Question：Which of the following is not a valid reason why the directors of a company might decide to retain earnings rather than pay them out as dividends?

　　A. Retention of earnings avoids the possibility of a change in control resulting from an issue of new shares

　　B. Finance from retained earnings has no cost as a source of finance.

　　C. The shareholders generally wish to make a capital profit

　　D. Retention of earnings allows the directors to undertake investment projects without involving the shareholders

　　The correct answer is: Finance from retained earnings has no cost as a source of finance.

　　解析：Finance from retained earnings has the same cost as the rest of the equity capital. However their use does not incur transaction costs.

　　If the shareholders wish to make a capital profit (2) then they will prefer their income in the form of capital growth rather than dividends. Thus they will be in favour of the company operating a policy of high retentions.

　　Since no change is made to the structure of the ownership of the business, the use of retentions (3) does avoid the possibility of a change in control.

　　4 is a valid reason. In this situation the directors will not have to go to the general meeting to obtain permission for a further capital issue to finance new projects. The use of retained earnings therefore allows them greater autonomy in their decisions.

　　Question：A company has issued 6% irredeemable preferred shares of $1 each, and 6% irredeemable bonds. The current market value of the preferred shares is $0.75 each and the current market value of the bonds is $96.00 per $100 nominal. The rate of tax is 25%.

　　What is the cost of the preference shares and the cost of the bonds?

　　A. Cost of preferred shares 8%, cost of bonds 4.7%

　　B. Cost of preferred shares 8%, cost of bonds 4.5%

　　C. Cost of preferred shares 6%, cost of bonds 4.5%

　　D. Cost of preferred shares 6%, cost of bonds 4.7%

　　The correct answer is: Cost of the preferred shares is 8%, cost of the bonds is 4.7%.

　　Cost of preferred shares = (6/75) x 100% = 8%

　　Cost of bonds = (1 - 0.25) (6/96) x 100% = 4.6875%, say 4.7%.