100% satisfaction guarantee Immediately available after payment Both online and in PDF No strings attached
logo-home
FIN4801 Assignment 5 2024 (Detailed solution) R53,06   Add to cart

Exam (elaborations)

FIN4801 Assignment 5 2024 (Detailed solution)

 26 views  0 purchase

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,...

[Show more]

Preview 2 out of 5  pages

  • August 28, 2024
  • 5
  • 2024/2025
  • Exam (elaborations)
  • Questions & answers
book image

Book Title:

Author(s):

  • Edition:
  • ISBN:
  • Edition:
All documents for this subject (14)
avatar-seller
GeniusGears
FIN4801


Assignment 5


2024


Detail Solution

, a) Impact of Capital Structure Changes on Risk Profile and Expected Return
1. Financial Leverage and Risk Profile:


Financial Leverage: Financial leverage refers to the use of debt to finance the
company’s assets. A higher level of debt increases financial leverage, while a
reduction in debt decreases it.


Impact on Risk Profile: When a company reduces its financial leverage by lowering
its debt levels, as Offices Ltd. plans to do, the risk profile of the company generally
decreases. This is because debt introduces fixed obligations in the form of interest
payments, which can strain cash flows, especially in periods of low profitability or
economic downturns. A reduction in debt lowers the likelihood of financial distress
and bankruptcy, thus reducing the company’s overall risk profile.


Systematic Risk (Beta): The systematic risk of a company, as measured by its
beta, is influenced by its leverage. Beta measures the sensitivity of the company's
returns relative to the market. High leverage amplifies the sensitivity (beta) because
debt magnifies the impact of business risks on equity holders. By reducing debt,
Offices Ltd. is expected to lower its beta from its current level of 1.9, indicating a
decrease in systematic risk relative to the market.


Default Risk: A company with high levels of debt faces increased default risk due to
the obligation to meet fixed interest payments. Lowering debt reduces default risk,
which improves the company’s creditworthiness and might result in lower interest
rates on future borrowings.


2. Expected Return:


Return on Equity (ROE): The return on equity is affected by leverage due to the
difference in cost between debt and equity. With high leverage, the ROE can be
higher during profitable periods due to the tax shield provided by debt (interest
expense is tax-deductible). However, if profitability is low, the high interest costs can
erode returns to shareholders.


Impact of Reduced Leverage on Expected Return: With a reduction in debt,
Offices Ltd. would experience lower interest expenses, which could improve net
income and consequently, the return on equity (ROE). However, the direct impact on
expected return depends on how the market perceives the change in risk. Typically,

The benefits of buying summaries with Stuvia:

Guaranteed quality through customer reviews

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

Quick and easy check-out

You can quickly pay through EFT, credit card or Stuvia-credit for the summaries. There is no membership needed.

Focus on what matters

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 this summary from?

Stuvia is a marketplace, so you are not buying this document from us, but from seller GeniusGears. Stuvia facilitates payment to the seller.

Will I be stuck with a subscription?

No, you only buy this summary for R53,06. You're not tied to anything after your purchase.

Can Stuvia be trusted?

4.6 stars on Google & Trustpilot (+1000 reviews)

79271 documents were sold in the last 30 days

Founded in 2010, the go-to place to buy summaries for 14 years now

Start selling
R53,06
  • (0)
  Buy now