CFS Practice Qu / Tutorials

Q: Why does a carbon tax affect EBIT?

A: It increases operating costs, reducing EBIT.

Q: Does a carbon tax change WACC?

A: No, if financing and risk are unchanged, WACC stays the same.

Q: Ignoring taxes, why is a share repurchase equivalent to a cash dividend?

A: Both return cash to shareholders without changing firm value.

Q: How do shareholders receive value under a repurchase?

A: Higher share price due to fewer shares outstanding.

Q: Why does firm value change after issuing debt?

A: Interest tax shields increase firm value.

Q: Which MM proposition explains this?

A: Modigliani-Miller Proposition I (with corporate taxes).

Q: What does Trade-Off Theory say about capital structure?

A: Firms balance tax benefits of debt against financial distress costs.

Q: Why don't firms use 100% debt?

A: Bankruptcy and agency costs rise at high debt levels.

Q: One problem Imperial Breweries might face with high debt?

A: Higher probability of financial distress.

Q: Another problem from excessive debt?

A: Reduced financial flexibility and underinvestment risk.

Q: Why do firms prefer share repurchases over dividends? (Flexibility)

A: Repurchases are one-off; dividends imply ongoing commitment.

Q: How do repurchases relate to executive compensation?

A: They support share prices and option-based pay.

Q: How do repurchases offset dilution?

A: They counter new shares from employee option exercises.

Q: What signal can a repurchase send?

A: Management believes the stock is undervalued.

Q: What tax advantage do repurchases have?

A: Capital gains often taxed lower than dividends.

Q: Why do some firms prefer high dividend payouts? (Income demand)

A: Investors value regular cash income.

Q: What is the "bird-in-the-hand" argument?

A: Certain dividends preferred over uncertain capital gains.

Q: Behavioural reason for dividends?

A: Dividends act as a commitment device.

Q: How do dividends reduce agency costs?

A: They reduce free cash flow managers could waste.

Q: What is dividend signalling?

A: High dividends signal confidence in future earnings.

Q: Why are firms reluctant to cut dividends?

A: Markets react negatively to dividend cuts.

Q: Good reason for leasing: tax differentials?

A: Lessor values depreciation tax shields more.

Q: How does this benefit the lessee?

A: Lower lease payments.

Q: Leasing advantage regarding obsolescence?

A: Residual value risk transferred to lessor.

Q: Transaction cost advantage of leasing?

A: Lower costs than issuing debt or equity.

Q: Why is "off-balance sheet financing" a bad reason now?

A: IFRS 16 requires most leases on the balance sheet.

Q: Why is avoiding CapEx controls a bad reason to lease?

A: It reflects agency problems, not value creation.

Q: Why is "100% financing" a weak leasing argument?

A: Secured debt can also achieve high leverage.