ACIDEC 2018/MAF603 SUGGESTED SOLUTION QUESTION 1 a. CAPM required rate of return Acer AV + 1.00¥ (12-4) VV = 12% Bacs 4 + 1.68 ¥ (12-4) 17.2% Core 44140 (12-4) 15.2% Dell : 4+ 080¥ (12-4) 10.4% Risk-free (MTB): 4 + 0.00 ¥ (12-4) a iat 2 (8 x mark = 4 marks) b!©"Gonstruct the Security Market Line (SML) graph by indicating the position of the four (4) stocks in the diagram 20 BY Expected” Return (%)15, CY E(Rn) #12 by 10 ° | | Per eer reer elee cece eee 0 0s 1 18 Bm Beta (6 ¥ x% mark = 3 marks) ° ee Expected return | CAPM Required Evaluation (%). Return (%), Acer 42 412 Correctly pricedv” Bacs 23 72 Undervaluev Core 9 15.2 ‘Overvaluey” Dell 43 40.4 Undervalue” MTB Ee: 4 Correctly pricedv”ACIDEC 2018/MAF603 Based on the evaluation in (a) and (b) above, only two stocks are correctly priced; Acer and MTB whilst Bacs and Dell are underpriced. Thus, Mr. Yosef could invest in all combinations V of the portfolio except for Core ¥ because the price would drop soon “ when it is overpriced since the average return below the SML @ required return at CAPM. ¥ Mr. Yosef should buy more Stocks Bacs and Dell which is now underpriced because the price would rise vin the future. (10 ¥ x Yemark = § marks) Portfolio beta : 0.2% (1.00) ¥+0.2(1,65)+0.2(1.40)+0.2(0.80)+0:2 (0:00) v"" = 0.97 Portfolio's RR 0.2 (12)#0.2(17.2)#0.2(15.2)40.2(10.4) ¥40.2 4A). cnet = 11.76 Hen . or Hos 8 ke Portfolio's RR 4% + 0.97¥ (12-4) ¥ =11,76% (6 ¥ x %mark = 3 marks) i. __Isitpossible to have zero-beta portfolio of risky assets and; Yes, it is possible, vin theory, to construct a zero beta portfolio. Because such a portfolio's value does not fluctuate as a result of market movement ¥ and therefore, would have zero correlation v with the market movement. ji, Relates to (a), what would be its expected retum for zero-beta portfolio? A zero beta portfolio would have the expected return as the risk-free rate . In this case, it is 4%. ¥ Since it would have zero correlation with the market movement, the expected would be either equal to risk-free rate or relatively low rate of return ¥ compared to higher beta portfolio. (8 ¥ x1 mark =5 marks) (Total = 20 marks) QUESTION 2 A Before the issuance of RMS0 milion bond: i. The value of company. Equity = RM5.50 x 200 million = RM 1,100 million v Debt 80 million ~ VL 41,180 millionAGIDEC 2018/MAF603 ii, The cost of equity (Rs) Rs = Ro + (Ro - RB) (D/E)(1-Te) Rs = 12%Y + (12% - 6%v) (80/1 100%) (0.75) Rs = 12% + 0.33 = 12.33% ili, The earnings after interest and taxes (EAT) VL = EBIT (1- 0.25) Rwace Rwace = ENV (Rs) * DIV (Rb)(1-Te) 4,100 v / 4,180 (12.33%) + 80 ¥/1,180 (6%) (0.75) = 14.80% EBIT = 41.80% (RM 1,180 million) ¥ O75” = RM 185.65 million EAT = [RM 185.65 million - (6%¥ x RM 80 milion)] x 0.75 = RM 135.84 million (10v x % mark = 5 marks) After the issuance of RM50 million bond. i. The new value of company. VL= Wu 4TeB VL = RM 1,180 million ¥ + (0.257 x RM 50 million’) VL = RM 1,192.50 million” ii, The debt to equity ratio: 130 / 1,062.50 = 0.1223 v Debt = 130% Equity = 106254 Value = 1,192.5 ili, The new market value of share price (after repurchase 25 milllion units at par value). Equity value = —1,062,5v’ = RM6.07 per sharev No. of shares 175¥ACIDEC 2018/MAFG03 iv. The new cost of equity (Rs). Cost of debt before tax = 4.5%v / 0.75 ¥= 6% Ro + (Ro - RB) (B/S)(1-Te) 12%v + (12% - 6%) (130 1,062.5) (0.75) ¥ 12% + 0.58 = 12.55% v. The overall cost of capital (Rwace) Rwace = EBIT(1-To) VL = RM 185.65 million’ (0.75) ¥ RM 1,192.50 million” = 11.67% ¥ or Rwace = EN (Rs) + DIV (Rb)(1-To) 4,062.5 ¥ | 1,192.5v (12.55%)v + 130/1,192.5 (6%) (0.75) ¥ = 11.67% (20¥ x % mark = 10 marks) Reaction on the stock price listed on the stock market following on announcement on the choice of financing, improve in eaming and repurchase of its own shares. The choice of financing; debt has an impact on the stock price. As the firm, increase its DIE ratio from 7% (80/1100) to 12% (130/1,062.5), the risk of equity (Rs from 12.33% to 