Capital Structure II

Size: px
Start display at page:

Download "Capital Structure II"

Transcription

1 Capital Structure II

2 Introduction In the previous lecture we introduced the subject of capital gearing. Gearing occurs when a company is financed partly through fixed return finance (e.g. loans, loan stock & debentures) and partly through equity. We observed that loan financing is a cheap source of finance. It is cheap because there is low risk to lenders and also because it is tax deductible. According to the traditional view this results in a lowering of the WACC.

3 Gearing - Modigliani & Miller s View In 1958 a theory was published by Franco Modigliani and Merton Miller which said that it did not matter whether a company had a level of gearing of 2% debt or 90% debt. The WACC would remain unaltered.

4 Gearing, does not create shareholder wealth. (Modigliani & Miller 1958) They also postulated that the overall value of the company, and hence shareholder value cannot be altered due to the debt to equity ratio. This theory was based on some major assumptions and requires the company to operate in a perfect economy.

5 Quick explanation.. Their idea was that whilst WACC should intuitively decrease as the debt weighting rises, the cost of equity Ke will increase as the gearing increases by exactly the right amount to offset the debt effect and keep WACC constant. Why might this happen?

6 Example - La Mer again La Mer has two Yachts historic cost 1m each. One is financed by equity the other is financed by a 10% debenture. Let us assume that there is another business Sea plc that is identical to La Mer but is financed by 2m ordinary shares of 1 each.

7 Extract balance sheets. La Mer 1,000,000 Ordinary 1 1,000,000 10% Debentures 1,000,000 Total Financing 2,000,000 Sea plc 2,000,000 Ordinary 1 2,000,000 Total Financing 2,000,000

8 La Mer when all equity The return to shareholders was : Earnings 140, Number of ordinary shares 1,000,000 eps = 0.14 per share

9 Return on equity when gearing was 18%! After the second yacht is acquired the return to shareholders is: Profit for 2 yachts (2 x 140,000) 280,000 Less Loan interest at 10% 100, ,000 Shares in issue 1,000,000 eps 18p

10 Consider a shareholder in La Mer. Consider a shareholder who holds 1% of the equity of La Mer (i.e. 10,000 shares). Each share is expected to give a return of 18p. Suppose he decided to sell his shares in La Mer for 10,000, borrow an additional 10,000 at 10% (the current rate for borrowing) and then buy a 1% holding of ordinary shares in Sea plc (i.e. 20,000 shares). The shares in Sea plc will give a return of 14%, as it is all equity.

11 Personal gearing 10,000 La Mer eps 18p 1,800 20,000 Sea plc eps 14p 2,800 20,000 Sea plc eps 14p 2,800 Less loan interest 1,000 1,800 Both of the above investments offer the same risk and return (because in both cases only 10,000 of investor s own funds are at stake.).

12 Which implies that. If the return C is the same, and the risk (WACC) is the same, then the total value of the two companies must be the same as well. MV = C/WACC Vg = Vu

13 And so If in the above example, Sea s shares fell in price below La Mer s shares, the investor could make a switch from La Mer to the alternative, Sea plc and have the same risk and return while making a profit on the switch, because he would, for his 10,000, get more than 10,000 Sea shares, and more than 1,400.

14 But this is an arbitrage However this profit opportunity would be short lived as other rational investors would seek to do the same. The increased demand for shares in Sea plc, and the supply of Le Mar would drive the price of the shares toward equilibrium

15 Hence M&M original proposition The implication of the M & M proposition is that the value of the business is not affected by the financing method. The value of the business and the WACC are only effected by: The cash flows that the business s investments are expected to generate. The business risk.

16 The WACC does not depend on gearing!! The effect suggested by M & M is shown graphically in figure Here we can see that the effect of increased weight of loan finance in reducing WACC is exactly offset by the rising cost of equity. Therefore the WACC is impervious to the level of gearing and there is no optimum level of gearing. Contrast this to the traditional view shown in figure 11.2 in the previous lecture!

17 Or does it??? M&M s proposition may hold for a highly idealised world, a, text book world, perhaps, but relies upon some assumptions which do not hold in reality. The most important of these is probably taxation.

18 The M & M Assumptions M & M s theory relies upon the following assumptions: Shares can be bought and sold without dealing costs; Capital markets are efficient; Interest rates are equal between borrowing and lending; There are no bankruptcy costs; There is no taxation.

19 Traditional View Loan finance cheaper than equity and tax deductible, hence gearing lowers WACC. Shareholders and lenders not concerned about increased risk at lower levels of gearing. But as gearing increases both take fright and the WACC rises. Hence there is an optimum level of WACC

20 Modigliani & Miller Equity cost rises gently with gearing, exactly offsetting the proportion of cheap debt. WACC constant at all levels of gearing. Based upon some very debatable concepts of perfect markets and no tax. They eventually modified the theory.

21 Practical issues Directors sometimes use the assets of the business to their own advantage rather than those of the shareholders this is termed managerialism. Hence shareholders have to bear the agency cost of managerialism and trying to prevent it.

22 Agency Costs If gearing lowers WACC then it is in shareholder interests to gear up, but the loan capital has to be serviced with cash and management may not welcome this constraint. They may prefer equity finance, because the dividend is not compulsory, and this provides more freedom, termed an equity cushion.

