Question 1

A listed company is financed by debt and equity.

If it increases the proportion of debt in its capital structure it would be in danger of breaching a debt covenant

imposed by one of its lenders.

The following data is relevant:

The company now requires $800 million additional funding for a major expansion programme.

Which of the following is the most appropriate as a source of finance for this expansion programme?

Options :

A : Retained earnings

B : Private placement of a bond

C : Rights issue

D : Bank overdraft

Answer: C

Question 2

A company has:

• $6 million market value of equity

• $4 million market value of debt

• WACC of 11.04%

• Corporate income tax rate of 20%

According to Modigliani and Miller's theory of capital structure with tax, what is the ungeared cost of equity?

Options :

A : 12.00%

B : 10.16%

C : 16.24%

D : 12.54%

Answer: A

Question 3

Company Y plans to diversify into an activity where Company X has an equity beta of 1.6, a debt beta of zero

and gearing of 50% (debt/debt plus equity).

The risk-free rate of return is 5% and the market portfolio is expected to return 10%.

The rate of corporate income tax is 30%.

What would be the risk-adjusted cost of equity if Company Y has 60% equity and 40?bt?

Options :

A : 11.6%

B : 11.9%

C : 9.1%

D : 13%

Answer: B

Question 4

A company plans to acquire new machinery.

It has two financing options; buy outright using a bank loan, or a finance lease.

Which of the following is an advantage of a finance lease compared with a bank loan?

Options :

A : It is "off-balance sheet" and will not affect the company-s gearing.

B : The interest rate offered might be more favourable because the lessor has the security of the asset.

C : Tax depreciation allowances may be passed on to the company by the lessor.

D : The lessor provides maintenance of the asset.

Answer: B

Question 5

A listed company in a high growth industry, where innovation is a key driver of success has always operated a

residual dividend policy, resulting in volatility in dividends due to periodic significant investments in research

and development.

The company has recently come under pressure from some investors to change its dividend policy so that

shareholders receive a consistent growing dividend. In addition, they suggested that the company should use

more debt finance.

If the suggested change is made to the financial policies, which THREE of the following statements are true?

Options :

A : It may give a signal to the market that the company is entering a period of stable growth.

B : There may be a change to the shareholder profile due to 'the clientele effect'.

C : The directors will not have to take shareholder dividend preferences into consideration in future.

D : Retained earnings have a lower cost than debt finance.

E : The company-s financial risk will increase due to its increased use of debt finance.

Answer: A,B