12.55%) (v’) and value of firm (RM1,180 to 1,192.50), also increases (v) to reflect the tax shield of debt, (v). If the market perceives that the company needs more debt to fund capital expenditures due to opportunity, then the market should react positively. (7) Thus, stock price should rise on the day the information released. (7) However, if they are issuing debt and the market thinks this is a poor choice, the market will punish the stock. Debt will also affect the volatility of the equity. If they issue debt to buy back stock, the market will always act positively due to less shares for trade. (v) A buyback reduces the number of shares in a company held by the public, thus, the fraction of each remaining shareholder owns increases. In the near term, the stock price may rise (RM5.50 to approximately RM6.07) because shareholders know that a buy back will immediately boost earnings per share. (v) Firms, usually buy back when ‘eamings are good and stock prices is high. In view of long term, a buy back may or may not be beneficial to shareholders. (Any 5¥ x 1 mark = 5 marks) (Total: 20 marks)ACIDEC 2018/MAF603 QUESTION 3 a. Using Adjusted Present Value (APV) method, evaluate the feasibility of the proposal NPV (Basic) = — Initial Outlay + PV(Depn. Tax Shield) + PV After tax CF + PV Salvage Value Initial Outlay = -200mv PV (Depn Tax Shield) = + (200m - 10mv)/10¥ (0.25) v (A1o.6%\7.2001) v= +34.960475 PV Afier tax CF + 20m (0.75) (A2,12% 1.6901) = +25,3515 ++ 30m (0.75) (As, 129%;3.6048- A2,12%6;1.6901 = 1.9147) ¥ = +43,08075 + 40m (0.75) (A10,12%:5 6802 - A5,12%6;3 6048 = 2.0484) = +61.362 + 10m (P12%,1030.3220) V = +3.22 200m +34,960475 +25.3515 +43,08075 +61.362 +3.22 —32.02528 PV Salvage Value NPV (ac) NPV(Floatation Costs) loatation Cost + PV (Ammortisation’ Tax Saving) = = 1.5mv +(1,5m/10 x 0.26) ¥ (A10, 6%4;7.9801) ¥ = ~ 1.5m +0.2760037 ~ 1,2239963 NPV (Loan) = Loan ~ PV(Net Interest) - PV(Settiement) = 150m ¥-150m (0,08) v (1-0.25)(A10, 8%'6.7101) ¥-150m (P 10,8%0.4682) ¥ 150m ~ 60.3909 - 69.48 RM 20.1291 APV ~ 32.02528 ~1.2239963 + 20.1291 RM -13,120176v Decision: Reject the purchase of new cruise because the APVis negativev (20 x % mark = 10 marks) b, Loan from Ministry of Tourism — interest rate 2% less than risk free rate = 6%-2% = 4% NPV 150m — (150m x 0.04)¥(1-0.25)(AS, 8%;3.9927) ¥— SOmv (PS, 8%:0.6806) ¥ — (100m x 0.04) (1-0.25) (AB, 8%:5:7466-A5.8%;3.9927=1.7538) — 100m’ (PB, 8%:0.5403) = 150m ~ 17.96715 - 34.03 §.2617- 54.03 = RM3871115ACIDE 2018/MAF603 APY — 32,02528 + 38.71115 RM + 6.68587 Yes, accept the special loan from Ministry of Tourism because the APV is positive. 7” (10¥ x % mark = marks) ©, Difference between sensitivity analysis and scenario analysis. Sensitivity Analysis © A sensitivity analysis is a technique used to determine how different values of an independent variable impact a particular dependent variable under a given set of assumptions. ¥ * To conduct sensitivity analysis, take a certain variable involved in a potential investment and change it in order to see how that change would affect the overall investment. 7 © The investor may look at the number of units a company can sell or the current and potential interest rate. * The investor will change one such variable, keeping other variables equal, to see what kind of affect that has on the overall output. ¥ Scenario Analysis © This approach examines a number of different likely scenarios, where each scenario involves a confluence of factor, * Scenario analysis is done by performing multiple sensitivity analyses at the same time. v + This is more than just considering revenue and expenses. Expenses can manifest themselves in a number of ways including wages, pensions, benefits, costs associated with production, and so forth. By changing a combination of these factors, investors can get a feel for a number of different scenarios. Vv + Investors conducting this type of analysis will look at the variables that affect a company's bottom