Question 2

(a)"The optimal capital structure of a firm is often defined as the proportion of debt and equity that results in the lowest weighted average cost of capital (WACC) for the firm."

Required:

(i)Discuss the above statement based on the following theories:

lTraditional Theory;

lModigliani and Miller (No Tax); lModigliani and Miller (With Tax); lThe Pecking Order.

(16 marks)

(ii)Based on the answer in part 2(a)(i), in your opinion, which is the best capital structure theory? You are required to support your opinion with ANY TWO (2) reasons.

(5 marks)

(b)Anthony Lim is the chief executive director of AL Bakery Bhd. The share price of AL Bakery Bhd. was RM3.00 at 9.00 a.m. Anthony Lim was informed at 10.00 a.m. that Genting Bhd. is interested to take over AL Bakery Bhd with an offer price of RM3.50 per share. The official announcement of the potential acquisition was released on the newspapers and websites at 4.00 p.m. on the same day.

Assume that Anthony Lim is allowed to buy the shares of AL Bakery Bhd. Explain whether Anthony Lim be able to earn extraordinary return if he were to invest shares of AL Bakery Bhd. immediately after he was informed the news of acquisition at 10.00 a.m. in the following efficient market hypotheses:

(i)Weak form efficiency market hypothesis;

(ii)Semi-strong form efficiency market hypothesis; (iii)Strong form efficiency market hypothesis.