23 Signalling It has been suggested that raising loan finance signals confidence that the debt can be serviced.

24 Clientele effects It is possible that particular equity investors might be attracted to a company by its gearing, perhaps due to the risky volatility of eps and potential high returns!!

optimum capital Is it possible to increase shareholder wealth by changing the capital structure?

optimum capital Is it possible to increase shareholder wealth by changing the capital structure? 78 technical optimum capital RELEVANT TO ACCA QUALIFICATION PAPER F9 Is it possible to increase shareholder wealth by changing the capital structure? The first question to address is what is meant by capital

More information

Leverage. FINANCE 350 Global Financial Management. Professor Alon Brav Fuqua School of Business Duke University. Overview

Leverage. FINANCE 350 Global Financial Management. Professor Alon Brav Fuqua School of Business Duke University. Overview Leverage FINANCE 35 Global Financial Management Professor Alon Brav Fuqua School of Business Duke University Overview Capital Structure does not matter! Modigliani & Miller propositions Implications for

More information

Selecting sources of finance for business

Selecting sources of finance for business Selecting sources of finance for business by Steve Jay 08 Sep 2003 This article considers the practical issues facing a business when selecting appropriate sources of finance. It does not consider the

More information

Source of Finance and their Relative Costs F. COST OF CAPITAL

Source of Finance and their Relative Costs F. COST OF CAPITAL F. COST OF CAPITAL 1. Source of Finance and their Relative Costs 2. Estimating the Cost of Equity 3. Estimating the Cost of Debt and Other Capital Instruments 4. Estimating the Overall Cost of Capital

More information

Paper F9. Financial Management. Fundamentals Pilot Paper Skills module. The Association of Chartered Certified Accountants

Paper F9. Financial Management. Fundamentals Pilot Paper Skills module. The Association of Chartered Certified Accountants Fundamentals Pilot Paper Skills module Financial Management Time allowed Reading and planning: Writing: 15 minutes 3 hours ALL FOUR questions are compulsory and MUST be attempted. Do NOT open this paper

More information

Module 1: Corporate Finance and the Role of Venture Capital Financing TABLE OF CONTENTS

Module 1: Corporate Finance and the Role of Venture Capital Financing TABLE OF CONTENTS 1.0 FINANCING PRINCIPLES Module 1: Corporate Finance and the Role of Venture Capital Financing Financing Principles 1.01 Introduction to Financing Principles 1.02 Capitalization of a Business 1.03 Capital

More information

1 WACC. 1.1 Introduction ILLUSTRATION 1.1: OVERALL INVESTORS REQUIRED RETURN

1 WACC. 1.1 Introduction ILLUSTRATION 1.1: OVERALL INVESTORS REQUIRED RETURN 1 WACC 1.1 Introduction A business raises funds from its investors (both equity and debt investors) and uses those funds to try to generate returns. These investors are therefore taking a RISK by trusting

More information

Fundamentals Level Skills Module, Paper F9. Section A. Monetary value of return = $3 10 x 1 197 = $3 71 Current share price = $3 71 $0 21 = $3 50

Fundamentals Level Skills Module, Paper F9. Section A. Monetary value of return = $3 10 x 1 197 = $3 71 Current share price = $3 71 $0 21 = $3 50 Answers Fundamentals Level Skills Module, Paper F9 Financial Management December 2014 Answers Section A 1 A Monetary value of return = $3 10 x 1 197 = $3 71 Current share price = $3 71 $0 21 = $3 50 2

More information

Chapter 17 Corporate Capital Structure Foundations (Sections 17.1 and 17.2. Skim section 17.3.)

Chapter 17 Corporate Capital Structure Foundations (Sections 17.1 and 17.2. Skim section 17.3.) Chapter 17 Corporate Capital Structure Foundations (Sections 17.1 and 17.2. Skim section 17.3.) The primary focus of the next two chapters will be to examine the debt/equity choice by firms. In particular,

More information

THE COST OF CAPITAL THE EFFECT OF CHANGES IN GEARING

THE COST OF CAPITAL THE EFFECT OF CHANGES IN GEARING December 2015 Examinations Chapter 19 Free lectures available for - click here THE COST OF CAPITAL THE EFFECT OF CHANGES IN GEARING 103 1 Introduction In this chapter we will look at the effect of gearing

More information

Chapter 17 Does Debt Policy Matter?

Chapter 17 Does Debt Policy Matter? Chapter 17 Does Debt Policy Matter? Multiple Choice Questions 1. When a firm has no debt, then such a firm is known as: (I) an unlevered firm (II) a levered firm (III) an all-equity firm D) I and III only

More information

Fundamentals Level Skills Module, Paper F9

Fundamentals Level Skills Module, Paper F9 Answers Fundamentals Level Skills Module, Paper F9 Financial Management June 2009 Answers 1 (a) Weighted average cost of capital (WACC) calculation Cost of equity of KFP Co = 4 0 + (1 2 x (10 5 4 0)) =

More information

Net revenue 785 25 1,721 05 5,038 54 3,340 65 Tax payable (235 58) (516 32) (1,511 56) (1,002 20)

Net revenue 785 25 1,721 05 5,038 54 3,340 65 Tax payable (235 58) (516 32) (1,511 56) (1,002 20) Answers Fundamentals Level Skills Module, Paper F9 Financial Management December 2013 Answers 1 (a) Calculating the net present value of the investment project using a nominal terms approach requires the

More information

1 (a) Calculation of net present value (NPV) Year 1 2 3 4 5 6 $000 $000 $000 $000 $000 $000 Sales revenue 1,600 1,600 1,600 1,600 1,600

1 (a) Calculation of net present value (NPV) Year 1 2 3 4 5 6 $000 $000 $000 $000 $000 $000 Sales revenue 1,600 1,600 1,600 1,600 1,600 Answers Fundamentals Level Skills Module, Paper F9 Financial Management December 2011 Answers 1 (a) Calculation of net present value (NPV) Year 1 2 3 4 5 6 $000 $000 $000 $000 $000 $000 Sales revenue 1,600

More information

Long-term sources - those repayable beyond 1 year. No guaranteed return, but potential is unlimited. High risks require a high rate of return.

