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MC Question 19

Par Co currently has the following long-term capital structure:
$m $m
Equity finance
Ordinary shares 30·0
Reserves 38·4
68·4
Non-current liabilities
Bank loans 15·0
8% convertible loan notes 40·0
5% redeemable preference shares 15·0
70·0
Total equity and liabilities
138·4

The 8% loan notes are convertible into eight ordinary shares per loan note in seven years’ time. If not converted, the loan notes can be redeemed on the same future date at their nominal value of $100. Par Co has a cost of debt of 9% per year.

The ordinary shares of Par Co have a nominal value of $1 per share. The current ex dividend share price of the company is $10·90 per share and share prices are expected to grow by 6% per year for the foreseeable future. The equity beta of Par Co is 1·2.

The loan notes are secured on non-current assets of Par Co and the bank loan is secured by a floating charge on the current assets of the company.

Which of the following statements relating to the capital asset pricing model is correct?

A. The equity beta of Par Co considers only business risk
B. The capital asset pricing model considers systematic risk and unsystematic risk
C. The equity beta of Par Co indicates that the company is more risky than the market as a whole
D. The debt beta of Par Co is zero

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