line and use them to plan accordingly. v” (Any 5 points” from both sensitivity and scenario x 1 mark = § marks) (Total: 20 marks)ACIDEC 2018/MAF603 QUESTION 4 a) i) Present Value of Synergy RM7Z50,000 + RM250,000 + [0.75(RM450,000) 0.15 0.04 0.15 5,000,000vv + 6,250,000v v + 2,250,000 v RM13,500,000 ) i) NPV (Acquisition ~ cash offer) = Synergy - Premium Premium: Acquisition price @ cash price ~ Value of target pre acquisition (RM40 x 500,000) ¥ - 15,000,000") RM5,000,000 1 NPV Cash acquisition RM13,500,000 — RM5,000,000v RM8,500,000 @) fil) NPV (Acquisition — share offer) = Syneray - Premium Basis of shares exchange = 30,000,000 = 2: 1¥ ((orevery 1 shares hel in Soler, Ray Tech wlloffer2 sheres 16,000,000 bs Ray Tech, 2/1 x 600,000 = 1,000,000 unit of shares) Value of combined firm = RM30,000,000v+RM15,000,000v + RIM13,500,000v" = RM58,500,000 Acquisiton price @ cost of acquisition = 1,000,000v’ x RM58,500,000 3,000,000v = RM19,500,000 Premium: acquisition price @ cost of acquisition - Value of target pre acquisition RM19,500,000v — RIM15,000,000” RM4,500,000 nw NPV Share acquisition RM13,500,000 ~ RM4,500,000¥ RM9,000,000 Or NPY (stock) = [(value of target pre acquisition + synergy) - cost of acquisition to target] (RM15,000,000+RM13,500,000) ~ 19,500,000] M9,000,000 (18 x % mark = 9 marks)» ) 9) ACIDEC 2018/MAF603 ‘Shareholder’s Solar should proceed the acquisition with shares offer” because its NPV is positive and higher (RM9,000,000) than cash offer (RM8,500,000). (2¥ x % mark = 4 marks) White Knight is a friendly company who is invited to merge or to acquire the company in hostile acquisition so as to add value and increase its market capitalization. v_ The white knight is willing to pay a higher purchase price or it might promise not to lay off employees, fire managers or sell off divisions. ¥ Such a merger is considered good rather than the prospect of being taken over by a hostile raider. Greenmail defensive tactic refers to a targeted repurchase, V where @ company buys a certain amount of its own stock from an individual investor, usually at a substantial premium. ¥ These premiums can be thought of as payments to a potential acquirer to eliminate an unfriendly takeover attempt. (5 ¥ x 1 mark= 5 marks) Share swap would be the preferred if the management believed its shares are over valued. Y This is because the bidder will have to issue fewer shares than under normal circumtances. This will make the cost of acquisition become cheaper than paying cash. Also, pay by shares resulted in acquirer will giving away less number of shares so reduce the fraction of ownership in the merged firm. ¥ In addition, the main benefit of paying with stock is that it preserves cash. v Cash payment would be favored if the management believed that the real synergy benefits will be greater than what was estimated. ¥ This is because by paying cash the bidder gets rid of the target shareholders and keeps the company to itself. Therefore, then it would not have to share the greater than expected synergy gains with the target shareholders. ¥ Acquirers who pay with cash must either use their own cash balances or borrow money. Cash-rich companies don't have to borrow to affect large deals, but most companies do require external financing. In this case, acquirers must consider the impact on their cost of capital, capital structure, credit ratios and oredit ratings. (8 ¥ x1 mark= 5 marks) (Total: 20 marks)ACIDEC 2018/MAF603 QUESTION 5 ‘A. Three (8) factors influencing currency rates. * Inflation ¥ - A country with a lower inflation rate will cause a rise in currency value as its purchasing power increases relative to other countries. v + Interest rate v - Higher interest rates will cause a rise in curreney value as higher interest offers lenders a higher return relative to other countries. Vv * Current account deficit v - A country with a current account deficit where imports ‘exceed exports may expect to see its exchange rate