Long-term sources - those repayable beyond 1 year. No guaranteed return, but potential is unlimited. High risks require a high rate of return. Sources of Finance Ord Shares Total Finance Long Short Term Term Pref Shares Loans & Debens Bank O/D Leases Debt Factoring Long-term sources - those repayable beyond 1 year. Ordinary Shares The risk capital

More information

Fundamentals Level Skills Module, Paper F9

Fundamentals Level Skills Module, Paper F9 Answers Fundamentals Level Skills Module, Paper F9 Financial Management June 2008 Answers 1 (a) Calculation of weighted average cost of capital (WACC) Cost of equity Cost of equity using capital asset

More information

MM1 - The value of the firm is independent of its capital structure (the proportion of debt and equity used to finance the firm s operations).

MM1 - The value of the firm is independent of its capital structure (the proportion of debt and equity used to finance the firm s operations). Teaching Note Miller Modigliani Consider an economy for which the Efficient Market Hypothesis holds and in which all financial assets are possibly traded (abusing words we call this The Complete Markets

More information

Fundamentals Level Skills Module, Paper F9. Section A. Mean growth in earnings per share = 100 x [(35 7/30 0) 1/3 1] = 5 97% or 6%

Fundamentals Level Skills Module, Paper F9. Section A. Mean growth in earnings per share = 100 x [(35 7/30 0) 1/3 1] = 5 97% or 6% Answers Fundamentals Level Skills Module, Paper F9 Financial Management June 2015 Answers Section A 1 A 2 D 3 D Mean growth in earnings per share = 100 x [(35 7/30 0) 1/3 1] = 5 97% or 6% 4 A 5 D 6 B 7

More information

Use the table for the questions 18 and 19 below.

Use the table for the questions 18 and 19 below. Use the table for the questions 18 and 19 below. The following table summarizes prices of various default-free zero-coupon bonds (expressed as a percentage of face value): Maturity (years) 1 3 4 5 Price

More information

CAPITAL STRUCTURE [Chapter 15 and Chapter 16]

CAPITAL STRUCTURE [Chapter 15 and Chapter 16] Capital Structure [CHAP. 15 & 16] -1 CAPITAL STRUCTURE [Chapter 15 and Chapter 16] CONTENTS I. Introduction II. Capital Structure & Firm Value WITHOUT Taxes III. Capital Structure & Firm Value WITH Corporate

More information

Sources of, and raising short-term finance

Sources of, and raising short-term finance E. BUSINESS FINANCE 1. Sources of, and raising short-term finance 2. Sources of, and raising long-term finance 3. Internal sources of finance and dividend policy 4. Gearing and capital structure considerations

More information

Combination which capitalize on the wealth. FINANCIAL MANAGEMENT MAKE IT EASY TO LEARN Madhusudan Mishra CA Articled Assistant

Combination which capitalize on the wealth. FINANCIAL MANAGEMENT MAKE IT EASY TO LEARN Madhusudan Mishra CA Articled Assistant Combination which capitalize on the wealth. FINANCIAL MANAGEMENT MAKE IT EASY TO LEARN Madhusudan Mishra CA Articled Assistant CAPITAL STRUCTURE DECISION COMPOSITION OF CAPITAL STRUCTURE INDEFFERENCE POINT

More information

Chapter 15: Debt Policy

Chapter 15: Debt Policy FIN 302 Class Notes Chapter 15: Debt Policy Two Cases: Case one: NO TAX All Equity Half Debt Number of shares 100,000 50,000 Price per share $10 $10 Equity Value $1,000,000 $500,000 Debt Value $0 $500,000

More information

THE STOCK EXCHANGE. Agócs Adrienne

THE STOCK EXCHANGE. Agócs Adrienne THE STOCK EXCHANGE Agócs Adrienne OUTLINE The stock exchange shares, bonds and securities The main roles of the stock exchange Bulls and bears Types of securities Different information about the performance

More information

Most publicly limited companies (PLCs) will use a number of different sources of finance including:

Most publicly limited companies (PLCs) will use a number of different sources of finance including: Weighted Average Cost of Capital (WACC) Article by Bernard Vallely, FCCA, MBA, Current Examiner. RELEVANT TO : P1 Managerial Finance P2 Financial Management (Transitional Students) P2 Strategic Corporate

More information

Finance 2 for IBA (30J201) F.Feriozzi Resit exam June 14 th, 2011. Part One: Multiple-Choice Questions (45 points)

Finance 2 for IBA (30J201) F.Feriozzi Resit exam June 14 th, 2011. Part One: Multiple-Choice Questions (45 points) Question 1 Finance 2 for IBA (30J201) F.Feriozzi Resit exam June 14 th, 2011 Part One: Multiple-Choice Questions (45 points) Assume that financial markets are perfect and that the market value of a levered

More information

Options Pricing. This is sometimes referred to as the intrinsic value of the option.

