flexible credit line that can be drawn, repaid, and redrawn repeatedly
A revolving credit facility allows borrowers to draw funds up to a committed limit, repay them, and borrow again, making it ideal for managing short-term working capital needs.
In the presence of corporate taxes, how does adding moderate debt typically affect a firm's WACC?
Answer: WACC initially decreases due to the interest tax shield on debt
With corporate taxes, debt creates an interest tax shield that lowers the effective after-tax cost of debt, so moderate leverage reduces WACC and increases firm value.
What does a Debt Service Coverage Ratio (DSCR) of 1.2x indicate?
Answer: Net operating income is 20% higher than total debt service obligations
A DSCR of 1.2x means net operating income is 1.2 times total debt service (principal + interest), providing a 20% cushion above the minimum required payment.
In a corporate liquidation waterfall, which claim is satisfied first?
Answer: Senior secured debt holders
Senior secured creditors have first priority claim on assets in liquidation, followed by other creditors in descending order of seniority, with equity holders receiving any residual value last.