CONFIDENTIAL 1 AC220/JAN 2021/MAF 603

UNIVERSITI TEKNOLOGI MARA

TEST 2

COURSE : CORPORATE FINANCE

COURSE CODE : MAF603
EXAMINATION : 9 JANUARY 2021
TIME : 1 HOUR 15 MINUTES

INSTRUCTIONS TO CANDIDATES

1. This question paper consists of two (2) questions.

2. Write your FULL NAME and STUDENT ID on every pages of your answer paper.

3. Answer ALL questions in English.

4. Submit your answers in a pdf file format to respective GOOGLE CLASSROOM. Use your Full
Name and Student ID as the file name. See example below.

Abdul bin Razak_4C_2018123456

DO NOT TURN THIS PAGE UNTIL YOU ARE TOLD TO DO SO

This examination paper consists of 3 printed pages
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 CONFIDENTIAL 2 AC220/JAN 2021/MAF 603

QUESTION 1

Kappim Bhd is a levered company that involved in producing metal products. In order to
increase its revenue, the company plans to purchase 2 units of the latest model of furnace
structure from China. The cost of each furnace structure is RM1,450,000 including RM100,000
for transportation cost .

Mr. Fairuz, the vice president of finance has come up with proposed plan on how to raise the
needed funds for the purchase of the furnace structures as presented below:

Sources of funds Proposed issue price Stated Interest Underwriting

or Dividend cost
rate per annum
Redeemable bonds – 12% below 8% 4% on
RM1,000 par value with par value proposed
8 years maturity issue price
Preference shares – 10% above par value 10% 8% on
Par value RM100 per proposed
unit issue price
Ordinary shares EPS RM5 and P/E ratio 3 - 10% on
(inclusive current year proposed
dividends) issue price

The capital structure of Kappim Bhd is considered optimal and it is as follows:

Source of Financing RM
10% Redeemable bonds 2,000,000
8% Preference shares 2,000,000
Ordinary shares 3,500,000
Retained earnings 2,500,000

Last year, the dividends paid to ordinary shareholders was based on the EPS of RM5.00 while
the retention ratio is 70%. The dividend is expected to grow at a constant rate of 4%. The
bonds will be redeemed at par value at the end of the maturity period. Retained earnings
available for reinvestment amounted to RM1,250,000 and the corporate tax rate is 24%.

Required:

a. As the financial manager of the company, Mr. Fairuz asked you to prove him regarding
the cost of raising capital, from the cheapest to the most expensive cost. Compute the
following costs:

i. Cost of bonds
ii. Cost of preference shares
iii. Cost of internal equity
iv. Cost of external equity
(13 marks)

b. If Kappim Bhd were to purchase the furnace structures, which cost of equity it will incur,
kc or knc? Justify your answer.
(3 marks)

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 CONFIDENTIAL 3 AC220/JAN 2021/MAF 603

c. Areka Bhd is planning to invest in a new project that is significantly different from its
existing business operations. This company is financed 30% by debt and 70% by equity.
It has identified Mayang Bhd with business operations similar to the proposed investment.
Mayang Bhd has an equity beta of 0.81 and is financed 25% by debt and 75% by equity.

Assume that the risk-free rate of return is 4% per year, and that the equity risk premium is
6% per year. Assume also that all the companies pay tax at a rate of 24% per year.
Calculate a project-specific discount rate for the proposed investment.
(4 marks)
(Total: 20 marks)
QUESTION 2

a. The management team of Amazing Bhd. is considering a financial flexibility in an

investment opportunity. The company would have to raise RM8,000,000 in additional
funds if they were to take up the project. Currently, the company is an all equity and
expects to have perpetual EBIT of RM5,000,000 a year. The existing shareholders of
the company required 8% return for their investment in the company. This investment
opportunity is expected to increase the perpetual EBIT to RM6,000,000. The corporate
tax rate is 24%.

As the corporate financial manager of the company, you have suggested to the Board
of Director that the investment plan is to be financed entirely by 6% convertible bonds.
During the Board of Director meeting, you try to convince them by making statement that
issuing debts will increase the value of company and lower its overall weighted cost of
capital.

Required:
Prove your statements by computing the following:
i. Value of the company before and after capital restructuring.
ii. Overall cost of capital after the restructuring.
(10 marks)

b. ImTech Engineering is involved in construction business. Currently, the company is

ungeared with 40,000 units of ordinary shares outstanding with assets value at
RM1,000,000. The company expects operating income in the current period to be
RM450,000. Suppose that the company can exchange 4,000 unit of ordinary shares for
RM100,000 in debt paying 8% interest, from the standpoint of EPS, would the exchange
be wise? (Assume no tax).
(4 marks)

c. “A firm’s stockholders will never want the firm to invest in projects with negative net
present values”.

Comment on the above statement.

(4 marks)

d. In a world with no taxes, no transaction costs and no costs of financial distress,

“Moderate amount of borrowing will not increase the required return on a firm’s equity”

Is the above statement true or false? Explain.

(2 marks)
(Total: 20 marks)

END OF QUESTION PAPER

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