THEORY QUESTION

a)What does the term structure of interest rates indicate? What are the theories for describing the shape of the term structure of interest rates (the yield curve)? Describe each theory with examples. (10 marks)

b) The application of WACC to evaluate all projects may lead managers into accepting high-risk projects that do not compensate adequately for risk and into rejecting low-risk projects that compensate fully for the level of risk but may not have particularly high rates of return. Describe the situations when using a WACC is not appropriate and how these incorrect decisions may be made. (Hint: Use real life situation to explain your answer.) (10 marks)

c) Discuss the difference between a sticky dividend policy with a residual dividend policy. Which policy is more widely used by large corporations? What advantages does that policy have over the other? (Hint: Use real life situation to explain your answer). (10 marks)