Question

PLEASE WRITE ANSWER IN YOUR OWN WORDS BECASUE I HAVE TO SUBMIT THE ANSWER ON TURTIN

1. Provide an appropriate answer to the following questions:

a. What are the main differences between preference shares and ordinary shares? Explain.

b. Explain the concept of “Diversification” in finance.

c. Explain the terms systematic risk and unsystematic risk.

d. Explain each of the components of the Weighted Average Cost of Capital formula below:

WACC = [ D/V × (1 − Tc)r_debt] + (E/V × r_equity)

D =

V =

Tc =

r_debt =

E=

r_equity =

Answer 1

1.(a)Main differences between preference shares and ordinary shares are as follows:

i)The holders of ordinary shares have voting right,usaully one vote per share whereas preference shares holders often do not have voting right.

ii)Dividend on preference shares is guaranteed whereas dividend on ordinary shares is not.

(b)In Finance,diversification is the process of allocating capital in a way that reduces the exposure to any one particular assets or risk.It is the technique of allocating portfolio or capital to a mix of different investments.The ultimate goal of diversification is to reduce the voltality of the portfolio by offsetting the losses of one asset class by the gains of another asset class.

(c)Systematic risk refers to the probabilty of a loss associated with the entire market or the segment.It is also known as undiversifiable risk,volatility or market riskIt is a macro level risk.

Unsystematic risk is the danger that relates to a particular security or a portfolio of securities.It is also known as diversifiabe risk or non systematic risk.

(d)

D =Value of Debt

V =Sum of value of debt and value of equity

Tc =Tax rate

rdebt =Cost of debt

E=Value of equity

requity =Cost of equity

*Value can be Market value or book value,as required.