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QUESTION 1 - SHORT TERM FINANCINGJUNE 2018a) Strex Sdn Bhd needs to acquire RM950,000 in five months for a project. The company has the following options: Source 1: Issue a commercial paper with a value of RM50,000 each paper at 12 percent per annum. The issuing cost is RM3,000 per paper. Source 2: ...

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QUESTION 1 - SHORT TERM FINANCING JUNE 2018 a) Strex Sdn Bhd needs to acquire RM950,000 in five months for a project. The company has the following options: Source 1: Issue a commercial paper with a value of RM50,000 each paper at 12 percent per annum. The issuing cost is RM3,000 per paper. Source 2: A revolving credit agreement of RM1 million with 5 percent commitment fee on the unused fund and a 9 percent interest rate.

i)

Calculate the effective cost of financing for each source.

(8 marks)

Source 1 (commercial paper): Interest = RM 950000 x 12% x 5/12 = RM 47500 No of paper issue =

𝑅𝑅

950000

𝑅𝑅 50000

= 19 paper

Floatation cost = RM 3000 x 19 paper = RM 57000

EIR =

+ 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅

𝑅𝑅𝑅𝑅

12 x = 57000 𝑅𝑅𝑅𝑅 𝑅𝑅𝑅𝑅𝑅 − 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅− 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑅𝑅𝑅𝑅 𝑅 − 𝑅𝑅 57000 5

𝑅𝑅 47500 + 𝑅𝑅

x

12

= 29.66%

𝑅𝑅 950000 − 𝑅𝑅 47500

Source 2 (revolving credit agreement): Interest = RM 950000 x 9% x 5/12 = RM 35625 Unused loan = RM 1000000 - RM 950000 = RM 50000 Commitment fee = RM 50000 x 5% = RM 2500

EIR = ii)

𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 + 𝑅𝑅𝑅𝑅 𝑅𝑅𝑅𝑅𝑅

𝑅x

12

𝑅𝑅 35625 + 𝑅𝑅 2500 12 x 5

=𝑅𝑅 950000

= 9.63%

Determine the source of financing that Strex Sdn Bhd should choose.

(2 marks)

Source 2 is the best because it is the cheapest source of financing compared to other sources.

JUNE 2019 (SHORT TERM FINANCING) a) Bina Megah Berhad requires RM750,000 for its working capital needs. The firm is evaluating the following alternatives: Alternative 1 12-month simple interest loan at 7.5 percent per annum and the bank requires a compensating balance of 8 percent. Alternative 2 270-day commercial paper at 9 percent interest per annum and face value of RM50,000 per paper. The issuance cost is RM150 for each paper. Alternative 3 Revolving credit facilities that has a credit limit up to RM1 million. The bank charges 8.5 percent interest for 12 months and the commitment fee is 2 percent of the unused portion payable in advance. The bank requires RM50,000 compensating balance and currently the firm already has RM25,000 in its current account.

Decide the best alternative short-term financing based on the annual Effective Interest Rate (EIR). (10 marks)

Alternative 1 (simple loan): Loan = RM 750000 Interest = RM 750000 x 7.5% x 12/12 = RM 56250 Compensating balance = RM 750000 x 8% = RM 6000

EIR =

x

12

=

𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑅𝑅𝑅𝑅 𝑅𝑅𝑅𝑅𝑅 − 𝑅𝑅𝑅 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑅

x

𝑅𝑅 56250

12

= 8.15%

𝑅𝑅 750000 − 𝑅𝑅 6000

12

Alternative 2 (commercial paper): Interest = RM 750000 x 9% x 270/360 = RM 50625 No. of paper issue =

𝑅 𝑅 750000

𝑅𝑅 50000

= 15

Floatation cost = RM 150 x 15 = RM 2250

𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 + 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑅𝑅𝑅𝑅 50625 EIR =+ 𝑅𝑅 2250 𝑅𝑅𝑅𝑅 𝑅𝑅𝑅𝑅𝑅 − 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 − 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑅𝑅𝑅𝑅

x

360

=

𝑅𝑅

x

360

𝑅𝑅 750000 − 𝑅𝑅 50625 − 𝑅𝑅 2250

= 10.11%

270

Alternative 3 (revolving credit): Interest = RM 750000 x 8.5% x 12/12 = RM 63750 Unused loan = RM 1000000 - RM 750000 = RM 250000 Commitment fee = RM 250000 x 2% = RM 5000 Compensating balance = RM 50000 - RM 25000 = RM 25000

𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 + 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑅𝑅𝑅

12

EIR = 𝑅𝑅𝑅𝑅 𝑅𝑅𝑅𝑅𝑅 − 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑅𝑅𝑅𝑅𝑅𝑅𝑅 x =𝑅

𝑅𝑅 63750 + 𝑅𝑅 5000 12 x 25000 = 9.48% 𝑅𝑅 750000 − 𝑅𝑅 12

Alternative 1 is the best alternative short-term financing because it is the cheapest source of financing compared to other sources.

QUESTION 2 - LONG TERM FINANCING JUNE 2018 a) Relinex Holdings has decided to invest in a project in Korea. Considering that RM7 million of external funds is needed, the firm is required to identify a suitable source of financing for the project. The following are three sources of financing available. Source 1 Issue bonds that pay an 8 percent coupon with a maturity of 10 years. The firm plans to sell the bond at 5 percent discount. The underwriting fee is 3 percent of the selling price. The current corporate tax is 35 percent. Source 2 Issue preferred shares that pays 12 percent dividend at its par value. The floatation cost is at 14 percent of its current price of RM165. Source 3 Issue common shares at RM30 with growth rate of 6 percent. The dividend was paid at RM5.25 per share. The underwriting issue fee is 8.5 percent of the current price.

i)

Calculate the after-tax cost of debt, preferred shares and common shares. Source 1 (after-tax cost): C = 8% x RM 1000 = RM 80 SP = RM 1000 - (RM1000 x 5%) = RM 950 FC = 3% x RM 950 = RM 28.50 PV = RM 1000 N = 10 years T = 35%

Kdb =

𝑅 + [[[ − ((( − 𝑅𝑅)] ÷ 𝑅 [[[ + ((( − 𝑅𝑅)] ÷ 2

=

𝑅𝑅 80 + [[ 1000 − ((( 950 − 𝑅𝑅 28.50)] ÷ 10 = [[[ 1000 + (( 950 − 𝑅𝑅 28.50)] ÷ 2

Calculator finance: N = 10, PV = -921.50, PMT = 80, FV = 1000, I/Y = 9.2359%

Kd = Kdb (1 - T) = 9.2359 x (1 - 0.35) = 6.0033%

9.24%

(8 marks)

Source 2 (Preferred stock): Dps = 12% x RM 100 = RM 12 PV = RM 100 MP = RM 165 FC = 14% x RM 165 = RM 23.10

Kps =

𝑅 𝑅𝑅

𝑅𝑅 − 𝑅𝑅

𝑅𝑅 12

= 𝑅𝑅 165 − 𝑅𝑅

= 8.4567%

23.10

Source 3 (Common stock): SP = RM 30 g = 6% d0 = RM 5.25, d1 = RM 5.25 (1 + 0.06) = RM 5.565 FC = 8.5% x RM 30 = RM 2.55

Kcs =

ii)

𝑅1

𝑅𝑅 − 𝑅𝑅

+g=

𝑅𝑅 5.565 𝑅𝑅 30 − 𝑅𝑅 2.55

+ 0.06 = 26.27%

Determine the source of financing that Relinex Holdings Berhad should choose if the internal rate of return is 6.5 percent.

(2 marks)

Relinex Holdings Berhad should choose source 1 because it is the cheapest source of financing compared to other sources.

b) Intelekz Corporation plans to start a new project in Indonesia to enlarge its market share. The total cost of the new project is RM17 million. It is estimated that the after-tax cash inflows is RM1.8 million per year perpetually. The firm has a debt-to-equity ratio of 50 percent. The firm’s cost of equity is 8.5 percent and cost of debt is 6.5 percent. The underwriting fee of equity and debt is estimated at 5.5 percent and 3 percent, respectively. The corporate tax is 30 percent. Calculate: Actual cost = RM 17 000 000 After-tax cash inflows = RM 1 800 000 DER = 50% @ 0.5 V = 1.5 D/V = 0.5/1.5 = ⅓ E/V = 1/1.5 = ⅔ Re = 8.5% Rd = 6.5% Fe = 5.5% Fd = 3% T = 30%

i)

NPV of the project, if floatation costs are required to be ignored.

