TEST 2 JUNE 2021/MAF603

UNIVERSITI TEKNOLOGI MARA

ONLINE COMMON TEST 2

COURSE : CORPORATE FINANCE

COURSE CODE : MAF603
TEST : JUNE 2021
TIME : 2 HOURS

INSTRUCTIONS TO CANDIDATES

1. This is an online test question consist of 30 Multiple Choice Questions.

2. Click "SAVE/NEXT/FINISH/SUBMIT" button for each question and after completed.

3. Answer ALL questions.

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

This examination paper consists of 3 printed pages

Instruction: Choose the most appropriate answer.

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1. Yellow Bhd plans to issue new debenture with no maturity period to finance one of its
projects. Yellow Bhd will offer 10% coupon rate of interest to be paid annually. The
debenture will be issued at premium 8.6% above its par value. The par value and
corporate tax rate is RM1,000 and 24% respectively. Calculate the cost of new
debentures.

A. 5%
B. 6%
C. 7%
D. 8%

(1 mark)

2. A firm issue 12% preferred shares at price RM220. The flotation cost on new issue of
preferred shares is RM2.00 per share. If the par value is RM200, how much is the
effective cost of preferred shares?

A. 10.43%
B. 11.01%
C. 12.07%
D. 13.54%

(1 mark)

Question 3 and Question 4 refer to the following scenario:

The board of directors Blue Bhd has approved the issuance of new ordinary shares as part
of financing the business expansion. The flotation cost of new ordinary stocks is estimated at
10% from the market price. The shares are currently traded at market price RM45.00 per
share. Last year, Blue Bhd declared dividend on ordinary shares at RM5.00 per share. For
next year, the board believed that the expansion will improve the firm’s performance and
dividend to grow at a rate of 6%.

3. Compute the cost of internal equity.

A. 19.09%
B. 18.60%
C. 10.08%
D. 17.78%
(1 mark)

4. Compute the cost of new ordinary shares.

A. 19.08%
B. 18.60%
C. 10.08%
D. 17.78%

(1 mark)

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5. Brown Bhd financed its new chalets and resorts using borrowings. The number of
tourists stayed at its chalets and resorts dropped heavily for the last two years due to
inter-state travel ban. Brown Bhd has difficulty to alleviate the cash flow problem
including servicing its debt. If the inter-state travel ban persists, Brown Bhd will expose to
the situation of:

A. Agency Problem.
B. Merger and Acquisition
C. Financial Distress.
D. Restructuring Exercise.
(1 mark)

6. Capital Asset Pricing Model (CAPM) is used to estimate the cost of equity for project
appraisal. The following statement is TRUE about the assumptions of applying CAPM,
EXCEPT:

I. Investors may borrow at risk free rate

II. The portfolio investment must be large and well diversified
III. Incurs flotation cost on the issuance of new shares
IV. Investors are rational and risk-takers attitude

A. I and II
B. III and IV.
C. II, III and IV
D. I, II, III and IV

(1 mark)

Question 7 and Question 8 refer to the following scenario:

Below is the optimal capital structure of Silver Bhd as at 31 May 2021

Capital RM
10% Bonds 200,000
8% Preferred Shares 300,000
Common Equity 500,000
1,000,000

Silver Bhd plans to use various internal and external sources of financing to fund the project
and has estimated the individual cost of capital as follows:
i. Pre-tax cost of 10% Bonds is 7%
ii. Cost of 8% Preferred Shares is 11%
iii. Cost of internal and external equity is 19% and 21% respectively
Silver Bhd forecast retained earnings of RM100,000 for the coming year. Only 50% of the
retained earnings are available for re-investment purposes. The corporate tax rate is 24%.

7. Ascertain the weighted average cost of capital if project financed with retained earnings

A. 13.86%
B. 13.76%

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C. 14.20%
D. 14.25%
(1 marks)

8. Suggest the new marginal average cost of capital if the project cost exceed RM150,000.

A. 12.27%
B. 13.56%
C. 14.86%
D. 15.20%
(2 marks)

9. Green Ltd has reported declining earnings before interest and tax (EBIT) for three
consecutive years due to economic recession. This year, EBIT has reduced again by
10% from the last year reported earnings RM30 million. The firm’s unlevered cost of
capital is 20%. Real Consulting Ltd has estimated the value of Green Ltd would be
reduced to RM180 million. If the net present value of liquidation and litigation cost are
RM35 million and RM15 million respectively. Determine the present value of tax shield
on debt.

A. RM50 million
B. RM95 million
C. RM135 million
D. RM230 million

(2 marks)

10. Which of the following does not make the firm more susceptible to meet its financial
obligation and ultimately lead to a financial distress?

I. High vulnerability of the company's revenues to the changes on economic macro

policy.
II. 60% of the operation costs are fixed in nature.
III. Physical non-current assets which are relatively illiquid and difficult to market.
IV. The choice of financing is affected by the price volatility.

A. I and II
B. III and IV.
C. II, III and IV
D. I, II, III and IV

(1 mark)

11. Which one is the reason cost of debt must be net of corporate tax?
A. Regulation imposed by Inland Revenue Board
B. Interest on redeemable debt is paid until period of maturity expires.
C. Interest on irredeemable debt is to be held indefinitely
D. Interest payments on debt are tax deductible.
(1 mark)

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12. Develop steps to determine weighted average cost of capital (WACC) in correct order of
sequence.
A. Calculate after tax of individual cost of capital, determine the weightage of each
component cost of capital, determine the weight in percentage, computes the firms
WACC
B. Determine the weightage of each component cost of capital, determine the weight in
percentage, calculate after tax of individual cost of capital, computes the firms WACC
C. Calculate after tax of individual cost of capital, determine the weight in percentage,
determine the weightage of each component cost of capital, computes the firms
WACC
D. Computes the firms WACC, calculate after tax of individual cost of capital, determine
the weightage of each component cost of capital, determine the weight in percentage

(1 marks)

13. Red Co. has issued a 5% corporate bond at a premium of 10% from the par value of
RM1,000. The flotation cost is 5% of the issued price. The period of redemption is 10
years and will redeem at value of RM1,020. The corporate tax is 24%. What is the best
estimate of the cost of the corporate bond?

A. 4.60%
B. 3.50%
C. 5.25%
D. 8.62%
(2 mark)

14. The following statement is regarding the beta of a firm. Which one of the following
combinations (true/false) relating to the statements is correct?

Statement 1: The de-geared beta assets is to capture the business risk of similar
projects of the existing company business.
Statement 2: The re-geared beta equity of proxy company is to capture the financial risk
of a proxy company.

Statement 1 Statement 2
A. True True
B. True False
C False True
.
D False False
.
(1 mark)

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15. Purple Bhd is a confectionary manufacturer wishes to embark into medical equipment
supplies in view of good market outlook in the health industry. Currently, Purple Bhd has
400 million and 100 million, equity value and debt value respectively. A proxy company
currently in the medical equipment supplies has beta equity value of 1.55 and equity to
debt ratio of 3 to 2.

The rate of return on Malaysian Treasury Bills is paying at 3% per annum. The average
return on stock market is 10% and the corporate tax is 24%. Advise Purple Bhd the
estimate cost of discount rate (Ke) in medical equipment supplies.

A. 13.8%
B. 12.5%
C. 11.6%
D. 10.2%
(2 marks)

16. Invest Consulting Ltd advises the board members of Black Bhd to revise the firm’s
current weighted average cost of capital (WACC) to appraise the potential of new
project. Which of the following statements are CORRECT about the characteristics of
the new project?

I. The cost of the new project will not affect Black Bhd’s current capital structure
II. Black Bhd need to have a specific financing for the new project that requires huge
funding.
III. The new project is big relative to the size of Black Bhd
IV. The new project is related to the existing business of Black Bhd

A. II and III only

B. I and IV only
C. III and IV only
D. I and II only

(1 marks)

17. Magenta Ltd plans to issue 1,000 unit of 5% Irredeemable Bonds to raise additional
capital for the expansion of the business. The nominal value of the bond is RM100 per
unit and currently selling as a discount of 2%. Maxes need to incur cost 10% of the
market value during the issuance process. Assume the tax rate is 25%, calculate the
after-tax cost of debt.
A. 3.83%
B. 4.17%
C. 4.25%
D. 5.67%
(2 marks)

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18. Shareholder of Small Pharmacy Bhd have expected return of 10% from its’ ordinary
shares, which have a beta of 1.5. The expected market return is 8%. What will be the
expected return for shareholders of Health Line Pharmacy, which have a beta of 1.2?
A. 8.0%
B. 8.6%
C. 8.8%
D. 10%
(2 marks)

19. The asset βeta (βa) or ungeared βeta is the βeta value that used to capture the following
types of risk which arising from the asset of the business such as:

