You discover an investment costing $3,000 which has an expected total return of 15% pa, but a required return of only 11% pa. Of the 15% pa total expected return, the capital return is expected to be 8% pa. Assume that the required return of 11% remains constant, the dividends can only be re-invested at 11% pa and all returns are given as effective annual rates.

Which of the following statements is NOT correct?

a.When plotted on the Security Market Line, the investment would have a positive alpha.

b.You would use a discount rate of 11% to find the NPV of this investment

c.The expected dividend return is 7%

d.The investments price at time t=20 would be $49,099.61

e.The investment is currently under-priced

Which statement about capital structure is the most correct?

a.The more the company borrows, the lower will be the after-tax WACC. This increases the present value of the firm free cash flows which represents the value of the levered firm. Therefore, a firm should always seek to borrow as much debt as possible.

b.The more the company borrows, the higher will be its tax shields, therefore a company will always prefer to issue debt than equity.

c.Because the cost of debt is cheaper than the cost of equity, a company should use as much debt as possible to finance their projects

d.Lenders rank ahead of shareholders when the company goes bankrupt. This increased risk for shareholders means the cost of equity is higher than the cost of debt.

e.A company should always try to reduce its debt because of the high bankruptcy risk associated with debt. A company should aim to have 100% equity financing if it is possible.

Which of the following would reduce a firm's WACC after tax?

a.A firm invests in an average-risk project using equity, rather than debt financing.

b.A supermarket chain decides to establish hardware stores which increases its systematic risk.

c.A firm issues shares and uses the proceeds to pay off a bank loan.

d.A firm issues bonds and uses the proceeds to repurchase stock.

e.A firm significantly improves its operating cost control to boost profits.