Options Pricing. This is sometimes referred to as the intrinsic value of the option. Options Pricing We will use the example of a call option in discussing the pricing issue. Later, we will turn our attention to the Put-Call Parity Relationship. I. Preliminary Material Recall the payoff

More information

Sources of finance (Or where can we get money from?)

Sources of finance (Or where can we get money from?) Sources of finance (Or where can we get money from?) Why do we need finance? 1. Setting up a business 2. Need to finance our day-to-day activities 3. Expansion 4. Research into new products 5. Special

More information

cost of capital, 01 technical this measurement of a company s cost of equity THere are two ways of estimating the cost of equity (the return

cost of capital, 01 technical this measurement of a company s cost of equity THere are two ways of estimating the cost of equity (the return 01 technical cost of capital, THere are two ways of estimating the cost of equity (the return required by shareholders). Can this measurement of a company s cost of equity be used as the discount rate

More information

Part 9. The Basics of Corporate Finance

Part 9. The Basics of Corporate Finance Part 9. The Basics of Corporate Finance The essence of business is to raise money from investors to fund projects that will return more money to the investors. To do this, there are three financial questions

More information

CAPITAL STRUCTURE AND DIVIDEND POLICY

CAPITAL STRUCTURE AND DIVIDEND POLICY CAPITAL STRUCTURE AND DIVIDEND POLICY Capital Structure In the section of the notes titled Cost of Capital, we examined how the cost of capital is determined. From those notes, you should have discovered

More information

Paper F9. Financial Management. Specimen Exam applicable from December 2014. Fundamentals Level Skills Module

Paper F9. Financial Management. Specimen Exam applicable from December 2014. Fundamentals Level Skills Module Fundamentals Level Skills Module Financial Management Specimen Exam applicable from December 2014 Time allowed Reading and planning: 15 minutes Writing: 3 hours This paper is divided into two sections:

More information

7 CAPITAL STRUCTURE AND FINANCIAL LEVERAGE

7 CAPITAL STRUCTURE AND FINANCIAL LEVERAGE 7 CAPITAL STRUCTURE AND FINANCIAL LEVERAGE Capital structure refers to the way a corporation finances its assets through some combination of equity and debt. A firm's capital structure is then the composition

More information

1) Firm value and stock value We demonstrate that maximizing the value of the rm s equity is equivalent tomaximizing the value

1) Firm value and stock value We demonstrate that maximizing the value of the rm s equity is equivalent tomaximizing the value Financial Leverage and Capital Structure Policy A) Introduction The objective of the capital structure decision, like any corporate objective, should be to maximize the value of the rm s equity. In this

More information

Long Term Business Financing Strategy For A Pakistan Business. Byco Petroleum Pakistan Limited

Long Term Business Financing Strategy For A Pakistan Business. Byco Petroleum Pakistan Limited Long Term Business Financing Strategy For A Pakistan Business Byco Petroleum Pakistan Limited Contents Why We Need Financing Strategy 3 How Financing Strategies are driven? 4 Financing Prerequisite for

More information

Answer of Multiple Choice Questions 1. (A) 2. (A) 3. (B) 4. (A) 5. (D) 6. (C) 7. (D) 8 (A) 9 (B) 10 (A)

Answer of Multiple Choice Questions 1. (A) 2. (A) 3. (B) 4. (A) 5. (D) 6. (C) 7. (D) 8 (A) 9 (B) 10 (A) 1. is concerned with the acquisition, financing, and management of assets with some overall goal in mind. A. Financial management B. Profit maximization C. Agency theory D. Social responsibility 2. Jensen

More information

Indicative Content. 1.1.1 The main types of corporate form. 1.1.2 The regulatory framework for companies. 1.1.6 Shareholder Value Analysis.

Indicative Content. 1.1.1 The main types of corporate form. 1.1.2 The regulatory framework for companies. 1.1.6 Shareholder Value Analysis. Unit Title: Corporate Finance Unit Reference Number: L/601/3900 Guided Learning Hours: 210 Level: Level 6 Number of Credits: 25 Learning Outcome 1 The learner will: Understand the role of the Corporate

More information

Section 3 Financial and stock market ratios

Section 3 Financial and stock market ratios Section 3 Financial and stock market ratios Introduction 41 Ratio calculation 42 Financial status ratios 43 Stock market ratios 45 Debt: short-term or long-term? 47 Summary 48 Problems 49 INTRODUCTION

More information

Taxable cash flow 556 1,485 1,530 2,308 Taxation (167) (446) (459) (692) CA tax benefits

Taxable cash flow 556 1,485 1,530 2,308 Taxation (167) (446) (459) (692) CA tax benefits Answers Fundamentals Level Skills Module, Paper F9 Financial Management June 2011 Answers 1 (a) Net present value evaluation of new confectionery investment Year 1 2 3 4 5 $000 $000 $000 $000 $000 Sales

More information

There was no evidence of time pressure in this exam and the majority of candidates were able to attempt all questions within the time limit.

