Using your own example and diagrams and referring to academic literature, explain the logic underpinning the proposition that debt policy is irrelevant in a world where markets are perfectly competitive and efficient. Expand your answer by considering a situation where corporate taxes have been introduced and interest payments on debt are tax deductible. What implications does this new situation (where interest payments on debt are tax deductible) have for debt policy?
The assignment should cover these subjects
1.1 Understand why it is reasonable to assume that financial securities are fairly priced.
1.2 Be proficient at describing the major types of financial securities that are issued by companies.
1.3 Demonstrate knowledge of pay out policy and the differences between dividend payout and stock repurchases.
1.4 Explain the ways investors interpret information about changes to dividend payout and the reasons why companies find stock repurchases more flexible.
1.5 Demonstrate intellectual understanding of the reasons why payout policy does not affect shareholder value when financial markets are perfectly competitive and informationally efficient.
1.6 Show how frictions in markets, such as the different tax treatment of dividends and capital gains can influence corporate financing policy.
1.7 Demonstrate knowledge of the conditions under which changes to capital structure does not increase total firm value when markets are perfectly competitive and informationally efficient.
1.8 Describe the reasons why the tax treatment of interest expense on debt leads to the value of interest tax shields and why this encourages mergers.
1.9 Be able to explain why corporations merge and describe the gains and costs of mergers.
1.10 Be able to analyse and calculate the weighted average cost of capital, both with and without taxes where the interest payment on debt is a tax-deductible expense.
1.11 Provide an informed discussion that synthesises evidence on topics such as pay-out policy, debt policy, mergers and corporate governance.
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