(4 marks)

WACC = (E/V) Re + (D/V) Rd (1-T) = (⅔ x 8.5) + [(⅓ x 6.5) x (1 - 0.3)] = 7.183%

NPV =

ii)

𝑅 𝑅𝑅ℎ 𝑅 𝑅𝑅𝑅 𝑅

- Initial cost = 𝑅𝑅

𝑅 𝑅𝑅𝑅

1 800 000

- RM 17 000 000 = RM 8 059 167.479

0.07183

NPV of the project, if flotation costs are to be considered.

(6 marks)

WAFC = (E/V) Fe + (D/V) Fd = [⅔ x 5.5] + [⅓ x 3] = 4.667% True cost =

NPV =

𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑅𝑅𝑅𝑅

1 − 𝑅𝑅𝑅𝑅

𝑅𝑅𝑅ℎ 𝑅𝑅𝑅𝑅𝑅

𝑅𝑅𝑅𝑅

= 𝑅𝑅

17 000 000

1 − 0.04667

- True cost =

= RM 17 832 230.18

𝑅𝑅 1 800 000

0.07183

- RM 17 832 230.18 = RM 7 226 937.296

JUNE 2019 (LONG TERM FINANCING) a) GMC Berhad is an established company dealing in telecommunication business. Recently, the company had tendered a ten-year project that cost RM100 million. The company’s current Debt- to-Equity Ratio (DER) is 2.5 and it wishes to maintain the ratio for this coming project. The cost of enquiry and pre-tax cost of debt are 11 percent and 8.5 percent respectively with a tax bracket or 24 percent. Should the company need additional financing for the project, the share issuance will cost 5 percent whilst the bond underwriting costs 3.5 percent. The project will generate after- tax cash inflows of RM25 million annually. Determine Net Present Value (NPV) of the project considering the floatation cost.

(10 marks)

Actual cost = RM 100000000 N = 10 years Re = 11% Rd = 8.5% T = 24% Fe = 5% Fd = 3.5% After-tax cash inflows = RM 25000000 DER = 2.5 V = 3.5 D/V = 2.5/3.5 = 0.7143 E/V = 1/ 3.5 = 0.2857 WACC = (E/V) Re + (D/V) Rd (1-T) = [0.2857 x 11] + [(0.7143 x 8.5) x (1 - 0.24)] = 7.75% WAFC = (E/V) Fe + (D/V) Fd = [0.2857 x 5] + [0.7143 x 3.5] = 3.93% True cost =

𝑅 𝑅𝑅𝑅𝑅𝑅 𝑅𝑅𝑅𝑅

1 − 𝑅 𝑅𝑅𝑅

= 𝑅𝑅 100000000= RM 104090767.10 1 − 0.0393

NPV with FC (Calculator finance:) CFO = - RM 104090767.10 CO1 = RM 25000000 FO1 = 10 I/Y = 7.75% NPV = RM 65569445.50

b) Naina Berhad is planning to raise additional capital for its expansion plan. The firm can issue a ten-year bond at 2 percent discount, which pays 10 percent annual coupon and the underwriting cost is 3 percent of the bond par value. The firm tax rate is 35 percent. The firm can also raise capital through issuance of preferred stock, which has RM100 par value and pays 8 percent fixed dividend. The preferred stock could be issued at a discount of RM35 below its par value and the floatation of RM2 per unit must be paid for the issuance. Besides the two types of financing, the firm can obtain additional funds through common shares. Its common share is currently selling at RM55 per unit and the firm expects to pay RM4 dividend per share next year at the growth rate of 7.1 percent. As a strategy to attract more investors, the new common shares will be priced at RM5 discount of selling and the firm needs to pay RM3 per share for the issuance. Currently, the firm maintains its capital structure as follows: Debt:

30 percent

Preferred stock:

10 percent

Common stock:

60 percent

i)

Calculate the after-tax cost of issuing bonds.

