Week 9- Capital Structure

Question 1

What is gearing?

Answer 1

The ratio of a companys totamarket value of debt capital to the total market value of its equity capital (or total assets)

Basically debt vs equity

Question 2

what is the formula for gearing?

Answer 2

B/s (debt over equity)

Question 3

why is gearing important?

Answer 3

It is importnat to know how highly geared your company is because teh higher the gearing the more of company is financed by debt and the higher the risk the company is to defaulting

Question 4

What are the two costs of bankruptcy?

Answer 4

Direct (fees paid to lawyer, investment banks etc. involved in bankruptcy) and Indirect (economic losses incurred as a result of bankruptcy eg. loss of customers, suppliers etc.)

Question 5

What type of risk is Business and Financial risk sub components of?

Answer 5

Systemeatic risk

Question 6

What is business risk?

Answer 6

The systematic risk of the net cash flows that come from the operation of the companies assets.

Question 7

Do both equity and debt holders bear business risk?

Answer 7

Yes

Question 8

What is financial risk?

Answer 8

Refers to the risk of not getting paid.

Question 9

Do both equity and debt holders bear financial risk?

Answer 9

No only equity holders because debt holders get paid first so equit holders might not receive their dividend if the business cant afford it after paying debt holders

Question 10

When does financial risk increase?

Answer 10

As gearing increases

Question 11

What are the two types of capital structure?

Answer 11

Entirely financed by equity ( Unlevered)
Both debt and equity (levered)