TEST 2 JAN 2022/MAF603

UNIVERSITI TEKNOLOGI MARA

COMMON TEST 2

COURSE : CORPORATE FINANCE

COURSE CODE : MAF603
TEST : JAN 2022
TIME : 2 HOURS

INSTRUCTIONS TO CANDIDATES

1. This is an online test question consist of 25 Multiple Choice Questions.

2. Click "SAVE/NEXT/FINISH/SUBMIT" button for each question and after completed.

3. Answer ALL questions.

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

This examination paper consists of 3 printed pages

Instruction: Choose the most appropriate answer.

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1. Selagi Bhd’s cost of external equity is 12%. The ordinary shares of Selagi are currently
selling at RM10. Any issuance of new shares will result in an issue cost of 10% of their
market value. The annual growth rate of the dividend is expected to be 5%. Calculate the
internal cost of Selagi’s share capital?

A. 6.3%
B. 11.00%
C. 11.30%
D. 11.8%
(2 marks)

2. Mahbob Bhd is currently evaluating a project to construct a mosque where the total cost
is RM2,500,000. The current weightage of financing for debt is 25%, comprised of
RM200,000 worth of 10% Irredeemable bonds with a par value of RM100. If the current
cost of debt is 8%, calculate the number of irredeemable bonds to be issued to finance
the project. Assume there is no tax.

A. 1,600 units
B. 5,000 units
C. 6,250 units
D. 20,000 units
(2 mark)

3. BigWhiz Bhd is a company selling baby and childcare products. BigWhiz plan to venture
in selling child car seat to increase the revenue and capture bigger market share.
However, the capital needed for the venture is not drawn from its company pool of fund
and resulted in increase of the debt-to-equity ratio from 2:5 to 4:5. Calculate the new
equity beta for the company if the asset beta of BigWhiz is 0.8. Ignore tax.

A. 1.12
B. 1.44
C. 1.80
D. 2.80
(1 mark)

4. 10% of Company Z’s capital was raised through the issuance of preference shares. The
fair value of 8% preference shares with a par value of RM1 is RM2.50. Company Z
intends to issue 1,000 units of preference shares to raise additional capital for the firm at
a discount of 10% from its fair value. Calculate the cost of preference shares if the
flotation cost is RM0.25. Assume the tax rate is 25%.

A. 3.00%
B. 3.56%
C. 4.00%
D. 5.00%
(1 mark)

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5. The following are the details on the capital structure and cost of capital of Andrea Bhd:

Cost of capital Weightage of

financing

Common Equity Ke: 10.5% 75%

Retained earning Kne: 11.8%

7% Preference Shares Kp:12% 10%

10% Redeemable bonds Kd (after-tax): 9% 15%

Andrea plans to invest in a new project related to its business, and the total equity
financing required is RM450,000. Calculate the overall cost of capital for Andrea if the
retained earnings available for reinvestment are RM400,000. Assume the tax rate is
25%.
A. 8.55%
B. 10.43%
C. 11.06%
D. 11.40%
(2 mark)

6. Consider the following statements:

Statement 1: The cost of external equity is higher than the cost of internal equity
due to the floatation costs.

Statement 2: The Capital Asset Pricing Model does not consider the risk in
computing the cost of capital.

Which one of the following combinations (true or false) relating to the above statements
is correct?

A. Statement 1 is true; statement 2 is false

B. Statement 1 is false; statement 2 is true
C. Both statements are true
D. Both statements are false
(2 mark)

7. Kertiga Bhd is involved in the livestock breeding business. The firm plans to venture into
a new project of manufacturing medical equipment as part of the firm’s diversification
plan. Kertiga is a family business with 100% equity financing. In order to compute project
specific costs, a proxy company (Elektrom Bhd) has been identified. Elektrom is a
levered firm with a beta of 1.5, and 25% of capital comes from the issuance of bonds.
The expected return from a risk-free investment is 4%, and the market risk premium is
7%. Assume the tax rate is 25% and calculate the Kertiga’s cost for the new project.

