F3 Exam Dumps : Financial Strategy

Workings:

BBA remits BS40 million.

Withholding tax in country B = 25%:

Tax = 25% × 40 = BS10m

Net remitted = 40 − 10 = BS30m

Company AAB pays tax of 10% on cash received:

Tax = 10% × 30 = BS3m

Net after tax = 30 − 3 = BS27m

Exchange rate: A$1 = BS3 →

\text{AAB receives in A$} = \frac{BS27m}{3} = \text{A\$9m}

Under traditional (pre–Modigliani & Miller) capital structure theory, there is an assumed inverse relationship between WACC and company value. The idea is:

As a firm moves towards its optimal capital structure, the WACC falls, and the total value of the firm (equity + debt) rises.

Beyond that optimal point, extra gearing increases financial risk, so the required return from both debt and equity goes up, causing WACC to rise and firm value to fall.

So, within this framework, if a company’s WACC increases, that means it has moved away from its optimal capital structure, and the value of the company will decrease.

Therefore, under traditional theory, an increase in WACC → decrease in company value, so the correct answer is B.

If the company switches from a residual dividend policy to a stable, growing dividend and increases its use of debt:

A. This does signal to the market that the company may be entering a more stable, mature growth phase – True.

B. A more stable dividend stream can attract a different type of investor (clientele effect) – True.

C. Directors still need to consider shareholder preferences; this statement is incorrect – False.

D. Retained earnings have an opportunity cost equal to the cost of equity and are generally not cheaper than debt – False.

E. More debt increases financial gearing and therefore financial risk – True.

Answer (200273):