Module 7

Question 1

The capital structure of an enterprise consists of :

Answer 1

debt and equity funds.

Question 2

The sources and composition of the
two types of capital determine to a considerable extent the :

Answer 2

financial stability and long-term solvency of the
firm.

Question 3

Equity capital is :

Answer 3

risk capital, and the return on investment to an investor is subject to many uncertainties.

Question 4

Debt capital must be paid on a :

Answer 4

specified date, usually with interest, if the firm is to survive.

Question 5

A company’s capitalization usually depends on :

Answer 5

1.the industry
2.the financial position of the company
3.the philosophy of management.

Question 6

It is the company’s ability to satisfy long-term debt as it becomes due.

Answer 6

Solvency

Question 7

Another term for solvency

Answer 7

Leverage and debt service

Question 8

Another important consideration is the size of debt in the firm’s capital structure, which is referred to as :

Answer 8

financial leverage.

Question 9

Solvency also depends on :

Answer 9

earning power; in the long run a company will not satisfy its debts unless it earns profits.

Question 10

A leveraged capital structure subjects the company to fixed interest charges, which contributes to :

Answer 10

earnings instability.

Question 11

Excessive debt may also make it difficult for the firm to borrow funds at reasonable rates during :

Answer 11

tight money markets.

Question 12

This ratio compares total liabilities (total debt) to total assets.

Answer 12

The debt ratio

Question 13

This ratio shows the percentage of total funds obtained from creditors.

Answer 13

Debt ratio

Question 14

Creditors would rather see a low debt ratio because :

Answer 14

there is a greater cushion for
creditor losses if the firm goes bankrupt.

Question 15

Scale of High debt ratio

Answer 15

Higher than 50%

Question 16

Sclae of low debt ratio

Answer 16

Lower than 50%

Question 17

Formula for debt ratio

Answer 17

Debt ratio = average total liabilities / average total asset

Question 18

It is an important measure of the capital structure of a business.

Answer 18

The relationship of equity to total liabilities

Question 19

As stockholders’ equity increases in relation to total liabilities, the margin of protection to creditors :

Answer 19

increases, other things remaining unchanged.

Question 20

If the equity to debt ratio is high, this means that :

Answer 20

1.less vulnerable to declines in business or in the economy
2.the cost of carrying debt is reduced
3.company should be able to meet its obligations more easily.

Question 21

Indication of high equity to debt ratio

Answer 21

More than 100%

Question 22

Indication of low equity to debt ratio

Answer 22

Lower than 100%

Question 23

Formula of equity to debt ratio

Answer 23

Equity to debt ratio = shareholder’s equity / total liabilities

Question 24

This ratio provides a measure of the relative claims of the owners and creditors against the resources of the
firm.

Answer 24

Equity to debt ratio

Question 25

A high value of the equity to debt ratio shows that the :

Answer 25

claims of the owners are greater than those of the creditors.

Question 26

A high value of equity to debt ratio is viewed by creditors as a :

Answer 26

favorable sign that the firm has a high degree of security.

Question 27

It is the reciprocal of the equity to debt ratio.

Answer 27

The debt to equity ratio

Question 28

This ratio measures the amount of leverage used by a company.

Answer 28

Debt to equity ratio

Question 29

Debt to equity ratio measures the number of times the shareholders capital has been :

Answer 29

leveraged by the use of debt.

Question 30

A highly leveraged company involves a substantial use of :

Answer 30

debt and a limited use of equity.

Question 31

Investors generally consider a :

Answer 31

higher debt to equity ratio favorable

Question 32

Creditors favor a :

Answer 32

lower ratio, because this ratio is an indicator of creditors’ risk.

Question 33

Generally, the higher relative amount of debt in the capital structures of an enterprise :

Answer 33

the larger the volatility of net earnings

Question 34

Formula for debt to equity ratio

Answer 34

Debt to equity ratio = total liabilities / shareholder's equity

Question 35

Indication of high debt to equity ratio

Answer 35

More than 100%

Question 36

Indication of low debt to equity ratio

Answer 36

Lower than 100%

Question 37

This measures the proportion of the firm’s assets that are provided or claimed by the shareholders.

Answer 37

The shareholders equity to total assets ratio

Question 38

The less leveraged the company :

Answer 38

the safer the creditors' interests.

Question 39

A high ratio of shareholders’ equity to assets can represent a :

Answer 39

relatively large degree of security for the firm, but it also indicates that the firm is not highly leveraged.

Question 40

On the other hand, if the shareholders’ equity is a small proportion of total assets, the firm may be viewed as being :

Answer 40

financially weak, because the shareholders would be viewed as having a relatively small investment in the firm.

Question 41

Formula for shareholder's equity to total asset ratio

Answer 41

Shareholder's equity to total asset = Shareholder's equity / total asset

Question 42

Indication of high equity to total assets

Answer 42

More than 50%

Question 43

Indication of low equity to total asset

Answer 43

Lower than 50%

Question 44

It is a measure of the debt position of a firm in relation to its earnings.

Answer 44

The number of times interest is earned ratio ( NTIE )

Question 45

This ratio emphasizes the importance of a company’s covering total interest charges.

Answer 45

Number of times interest is earned NTIE

Question 46

The NTIE ratio indicates the company’s ability to :

Answer 46

meet interest payments and the degree of safety available to creditors.

Question 47

Formula for NTIE

Answer 47

Number of times interest is earned = Earnings before interest and taxes (EBIT) / interest expense

Question 48

High indication of NTIE

Answer 48

More than 3-4 ratio

Question 49

Low indication of NTIE

Answer 49

Lower than 1-2

Question 50

A problem with the times interested earned ratio is that is based on EBIT, which it is not really a measure of cash available to pay interest. A more accurate way is to use earnings before interest, taxes, and depreciation. What ratio is this ?

Answer 50

Cash Coverage Ratio

Question 51

Formula for Cash coverage ratio

Answer 51

Cash coverage ratio = Earninge before interest, taxes, and depreciation (EBITD) / Interest

Question 52

Indication of high cash coverage

Answer 52

More than 1 ratio

Question 53

Indication of low cash coverage ratio

Answer 53

Lower than 1 ratio

Question 54

Managers want to generate cash from :

Answer 54

operations using a minimum of noncash working capital resources

Question 56

The efficiency and cash generating ability of a firm can be measured by the :

Answer 56

cash conversion cycle and free cash flow.

Question 57

This is a valuable tool for evaluating the cash position of a business.

Answer 57

Free Cash Flow.

Question 58

It is a measure of operating cash flow available for corporate purposes after providing sufficient fixed asset additions to maintain current productive capacity and dividends and to reduce its debts or add to its liquidity.

Question 59

The greater the free cash flow :

Answer 59

the greater its options.

Question 60

Formula for free cash flow

Answer 60

Free cash flow = cash flow from operations - cash used to purchase fixed assets - cash dividends