ACCA Advanced Financial Management (AFM) Practice Exam

What characterizes an unlevered firm?

1. It has a high level of debt

2. It has no debt

3. It is facing bankruptcy

4. It has substantial equity financing

The correct answer is: It has no debt

An unlevered firm is characterized by having no debt in its capital structure. This means that all of its financing comes from equity, which can lead to a lower risk profile compared to leveraged firms that rely on debt. The absence of debt also means that the firm does not have to make interest payments, allowing it to reinvest its earnings back into the business or distribute them to shareholders without the obligation of debt service. In contrast, firms with high levels of debt can face greater financial risk, especially if business conditions change. Companies facing bankruptcy often grapple with the consequences of excessive leverage, while firms characterized by substantial equity financing might still have some level of debt but are distinguished from an unlevered firm by the presence of that debt. Thus, the defining characteristic of an unlevered firm is indeed the absence of debt.