Capital Structure and Financial Distress: Master the Basics for MBA Success

Question 1

The debt-to-equity ratio measures a firm's:

Accepted Answer

Solvency

Answer

Liquidity

Answer

Profitability

Answer

Efficiency

Question 2

The primary goal of a bankruptcy reorganization plan is to:

Accepted Answer

Rehabilitate the firm's operations

Answer

Liquidate the firm's assets

Answer

Maximize creditor recovery

Answer

Protect the interests of management

Question 3

Which of the following is NOT a primary factor influencing a firm's optimal capital structure?

Accepted Answer

Management's personal preferences

Answer

Industry in which the firm operates

Answer

Size of the firm

Answer

Tax laws and regulations

Question 4

What is a strategy for reducing a firm's exposure to financial distress risk?

Accepted Answer

Improving operational efficiency

Answer

Issuing more debt

Answer

Repurchasing shares

Answer

Increasing dividends

Question 5

A company with a high debt-to-equity ratio is considered:

Accepted Answer

Leveraged

Answer

Financially distressed

Answer

Bankrupt

Answer

Unlevered

Question 6

Which of the following is considered a traditional theory of capital structure?

Accepted Answer

Trade-off Theory

Answer

Pecking Order Theory

Answer

Market Timing Theory

Answer

Agency Theory

Question 7

According to the Pecking Order Theory, firms prefer to raise capital through which source first?

Accepted Answer

Retained earnings

Answer

Equity

Answer

Debt

Answer

External financing

Question 8

Which type of covenant in a debt agreement restricts a firm's ability to take on additional debt?

Accepted Answer

Negative pledge covenant

Answer

Maintenance covenant

Answer

Sinking fund covenant

Answer

Call provision

Question 9

Which financial metric is most commonly used to predict the likelihood of a firm experiencing financial distress?

Accepted Answer

Debt-to-equity ratio

Answer

Current ratio

Answer

Return on assets

Answer

Profit margin

Question 10

Which of the following is NOT a typical sign of financial distress?

Accepted Answer

High profitability

Answer

Missed debt payments

Answer

Declining sales

Answer

Breach of debt covenants

Question 11

How can a firm's capital structure affect its vulnerability to financial risk and the potential costs associated with bankruptcy?

Accepted Answer

It can either increase or decrease financial risk and bankruptcy costs, depending on the firm's circumstances.

Answer

It has no impact on financial risk or bankruptcy costs.

Answer

It increases financial risk but reduces bankruptcy costs.

Answer

It reduces financial risk but increases bankruptcy costs.

Question 12

Identify the type of debt that holds the highest priority in a firm's capital structure.

Accepted Answer

Senior secured debt

Answer

Junior subordinated debt

Answer

Convertible debt

Answer

Unsecured debt

Question 13

The primary objective of capital structure optimization is to:

Accepted Answer

Minimize the firm's weighted average cost of capital

Answer

Maximize the firm's market capitalization

Answer

Meet the firm's short-term liquidity needs

Answer

Guarantee the firm's solvency

Question 14

The likelihood of a firm experiencing financial distress tends to:

Accepted Answer

Increase with a higher debt-to-equity ratio

Answer

Decrease with a lower cost of equity

Answer

Remain unaffected by firm size

Answer

Be accurately predicted using only historical financial data

Question 15

A firm's ability to meet its short-term financial obligations is best measured by its:

Accepted Answer

Current ratio

Answer

Debt-to-equity ratio

Answer

Return on equity

Answer

Earnings per share

Question 16

The process of adjusting a firm's capital structure to improve its financial health and avoid bankruptcy is known as:

Accepted Answer

Debt restructuring

Answer

Leveraged buyout

Answer

Initial public offering

Answer

Merger

Question 17

Which type of debt typically has the highest seniority and security?

Accepted Answer

Senior secured debt

Answer

Subordinated debt

Answer

Unsecured debt

Answer

Convertible debt

Question 18

What is a primary benefit of debt financing?

Accepted Answer

Potential tax savings due to interest deductibility

Answer

Lower interest payments compared to equity financing

Answer

Reduced financial risk for the firm

Answer

Increased flexibility in capital structure

Question 19

A firm with a high debt-to-equity ratio is generally considered to have a:

Accepted Answer

Higher financial distress risk

Answer

Lower cost of capital

Answer

Greater financial flexibility

Answer

Lower tax burden

Question 20

Which of the following financial ratios is used to measure a firm's ability to meet its interest payments?

Accepted Answer

Times interest earned ratio

Answer

Debt-to-equity ratio

Answer

Current ratio

Answer

Return on equity

Question 21

Which of the following can NOT lead to increased financial distress risk?

Accepted Answer

Government support

Answer

Economic recession

Answer

Industry decline

Answer

Poor management decisions

Question 22

Which of the following is NOT a type of secured debt?

Accepted Answer

Unsecured loan

Answer

Mortgage

Answer

Convertible bond

Answer

Equipment loan

Question 23

Which of the following is a primary goal of capital structure optimization?

Accepted Answer

Maximizing firm value

Answer

Minimizing financial distress risk

Answer

Reducing agency costs

Answer

Increasing employee morale

Question 24

Which of the following is NOT a typical factor considered in capital structure decisions?

