Financial Management: WACC, Equity vs Debt Financing, and Financial Risk Measurement

Online Exam - financial
management

TABLE OF CONTENTS
QUESTION 2...................................................................................................................................3
A..................................................................................................................................................3
B..................................................................................................................................................3
C..................................................................................................................................................4
REFERENCES................................................................................................................................6

QUESTION 2
A
Current market value weighted average cost of capital (WACC)
WACC= (E/ V * Re) + [(D/ V * Rd * (1 – Tc)]
Where
E= market value of total equity
D= market value of total debt
V= total market value of debt and equity that is E + D
Re= total cost of equity
Rd= total cost of debt
Tc= income tax rate
Equity- 40 million
Preference= 18 million
Debenture= 210 million
Bank loan= 30 million
Total value= 298 million
WACC= (40 / 298 * 1.4) + (18/ 298 * 10%) + [(210/ 298 * 6%) + (30 / 298 * 7 %) * (1 – 20%)
= 0.187 + 0.006 + (0.042 + 0.007 * 0.8)
= 0.193 + 0.0392
= 0.2322
B
Investor has the main objective for investing into company is to have higher level of
return. The are two ways in which funds can be provided such as equity & debt. In case of equity
financing there are higher possibilities are considered to have higher level of return as compared
to debt due to several reasons. There are larger possibilities of obtaining the return on equity as
compared to debt due to the reason of achieving higher profitability which is basically taken into
consideration for providing divided to equity shareholders. Debt is considered to be an obligation
which possesses fix ate of interest that can be obtained by provided. In case of equity there is
possibility of getting higher return by using available equity. The main reason behind conducting