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Hello Sir,
Which of the following actions is LEAST likely to increase shareholder wealth?
1 The weighted average cost of capital is decreased by a recent financing decision
2 The financial rewards of directors are linked to increasing earnings per share
3 The board of directors decides to invest in a project with a positive net present value
4 The annual report declares full compliance with the corporate governance code
Answer
2
Can you please clarify why no 2 is the least likely to increase shareholder wealth
and also for no 1 option if the WACC decreased how it will affect the shareholders wealth and how it can be decreased by a financing decision?
Thanks
Although 2 may end up increasing shareholders wealth, it is the least likely because the wealth will only increase after the EPS has actually increased and not simply because the future rewards are linked to the future EPS.
The cost of capital depends on how the company is financed (raising more debt will reduce the WACC as explain in my free lectures). If the WACC falls, then the overall cost of borrowing is lower and this will increase the amount available to shareholders which in turn will therefore increase shareholders wealth.
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