Individual Assignment (15%)

Due date: 25 April 2016 (late submission will not entertained)

Question 1: (10 MARKS)
Unlevered Beta: Hicom motors has RM10 million in assets, which were
financed with RM2 million debt and RM8 million equity. Hicoms beta
currently is 1.2 and its tax is 40%. Use the Hamada equation to find the
Hicoms unlevered beta, bU.
If the capital structure changes into 4 million debt and 6 million equity, what
will the levered beta, bL.

Question-2: (20 MARKS)

Zelnick Inc. is an all-equity firm with 400,000 shares outstanding. It has
$6,000,000 of EBIT, which is expected to remain constant in the future. The
company pays out all of its earnings, so earnings per share (EPS) equal
dividends per shares (DPS). Its tax rate is 35%.
The company is considering issuing $10,000,000 of 6.0% bonds at par value
and using the proceeds to repurchase stock. The risk-free rate is 2.5%, the
market risk premium is 5.0%, and the beta is currently 1.10, but the CFO
believes beta would rise to 1.40 if the recapitalization occurs.
a) Assuming that the shares can be repurchased at the price that existed
prior to the recapitalization, what would the price be following the
recapitalization?

Question-3 (30 MARKS)

Forelli Products Company is a growing manufacturer of automobile
accessories whose stock is actively traded on the over-the-counter (OTC)
market. During 2009, the Dallas-based company experienced sharp
increases in both sales and earnings. Because of this recent growth, Kate
Einhorn, the company's treasurer, wants to make sure that available funds
are being used in their fullest. The company policy is to maintain the current
capital structure proportions of 30% long-term debt, 10% preferred stock,

and 60% common stock equity for at least the next 3 years. The firm is in the
40% tax bracket.
Forelli's division and product managers have presented several competing
investment opportunities to Einhorn. However, because funds are limited,
choices of which projects to accept must be made. The investment
opportunities schedule (IOS) is shown in the table below

Invest
ment
Opport
unity
A

IRR

Initial
Invest
ment

15%

22%

25%

23%

17%

19%

14%

400,00
0
200,00
0
700,00
0
400,00
0
500,00
0
600,00
0
500,00
0

To estimate the firm's weighted average cost of capital (WACC), Einhorn

contacted a leading investment banking firm, which provided the financing
cost data shown in the following table.

Financing Cost Data Forelli Prodcuts Company

Long-term debt:
The firm can raise $450,000 of additional debt by selling 15-year,$1,000 parvalue, 9% coupon interest rate bonds that pay annual interest. It expects to

net $960 per bond after flotation costs. Any debt in excess of $450,000 will
have a before-tax cost, of 13%.

Preferred stock:
Preferred stock, regardless of the amount sold, can be issued with a $70 par
value and a 14% annual dividend rate and will net $65 per share after
flotation costs.

Common stock equity

The firm expects dividends and earnings per share to be $0.96 and $3.20,
respectively, in 2010 and to continue to grow at a constant rate of 11% per
year. The firm's stock currently sells for $12 per share. Forelli expects to have
$ 1,500,000 of retained earnings available in the coming year. Once the
retained earnings have been exhausted, the firm can raise additional funds
by selling new common stock, netting $9 per share after underpricing and
flotation costs.

a. Calculate the cost of each source of financing, as specified:

1.
2.
3.
4.
5.

Long-term debt, first $450,000

Long-term debt exceeding $450,000
Preferred stock, all amounts.
Common stock equity, first $1,500,000.
Common stock equity, greater than $1,500,000.

b. Find the break points associated with each source of capital, and use them
to specify each of the ranges of total new financing over which the firm's
weighted average cost of capital (WACC) remains constant.
c. Calculate the weighted average cost of capital (WACC) over each of the
ranges of total new financing specified in part b.
d. Using your findings in part c along with the investment opportunities
schedule (IOS), map the the firm's weighted marginal cost of capital (WMCC)

against its IOS (total new financing or investment on the x axis and
weighted average cost of capital and IRR on the y axis).
e. Which, if any, of the available investments would you recommend that the
firm accept? Explain your answer.

Question-3: (20 MARKS)

The Gombak Toy Corporation currently uses am injection molding machine
that was purchased 2 years ago. This machine is being depreciated on a
straight line basis and it has 6 years of remaining life. Its current book value
is RM2100 and it can be sold for RM2500 at this time. Thus the annual
depreciation expenses is RM2100/6=RM350 per year. No salvage value.
Gombak Corporation is offered a replacement new machine which has a cost
of RM8,000, and estimated useful life of 6 years, and an estimated salvage
value of RM800. This machine falls into the MARCS 5-year class (20%, 32%,
19%, 12%, 11% and 6%). The replacement machine would permit an output
expansion, so sales would rise by RM1000 per year. Even so the new
machines much greater efficiency would cause operating expenses to
decline by RM1500 per year.
The new machine would require that inventories be increased by RM2000,
but account payable would increase by RM500.
The tax is 40% and its WACC is 15%.
Should it replace the old machine?

Question 4: (20 marks)

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