There was no evidence of time pressure in this exam and the majority of candidates were able to attempt all questions within the time limit. Examiner s General Comments Performance on F3 in May was a distinct improvement over some previous diets. This improvement was evident in both home and overseas centres although there were significant

More information

- Once we have computed the costs of the individual components of the firm s financing,

- Once we have computed the costs of the individual components of the firm s financing, WEIGHTED AVERAGE COST OF CAPITAL - Once we have computed the costs of the individual components of the firm s financing, we would assign weight to each financing source according to some standard and then

More information

6. Debt Valuation and the Cost of Capital

6. Debt Valuation and the Cost of Capital 6. Debt Valuation and the Cost of Capital Introduction Firms rarely finance capital projects by equity alone. They utilise long and short term funds from a variety of sources at a variety of costs. No

More information

The cost of capital. A reading prepared by Pamela Peterson Drake. 1. Introduction

The cost of capital. A reading prepared by Pamela Peterson Drake. 1. Introduction The cost of capital A reading prepared by Pamela Peterson Drake O U T L I N E 1. Introduction... 1 2. Determining the proportions of each source of capital that will be raised... 3 3. Estimating the marginal

More information

1. CFI Holdings is a conglomerate listed on the Zimbabwe Stock Exchange (ZSE) and has three operating divisions as follows:

1. CFI Holdings is a conglomerate listed on the Zimbabwe Stock Exchange (ZSE) and has three operating divisions as follows: NATIONAL UNIVERSITY OF SCIENCE AND TECHNOLOGY FACULTY OF COMMERCE DEPARTMENT OF FINANCE BACHELOR OF COMMERCE HONOURS DEGREE IN FINANCE PART II 2 ND SEMESTER FINAL EXAMINATION MAY 2005 CORPORATE FINANCE

More information

Business Finance. Theory and Practica. Eddie McLaney PEARSON

Business Finance. Theory and Practica. Eddie McLaney PEARSON Business Finance Theory and Practica Eddie McLaney PEARSON Harlow, England London New York Boston San Francisco Toronto Sydney Auckland Singapore Hong Kong Tokyo Seoul Taipei New Delhi Cape Town Säo Paulo

More information

Interpretation of Financial Statements

Interpretation of Financial Statements Interpretation of Financial Statements Author Noel O Brien, Formation 2 Accounting Framework Examiner. An important component of most introductory financial accounting programmes is the analysis and interpretation

More information

If you ignore taxes in this problem and there is no debt outstanding: EPS = EBIT/shares outstanding = $14,000/2,500 = $5.60

If you ignore taxes in this problem and there is no debt outstanding: EPS = EBIT/shares outstanding = $14,000/2,500 = $5.60 Problems Relating to Capital Structure and Leverage 1. EBIT and Leverage Money Inc., has no debt outstanding and a total market value of $150,000. Earnings before interest and taxes [EBIT] are projected

More information

CHAPTER 15 Capital Structure: Basic Concepts

CHAPTER 15 Capital Structure: Basic Concepts Multiple Choice Questions: CHAPTER 15 Capital Structure: Basic Concepts I. DEFINITIONS HOMEMADE LEVERAGE a 1. The use of personal borrowing to change the overall amount of financial leverage to which an

More information

ACTIVITY 8.1 A MARGINAL PLAY

ACTIVITY 8.1 A MARGINAL PLAY LESSON 8 BUYING ON MARGIN AND SELLING SHORT ACTIVITY 8.1 A MARGINAL PLAY Stockbroker Luke, Katie, and Jeremy are sitting around a desk near a sign labeled Brokerage Office. The Moderator is standing in

More information

ICAP GROUP S.A. FINANCIAL RATIOS EXPLANATION

ICAP GROUP S.A. FINANCIAL RATIOS EXPLANATION ICAP GROUP S.A. FINANCIAL RATIOS EXPLANATION OCTOBER 2006 Table of Contents 1. INTRODUCTION... 3 2. FINANCIAL RATIOS FOR COMPANIES (INDUSTRY - COMMERCE - SERVICES) 4 2.1 Profitability Ratios...4 2.2 Viability

More information

Institute of Chartered Accountant Ghana (ICAG) Paper 2.4 Financial Management

Institute of Chartered Accountant Ghana (ICAG) Paper 2.4 Financial Management Institute of Chartered Accountant Ghana (ICAG) Paper 2.4 Financial Management Final Mock Exam 1 Marking scheme and suggested solutions DO NOT TURN THIS PAGE UNTIL YOU HAVE COMPLETED THE MOCK EXAM ii Financial

More information

Understanding gearing Version 5.0

Understanding gearing Version 5.0 Understanding gearing Version 5.0 This document provides some additional information to help you understand the financial planning concepts discussed in the SOA in relation to gearing. This document has

More information

Chapter 15. Learning Objectives Principles Used in This Chapter 1.A Glance at Capital Structure Choices in Practice 2.Capital Structure Theory

Chapter 15. Learning Objectives Principles Used in This Chapter 1.A Glance at Capital Structure Choices in Practice 2.Capital Structure Theory Chapter 15 Capital Structure Policy Agenda Learning Objectives Principles Used in This Chapter 1.A Glance at Capital Structure Choices in Practice 2.Capital Structure Theory 3.Why Do Capital Structures

More information

Copyright 2009 Pearson Education Canada

Copyright 2009 Pearson Education Canada d) If Dorval calls in the outstanding bonds, a bondholder who currently owns bonds with $100,000 of face value will have to sell them back to the firm at face value. The bonds would be more valuable than

More information

Leverage and Capital Structure

Leverage and Capital Structure Leverage and Capital Structure Ross Chapter 16 Spring 2005 10.1 Leverage Financial Leverage Financial leverage is the use of fixed financial costs to magnify the effect of changes in EBIT on EPS. Fixed

More information

BUS303. Study guide 2. Chapter 14

BUS303. Study guide 2. Chapter 14 BUS303 Study guide 2 Chapter 14 1. An efficient capital market is one in which: A. all securities that investors want are offered. B. all transactions are closed within 2 days. C. current prices reflect

