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Question 99 capital structure, interest tax shield, Miller and Modigliani, trade off theory of capital structure

A firm changes its capital structure by issuing a large amount of debt and using the funds to repurchase shares. Its assets are unchanged.

Assume that:

The firm and individual investors can borrow at the same rate and have the same tax rates.
The firm's debt and shares are fairly priced and the shares are repurchased at the market price, not at a premium.
There are no market frictions relating to debt such as asymmetric information or transaction costs.
Shareholders wealth is measured in terms of utiliity. Shareholders are wealth-maximising and risk-averse. They have a preferred level of overall leverage. Before the firm's capital restructure all shareholders were optimally levered.

According to Miller and Modigliani's theory, which statement is correct?

(a) The firm's share price and shareholder wealth will both decrease. This is because the firm will have more debt and therefore more risk so the discount rate applied to its cash flows will be higher, decreasing the value of the firm and therefore the value of the firm's equity and share price.

(b) The firm's share price and shareholder wealth will both increase. This is because the firm will have more debt which will amplify the returns of equity investors. This will mean that returns on equity can be much higher and investors will pay a premium for this, leading to an increase in the stock price.

(c) The firm's share price and shareholder wealth will both increase since it has more debt and therefore more tax shields.

(d) The firm's share price will increase due to the higher value of tax shields. But shareholder wealth will remain unchanged because capital structure is irrelevant when investors can use home-made leverage to create tax-shields themselves.

(e) The firm's share price and shareholder wealth will both increase. This is because the cost of debt is cheaper than equity, leading to a lower (before and after tax) WACC. This lower WACC will lead to a higher value of the firm and a higher share price.

Question 101 payout policy, no explanation

An established mining firm announces that it expects large losses over the following year due to flooding which has temporarily stalled production at its mines. Which statement(s) are correct?

(i) If the firm adheres to a full dividend payout policy it will not pay any dividends over the following year.

(ii) If the firm wants to signal that the loss is temporary it will maintain the same level of dividends. It can do this so long as it has enough retained profits.

(iii) By law, the firm will be unable to pay a dividend over the following year because it cannot pay a dividend when it makes a loss.

Select the most correct response:

Question 103 option

Below are 4 option graphs. Note that the y-axis is payoff at maturity (T). What options do they depict? List them in the order that they are numbered.

Question 129 debt terminology

Question 182 NPV, IRR, pay back period

A project's NPV is positive. Select the most correct statement:

Question 270 real estate, DDM, effective rate conversion

You own an apartment which you rent out as an investment property.

What is the price of the apartment using discounted cash flow (DCF, same as NPV) valuation?

Assume that:

You just signed a contract to rent the apartment out to a tenant for the next 12 months at $2,000 per month, payable in advance (at the start of the month, t=0). The tenant is just about to pay you the first $2,000 payment.
The contract states that monthly rental payments are fixed for 12 months. After the contract ends, you plan to sign another contract but with rental payment increases of 3%. You intend to do this every year.
So rental payments will increase at the start of the 13th month (t=12) to be $2,060 (=2,000(1+0.03)), and then they will be constant for the next 12 months.
Rental payments will increase again at the start of the 25th month (t=24) to be $2,121.80 (=2,000(1+0.03)²), and then they will be constant for the next 12 months until the next year, and so on.
The required return of the apartment is 8.732% pa, given as an effective annual rate.
Ignore all taxes, maintenance, real estate agent, council and strata fees, periods of vacancy and other costs. Assume that the apartment will last forever and so will the rental payments.

Question 398 financial distress, capital raising, leverage, capital structure, NPV

A levered firm has zero-coupon bonds which mature in one year and have a combined face value of $9.9m.

Investors are risk-neutral and therefore all debt and equity holders demand the same required return of 10% pa.

In one year the firm's assets will be worth:

$13.2m with probability 0.5 in the good state of the world, or
$6.6m with probability 0.5 in the bad state of the world.

A new project presents itself which requires an investment of $2m and will provide a certain cash flow of $3.3m in one year.

The firm doesn't have any excess cash to make the initial $2m investment, but the funds can be raised from shareholders through a fairly priced rights issue. Ignore all transaction costs.

Should shareholders vote to proceed with the project and equity raising? What will be the gain in shareholder wealth if they decide to proceed?

Question 615 debt terminology

Question 712 effective rate conversion

An effective monthly return of 1% ##(r_\text{eff monthly})## is equivalent to an effective annual return ##(r_\text{eff annual})## of:

Question 901 Basel accord

The below graph from the RBA shows the phase-in of the Basel 3 minimum regulatory capital requirements under the Basel Committee on Banking Supervision (BCBS) on the left panel and in Australia under the Australian Prudential Regulatory Authority (APRA) on the right panel.

Which of the following statements about the Basel 3 minimum regulatory capital requirements as at 2019 is NOT correct? All minimum amounts exclude the 2.5% counter-cyclical buffer.

The Basel 3 minimum regulatory capital requirement as a percent of Risk Weighted Assets (RWA) is: