Question 1

Section B - Case 2: NeuroLink Prosthetics

Scenario: NeuroLink Prosthetics is a MedTech firm. It has 10 million ordinary shares in issue, currently trading at $4.50 per share. The company's equity beta is 1.2. The risk-free rate of return is 4% and the expected return on the market portfolio is 10%. NeuroLink also has $15 million (nominal value) of 6% redeemable bonds, currently trading at $95 per $100 nominal, redeemable at par in 5 years. The corporate tax rate is 25%.

NeuroLink needs to raise an additional $5 million for R&D. The CFO suggests following the Pecking Order Theory.

Question: According to the Pecking Order Theory, what is the preferred order of financing sources?

Accepted Answer

Recall the Pecking Order Theory, which is based on asymmetric information. Managers prefer sources of finance that require the least amount of disclosure and have the lowest issue costs.

Question 2

What mistakes do candidates make on this ACCA question?

Accepted Answer

Thinking that debt is always bad and equity is preferred, which contradicts the theory.

How to approach this question

Full Answer

Common mistakes

Practice the full ACCA FM — Financial Management Practice Exam 6

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