Based on your understanding of the capital structure theory do you agree with the following statement:

“In a world without taxes and without bankruptcy costs the best capital structure would be maximum debt and minimum equity, and in a world with taxes and bankruptcy costs the best capital structure is maximum equity and minimum debt.

Agree or Disagree?

If you agree with the above statement, explain and justify why you agree.

If you disagree with the above statement, explain and justify why you disagree

(Use diagrams to justify your answer)

Question 2

Sweets of Oman SAOG is a food products company with a constant level of earnings which are expected to continue well into the future. The company’s EBIT is 760,000 Rials per year which are expected to continue in perpetuity. The company’s debt now stands at 2.5 million Rials. Assume tax rate is 30%, and that unlevered cost of capital is 19%. Assume cost of debt is 10%

a) Calculate the value of the firm ?

b) Calculate the company’s cost of equity capital ?

c) What is the WACC ?

d) Based on the above figures, do you agree with the statement that “ ‘debt’ is a disadvantage to Sweets of Oman , and the company should not borrow” ?

Yes or No ? explain and Justify

FINAL ANSWER
Value of firm
Cost of equity capital
WACC
Company should not borrow	Yes or No

Question 3)

United Electric company currently has 10,000 shares outstanding and the market value of each share is 10 Rials. Its debt equity ratio is 3. Interest rate on debt is 8% and EBIT is 100,000 Rials. The company is expecting a 50% increase in EBIT due to expected boom.

United Electric is planning to change its debt equity ratio to 0.333 ( that is by selling equity shares at 10 Rials each. The company is expecting a 50% increase in EBIT due to expected boom.

Tax is zero b

Calculate Break-even point?

Final Answer
Break-even point

Question 4)

According to the pecking order theory, firms which require money for investment should pay less dividends. Do you agree or disagree?

If you agree with the statement explain why

If you disagree with the statement explain why

Question 5)

Statement A: Dividends are relevant

Statement B: Dividend policy is irrelevant

1. Agree with both A and B

2. Agree with A, but disagree with B

3. Agree with B, but disagree with A

4. Disagree with both A and B

Question 6)

What are the different types of bankruptcy costs? Mention at least two

Answer rating: 100% (QA)

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