(3 marks)

C = 10% x RM 1000 = RM 100 FC = 3% x RM 1000 = RM 30 PV = RM 1000 MP = RM 1000 - (RM 1000 x 2%) = RM 980 N = 10 years T = 35%

Kdb =

𝑅 + [[[ − ((( − 𝑅𝑅)] ÷ 𝑅 𝑅𝑅 100 + [[[ 1000 − ((( 980 − 𝑅𝑅 30)] ÷ 10 [[[ 1000 + ((( 980 − 𝑅𝑅 30)] ÷ 2 = [[[ + ((( − 𝑅𝑅)] ÷ 2 =

Calculator finance: N = 10, PV = -950, PMT = 100, FV = 1000, I/Y = 10.84%

Kd = Kdb (1 - T) = 10.84 (1 - 0.35) = 7.046%

10.84%

ii)

Calculate the costs of preferred stock and common stock.

(4 marks)

Cost of preferred stock, Kps: Dps = 8% x RM 100 = RM 8 PV = RM 100 MP = RM 100 - RM 35 = RM 65 FC = RM 2

Kps =

𝑅 𝑅𝑅

=

𝑅 𝑅− 𝑅𝑅

𝑅𝑅 8 𝑅𝑅 65 − 2

= 12.70%

Cost of common stock, Kcs: MP = RM 55 - RM 5 = RM 50 d1 = RM 4 g = 7.1% FC = RM 3

Kcs =

𝑅1

𝑅𝑅 − 𝑅𝑅+

iii)

𝑅𝑅 4 + 0.071 = 15.61% g = 𝑅𝑅 50 − 𝑅𝑅 3

Compute the Weighted Average Cost of Capital (WACC).

(3 marks)

Capital

Weight

Cost of Capital (%)

Average Cost of Capital (%)

Debt

0.30

7.046

0.30 x 7.046 = 2.1138

Preferred stock

0.10

12.70

0.10 x 12.70 = 1.2700

Common stock

0.60

15.61

0.60 x 15.61 = 9.366

TOTAL

1.00

WACC = 12.7498%

QUESTION 3 - CAPITAL BUDGETING JUNE 2018 a) Halton Group is considering one of the two mutually exclusive projects: VOGUE and FAMOUS. The after-tax cash flows for the project are as follows: Year

VOGUE (RM)

FAMOUS (RM)

0

(160 ,000)

(220,000)

1

50,000

25,000

2

50,000

35,000

3

50,000

60,000

4

50,000

54,000

5

50,000

38,000

6

-

30,000

Assuming the cost of capital is 12 percent, you are required to: i)

Calculate Payback Period, Net Present Value, Profitability Index and Internal Rate of Return for both projects.

(13 marks)

VOGUE PB =

𝑅𝑅 𝑅𝑅 160 000

𝑅𝑅𝑅𝑅𝑅𝑅 = = 𝑅 𝑅𝑅 50 000

3.2 years

NPV = PMT (PVIFAk,n) - IO CF0 = - RM 160 000 CF1 = RM 50 000 FO1 = 5 I = 12% NPV = RM 20 238.81 IRR = 16.99%

PI =

𝑅 𝑅𝑅+ 𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑅𝑅𝑅𝑅

=

𝑅𝑅 20 238.81 + 𝑅𝑅 160 000 = 𝑅𝑅 160 000

1.13 times

FAMOUS PB = ( − 1) +

𝑅𝑅 − 𝑅𝑅𝑅 𝑅𝑅𝑅𝑅𝑅𝑅 𝑅𝑅𝑅𝑅 = 𝑅𝑅 𝑅𝑅 𝑅𝑅𝑅𝑅

(5 - 1) +

𝑅𝑅 220 000 − 𝑅𝑅 174 000 = 𝑅𝑅 38 000

5.21 years

NPV = [CF1 (PVIFk,n) + CFn (PVIFk,n)] - IO CF0 = - RM 220 000 CF1 = RM 25 000 CF2 = RM 35 000 CF3 = RM 60 000 CF4 = RM 54 000 CF5 = RM 38 000 CF6 = RM 30 000 I = 12% NPV = (RM 55 990.84) IRR = 2.74%

PI =

ii)

𝑅𝑅𝑅 + 𝑅𝑅𝑅𝑅𝑅𝑅𝑅

𝑅𝑅𝑅𝑅

=

− 𝑅𝑅 55 990.84 + 𝑅𝑅 220 000 = 𝑅𝑅 220 000

0.75 times

Determine the best project that Halton Group should invest in.

