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Supplementary objective test questions

31 Leslie Co is an all equity financed company which has $100 million of equity (at
market value) in issue. Its cost of equity is 15%.

In order to take advantage of tax relief on debt interest, the company intends to
change its capital structure by raising $25 million of debt finance and using it to
repurchase shares.

Assuming that the rate of corporate income tax is 40%, what will be the
weighted average cost of capital of Leslie Co, assuming that the
assumptions underpinning Modigliani and Miller’s gearing theory apply?

A 13.50%

B 13.00%

C 13.24%

D 13.64%

32 A and B are two companies that are the same in every way apart from their
capital structures.

A has an equity value of $80 million and debt value of $25 million.

B’s debt value is $41 million.

The rate of corporate income tax is 25%.

What is the value of the equity of B, using Modigliani and Miller’s gearing
theory?

A $65 million

B $68 million

C $99 million

D $109 million

33 According to Modigliani and Miller’s dividend Irrelevance theory, the
process of ‘manufacturing dividends’ refers to which of the following?

A Investing plans designed to create regular returns to shareholders

B Creative accounting to allow dividends to be paid

C Investors selling some shares to realise some capital gain

D Dividends from manufacturing businesses

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