More information

Ch. 18: Taxes + Bankruptcy cost

Ch. 18: Taxes + Bankruptcy cost Ch. 18: Taxes + Bankruptcy cost If MM1 holds, then Financial Management has little (if any) impact on value of the firm: If markets are perfect, transaction cost (TAC) and bankruptcy cost are zero, no

More information

FINANCIAL SERVICES BOARD COLLECTIVE INVESTMENT SCHEMES

FINANCIAL SERVICES BOARD COLLECTIVE INVESTMENT SCHEMES FINANCIAL SERVICES BOARD COLLECTIVE INVESTMENT SCHEMES INTRODUCTION This booklet will provide you with information on the importance of understanding ways in which Collective Investment Schemes ( CIS )

More information

Fundamentals Level Skills Module, Paper F9. Section B

Fundamentals Level Skills Module, Paper F9. Section B Answers Fundamentals Level Skills Module, Paper F9 Financial Management September/December 2015 Answers Section B 1 (a) Market value of equity = 15,000,000 x 3 75 = $56,250,000 Market value of each irredeemable

More information

RATIO ANALYSIS & CASH FLOW 23 APRIL 2015 Section A: Summary Content Notes

RATIO ANALYSIS & CASH FLOW 23 APRIL 2015 Section A: Summary Content Notes RATIO ANALYSIS & CASH FLOW 23 APRIL 2015 Section A: Summary Content Notes 1. Introduction The cash flow statement reflects the movement of cash within an enterprise during a specific period. The Companies

More information

Chapter 7: Capital Structure: An Overview of the Financing Decision

Chapter 7: Capital Structure: An Overview of the Financing Decision Chapter 7: Capital Structure: An Overview of the Financing Decision 1. Income bonds are similar to preferred stock in several ways. Payment of interest on income bonds depends on the availability of sufficient

More information

University of Waterloo Midterm Examination

University of Waterloo Midterm Examination Student number: Student name: ANONYMOUS Instructor: Dr. Hongping Tan Duration: 1.5 hours AFM 371/2 Winter 2011 4:30-6:00 Tuesday, March 1 This exam has 12 pages including this page. Important Information:

More information

Principles of Corporate Finance

Principles of Corporate Finance Principles of Corporate Finance Chapter 18. Does debt policy matter? Ciclo Profissional 2 o Semestre / 2009 Graduaccão em Ciências Econômicas V. Filipe Martins-da-Rocha (FGV) Principles of Corporate Finance

More information

THE FINANCING DECISIONS BY FIRMS: IMPACT OF CAPITAL STRUCTURE CHOICE ON VALUE

THE FINANCING DECISIONS BY FIRMS: IMPACT OF CAPITAL STRUCTURE CHOICE ON VALUE IX. THE FINANCING DECISIONS BY FIRMS: IMPACT OF CAPITAL STRUCTURE CHOICE ON VALUE The capital structure of a firm is defined to be the menu of the firm's liabilities (i.e, the "right-hand side" of the

More information

Dividend Policy. Vinod Kothari

Dividend Policy. Vinod Kothari Dividend Policy Vinod Kothari Corporations earn profits they do not distribute all of it. Part of profit is ploughed back or held back as retained earnings. Part of the profit gets distributed to the shareholders.

More information

CHAPTER 13 Capital Structure and Leverage

CHAPTER 13 Capital Structure and Leverage CHAPTER 13 Capital Structure and Leverage Business and financial risk Optimal capital structure Operating Leverage Capital structure theory 1 What s business risk? Uncertainty about future operating income

More information

1. What is a recapitalization? Why is this considered a pure capital structure change?

1. What is a recapitalization? Why is this considered a pure capital structure change? CHAPTER 12 CONCEPT REVIEW QUESTIONS 1. What is a recapitalization? Why is this considered a pure capital structure change? Recapitalization is an alteration of a company s capital structure to change the

More information

Chapter 14 Capital Structure in a Perfect Market

Chapter 14 Capital Structure in a Perfect Market Chapter 14 Capital Structure in a Perfect Market 14-1. Consider a project with free cash flows in one year of $130,000 or $180,000, with each outcome being equally likely. The initial investment required

More information

6. Show all your workings. icpar

6. Show all your workings. icpar CERTIFIED PUBLIC ACCOUNTANT FOUNDATION LEVEL 1 EXAMINATION F1.3: FINANCIAL ACCOUNTING MONDAY: 10 JUNE 2013 INSTRUCTIONS: 1. Time Allowed: 3 hours 15 minutes (15 minutes reading and 3 hours writing). 2.

More information

Ratio Analysis CBDC, NB. Presented by ACSBE. February, 2008. Copyright 2007 ACSBE. All Rights Reserved.

Ratio Analysis CBDC, NB. Presented by ACSBE. February, 2008. Copyright 2007 ACSBE. All Rights Reserved. Ratio Analysis CBDC, NB February, 2008 Presented by ACSBE Financial Analysis What is Financial Analysis? What Can Financial Ratios Tell? 7 Categories of Financial Ratios Significance of Using Ratios Industry

More information

Chapter 1: The Modigliani-Miller Propositions, Taxes and Bankruptcy Costs

Chapter 1: The Modigliani-Miller Propositions, Taxes and Bankruptcy Costs Chapter 1: The Modigliani-Miller Propositions, Taxes and Bankruptcy Costs Corporate Finance - MSc in Finance (BGSE) Albert Banal-Estañol Universitat Pompeu Fabra and Barcelona GSE Albert Banal-Estañol

More information

TPPE17 Corporate Finance 1(5) SOLUTIONS RE-EXAMS 2014 II + III

TPPE17 Corporate Finance 1(5) SOLUTIONS RE-EXAMS 2014 II + III TPPE17 Corporate Finance 1(5) SOLUTIONS RE-EXAMS 2014 II III Instructions 1. Only one problem should be treated on each sheet of paper and only one side of the sheet should be used. 2. The solutions folder

More information

DUKE UNIVERSITY Fuqua School of Business. FINANCE 351 - CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2.