(3 marks)

Halton Group should invest in project VOUGE because it’s payback period is shorter, NPV is positive, PI > 1, and IRR is higher.

b) Willy Holdings Bhd plans to install a new machine: Machine P and MAchine Q. The cash flows of the two mutually exclusive machines are as follows: Year

0

1

2

3

4

Machine P (RM)

(600,000)

350,000

350,000

350,000

350,000

MAchine Q (RM)

(900,000)

450,000

450,000

450,000

450,000

Calculate the crossover rate of the two machines.

(4 marks)

Year

Machine P (RM)

Machine Q (RM)

Difference (RM)

0

(600 000)

(900 000)

300 000

1

350 000

450 000

(100 000)

2

350 000

450 000

(100 000)

3

350 000

450 000

(100 000)

4

350 000

450 000

(100 000)

Crossover rate: CF0 = RM 300 000 CO1 = - RM 100 000 FO1 = 4 CPT IRR = 12.59%

JUNE 2019 (CAPITAL BUDGETING) a) Annual cash flows of two independent projects are given as follows: Year

Project X (RM)

Project Y (RM)

0

(40,000)

(43,000)

1

15,000

16,000

2

17,000

16,000

3

16,000

16,000

4

18,000

16,000

The required rate of return on each project is 10 percent and the required payback period is 3 years. i)

Determine which project to accept based on the payback period criteria.

(5 marks)

Project X: PB = ( − 1) +

Project Y:

= 𝑅𝑅

𝑅𝑅 − 𝑅𝑅𝑅 = 𝑅𝑅𝑅𝑅 (2-1) 𝑅𝑅 𝑅𝑅

+

𝑅𝑅 40000 − 𝑅𝑅 15000 = 2.47 𝑅𝑅 17000

days

43000

= 2.69 days

𝑅𝑅 16000

PB = 𝑅𝑅

𝑅𝑅𝑅𝑅𝑅𝑅 𝑅

Accept both projects because the payback period for both periods is lower than 3 years.

ii)

Justify the acceptability of each project based on the Net Present Value (NPV) criteria. (7 marks)

Project X: NPV = [CF1 (PVIFk,n) + CFn (PVIFk,n)] - IO CF0 = - RM 40000 CF1 = RM 15000 CF2 = RM 17000 CF3 = RM 16000 CF4 = RM 18000 I = 10% NPV = RM 12001.23

Project Y: NPV = PMT (PVIFAk,n) - IO CF0 = - RM 43000 CF1 = RM 16000 FO1 = 4 I = 10% NPV = RM 7717.85 Both are independent projects, so accept both projects because NPV is positive.

iii)

Calculate the Internal Rate of Return (IRR) for each project. State the acceptability of the projects at the rates, respectively.

(4 marks)

Project X: CF0 = - RM 40000 CF1 = RM 15000 CF2 = RM 17000 CF3 = RM 16000 CF4 = RM 18000 I = 10% IRR = 22.86%

Project Y: CF0 = - RM 43000 CF1 = RM 16000 FO1 = 4 I = 10% IRR = 18.05%

Accept both projects because the IRR of both projects is greater than 10%.

b) Explain the term 'crossover rate’ and its importance in project decision making. (4 marks)

Crossover rate (COR) is the rate at which both projects under evaluation have the same NPV. SO, at the COR, a company is indifferent or neutral on which project to be accepted and rejected. The importance of the COR is that it becomes the cut-off rate for project decision making. For example, if the required return is below the COR, we can accept both Project A because it has higher NPV and otherwise, if the required return is above the COR, we can accept project B due to its higher NPV....