Question 4 (This question has three parts, (a), (b), and (c))

(a) Why is the return on a company's debt lower than the return on its equity? 2 marks

(b) If a company borrowed funds to buy back some of its own shares, how will this transaction affect thecompany's capital structure? Explain what impact this change might have on the value of the company. 4 marks

(c) Does the pecking order theory of capital structure suggest that companies should have an optimal capital structure (or leverage ratio)? 4 marks