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Help pls! Capital Structure

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › Help pls! Capital Structure

  • This topic has 1 reply, 2 voices, and was last updated 10 years ago by John Moffat.
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  • May 17, 2015 at 4:29 pm #246611
    Mike
    Participant
    • Topics: 11
    • Replies: 16
    • ☆

    Which of the following statement concerning capital structure theory is correct?

    A. In the traditional view, there is a linear relationship between the cost of equity and financial risk

    B. Modigliani and Miller said that, in absence of tax, the cost of equity would remain constant.

    C. Pecking order theory indicates that preference shares are preferred to convertible debt as a source of finance.

    There’s a debate between A and B.

    May 17, 2015 at 4:52 pm #246614
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54759
    • ☆☆☆☆☆

    There is no debate!! 🙂

    M&M do not say that the cost of equity will remain constant at all – they say (in the absence of tax) that the WACC will remain constant.

    The traditional view is that the cost of equity will rise with greater financial risk, but not necessarily linearly. (It is M&M who proved it rises linearly (subject to how gearing is measured)).

    The correct answer is C

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