CONFIDENTIAL, ACIJUN 2019/MAF603 UNIVERSITI TEKNOLOGI MARA FINAL EXAMINATION COURSE CORPORATE FINANCE COURSE CODE MAF603 EXAMINATION JUNE 2019 TIME 3 HOURS INSTRUCTIONS TO CANDIDATES 1 This question paper consists of five (5) questions. 2. ‘Answer ALL questions in the Answer Booklet. Start each answer on a new page. 3 Do not bring any material into the examination room unless permission is given by the invigilator. 4 Please check to make sure that this examination pack consists of ')_ the Question Paper ji) a two-page Appendix 1 (Present Value Table) iil) an Answer Booklet - provided by the Faculty 5 ‘Answer ALL questions in English, DO NOT TURN THIS PAGE UNTIL YOU ARE TOLD TO DO SO This examination paper consists of 8 printed pages (© Hak Cipta Universiti Teknologi MARA CONFIDENTIALCONFIDENTIAL 2 ACIJUN 2019/MAF603 QUESTION 1 Moonbay Bhd decides to invest its excess funds into Valet Bhd and Primus Bhd. Valet Bhd is an established company that has stable revenue stream whilst Primus Bhd is a growing company that ventures into several projects. The data regarding the proposed investments are as follows: State of Economy | Probabitity| Return (%) pear CI Recession 0.20 8.00 5.00 Normal 0.50 | 12.00 I 15.00 Boom 0.30 16.00 18.00 | Recently, the Central Bank of Malaysia has issued a new Malaysian Treasury Bills at the rate of 4 percent interest. The estimated market risk premium announced by the Malaysian Bourse is 7%. The market analyst forecasted that Valet Bhd and Primus Bhd is negatively correlated at -0.95. Required: a. Calculate the expected return and the standard deviation for Valet Bhd and Primus Bhd. (6 marks) b, Calculate the expected return and standard deviation of the portfolio that consists of 45% and 55% investment in Valet Bhd and Primus Bhd respectively. (4 marks) c. Based on the answer in (a) and (b), suggest the best possible choice of investment for a high risk aversion firm like Moonbay Bhd. Why? (2 marks) d. Assuming the stock of Valet Bhd has a beta of 0.83 and stock of Primus Bhd has a beta of 1.25, compute the portfolio required rate of return using Capital Asset Pricing Model (CAPM), (3 marks) . The following table contains beta mesurement for Valet Bhd and Primus Bhd plus two betas of other securities for comparison. Securities Industry Beta Measurement Hearsay Bhd Utilities 0.42 Valet Bhd Power and Energy 0.83 Primus Bhd Oil and Gas 1.25 Intel Bhd ‘Semiconductors 2.38 Comment on the beta measurement above with regards to the sensitivity of each security to a market-wide risk portfolio. (5 marks) (Total: 20 marks) (© Hak Cipta Universiti Teknolog! MARA CONFIDENTIALCONFIDENTIAL 3 ACIJUN 2019/MAF603 QUESTION 2 Lotus Sdn Bhd (Lotus) is a levered firm that has an outstanding debt amounted to RM1,000,000 which was borrowed from RHB Bank Bhd. The bank charged an interest rate at 10% per annum. The earnings before interest and tax (EBIT) is expected to be RM600,000 in perpetuity. Lotus is a company approved with a pioneer status certificate issued by Malaysian Investment Development Authority (MIDA) until the year 2019. The pioneer status has allowed Lotus to utilize the tax exemption incentive before it expires next year. The market rate for the cost of equity of unlevered company is determined at 12% per year. Required: a. For the year 2019, compute the value of Lotus Sdn Bhd and its cost of equity (3 marks) b. Assuming the pioneer status has expired in the year 2019 and the corporate tax rate is charged at 24%, calculate the following: i, Value of Lotus Sdn Bhd ii, Cost of equity (Rs) ili. Weighted average cost of capital (Rwacc) (6 marks) c. For the year 2020, Lotus decided to change its capital structure by issuing additional debt of RM1,200,000 to finance new project. In anticipation of new debt and corporate tax rate is 24%, whilst other information remained unchanged, determine the following: i. New value of Lotus Sdn Bhd i. New cost of equity (Rs) New weighted average cost of capital (Rwacc) (6 marks) d. Discuss the effect of the changes during year 2020 in comparison to year 2019 on the value of firm, cost of equity and overall cost of capital in the worid with taxes. (Note: calculation is not required) (5 marks) (Total: 20 marks) (© Hak Cipta Universiti Teknologi MARA CONFIDENTIALCONFIDENTIAL, 4 ACIJUN 2019/MAF603 QUESTION 3 Dolla Bhd, a glove manufacturing company, wishes to evaluate an investment in a new production machinery. The machinery would enable the company to satisfy the increasing demand for existing gloves. The investment will not change the existing level of business risks’ of Dolla Bhd. The machinery will cost RM3.6 million, payable before the operation commences. The scrap value of the machinery is estimated at RMO.6 million. The