CONFIDENTIAL AC/DEC 2018/MAF603

UNIVERSITI TEKNOLOGI MARA

COMMON TEST 2

COURSE : CORPORATE FINANCE

COURSE CODE : MAF603
TEST : DEC 2018
TIME : 1 HOUR 30 MINUTES

INSTRUCTIONS TO CANDIDATES

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

2. Answer ALL questions

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

This examination paper consists of 3 printed pages

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QUESTION 1

Fenin Bhd is an all-equity firm proposes to repurchase parts of its common stock by
issuing corporate debt amounting to RM5.0 million. The cost of financing charged at the
rate of 8% per annum. Currently, the company has perpetual earnings before interest
and taxes (EBIT) of RM1.5 million per year. The outstanding number of shares is 2.5
million units worth at RM5.00 per share. Assume that there are no taxes and bankruptcy
costs.

Required:

A. Calculate the following for Fenin Bhd., BEFORE and AFTER the proposal:

i. The value of company.

ii. The market value of company’s equity.

iii. The cost of equity.

iv. The overall cost of capital.

(10 marks)

B. Assuming the company’s tax rate is 25% and EBIT remains at RM1.5 million per
year, determine the following for Fenin Bhd BEFORE and AFTER the proposal:

i. The new value of firm.

ii. The new overall cost of capital

(5 marks)

C. “The proposed new capital structure will expose the company to a greater
financial risk and higher cost of equity in the absence of taxes.”

Do you agree with this statement? Justify your argument.

(3 marks)

D. Suggests two (2) assumptions used in the Modigliani Miller Propositions with
corporate taxes
(2 marks)

(Total: 20 marks)

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QUESTION 2

Signature Bhd is planning to acquire a new highly automated machine with the initial cost
amounting to RM25 million. The machine has an expected useful life of 5 years. The
estimated cash flow before tax that will generate throughout the machine’s life is as
follows:

Year Cash Flow

0 (RM25 million)
1 RM4 million
2 RM8 million
3–5 RM10 million

The above cash flows do not include the annual maintenance cost of RM250,000 for the
5 years’ life of the machine. At the end of the fourth year, Signature Bhd will incur an
additional cost of RM1.5 million to repair and overhaul the machine. The repair and
overhaul expenses is considered as operating expenses and need not be capitalized to
the cost of machine.

The company has arranged for a RM19 million State Government loan to finance partially
the cost of acquiring the new machine. The interest rate is 4% which is half of the
commercial bank rate and it is payable at the end of each year based on the outstanding
balance of the debt at the beginning of the year.

The loan is to include a processing fee of 5 percent of the gross proceeds of the loan.
The processing fee is to be amortized in full in the first year of operation. The loan will be
repaid in four (4) equal annual instalments of RM5 million per year, at the end of each
year starting from year one (1).

The required rate of return on the firm’s unlevered equity is 14%, the risk-free rate is 4%,
and the corporate tax rate is 25%. The new machine is depreciated using reducing
balance method at the rate of depreciation is 10% per annum.

Required:

a) Compute the Net Present Value (NPV) of the new machine if Signature Bhd is
100-percent equity financed.
(8 marks)

b) Calculate the Adjusted Present Value of the new machine, and determine whether
Signature Bhd should proceed to purchase it.
(9 marks)

c) Briefly explain the sensitivity analysis.

(1 marks)

d) Discuss two (2) drawbacks of sensitivity analysis

(2 marks)
(Total: 20 marks)

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 END OF QUESTION PAPER

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