JAIIB · AFM

Capital structure and cost of capital

Chapter notes, video classes, MCQ practice tests and quick-revision one-liners for Accounting and Financial Management for Bankers — JAIIB.

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What is capital structure in the context of a firm?

Capital structure refers to the mix of long-term sources of funds used by a firm, including equity, preference shares, debentures, and long-term debt, to finance its assets and operations.

What is the primary goal of capital structure decisions in a firm?

To maximize firm value and minimize overall cost of capital.

What is the optimum capital structure?

Optimum capital structure is the combination of debt and equity that minimises the overall cost of capital (WACC) and maximises the market value of the firm.

What does the term 'leverage' refer to in financial management?

Use of fixed cost sources to magnify returns to equity holders.

What is the cost of capital?

Cost of capital is the minimum rate of return that a firm must earn on its investments to satisfy the expectations of its investors and maintain the market value of its shares.

What is the formula for the cost of preference shares (irredeemable)?

Cost = Annual dividend divided by current market price.

How is the Weighted Average Cost of Capital (WACC) calculated?

WACC is calculated by weighting the cost of each component of capital (equity, preference, debt) by its proportion in the total capital structure and summing the weighted costs.

Which theory suggests firms prefer internal financing over external financing?

Pecking Order Theory by Myers and Majluf.

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