Free Access CIMA F3 New Release

Page: 22 / 32

Question 88

A company is currently all-equity financed with a cost of equity of 9%.

It plans to raise debt with a pre-tax cost of 3% 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 25%.

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?

Options:

11.5%

18%

11.3%

90%

Question 89

A listed company in a high growth industry, where innovation is a key driver of success has always operated a residual dividend policy, resulting in volatility in dividends due to periodic significant investments in research and development.

The company has recently come under pressure from some investors to change its dividend policy so that shareholders receive a consistent growing dividend. In addition, they suggested that the company should use more debt finance.

If the suggested change is made to the financial policies, which THREE of the following statements are true?

Options:

It may give a signal to the market that the company is entering a period of stable growth.

There may be a change to the shareholder profile due to 'the clientele effect'.

The directors will not have to take shareholder dividend preferences into consideration in future.

Retained earnings have a lower cost than debt finance.

The company's financial risk will increase due to its increased use of debt finance.

Question 90

Which of the following best explains why the interest rate parity model is highly effective in practice?

Options:

Governments actively manage their exchange rates so that parity holds

Divergence from parity is impossible because exchange rates drive interest rates

Any divergence from parity can be observed by the market and corrected by arbitrage

Speculative forces drive the interest rates and exchange rates together to achieve parity.

Question 91

A listed company follows a policy of paying a constant dividend. The following information is available:

• Issued share capital (nominal value $0.50) $60 million

• Current market capitalisation $480 million

The shareholders are requesting an increased dividend this year as earnings have been growing. However, the directors wish to retain as much cash as possible to fund new investments. They therefore plan to announce a 1-for-10 scrip dividend to replace the usual cash dividend.

Assuming no other influence on share price, what is the expected share price following the scrip dividend?

Give your answer to 2 decimal places.

$ ?