1
Q
Through which methods can a firm finance its fixed assets?
A
- Equity or
2. Long-term debt
2
Q
What are the tax benefits of paying interest?
A
- It is an expense item in the firm’s statement of financial performance
- It reduces the earnings before tax (EBT) used in calculating the firm’s tax liability.
- After tax cost of debt = interest rate x (1 - tax rate)
- The dividends paid on ordinary shares come from the net income (EAT)
3
Q
The firm’s cost of capital is also referred to as what?
A
The required rate of return
4
Q
Explain the Cost of Capital.
A
- The cost of capital depends on the proportion that each form of financing contributes to the total financing of a firm and the required rate of return on each form of financing.
- The cost of capital is a weighted average cost.
5
Q
Explain Financial Leverage (Gearing)
A
- It involves the use of debt financing in order to increase the EPS and the value of the firm.
- The value of the firm can be increased by lowering the firm’s cost of capital.
- Cost of capital can be lowered by increasing the debt-equity ratio.