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A. 7.60%
B. 11.88%
C. 12.40%
D. 14.50%
(2 mark)

8. The following is the optimal capital structure of Daim Bhd:

Common Equity 70%

Preference Shares 20%

Debt 10%

The maximum capex of Daim is RM350,000. Which of the following statements is not
true?
A. Daim should issue new shares if the cost of investment exceeds RM350,000.
B. RM500,000 has been set aside by Daim as retained earnings for reinvestment.
C. If the investment requires RM250,000 equity financing, Daim have to use external
cost of equity for the computation of overall cost of equity.
D. RM350,000 is the maximum capital expenditure that Daim could spend if it used up
all of its retained earnings.
(1 mark)

Question 9 and Question 10 refer to the following scenario:

Ketty Bhd plans to issue 7% Redeemable Debentures to raise additional capital for the
expansion of the business. The nominal value of the bond is RM1000 per unit, and it is
currently selling at a discount of 10% of its par value. Ketty needs to incur a cost of 5% of the
market value during the issuance process. The debenture will be redeemed at par value
after a maturity period of 5 years. Assume the tax rate is 25%.
9. Ali, the financial manager, estimates that the cost should be between 7% and 12%. The
best estimate of the after-tax cost of debt is ______.
A. 7.17%
B. 7.33%
C. 8.27%
D. 11.02%
(2 mark)

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10. The expected expansion cost of Ketty Bhd is RM750,000 and the current debt to equity
ratio of Ketty is 1:3. If the net proceeds per issued debenture is RM800, calculate the
number of debentures to be issued by Ketty.
A. 213
B. 234
C. 284
D. 313
(2 mark)

11. Euromidah Bhd is a company involved in the retail industry, selling textiles in Batu Pahat.
Euromidah raised the capital through the issuance of both equity (60%) and debt (40%).
Euromidah uses CAPM to calculate the cost of equity where a beta of 1.5 is normally
used for the calculation. Consider the following statements:

Statement 1: The beta of 1.5 takes into account both business and financial risk.

Statement 2: Euromidah does not have to revise the current WACC if a new
upcoming project is 100% financed by the issuance of debentures.

Which one of the following combinations (true or false) relating to the above statements
is correct?

A. Statement 1 is true; statement 2 is false

B. Statement 1 is false; statement 2 is true
C. Both statements are true
D. Both statements are false
(2 mark)

12. Which of the following statements define the cost of capital?

1. The rate at which a company must earn to satisfy its investors at a
particular degree of risk.
2. The minimum rate of return that a company must generate in order to pay
for the cost of acquiring capital from its investors.
3. The cost to the businesses of funds contributed by investors.
A. 1 and 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1, 2 and 3
(1 mark)

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13. Poli Bhd is a manufacturing company located in Subang Jaya, Selangor. Before the
issuance of RM50 million bond to repurchase its own units of shares, the value of the
firm was RM1,480 million with RM100 million outstanding debt. The unlevered cost of
capital is 10%. A corporate tax rate is applicable at 25% with the pre-tax cost of debt
is 6% and after-tax cost of debt is 4.5%.

Calculate the new cost of equity (Rs) if the firms’ value increase to RM1,650 million
after execution of the capital restructure.

A. 10.30%
B. 10.10%
C. 10.22%
D. 10.4125%
(2 marks)

14. Bibilon Bhd is a company involves in pharmaceutical industry. Currently, the

company’s level of equity to total assets ratio is 0.75:1 with outstanding debts worth
RM50 million. Calculate the value of the firm.

A. RM 66.67 million
B. RM 200 million
C. RM 87.50 million
D. RM160 million
(2 marks)

15. Debt financing occurs when a company raises money by selling debt instruments to
investors. Briefly explain the effect of issuing more debt towards a firm’s overall cost
of capital in world with taxes

A. Overall cost of capital is expected to increase

B. Weightage cost of capital is expected to decrease
C. Overall cost of capital is expected to have no changes
D. Value of the firm is expected to increase
(1 marks)

Question 16 and Question 17 refer to the following scenario

Dalili Tech Bhd, a company which currently holds pioneer-status is assessing its company’s
existing capital structure. At present, the firm has a debt-to-equity ratio of 10% with the
annual interest payments on its outstanding debt, amounts to RM2 million. The interest rate
is 4% while the earnings before interest and tax is RM55 million.

