Question 5. (This question has three sub-questions: (a), (b) and (c)) (a) From the figure below,...

 

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Question 5. (This question has three sub-questions: (a), (b) and (c)) (a) From the figure below, as per the proposition of Modigliani and Miller -2, explain the relationship between cost of debt and cost of ordinary shares. (5 marks) B. Changing cost of debt 20% Expected return 15% 10% 5% Cost of ordinary shares (kos) Cost of assets (KAssets) Cost of debt (KDebt) 0% 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 Debt/Equity ratio (VDebt/Vos) (b) What do you mean by the concept interest tax shield? Up to what extend companies take benefit of interest tax shield. What are the consequences of enjoying interest tax shield when a company obtains 90% of its capital in the form of debt? (5 marks) (c) Investing in shares is always perplexing. You have been taught the concept of beta in the classroom. After the class, you discussed the concept of Beta among your friends at a local café. One of your mates is considering investing in one of two shares. The first has a beta of 1.6. The second has a beta of -2 (a negative number!). Explain in detail how you can advise your mate to use this information to decide about which share to invest in 2022 and explain what is meant by a stock with a beta value of -2. (5 marks) Question 5. (This question has three sub-questions: (a), (b) and (c)) (a) From the figure below, as per the proposition of Modigliani and Miller -2, explain the relationship between cost of debt and cost of ordinary shares. (5 marks) B. Changing cost of debt 20% Expected return 15% 10% 5% Cost of ordinary shares (kos) Cost of assets (KAssets) Cost of debt (KDebt) 0% 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 Debt/Equity ratio (VDebt/Vos) (b) What do you mean by the concept interest tax shield? Up to what extend companies take benefit of interest tax shield. What are the consequences of enjoying interest tax shield when a company obtains 90% of its capital in the form of debt? (5 marks) (c) Investing in shares is always perplexing. You have been taught the concept of beta in the classroom. After the class, you discussed the concept of Beta among your friends at a local café. One of your mates is considering investing in one of two shares. The first has a beta of 1.6. The second has a beta of -2 (a negative number!). Explain in detail how you can advise your mate to use this information to decide about which share to invest in 2022 and explain what is meant by a stock with a beta value of -2. (5 marks)

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a Modigliani and Miller Proposition 2 Modigliani and Millers Proposition II with taxes states that the cost of equity increases linearly with leverage debtequity ratio This is because as a company tak... View the full answer