QUESTION 3

a) i. Total financing needed = total equity + total debt

= (RM 16 x 500,000 shares) + RM 1,000,000

= RM 8,000,000 + RM 1,000,000

= RM 9,000,000

ii. Proportion of debt in capital structure

RM 1,000,000 / RM 9,000,000

=0.11

iii. After tax cost of debt

$1000
$+

YTM = +$1000
2
1000995
80+ 20
= 995+$1000
2

= 0.0805 / 8.05%
After tax cost of debt = 0.0805 x (1-0.26)

= 0.05957 / 6%
iv. Cost of the equity

Cost of the equity = Risk free rate + Beta (Market risk premium - Risk free rate)
= 7% + 1.5 (11% - 7% )
= 13%

v. Weighted Average Cost of Capital

Weighted Average Cost of Capital = We x Re + Wd x Rd x ( 1 - Tc)

= (0.89)(0.13) + (0.11)[(0.805)(1-0.26)]
= 0.1157 + 0.0655
= 0.1812 / 18.12%

b) Interpret the meaning of the answer in v.

WACC represents the minimum rate of return at which a company produces value for its
investors. For this company has a WACC of 18.12%. That means that our cost of capital
provides us with an indication of how the market views the risks of our asset.

c) Why is the cost of debt of a company is always less than a cost of equity of the company?

The cost of debt can never be higher than the cost of equity because debt is a contractual
obligation between a company and its creditors. The contract outlines the repayment of
borrowed money typically with interest or fees to the creditors in payment for the use of that
capital. The legal contract between creditor and company always places the creditors
repayment rights above those of any distributions to equity holders. Equity holders will
never accept a return on investment that is lower than debt holders. This is because equity
holders are always subordinate to debt holders and do not receive a contractual obligation to
be repaid their capital. If this offer existed, then equity investors would simply purchase the
debt since it offers superior protection on their capital and superior returns in comparison to
the equity investment.
QUESTION 4

estimated useful life 6 years

salvage value RM 15,000
installation cost RM 50,000
sales rise RM 55,000 per year
operating expense decline RM 10,000 per year
new machine require increment in inventories by RM 150,000
account payable simultaneously increase by RM 100,000
hired outside technical consultant for RM 75,000
TTC adopts straight line depreciation method
corporate tax 25%

a) Initial investment

Cost of equipment RM 340,000

Installation cost RM 50,000
Net working (RM 150k-RM
capital 100k) RM 50,000
Initial Investment RM 440,000
Old machine (RM 260,000)
Cost for the new machine RM 180,000

b) operating cash flow

Revenue RM 55,000
Operating cost RM 10,000
Gross profit RM 45,000
Depreciation Expense
RM 30,000
(RM180k/6yrs)
RM (RM
supervisor cost
75,000 105,000)
Earning before income taxes (RM 60,000)
Tax 25% RM 0
Net loss (RM 60,000)
Depreciation Expense RM 30,000
Operating cash flow (RM 30,000)
c) Terminal cash flow

After-tax salvage = salvage - T(salvage - book value)

After-tax salvage = RM 15,000 - 0.25((RM 15,000 -(RM 390k-RM
390k))
After-tax salvage = RM 11,250

Changes in networking capital = RM 150,000 - RM 100,000

Changes in networking capital = RM 50,000

Total Terminal cash flow = RM 11,250 + RM 50,000

Total Terminal cash flow = RM 61,250

d) NPV = -Initial investment + Accumulated cash flows

1
61,250 1
(1.15)6
= 180,000 + +( ) (-RM 30,000)
(1.15)6 0.15
NPV = -RM 170,550.12

e) Payback period = 3( initial investment - accumulated cash flow up to year 3/cash flow in year 4)
Payback period = 3((RM 180,000 + RM 165,000)/RM 220,000)
Payback period = 3.07 years

No. because this project comes with negative NPV and the payback period also misses the cut off
period by seven month than the maximum payback period set by management. This project
f) should be abandoned.
QUESTION 5

5a) Q = FC / ( P - VC )

= 1 600 000 / (30 - 14)

= 100 000 UNITS

THEREFORE ; 100 000 = FC / 30 10

= RM2 000 000.00

5b) EBIT = (P x Q) - FC (VC x Q)

= (30 x 250 000) 2 000 000 (10 x 250 000)

= 3 000 000

DOL = % change in EBIT / % change in Sales , Q x (P - VC) / Q x (P - VC) - FC

= 3 000 000 / 150 000 , = 250 000 (30 - 10) / 250 000 (30 - 10) 2
000 000

= 20 , = 5 000 000 / 3 000 000

, = 1.67
5c.i) STOCK PLAN , BOND PLAN

= 4 000 000 / 50 , = 4 000 000 / 0.12

= 80 000 , = 33 333.33

I = 0.12 x 4 000 000

= 480 000

(EBIT I) (1 t) P / S = (EBIT I) (1 t) P / S

(EBIT 0) (1 0.3) 0 / 80 000 = (EBIT 480 000) (1 0.3) 0 / 33 333.33

0.7 EBIT / 80 000 = 0.7 EBIT 336 000 / 33 333.33

23 333.33 EBIT = 56 000 EBIT 26 880 000 000

26 880 000 000 = EBIT (56 000 23 333.33)

EBIT = 26 880 000 000 / 32 666.67

EBIT = 822 857.06

5c.ii) When the EBIT up to 822 857.06 the stock plan is the best because when involving less
leverage it will generate a higher EPS.
QUESTION 6

a) Briefly explain why some individual investors favour a low dividend payout.

- Individuals in upper income tax brackets might prefer lower dividend payouts because
the effective tax rate on dividend income is higher than the tax rate on capital gains.
- Flotation costs low payouts can decrease the amount of capital that needs to be raised,
thereby lowering flotation costs
- Dividend restrictions debt contracts might limit the percentage of income that can be
paid out as dividends

b) Almetra Corporation has 500,000 shares outstanding, selling at RM40 per share. Recently,
Almetra announced 3 for 1 split for its common shares and reported a net income of
RM3,000,000.

i) After paying the stock split, calculate the firms earnings per share (EPS).

Earnings Per Share (EPS) = Net Income Preferred Dividends

Weighted Average Common Shares Outstanding
= RM3,000,000
500,000 X 3
= RM2.00

ii) If you own 2,000 shares of the stock before stock split, discuss the effect of the stock
split on your total earnings in the firm.

- One of the effect is the number of shares will be increase. A 3-1 split will result in
2,000 X 3 = 6,000 new shares outstanding

- The stock price is reduced when the stock splits which is now the price is RM13.33
per share (RM40/3).