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Subject F3: Financial Strategy

28 Which of the following statements is part of the traditional theory of
gearing?

A There must be taxes

B There must exist a minimum WACC

C Cost of debt increases as gearing decreases

D Cost of equity increases as gearing decreases

29 The traditional view of gearing concludes that:

A The value of the company reduces as the gearing level increases

B The value of the company increases as the gearing level increases

C The value of the company is unaffected by the gearing level

D There is an optimum gearing level at which the value of the company is
maximised

30 May Co has a gearing ratio of 30:70 (debt : equity by market value).

The shareholders of May Co currently require a return of 13% and the lenders
require a return of 7%. The rate of corporate income tax is 30%.

Morgan Co is a company that operates in the same business sector as May Co,
but it is an all-equity financed company.

What is the cost of equity of Morgan Co assuming that the assumptions
underpinning Modigliani and Miller’s gearing theory apply? ____________
(enter your answer as a percentage, to one decimal place)

398