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    AF208 Revision Package Solutions S1 2023

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    Vinal Prasad
    The document discusses several topics related to finance: 1) It explains the relationship between a firm's value and its cost of capital, and how firms that earn more than their cost of capital will increase in value while those earning less will decrease in value. 2) It describes how debtholders generally have a lower required rate of return than shareholders but more contractual rights to payments. 3) Using more debt could lower a firm's overall cost of capital due to debt generally having a lower cost, but this also increases the firm's financial risk for shareholders. 4) The optimal capital structure maximizes firm value but cannot be directly calculated or fully explained by theories of capital structure.

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    AF208 Revision Package Solutions S1 2023

    Uploaded by

    Vinal Prasad
    39 views3 pages
    The document discusses several topics related to finance: 1) It explains the relationship between a firm's value and its cost of capital, and how firms that earn more than their cost of capital will increase in value while those earning less will decrease in value. 2) It describes how debtholders generally have a lower required rate of return than shareholders but more contractual rights to payments. 3) Using more debt could lower a firm's overall cost of capital due to debt generally having a lower cost, but this also increases the firm's financial risk for shareholders. 4) The optimal capital structure maximizes firm value but cannot be directly calculated or fully explained by theories of capital structure.

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    Document contains final exam revision package for s1 2023

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    The document discusses several topics related to finance: 1) It explains the relationship between a firm's value and its cost of capital, and how firms that earn more than their cost of capital will increase in value while those earning less will decrease in value. 2) It describes how debtholders generally have a lower required rate of return than shareholders but more contractual rights to payments. 3) Using more debt could lower a firm's overall cost of capital due to debt generally having a lower cost, but this also increases the firm's financial risk for shareholders. 4) The optimal capital structure maximizes firm value but cannot be directly calculated or fully explained by theories of capital structure.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    39 views3 pages

    AF208 Revision Package Solutions S1 2023

    Uploaded by

    Vinal Prasad
    The document discusses several topics related to finance: 1) It explains the relationship between a firm's value and its cost of capital, and how firms that earn more than their cost of capital will increase in value while those earning less will decrease in value. 2) It describes how debtholders generally have a lower required rate of return than shareholders but more contractual rights to payments. 3) Using more debt could lower a firm's overall cost of capital due to debt generally having a lower cost, but this also increases the firm's financial risk for shareholders. 4) The optimal capital structure maximizes firm value but cannot be directly calculated or fully explained by theories of capital structure.

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    Revision Package Solutions S1 2023

    Cost of Capital

    The relationship between firm value and the cost of capital is that firms earning more than the
    cost of capital will increase in value, while firms earning less than the cost of capital will
    decrease in value. The cost of capital represents the weighted required rate of return for each
    of the sources of long-term finance used by the firm. When the firm earns the cost of capital,
    the contributors of capital are all earning their required returns. If the contributors of equity
    capital do not receive their required returns, they will sell their shares and the share price will
    fall. Decreases in share price represent a decrease in the value of the firm. When debtholders
    do not receive their required return (i.e. coupon payments are not made) they can arrange to
    have the assets of the firm liquidated in order to obtain the return of principal.

    Debtholders usually have a lower required rate of return than do shareholders in the same
    company. Debtholders normally have contractual rights to receive interest payments and a
    return of the principal borrowed by the company. Ordinary shareholders, on the other hand,
    do not have a contractual right to receive dividends. They may receive no dividends at all, or
    may have the level of dividend reduced when the company does not perform as well as it
    should or needs to retain funds for investment opportunities. Further, shares do not have a
    maturity date and shareholders cannot expect to have their capital returned by the company at
    some time in the future (an exception to this is when the company decides to hold a share
    buy-back).

    Using more debt in the firm’s capital structure could lower the overall cost of capital because
    the cost of debt is usually lower than the cost of equity. As the returns to debtholders are
    normally fixed by the rate of interest, more debt should mean higher returns to shareholders if
    the company maintains its profitability. However, as the proportion of debt in the capital
    structure increases, the shareholders’ required return will increase to reflect the increased
    financial risk of the firm.

    The optimal capital structure is the mix of contracted debt and equity that maximises the
    value of the firm. While a firm’s capital structure can be calculated by observing the relative
    proportions of debt and equity used to finance the firm, the optimal capital structure cannot
    be observed so cannot be ‘calculated’. Further, no theory of capital structure can fully explain
    the observed capital structure choices of firms, so we cannot solve the optimal capital
    structure problem.

    Short Term Finance – Working Capital

    Revenue: .043 × 600 000 = $25 800

    Costs:

    interest: $2700 + $600 = $3300.

    Collection: $10 800 + $3600 = $14 400.

    Total cost = $17 700.

    Yes, an $8100 surplus. Faster collection would reduce interest costs and probably collection
    costs.

    Dividend Policy

    (a) Current share price =   1 000 000 $500 000   25       EPS E P = $12.50 A
    20% bonus issue will decrease Bell share price from $12.50 to $10.42 [= $12.50/1.20
    (b) ] (b) The market value of 100 shares prior to the bonus issue was $1250 [= $12.50 –
    100]. Following the bonus issue the investor will receive 20 additional shares but the
    share price will be reduced to $10.42, leaving the total value of the portfolio
    unchanged [$10.42 – 120 = $1250].
    Planning Investments – Discounted Cash Flow Techniques

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