Capital Structure

Question 1

What are the common forms of short term and long term debt?

Answer 1

• S/T notes payable, commercial paper, line-of-credit arrangements
• L/T notes payable, debentures, bonds and finance leases

Question 2

In order to classify a lease as a finance lease, a lessee must meet one of the following 5 criteria:

Answer 2

• Ownership transfer at the end of the lease
• Written purchase option that the lessee is reasonably certain to exercise
• Net present value of all lease payments and guaranteed residual value is equal to or substantially exceeds the underlying asset’s FV
• Economic life of the underlying asset is primarily encompassed within the term of the lease
• Specialized asset such that it will not have an expected alternative use to the lessor when the lease ends
• if none of these are met or the lease is ST, it will be an operating lease

Question 3

What are examples of equity financing?

Answer 3

• preferred stock (cumulative dividends, participating feature, voting rights)
• common stock

Question 4

What are the 3 common methods of computing the cost of RE?

Answer 4

1. capital asset pricing model (CAPM)
2. discounted cash flow (DCF)
3. bond yield plus risk premium (BYRP)

Question 5

What is the CAPM formula?

Answer 5

risk free rate + [beta * (market return - risk free rate)]

beta= 1, stock is as volatile as the market
beta >1, stock is more volatile than market
beta <1, stock is less volatile than the market

Question 6

What is the DCF/dividend growth/cost of RE model?

Answer 6

(D1/Po) + g

D1= the dividend per share expected at the end of one year
Po= current market value or price of the outstanding common stock
g= the constant rate of growth in dividends

Question 7

What is the BYRP formula?

Answer 7

pretax cost of LT debt + market risk premium

Question 8

What are examples of current assets?

Answer 8

• cash and cash equivalents
• inventory
• AR
• notes receivable
• prepaids
• marketable securities

Question 9

What are examples of non current assets?

Answer 9

• LT investments
• PPE (fixed assets)
• intangibles
• deferred tax assets

Question 10

What is operating leverage?

Answer 10

• the degree to which a company uses fixed operating costs rather than variable operating costs
• ex: nursing homes and hospitals are required to meet minimum staffing levels to maintain bed capacity. salaries represent a fixed cost of maintaining capacity and result in higher operating leverage

Question 11

What is a levered firm?

Answer 11

• a company that has debt in its capital structure
• an unlevered firm only has equity in its structure (no debt)

Question 12

What is the formula for the value of a levered firm?

Answer 12

value of an unlevered firm + present value of the interest tax savings

present value of the int tax savings= T * (r*D)/r
T= corporate tax rate
r= int rate on debt
D= amount of debt

Question 13

Commercial paper:

Answer 13

• matures in 270 days or less
• does not have an active secondary market
• can be sold to the money markets through a variety of intermediaries including brokers, dealers, investment brokers or from one company to the other
• interest rate is below the prime rate but above the treasury bill rate