Corporate Finance Assignment: Questions and Answers with Solutions

This finance assignment presents a series of questions designed to assess understanding of key corporate finance concepts. The questions cover a range of topics, including share valuation, dividend calculations, debt-equity ratios, cost of capital (WACC), Earnings Per Share (EPS), Dividends Per Share (DPS), financial leverage, and credit ratings. The assignment includes scenario-based questions requiring calculations and analysis of financial metrics. Further questions explore the implications of debt financing, the order of priority for claims on assets, and the factors influencing a firm's creditworthiness. This assignment helps to reinforce fundamental principles in financial management and provides a practical application of these concepts.

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Questions 1 to 6 refer to the following scenario:
When it started a few years ago, a firm issued shares at R2 a share, and
raised R600,000 in equity. These shares now trade at R6 a share on the open
market. The debt-equity mix is currently 10% (10% debt, 90% equity). The
firm has generated a net profit of R150,000 this year and, as a rule, pays out
50% of its profit as dividends to shareholders.
Question 1
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How many shares are there in issue?
Select one:
a. 600,000
b. 300,000
c. 100,000
Question 2
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What will the total amount of dividends be?
Select one:
a. R100,000
b. R75,000
c. R300,000
d. R15,000
e. R150,000
Question 3
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What will the EPS be?
Select one:
a. R0.25

b. R3.00
c. R0.50
d. R1.50
e. R0.75
Question 4
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What will the DPS be?
Select one:
a. R0.50
b. R0.75
c. R3.00
d. R1.50
e. R0.25
Question 5
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If the firm were to take on more debt, and double its debt-equity mix to 20%,
with no equity changes, what would the EPS be?
Select one:
a. R1.50
b. R0.50
c. R0.75
d. R3.00
e. R0.25
Question 6
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If the firm were to take on more debt, and double its debt-equity mix to 20%,
with no equity changes, what would the DPS be?
Select one:

a. R0.25
b. R0.75
c. R0.50
d. R1.50
e. R3.00
Question 7
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Questions 7 to 11 refer to the following scenario:
A firm finances 20% of its assets by means of debt, and the remainder
through equity. The interest rate on its debt is 12%, and the firm is subject to
tax at the standard corporate tax rate. The shareholders demand a return of
20% on their equity. What is the firm's debt-equity ratio?
Select one:
a. 80%
b. 25%
c. 40%
d. 66.6%
e. 20%
Question 8
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What is the firm’s cost of capital?
Select one:
a. 17.73%
b. 15.46%
c. 20%
d. 8.64%
e. 18.4%
f. 12%
Question 9
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If the firm decides to gear up somewhat, and now finances 40% of its assets
by means of debt and the remainder through equity, what is the firm’s debt-
equity ratio now?
Select one:
a. 20%
b. 80%
c. 40%
d. 25%
e. 66.67%
Question 10
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With the same tax rate and return on equity as the question before, what is
the firm’s cost of capital now that is has geared up?
Select one:
a. 8.64%
b. 12%
c. 15.46%
d. 20%
e. 18.4%
f. 17.73%
Question 11
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As indicated in the last two questions, has increasing the gearing of the firm
increased or decreased the cost of capital?
Select one:
a. Increased the cost of capital
b. Decreased the cost of capital
c. The cost of capital has remained the same
Question 12
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Claims on assets would be most relevant in a situation where a company is:
Select one:
a. Being liquidated
b. Making a profit
c. Making a loss
d. A going concern
Question 13
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If the corporate tax rate were to decrease, from a purely WACC perspective,
what would a business want to do?
Select one:
a. It would not affect the WACC
b. Carry less debt
c. Carry more debt
Question 14
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In a low interest rate environment, a firm might be more inclined to take on
more debt. What are some potential downsides of taking on too much debt?
Select more than one:
a. Having a higher debt-equity ratio reduces the voting power of the existing
shareholders.
b. Investors and creditors may feel there is too much debt being carried, and
get spooked.
c. The firm may not be able to meet interest repayments when interest rates
go up.
d. Increased debt levels would lead to an increased WACC.
Question 15
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In partnerships, a difference between a general partner and a limited partner
is:
Select one:
a. General partners form general partnerships; limited partners form limited
companies
b. General partners are preferential owners; limited partners are residual
owners
c. General partners have a full say in management; limited partners have
none
Question 16
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Right now, are interest rates in South Africa relatively higher or lower than
they were in 2008?
Select one:
a. They are at roughly the same level
b. Relatively higher
c. Relatively lower
Question 17
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The general trade-off made by the different types of creditors and owners of
a business could be summarised as:
Select one:
a. Having a priority claim on income or assets = having to accept a reduced
amount of the claim
b. Having a fixed amount of your claim on income or assets = having no
certainty of the claim
c. Having control of the business = having no claim on income or assets
d. Having a preferential claim on income or assets = having less say in how
the business is run
Question 18
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Which is the correct order for the flow of responsibility in a company?
Select one:
a. Management is responsible to the board, which is responsible to the
shareholders
b. The board is responsible to the shareholders, who are responsible to
management
c. The shareholders are responsible to management, who are responsible to
the board
d. Management is responsible to the shareholders, who are responsible to
the board
Question 19
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Which of the following factors are of primary importance for determining a
firm’s credit rating?
Select more than one:
a. The firm’s history of meeting payments on time
b. The quality of assets pledged as security or surety
c. The firm’s potential to generate income
d. The firm’s liquidity
e. The directors’ standing in the business community
Question 20
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Which of the following is the correct order of priority for claims on income or
assets?
Select one:
a. Creditors, then preference shareholders, then ordinary shareholders
b. Preference shareholders, then creditors, then ordinary shareholders
c. Ordinary shareholders, then preference shareholders, then creditors
d. Preference shareholders, then ordinary shareholders, then creditors
e. Creditors, then ordinary shareholders, then preference shareholders