Question 1

a)Explain why the return required by ordinary shareholders is different from that of the return required by bondholders. Explain this in the context of when considering the mix of debt and equity in the capital structure.(10 Marks)

b)Calet plc has the following capital structure:

i.Common stock: 1,000,000 common stock of nominal value 25p per share and a market value of 79p per share. A dividend of 6p per share has just been paid and dividends are expected to grow by 5%per year for the foreseeable future.

ii.Preference shares: 250000 preference shares of nominal value 50p per share and market value of 42p per share. The annual net dividend of 7.5 % has just been paid.

iii.Bonds: 100,000 of 7% irredeemable bonds with a market price of 102 per 100 nominal. The annual interest payment has just been made.

The corporate tax rate is at 30%.

Required:

You are asked to compute the weighted averagecost of capital for Calet plc based on the information given. (20m)

Question 2

a)What are financial distress costs? How are they related to the firm's financing decisions? (10 Marks)

b)Describe how financial leverage ratiosareused to help managers make financing decisions. (10 Marks)

c)Explain with the use of a diagram, the traditional view ofcapital structure theory. State any assumptions used in this theory.(10 Marks)

(Total 30 Marks)

Question 3

Thompson Ltd projects its sales for the next year to be $4,000,000. It expects to earn 5% of that amount after taxes. Thompson is now in the process of projecting its financing needs. The company has made the following assumptions:

i)Current assets are equal to 20% of sales.

ii)Fixed assets are to remain at their current level of $1000,000.

iii)Common equity is currently at $0.80 million.

iv)Thompson pays out half of its after-tax earnings in dividends.

v)The company has short-term payables and trade credit that equal to 10% of sales.

vi)The company has no long-term debt outstanding.

Required:

a)Calculate Thompson Ltd.'s financing needs for the coming year. (11 Marks)

b)Distinguish between a firm's three components of its overall planning process:

i.The short-term operating financial plan.

ii.The long-term operating financial plan

iii.And the strategic plan( 9 Marks)

(Total 20 Marks)