DUKE UNIVERSITY Fuqua School of Business. FINANCE 351 - CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2. DUKE UNIVERSITY Fuqua School of Business FINANCE 351 - CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Suppose the corporate tax rate is 40%, and investors pay a tax

More information

RELEVANT TO ACCA QUALIFICATION PAPER F9. Studying Paper F9? Performance objectives 15 and 16 are relevant to this exam

RELEVANT TO ACCA QUALIFICATION PAPER F9. Studying Paper F9? Performance objectives 15 and 16 are relevant to this exam RELEVANT TO ACCA QUALIFICATION PAPER F9 Studying Paper F9? Performance objectives 15 and 16 are relevant to this exam Business finance Section E of the Paper F9, Financial Management syllabus deals with

More information

The Interpretation of Financial Statements. Why use ratio analysis. Limitations. Chapter 16

The Interpretation of Financial Statements. Why use ratio analysis. Limitations. Chapter 16 The Interpretation of Financial Statements Chapter 16 1 Luby & O Donoghue (2005) Why use ratio analysis Provides framework Comparison to previous years Trends identified Identify areas of concern Targets

More information

Paper F9. Financial Management. September/December Fundamentals Level Skills Module. The Association of Chartered Certified Accountants

Paper F9. Financial Management. September/December Fundamentals Level Skills Module. The Association of Chartered Certified Accountants Fundamentals Level Skills Module Financial Management September/December 2015 Time allowed Reading and planning: 15 minutes Writing: 3 hours This question paper is divided into two sections: Section A

More information

Margin Trading. A. How Margin Works? B. Why Trading on Margin Can Be Very Risky and Is Not Suitable for Everyone? C. Conclusion

Margin Trading. A. How Margin Works? B. Why Trading on Margin Can Be Very Risky and Is Not Suitable for Everyone? C. Conclusion A. How Margin Works? B. Why Trading on Margin Can Be Very Risky and Is Not Suitable for Everyone? C. Conclusion 2 An investor who purchases securities may pay for the securities in full, from his own resources,

More information

The Modigliani-Miller Theorem The New Palgrave Dictionary of Economics Anne P. Villamil, University of Illinois

The Modigliani-Miller Theorem The New Palgrave Dictionary of Economics Anne P. Villamil, University of Illinois The Modigliani-Miller Theorem The New Palgrave Dictionary of Economics Anne P. Villamil, University of Illinois The Modigliani-Miller Theorem is a cornerstone of modern corporate finance. At its heart,

More information

FINANCIAL MANAGEMENT

FINANCIAL MANAGEMENT FINANCIAL MANAGEMENT PROFESSIONAL 2 EXAMINATION - AUGUST 2008 NOTES Answer all three questions from Section A. Answer two questions only from Section B. (If you provide answers to more questions than required

More information

CHAPTER 17 Does Debt Policy Matter?

CHAPTER 17 Does Debt Policy Matter? CHPTR 17 Does Debt Policy Matter? nswers to Practice Questions 1. a. The two firms have equal value; let represent the total value of the firm. Rosencrantz could buy one percent of Company B s equity and

More information

Fundamentals Level Skills Module, Paper F9

Fundamentals Level Skills Module, Paper F9 Answers Fundamentals Level Skills Module, Paper F9 Financial Management December 2008 Answers 1 (a) Rights issue price = 2 5 x 0 8 = $2 00 per share Theoretical ex rights price = ((2 50 x 4) + (1 x 2 00)/5=$2

More information

Capital Structure. Itay Goldstein. Wharton School, University of Pennsylvania

Capital Structure. Itay Goldstein. Wharton School, University of Pennsylvania Capital Structure Itay Goldstein Wharton School, University of Pennsylvania 1 Debt and Equity There are two main types of financing: debt and equity. Consider a two-period world with dates 0 and 1. At

More information

Test3. Pessimistic Most Likely Optimistic Total Revenues 30 50 65 Total Costs -25-20 -15

Test3. Pessimistic Most Likely Optimistic Total Revenues 30 50 65 Total Costs -25-20 -15 Test3 1. The market value of Charcoal Corporation's common stock is $20 million, and the market value of its riskfree debt is $5 million. The beta of the company's common stock is 1.25, and the market

More information

Chapter. Financial Analysis

Chapter. Financial Analysis Chapter 18 Financial Analysis Financial analysis The objective of financial statements is to provide information to all the users of these accounts to help them in their decision-making. Note that most

More information

Lecture 4: Properties of stock options

Lecture 4: Properties of stock options Lecture 4: Properties of stock options Reading: J.C.Hull, Chapter 9 An European call option is an agreement between two parties giving the holder the right to buy a certain asset (e.g. one stock unit)

More information

Paper F9. Financial Management. Friday 5 December 2014. Fundamentals Level Skills Module. The Association of Chartered Certified Accountants