A. Default risk
B. Business risk
C. Financial risk
D. Both business risk and financial risk
(1 marks)

20. Which of the following are the assumption that lie behind the Modigliani-Miller theory in
a world without tax?
I. No tax
II. No transaction cost
III. Individuals and corporations borrow at same rate
IV. Individuals borrow at higher rate compared to corporations

A. I, II and IV only
B. I, II and III only
C. I and III only
D. All the above
(1 marks)

21. Which of the following are considered as direct cost of financial distress?
I. Loss of potential sales as customers had switched to other competitors
II. Cost of hiring lawyers before and during bankruptcy
III. Cost to appoint a liquidator
IV. Fees to pay all the legal claims made by the stakeholders

A. I only
B. I, II and III only
C. II, III and IV only
D. All the above

(1 marks)

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22. What is / are the rationale(s) of using internal financing as proposed by Pecking-Order
Theory?
I. Firms does not have to incur transaction cost to obtain it
II. Firms does not have to pay the taxes associated with paying dividends
III. It is generally less expensive than the external financing

A. I only
B. I and II only
C. I and III only
D. I, II and III.
(1 marks)

23. Which of the following describe the selfish strategy undertook by the shareholders
during financial distress?
A. The shareholders influence the managers to invest in low risk project
B. The shareholders influence the managers to invest in positive net present
value (NPV) project
C. Pay extra dividend to the shareholders in times of financial distress
D. Pay high interest to the bondholders
(1 marks)

24. Which of the following justify the relevance of Pecking Order Theory?
I. Companies want to minimize issuance cost
II. Companies will want to minimize the time and expense involved in
persuading outside investors of the merits of the project.
III. The existence of asymmetrical information and the presumed information
transfer that result from management actions.

A. I only
B. I and II
C. II and III
D. I, II and III
(1 marks)

25. Which of the following statements do not describe the Modigliani-Miller Proposition I in
a world without tax.
A. The value of the all equity firm is the same as the value of the levered firm
B. The value of the levered firm is more than the value of the levered firm
C. If VL > VU, shareholders can borrow on personal account and buy shares in all
equity company using personal, and they can get the same dividend as in the
levered firm.
D. Firms cannot change the total value of its outstanding securities by changing
proportions of its capital structure.
(1 marks)

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26. Consider the following statements

Statement 1: In a world of no taxes, the value of the firm is unaffected by capital
structure.
Statement 2: In a world of taxes, but no bankruptcy costs, the value of the firm
increases with leverage.

Which one of the following combinations (true/false) relating to the above statements
is correct?

Statement 1 Statement 2
A. True True
B. True False
C. False True
D. False False

(1 marks)

Question 27 and Question 28 refer to the following scenario:

Excellent Trust Bhd is currently an all-equity firm, but it can borrow at 10% rate of interest
per annum. The firm expects its earnings before interest and tax (EBIT) to be RM100,000
every year in perpetuity. The firm’s cost of equity is 20%. The corporate tax rate is 25%.

27. Determine the current value of the firm.

A. RM 350,000
B. RM 375,000
C. RM 500,000
D. RM 75,000

(2 marks)

28. Determine the new value of Excellent Trust Bhd if the firm borrows RM50,000 and uses
the proceeds to repurchase shares

A. RM 12,500
B. RM 362,500
C. RM 375,000
D. RM 387,500

(2 marks)

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29. Raya Energy Berhad has 5 million ordinary shares with a market price of RM8.00 per
share. It also has RM60 million perpetual debt with a pre-tax cost of 7%. The firm’s
cost of equity is 16% and the company tax rate is 25%. Determine the firm’s weighted
average cost of capital (RWACC) and earnings before interest and taxes (EBIT).

A. RWACC 9.55%, EBIT RM 12.73 million

B. RWACC 8.21%, EBIT RM 15.52 million
C. RWACC 7.75%, EBIT RM 10.23 million
D. RWACC 6.18%, EBIT RM 22.11 million

(2 marks)

30. Rampai Bhd has a debt to equity ratio of 1:3. The firm’s weighted average cost of
capital (RWACC) is 18%, and its pre-tax cost of debt is 8%. The corporate tax rate is
25%. What is the firm’s unlevered cost of equity capital (Ro)?

A. 21.3%
B. 19.2%
C. 22.0%
D. 18.5%
(2 marks)

TOTAL: 40 MARKS

END OF QUESTIONS

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