Capital Structure in Business Finance : Practice MCQ Questions & Answers with Explanations

The correct answer is C: The average cost of all sources of finance weighted by their proportion in capital structure.

WACC represents the average rate a company is expected to pay to all its security holders to finance its assets. It is calculated by weighting the cost of each component (equity, debt, preference shares) by its proportion in the total capital structure. WACC is used as the discount rate in NPV calculations.

The correct answer is C: Trading on equity.

Financial leverage, also known as trading on equity, refers to the use of borrowed funds (debt) to increase the potential return on equity. When a company borrows at a fixed interest rate and earns a higher return on the borrowed funds, the surplus accrues to equity shareholders, thereby magnifying their returns.

The correct answer is D: Return on capital employed (ROCE).

ROCE measures how efficiently a company generates profit from its capital. It focuses on overall profitability and operational efficiency rather than revealing the proportion of debt vs equity in the capital structure. Debt-equity ratio, financial leverage, and capital gearing ratio all directly analyse capital structure by comparing debt and equity financing.