Answer this MCQ for Question 1:

Question 1: Part A:

Suppose that a new government is elected and it changes the law applying to firms to:

Allow dividend payments to be tax deductible

Stop interest expense on debt from being tax deductible

Holding other factors constant, and assuming that firms seek to maintain an optimal capital structure in accordance with trade-off theory, what would you expect to happen to the debt ratio of a firm with both equity and debt in its capital structure?

a. An increase in the debt ratio

b. A decrease in the debt ratio

c. The debt ratio would be unchanged

d. The debt ratio would double

e. None of the above or it is not possible to say

Part B:

Fun Tyne plc declares a dividend payment of 20p per share. Ignoring taxes and the time value of money, and assuming that markets are efficient, you would expect stock price to:

a. Immediately increase by 20p on the payment date

b. Immediately increase by 20p on the ex-dividend date

c. Immediately decrease by 20p on the declaration date

d. Immediately decrease

Part C:

The covariance between the return on Apple stock and the S&P 500 is 0.12. The variance of the return on the S&P 500 is 0.09. Apple stock is:

a. Riskier than the market

b. Less risky than the market

c. As risky as the market

d. Expected to have a good return when the market is doing poorly

e. None of the above