depreciate, since the supply of the currency (imports) will exceed the demand for the currency (exports). + Public debt v - Countries with large public deficits and debts are less attractive to foreign investors because large debt results in higher inflation and lower currency value. ~ * Political & economic stability “ - Political turmoil can cause @ movement of capital to more stable currencies as there will be a loss in confidence of the currency concemed. ¥ (10 v x % mark = 5 marks) B. Justify the effect of currency fluctuation in the following scenarios: ’) The US firm should benefit from this increase in the real value of the yen (strong yen) because they will more doliar in return when the exchange rate is $1 = ¥235 as. compared to $1 = ¥250. ji) Japan Airlines had signed contracts to take delivery of planes in the future and was using forward contracts to protect itself against a rise in the value of the dollar that ‘would increase the yen cost of buying the planes. When yen appreciates instead, the JAL will experience loss because it has to pay ¥180 stil of every $1 v’ Kyoto Inc. will suffer a great loss because the company paid more yen (100%8a145=¥14500) to own the building and now it will get lesser yen ($50/81485=44250) plus capital loss due to yen depreciation ¥. iv) Nafional Bank of Japan reduce the interest rates leads to lower in demand for deposits of Japanese bonds leading to a lower in currency value yen in relative to US dollar because it is expected to appreciate in value, ¥ (6 ¥x1=5 marks)ACIDEC 2018/MAF603 The premise of efficient market hypothesis: Efficient market hypothesis is one in which the stock prices fully reflect available information ¥. On the arrival of new information, the prices would immediately adjust to this information. Prices change rapidly to knowable information and information disseminates rapidly”. It implies that the stocks will be fairly priced “and day to day price changes will follow in a “random walk” ¥ over time. As a result, investors cannot beat the market and cannot obtain an extraordinary profit (Any 4 7 x 4 mark = 2 marks) Reaction of Stock Price to New Information in Efficient and {nefficient Markets ae ‘Overroactibn to “good news with reversion espouse fo “z00d ews" [New information is leaked pce respond before public Aiseiation| Efclent market response topood news 30-200 10420430 Ee Public Announcement date (3x4 mark = 3 marks) The empirical evidences on the efficient market hypothesis: i, The weak form Serial correlation ~ which involves only one security. A positive coefficient of serial correlation for a particular stocks indicates a tendency towards continuation. A negative coeffiecient of serial correlation indicates a tendency toward reversal, If price changes are truly random, itis a contradict situation if so many believe that process follows pattern. v 10ACIDEC 2018/MAF603 The semi strong form Event studies v — according to the EMH, a stock's abnormal returns at time should reflect the information at the same time. Y Any information released before then should have no effect on abnormal returns in this period because all of its influence would already have incorporated in the prices. ¥ The record of mutual funds v - refers to studies comparing mutual fund performance against the performance of a broad based index. Research findings found that mutual funds were unable to beat the market index consistently since mutual fund managers use publicly available information. Therefore, it is consistent with week form and semi-strong form efficiency. The strong form Insider trading v - even in the strongest adherents to the EMH, it is not a suprised to find markets are inefficient in the strong form. v This is due to insider trading. Insiders in the firms have across to information that is not generally available. However if the EMH holds, they should not be able to profit by trading the information. v (10 v x % mark = 5 marks) (Total: 20 marks) END OF SOLUTION 1