WW is a quoted manufacturing company. The Finance Director has addressed the shareholders during WW's annual general meeting-She has told the shareholders that WW raised equity during the year and used the funds to repay a large loan that was maturing, thereby reducing WW's gearing ratio At the conclusion of the Finance Director's speech one of the shareholders complained that it had been foolish for WW to have used equity to repay debt The shareholder argued that the Modigliani and Miller model (with tax) offers proof that debt is cheaper than equity when companies pay tax on their profits.
Which THREE arguments could the Finance Director have used in response to the shareholder?

• A. The shareholder was confusing the cost of capital with shareholder wealth
• B. A lower gearing ratio creates greater flexibility for WW in the future
• C. The Modigliani and Miller model would only be valid in practice if WW's shareholders were aware of the model and believed in its validity
• D. A lower gearing ratio will result in an increase in the value of the company
• E. WW was approaching a debt covenant limit and it was therefore important to reduce gearing.
• F. Reducing the gearing ratio has reduced the financial risk of WW which will benefit shareholders

A company is currently all-equity financed with a cost of equity of 8%.
It plans to raise debt with a pre-tax cost of 4% in order to buy back equity shares.
After the buy-back, the debt-to-equity ratio at market values will be 1 to 2.
The corporate income tax rate is 30%.
Which of the following represents the company's cost of equity after the buy-back according to Modigliani and Miller's Theory of Capital Structure with taxes?

• A. 8%
• B. 9.4%
• C. 9.8%
• D. 13.6%

Under traditional theory, an increase in a company's WACC would cause the value of the company to:

• A. Increase
• B. Stay the same
• C. Either increase or decrease
• D. Decrease

A company is based in Country Y whose functional currency is YS. It has an investment in Country Z whose functional currency is ZS This year the company expects to generate ZS20 million profit after tax.
Tax Regime
* Corporate income tax rate in Country Y is 60%
* Corporate income tax rate in Country Z Is 30%
* Full double tax relief is available
Assume an exchange rate of YS1 = ZS5
What is the expected profit after tax in YS if the ZS profit is remitted to Country Y?

• A. YS57.14 million
• B. YS1 60 million
• C. YS2 29 million
• D. YS6.67 million

The shares of a company in a high technology industry have been listed on a stock exchange for 10 years.
During this period, it has paid no dividends but invested all retained earnings in growth. The company is now entering a period of relatively stable growth and the directors are considering beginning to pay dividends They are reviewing the following suggestions made by members of the board:
* Pay cash dividends linked to growth in earnings
* Use a residual theory approach to establish cash dividends
* Issue scrip dividends (shares instead of cash)
* Continue to pay no dividends as dividends are irrelevant to the value of the company Which THREE of the following are correct statements for the directors to take into consideration when making a decision about future dividend policy?

• A. The residual theory of dividends suggest that dividends should only be paid after all operating costs have been met.
• B. Modigliani and Miller argue that, ignoring taxation, as long as positive net present value projects are invested in, shareholder wealth will increase, regardless of dividend payments.
• C. Ignoring taxation and administrative costs, shareholders can provide their own dividends by selling shares in the market
• D. Shareholder preferences for cash or scrip dividends will be influenced by their tax positions
• E. Neither cash nor scrip dividends will have an effect on earnings per share