Accepted Answer

Political environment

Answer

Cost of debt

Answer

Cost of equity

Answer

Size of the firm

Question 25

A firm's debt-to-equity ratio is a measure of its:

Accepted Answer

Financial leverage

Answer

Operating leverage

Answer

Shareholder wealth

Answer

Profitability

Question 26

What is the primary purpose of a corporate bankruptcy reorganization?

Accepted Answer

To restructure the company's debt obligations

Answer

To liquidate the company's assets

Answer

To merge the company with another entity

Answer

To recapitalize the company

Question 27

What is the primary goal of a bankruptcy reorganization plan?

Accepted Answer

To restore the company's financial health

Answer

To liquidate the company

Answer

To maximize shareholder value

Answer

To protect the interests of creditors

Question 28

Which of the following is NOT a relevant factor when determining the optimal capital structure of a firm?

Accepted Answer

Customer demographics

Answer

Expected profitability

Answer

Asset risk

Answer

Government regulations

Question 29

What is the primary advantage of debt financing, compared to equity financing?

Accepted Answer

Tax deductibility of interest payments

Answer

Increased flexibility for managers

Answer

Lower cost of capital

Answer

Reduced risk of financial distress

Question 30

What does the Debt-to-Equity Ratio measure?

Accepted Answer

The proportion of debt to equity financing used by a firm

Answer

The number of outstanding shares of stock

Answer

A firm's ability to pay short-term obligations

Answer

A firm's return on investment

Question 31

What is the Pecking Order Theory?

Accepted Answer

A theory that suggests firms prefer internal financing before external financing

Answer

A theory that predicts firms with higher growth opportunities will use more debt financing

Answer

A theory that explains why firms with high leverage ratios are more likely to experience financial distress

Answer

A theory that argues for the complete elimination of debt financing

Question 32

What is the primary goal of financial restructuring?

Accepted Answer

To restore the firm to financial health

Answer

To maximize shareholder value

Answer

To minimize the impact of financial distress on creditors

Answer

To liquidate the firm's assets

Question 33

Which of the following is NOT typically considered a factor that influences capital structure decisions?

Accepted Answer

Employee morale

Answer

Firm size

Answer

Industry characteristics

Answer

Regulatory environment

Question 34

A firm with a high debt-to-equity ratio is generally considered to be:

Accepted Answer

More vulnerable to financial distress

Answer

More financially stable

Answer

Less risky

Answer

More likely to pay dividends

Question 35

The weighted average cost of capital (WACC) is typically calculated by:

Accepted Answer

Multiplying the cost of each type of capital by its respective weight and summing the results

Answer

Adding the cost of each type of capital

Answer

Dividing the cost of each type of capital by its weight

Answer

Subtracting the cost of debt from the cost of equity

Question 36

Which of the following is NOT a potential consequence of financial distress?

Accepted Answer

Improved operational efficiency

Answer

Bankruptcy

Answer

Loss of market value

Answer

Increased cost of capital

Question 37

In general, how does an increase in debt financing impact a firm's risk of financial distress?

Accepted Answer

Elevates the risk

Answer

Exerts no impact on the risk

Answer

Mitigates the risk

Answer

Impacts the risk only in specific industries

Question 38

In a leveraged buyout, how is the financial distress risk of the acquired firm typically affected?

Accepted Answer

Heightened risk

Answer

Lowered risk

Answer

Depends on the acquired firm's industry

Answer

Unaffected

Question 39

Which of the following is an early warning sign that may indicate impending financial distress?

Accepted Answer

Declining cash flow

Answer

Positive net income

Answer

Stable customer base

Answer

Increasing sales

Question 40

What is a proactive measure that firms can take to reduce the likelihood of financial distress?

Accepted Answer

Maintaining a prudent capital structure

Answer

Investing in speculative ventures

Answer

Completely eliminating debt

Answer

Seeking government assistance

Question 41

In the context of managing financial distress, what primary role does a financial advisor play?

Accepted Answer

Providing specialized guidance and support

Answer

Assuming management control of the distressed firm

Answer

Ensuring a positive outcome in all cases

Answer

Negotiating with creditors solely on behalf of the firm

Question 42

A firm with a high level of debt financing is more likely to experience:

Accepted Answer

Increased financial risk

Answer

Lower cost of capital

Answer

Improved liquidity

Answer

Increased profitability

Question 43

A firm's financial leverage is best measured by its:

Accepted Answer

Debt-to-equity ratio

Answer

Interest coverage ratio

Answer

Current ratio

Answer

Quick ratio

Question 44

Which of the following is a sign of potential financial distress?

Accepted Answer

Decreasing interest coverage ratio

Answer

Improving cash flow from operations

Answer

Increasing return on assets

Answer

Increasing current ratio

Question 45

Which of the following is a potential consequence of financial distress for a firm?

Accepted Answer

Bankruptcy

Answer

Increased profitability

Answer

Higher stock prices

Answer

Lower cost of capital

Question 46

A firm's capacity to meet its debt obligations is referred to as its:

Accepted Answer

Debt service capacity

Answer

Solvency

Answer

Liquidity

Answer

Financial leverage

Question 47

Which of the following is a widely used model for predicting financial distress?

Accepted Answer

Altman Z-score

Answer

Return on assets

Answer

Debt-to-equity ratio

Answer

Current ratio

Question 48

The impact of financial distress on a firm's stakeholders may include:

Accepted Answer

Reduced employee morale

Answer

Higher stock prices

Answer

Increased profitability

Answer

Improved cash flow