16. Determine the value of the firm.

A. RM450 million
B. RM57 million
C. RM22 million
D. RM550 million
(2 marks)

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17. Calculate the firm’s expected return on equity

A. 11.5%
B. 11.25%
C. 10.6%
D. 10.4%
(2 marks)

18. The equity value of Basit Bhd, a levered firm is estimated at RM100,000 with 50,000
units of outstanding shares. In order to defend from a hostile takeover, the firm has
repurchased 10,000 unit of shares by issuing the new bonds to the stakeholders.

Calculate the new market value of share price if the firm’s value turns to be RM
120,000 after the repurchase.

A. RM3
B. RM2.50
C. RM2
D. RM16.67
(2 marks)

19. Equotaria Bhd has RM200 million worth of debt outstanding with current market
value of RM300 million. The interest rate on its debt outstanding is 7%. The required
rate of return on equity is 15%. The company pays corporation tax of 25%.

Calculate the unlevered cost of equity.

A. 10.2%
B. 15%
C. 17%
D. 10.8%
(2 marks)

Question 20 and Question 21 refer to the following scenario

Electrico Sdn Bhd is a major manufacturer of electronic equipment and has a perpetual EBIT
of RM6 million per year. The firm has no debt, and its equity shareholders require a 15%
return. The Chief Financial Officer of the firm is planning to issue a debt in future and
analyse that the current market interest rate is at 5%. Presently, the firm enjoys tax
exemption on its profits.
20. Determine the value of the firm.

A. RM 40 million
B. RM 120 million
C. RM 6 million
D. RM 0.9 million

(1 marks)

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21. Suppose Electrico Sdn Bhd decides to issue RM20 million bond to buy back part of
its equity
Determine the new value of the firm.
A. RM 60 million
B. RM 40 million
C. RM 20 million
D. RM 140 million
(2 marks)

22. When a firm has debt and there is a probability of bankruptcy or financial distress,
conflicts of interest may arise between stockholders and bondholders. Due to this,
stockholders are tempted to pursue selfish strategies.

Which statement is NOT true about selfish strategies?

A. Incentive to take large risks: The stockholders will receive nothing in recession
regardless of high or low risk project is selected.
B. Milking the property: Liquidating dividends by paying out extra dividends or
increase perquisites to stockholders
C. Incentive toward underinvestment: Though the investment has positive NPV but
if the increase in value cannot prevent bankruptcy, stockholders will turn it down
D. Incentive to increase coupon payment: The stockholders will increase the interest
payment to bondholders for their own benefit.
(1 marks)

23. Financing through debt means sourcing funds from a third party and agreeing to pay
the money back with interest, by a future date. The main advantage of debt financing
for a firm is:

I. no requirement to register with Securities Commission Malaysia for bond

issue
II. interest expense of a firm is tax deductible
III. unlevered firms have higher value than levered firms
IV. lower cost of equity

A. II only
B. II and IV only
C. III only
D. I and III only
(1 marks)

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24. A company with a high gearing ratio will tend to use loans to pay for operational
costs, which means that it could be exposed to increased risk during economic
downturns.

Which statement is TRUE about high gearing introduces additional risk for equity
shareholders?

A. There is the risk that if interest cannot be paid, the company will be commenced
on legal action
B. The amount available for dividends will be more consistent
C. On liquidation, lenders are paid after shareholders
D. More gearing will increase the cost of equity results in increase risks for both cost
of debt and equity
(1 marks)

25. Modigliani & Miller (M&M) Theorem made important contributions to understanding
the relationship between a firm's capital structure, value, and cost of capital. The
M&M Proposition I with corporate taxes states that:

I. Capital structure can affect firm value by an amount that is equal to the
present value of the interest tax shield
II. By raising the debt-to-equity ratio, the firm can lower its taxes and thereby
increase its total value
III. Firm value is maximized when its’ capital structure consists of all debt
IV. Increase in debt-to-equity ratio will not affect the firm’s value

A. I & II only
B. II & IV only
C. III only
D. I, II, and III
(1 marks)

TOTAL: 40 MARKS

END OF QUESTIONS