Question 1 (40 Marks) (Capital structure decision making, learning units 7, 13 and 14) Read the following case and then answer the required section below the case: Offices Ltd. is a construction company focused on office space, which in the past had a large market capitalisation and turnover, but, ...
FIN4801 Assignment 5 Full Solutions 2024 ;100 % TRUSTED workings, Expert Solved, Explanations and Solutions.
FIN4801 Assignment 5 Full Solutions 2024 ;100 % TRUSTED workings, Expert Solved, Explanations and Solutions.
FIN4801 Assignment 5 Full Solutions 2024 ;100 % TRUSTED workings, Expert Solved, Explanations and Solutions.
All for this textbook (26)
Written for
University of South Africa
Advanced Financial Management
All documents for this subject (14)
Seller
Follow
masterstudy
Reviews received
Content preview
FIN4801
Assignment 5 (COMPLETE ANSWERS)
2024
, FIN4801
Assignment 5 2024
Question 1
a.) Impact of Capital Structure Changes on Risk Profile and Expected Return
When a company changes its capital structure, particularly by altering the ratio of debt
to equity, the risk profile and expected return of the company are affected in the
following ways:
1. Risk Profile:
o Financial Risk: Increasing the proportion of debt in the capital structure
generally increases the company’s financial risk. This is because higher
debt levels lead to higher fixed obligations in the form of interest
payments, which the company must meet regardless of its operating
performance. Conversely, reducing debt, as Offices Ltd. plans to do,
would lower financial risk because there would be fewer interest
obligations.
o Operating Leverage: The reduction in financial leverage may also affect
the company's operating leverage. Lower debt reduces the sensitivity of
net income to changes in EBIT, thereby lowering the overall volatility of
earnings and reducing risk.
o Default Risk: A reduction in debt decreases the likelihood of default, as
the company will have lower interest payments and more cash reserves,
thus enhancing its creditworthiness.
2. Expected Return:
o Cost of Equity: According to the Capital Asset Pricing Model (CAPM), the
cost of equity (Ke) depends on the company’s beta, which reflects its
systematic risk. If a company reduces its leverage, the beta may decrease
because the company becomes less risky. A lower beta would reduce the
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller masterstudy. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for $2.50. You're not tied to anything after your purchase.