Capital Structure

• Choose two of the following questions – one from part “A” and one from part “B.” In your own word, briefly (2-4 sentences), answer the questions.

Questions

1. Choose one question:
   • What is financial leverage? How does it affect a firm’s financial risk?
   • What is the effect of financial leverage on a firm’s weighted average cost of capital (WACC)? What about firm value?
   • How is a firm’s optimal capital structure determined? Would the capital structure matter if there are no taxes and no bankruptcy costs?
2. Choose one question:
   • What is overleveraging? What is underleveraging?
   • Why would issuing new equity reduce the stock price? Why would it, instead, increase the stock price?
   • Why does capital structure matter? Why would it matter more during economic downturns?
   • Based on the article, what are the factors that affect the choice of capital structure?