ADVANCED FINANCIAL DECISION QUESTION AND ANSWERS PART3

ANSWER 1
(a) Assumptions of the traditional theories of capital structure:


There are only two forms of long term capital namely equity and long term debt
capital
There are no corporation and personal taxes.
The firm distributes all earnings attributable to owners as dividends, that is, adopts
100% payout ratio as its dividend policy.
The firm generates the same earnings before interest and tax (E.B.I.T) each year.
The investor’s have similar or homogenous expectations about the firm’s operating
profit.
The firm will remain operating as a going concern.




ANSWER 2
(a)Comment on the assertion that capital structure is strongly influenced by
managerial behaviour.
There are potential conflicts of objectives between owners and managers (agency
problems). Capital structure will be influenced by senior managers’ personal objectives,
attitudes to risk, compensation schemes and availability of alternative employment. A
risk-averse manager seeking security may use relatively little debt. Free cash flow (cash
flow available after replacement investment) is sometimes perceived to be used by
managers for unwise acquisitions/investments which satisfy their personal objectives,
rather than returning it to shareholders. Many such managerial/agency aspects may
influence capital structure.


QUESTION 3

Distinguish between the following terms as used in corporate reorganisation
and capital reconstruction:
i) Divestment and unbundling.
ii) Management buy-out and management buy-in.


ANSWER 4
i) Divestment and unbundling
Divestment is the withdrawal of investment in a business. This can be achieved
either by selling the whole business to a third party or by selling the business assets
piecemeal.


Unbundling is the process of selling off incidental non-core businesses to release
funds, reduce gearing and allow management to concentrate on their chosen core
businesses.


ii) Management buy-out and management buy-in
Management buyout-strictly this occurs where the executive managers of a
business join with financing institutions to buy the business from entity which
currently runs it. The managers may put up the bulk of the finance required for the
purchase.





Management buy-in– this is where a group of managers from outside the business
make the acquisition

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