investment will generate an annual before-tax net cash flows amounting to RM1.1 million per year for a period of six years. The cost of machinery is partially finance through an issuance of new debentures with a market value of RM1.0 million and the remaining balance funded from the issue of new shares. Commissions and legal fees amounting to 2% of the debentures value is to be settled in full by Dolla Bhd in the first year of its operation. These debentures will pay an annual interest before tax at the rate of 7%. Dolla Bhd will fully redeem the RM1.0 million debenture upon maturity at the end of machinery's life. Initial outlay of RMO.S million in working capital would also be required in the first year. The working capital is expected to increase at 2% per year for the remaining years. The working capital costs will be financed entirely using the company's equity. The yield on short-term government treasury bills is 5% per annum and the company's unlevered cost of equity is approximately 5% above the government treasury bills’ rate. Dolla Bhd. pays taxation at an annual rate of 24%. Tax-allowable depreciations on machinery are ona straight-line basis over the life of the machinery. Required: a. Using the Adjusted Present Value (APV) method, evaluate the viability of the proposed investment. (10 marks) b. Recalculate the Adjusted Present Value (APV) assuming the machinery is fully finance through the issuance of new debentures. Other information on the rate of flotation costs and its settlement, interest rate and term of redemption remained unchanged. (4 marks) Based on the Adjusted Present Value in (a) and (b) above, discuss the effect of debt financing on the appraisal of capital investment. (2 marks) d. Based on the evaluation of the proposed investment above: Suggest the type of analysis applied. Explain two (2) limitations of such an analysis. (4 marks) (Total: 20 marks) (© Hak Cipta Universiti Teknologi MARA CONFIDENTIAL,CONFIDENTIAL 5 ACIJUN 2019/MAF603 QUESTION 4 A The manager of HSR Bhd has submitted a proposal on the acquisition of KTM Bhd for its board of directors to consider. Both entities involved in the same line of rail transportation business. The acquisition will result in the overall reduction of operating costs by RM420,000 and research and development cost of RM180,000. The extracted financial statements of both firms are as follows: HSR Bhd KTM Bhd Number of shares outstanding 50 million 30 million Total earnings RM15 million RM9 million Price Earnings Ratio 8 times 5 times Dividend Payout Ratio 68% 35% Currently, HSR Bhd is experiencing a steady growth rate at 4.17% on its earings and dividends. Upon completion of the acquisition exercise, HSR Bhd predicts that the projection growth rate will be 6% per annum. HSR Bhd is using 12% discount rate to compute the present value of the synergy. Required: a. Calculate the total synergy of the acquisition from the following: i Synergy arising from reduction in cost and; ji, Synergy due to potential growth in HSR Bhd. ( marks) b. Compute the net present value of the acquisition: i If HSR Bhd is willing to offer RM52 million in cash; ji, If KTM Bhd agrees to accept one (1) unit of new shares offered in HSR Bhd for every two (2) units of shares held in KTM Bhd. (5 marks) ©. Based on your answer in (b) above, advise HSR Bhd, the choice of option for acquisition. (2 marks) “... When a firm enters an entirely different market that has litle or no synergy with its core business or technology through a merger or acquisition, some argue that this is good for the business...” (Source: adapted from Azhar Kazami (2002), Business Policy and Strategic Management) Discuss whether you agree with the above statement. (3 marks) © Hak Cipta Universiti Teknologi MARA CONFIDENTIALCONFIDENTIAL, 6 ACIJUN 2019/MAF603 A merger consisting of two-levered firm or one levered firm will benefit the bondholders but may affect shareholders adversely. Mergers and acquisition may give rise to “co-insurance effect’ i. Discuss the impact of “co-insurance effect” on the stockholders’ value and bondholders’ value. (3 marks) ji, Suggest two (2) strategies to be employed by stockholders to reduce the losses from “co-insurance effect’. (2 marks) (Total: 20 marks) QUESTION 5 A The foreign exchange market is the market in which participants are able to buy, sell, exchange and speculate on currencies. Participants are located all around the world. i Name three (3) types of market participants in the foreign exchange market. (3 marks) ii, Briefly explain two (2) elements of risks faced by the international firms. (2 marks) ‘Abraham, a British is planning to travel to Maldives during the summer holiday with his beloved wife. He searched on