Theories of Capital Structure Essay

1. Apple Corporation has 2.5 million shares outstanding with a market value of $2.00 each (expected return = 16%) and debt with a market value of $1, 000,000 and a return of 10% Required

a. What is the return on the capital of Apple Corporation? [Show all workings and formulae) [7.5 marks]

2. Samsung generates pre-tax earnings of $2,000,000 per year. Currently it has issued 1 million shares which sell for $10 each. Samsung has no debt in its capital structure. It is proposing a deal, which will allow it to borrow $5 million at 8% and buy back 500,000 shares and cancel them. Required

a. What will be the share price after the deal?

b. What is the weighted average cost of capital before and after the deal? [15 marks]

3. Nokia is all equity financed (that is it has no debt). Its shares have a return of 10%. Du is the same as Etisalat. It is predicting cash flows before tax and interest of $3 million a year for ever. The management of Du are trying to decide on their financing arrangements and face three scenarios: * Scenario 1: Borrow no money

* Scenario 2: Borrow $5 million at an interest rate of 6% with the balance coming from equity.

* Scenario 3: Borrow $10 million at an interest rate of 8% with the balance coming from equity.

In all three cases Du will have 1 million shares.


c. What will the share price under each scenario? [7.5 marks]

d. What is the weighted average cost of capital? [10 marks]

e. Discuss the advantages and disadvantages that may accrue to a firm and its shareholders, of the firm finances its projects using debt. [25 marks]


1. Discuss the Modigliani and Miller Theory of capital structure [10 marks] 2. Discuss the five theories of capital structure [25 marks]


Date / Time of Submission: 21:00 Hours 14th February 2013

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This last item is of particular importance; few students seem to understand what it means. If, for example, you allow another student to borrow your work and they subsequently copy some that work and present it as their own, you and they will both be punished even though someone else copied your work.

The risks of working with other students

Some assessment tasks are explicitly designed for group work, and it will be made clear that a group answer is expected from you. All other tasks are intended as an assessment of your individual comprehension and performance, and group answers are not permitted. In individually assessed forms of assessment your work must be different from that of every other student. Plagiarism can occur in assignments and any examination where the questions are issued to students in advance. In both cases it is possible for you to ask other people about how best to answer the questions or complete the necessary tasks

You should be aware that different modules and subjects may have different requirements. In some subjects, answers to questions may, for example, require every student on a module to employ or refer to the same diagram(s), concepts and the like in order to construct an acceptable answer. You should note, however, that even in these circumstances your explanations of what the diagrams mean, and any other writing referring to any common diagrams and concepts should all be in your own words. Moreover, the situation may be very different on other modules, where the submission of work that has a very similar structure, or the use of very similar materials such as concepts, diagrams, quotations and the like, to that of another student, may lead to you being accused of plagiarism.

The picture is complicated and, unfortunately, it is not possible to give advice that is directly relevant to every module you study. If you are unsure about how to avoid plagiarism in any specific module, then rather than hoping and guessing, you should ask for guidance from the member of staff who delivers that module.

Our overall advice is straightforward; by all means discuss how best to answer questions or complete tasks with your colleagues, but when it comes to actually writing your answers – DO IT ALONE! What happens if you get caught?

Contrary to some student rumours, getting caught and being punished for committing plagiarism is not an extremely unusual student offence.

Examination Boards may punish offending students in any manner that they deem fit. Typical punishments Boards may choose range from reducing grades, making students re-sit modules, through to failing students on a module or an entire award. The University regards this form of cheating as a serious offence. Full details of the range of likely punishments can be found on the University’s web-site under the heading ‘Procedures for dealing with suspected cases of academic dishonesty.

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