Paper F9. Financial Management. Friday 5 December 2014. Fundamentals Level Skills Module. The Association of Chartered Certified Accountants Fundamentals Level Skills Module Financial Management Friday 5 ecember 2014 Time allowed Reading and planning: 15 minutes Writing: 3 hours This paper is divided into two sections: Section A ALL 20 questions

More information

FN2 Ron Muller 2007-08 MODULE 4: CAPITAL STRUCTURE QUESTION 1

FN2 Ron Muller 2007-08 MODULE 4: CAPITAL STRUCTURE QUESTION 1 MODULE 4: CAPITAL STRUCTURE QUESTION 1 Gadget Corp. manufactures gadgets. The average selling price of this finished product is $200 per unit. The variable cost for these units is $125. Gadget Corp. incurs

More information

Ratio Analysis. A) Liquidity Ratio : - 1) Current ratio = Current asset Current Liability

Ratio Analysis. A) Liquidity Ratio : - 1) Current ratio = Current asset Current Liability A) Liquidity Ratio : - Ratio Analysis 1) Current ratio = Current asset Current Liability 2) Quick ratio or Acid Test ratio = Quick Asset Quick liability Quick Asset = Current Asset Stock Quick Liability

More information

Current liabilities and payroll

Current liabilities and payroll Chapter 12 Current liabilities and payroll Current liabilities are obligations that the business has to discharge within 12 months or its operating cycle if longer than one year. Obligations that are due

More information

For our curriculum in Grade 12 we are going to use ratios to analyse the information available in the Income statement and the Balance sheet.

For our curriculum in Grade 12 we are going to use ratios to analyse the information available in the Income statement and the Balance sheet. SUBJECT: ACCOUNTING GRADE 12 CHAPTER: COMPANIES LESSON: ANALYSIS AND INTERPRETATION-RATIOS LESSON OVERVIEW (KNOWLEDGE AREAS) LESSON 1. Introduction 2. Analysing of financial statements and its purpose

More information

Examination Paper, Solutions and Examiner s Report. Paper: Corporate Finance & Funding Fast Track

Examination Paper, Solutions and Examiner s Report. Paper: Corporate Finance & Funding Fast Track Examination Paper, Solutions and Examiner s Report Paper: Corporate Finance & Funding Fast Track October 2011 SECTION A Answer ONE COMPULSORY question QUESTION 1 The top executives of Wolfe plc are entitled

More information

Finding the Right Financing Mix: The Capital Structure Decision. Aswath Damodaran 1

Finding the Right Financing Mix: The Capital Structure Decision. Aswath Damodaran 1 Finding the Right Financing Mix: The Capital Structure Decision Aswath Damodaran 1 First Principles Invest in projects that yield a return greater than the minimum acceptable hurdle rate. The hurdle rate

More information

Contribution 787 1,368 1,813 983. Taxable cash flow 682 1,253 1,688 858 Tax liabilities (205) (376) (506) (257)

Contribution 787 1,368 1,813 983. Taxable cash flow 682 1,253 1,688 858 Tax liabilities (205) (376) (506) (257) Answers Fundamentals Level Skills Module, Paper F9 Financial Management June 2012 Answers 1 (a) Calculation of net present value (NPV) As nominal after-tax cash flows are to be discounted, the nominal

More information

Paper F9. Financial Management. Friday 7 June 2013. Fundamentals Level Skills Module. The Association of Chartered Certified Accountants.

Paper F9. Financial Management. Friday 7 June 2013. Fundamentals Level Skills Module. The Association of Chartered Certified Accountants. Fundamentals Level Skills Module Financial Management Friday 7 June 2013 Time allowed Reading and planning: Writing: 15 minutes 3 hours ALL FOUR questions are compulsory and MUST be attempted. Formulae

More information

Black Scholes Merton Approach To Modelling Financial Derivatives Prices Tomas Sinkariovas 0802869. Words: 3441

Black Scholes Merton Approach To Modelling Financial Derivatives Prices Tomas Sinkariovas 0802869. Words: 3441 Black Scholes Merton Approach To Modelling Financial Derivatives Prices Tomas Sinkariovas 0802869 Words: 3441 1 1. Introduction In this paper I present Black, Scholes (1973) and Merton (1973) (BSM) general

More information

Chapter 5 Valuing Stocks

Chapter 5 Valuing Stocks Chapter 5 Valuing Stocks MULTIPLE CHOICE 1. The first public sale of company stock to outside investors is called a/an a. seasoned equity offering. b. shareholders meeting. c. initial public offering.

More information

What are Capital Markets?

What are Capital Markets? What are Capital Markets? Capital markets are like any other markets, but differ in terms of the products traded and their organization. Capital markets deal with the trading of securities. Capital markets

More information

ACCOUNTING III Cash Flow Statement & Linking the 3 Financial Statements. Fall 2015 Comp Week 5

ACCOUNTING III Cash Flow Statement & Linking the 3 Financial Statements. Fall 2015 Comp Week 5 ACCOUNTING III Cash Flow Statement & Linking the 3 Financial Statements Fall 2015 Comp Week 5 CODE: CA$H Administrative Stuff Send an email to trentnelson@college.harvard.edu if you have not been added

More information

The Debt-Equity Trade Off: The Capital Structure Decision

The Debt-Equity Trade Off: The Capital Structure Decision The Debt-Equity Trade Off: The Capital Structure Decision Aswath Damodaran Stern School of Business Aswath Damodaran 1 First Principles Invest in projects that yield a return greater than the minimum acceptable

More information