google and found a nice hotel to stay within his budget limit. The rate of the hotel at booking time was $240 per night of stay per room. Abraham plans to bring £1,500 for the holiday. i. Caloulate the number of nights that Abraham and his wife could stay in Maldives assuming the exchange rate is £1.00 = $1.60. ii, Abraham plans to stay for 5 days in Maldives. How much in pound sterling (€) that he is able to take home assuming the exchange rate on the last day of his stay is £1.00 = $1.20. iil, Explain the effect on the changes of the currency rate from £1.00 = $1.60 to £1.00 = $1.20. ( marks) (© Hak Cipta Universit Teknologi MARA CONFIDENTIAL,CONFIDENTIAL, 7 ACIJUN 2019/MAF603 C. __ Below is the excerpt statement on an Apple stock analysis: “Shares of Apple Incorporation (Apple) lost 11.7% last month in December, according to data provided by S&P Global Market Intelligence. For perspective, the S&P 500 index also fell 9.3% in value last month as shown by the following chart. Dec 3 Dec 10) Dee 17 Biroreterren smotana etrmesr Pometty YCHARTS Matters became worsen when the CEO of Apple Incorporation, Tim Cook issued a letter on January 2, 2019, saying that revenue will be $84 billion for the fiscal first quarter, lower than the previous revenue of between $89 billion and $93 billion. Specifically, Cook cited the economic slowdown in China, weak on "I-Phone- X" sales and supply constraints contributes for the revenue shortfall. The updated report on revenue has sent the shares down another 6% since the end of December. At least a few analysts have cut their price targets on Apple over the last month, Which can affect the stock's performance in the short term. On the bright side, the sharp decline in the stock price has brought the valuation down to a cheap level. Apple is still one of the most valuable brands in the world, which could make the stock worth considering right now. Even though customers have not upgraded their iPhones as fast as management anticipated, Cook noted that, ‘there are more Apple devices being used than ever before, and it's a testament to the ongoing loyalty, satisfaction, and engagement of our customers." (Source: adapted from https:/Avww.fool. com/investing/2019) Based on the above statement, considering the market is a semi-strong form efficiency, advise the investors on the following: i The prediction of profit opportunities. (3 marks) (© Hak Cipta Universiti Teknologi MARA CONFIDENTIALCONFIDENTIAL, 8 ACIJUN 2019/MAF603 ii Whether Apple Incorporation stock should be on the investors’ buying list. (2 marks) D. Explain briefly the following implications of market efficiency for corporate finance concerning the following: The timing of decision ii, Speculation (6 marks) (Total: 20 marks) END OF QUESTION PAPER (© Hak Cipta Universit Teknolog! MARA CONFIDENTIAL,Vv IBo}OW.EL RISIONIUN BidIO HEH ‘WILNAGLINOS Table A-1: Present Value of RM1 Due at the End of n Periods Period 4% __5% 6% 7% __ 8% 9% 10% 12% 14% 16% 16% 18% 20% 24% 20% 9615-9524" 943403458259 9174 9091 8529 8772 8606 8621 8475 8333 —B0G5 TEI 2 $246 9070 8900 8734 8573 8417 8264 7972 7695 7561 7432 7182 6944 6504 6104 3 8890 8638 8396 8163 7938 7722 7513 7118 6750 6575 6407 6086 5787 248 4768 4 8548 8227 7921 7629 7350 7084 6830 6355 5021 5718 6523 5158 4823 4230 3725 5 821978357473 .7130 6808 64996209 5674 5194 4972 4761 4371 4019-3411. 2910 S 7903 7462 7050 6663 6302 5963 5645 5066 4556 4323 4104 3704 3349 2751 2074 7 7599-7107 66516227 58355470 5132 4523 3096 3759 3638 3139 2701 2218 1776 8 7307-6768 6274 5820 5403 5019 4665 4039 3508 3269 3050 2660 2326 1789 1388 8 7026 6446 5919 54395002 4604 4241 3606 13075 2843 2630 2285 1938 14431084 10 6756 6139 5584 508346324224 3855 3220 2607 2472 2967 1911 1615 1164 0847 11 6496 8847 52684751 42893875 35052875 2366 2149 1954 1619 1346 0098 0662 12 6246 5568 4970 44403071 3555 3186 2567 2076 1869 1685 1372 1122 0757 0817 13° 6006 5303 468841503677 32622807 2202 1821 1625 1452 1163 0935 0610 0404 14 8775 50514423. .3878 340520022633 2046 1597 1413 1252 0985 0779 0492 0316 15 5553 481041733624 315227452394 1827 1401 1229 10790835 0649 0307 0247 16.5339 488139363387 291925192176 1631 1228 1069 ©0930 07080541 0320 0193 17 8134 436337143166 27032311 19781456 1078 10929 0802 0600 0451 0258 0150 18 4936 4155-3503 2959 25022120 1799 1300 0946 0808 0691 0508 0376 0208 0118 19° 4746 3957 3305 2765-2317 1945 1635-1161 0829 07030596 0431 0313 0168 092 20-4564 3769-3118 258421451784 1486-1037 0728 0611 0514 0365 0261 0135 0072 21 438835892942 .2415 1987 1637 1351 0926 06380531 0443 0309 0217 0109 0056 22 4220 3418 2775 2257-1839 .1502 122808260560 0462 0382 0262 0181 0088 0044 23° 4057 3258-2618 210917031378 11170738 0491-0402 0329 10222 0151 0071 0034 24 300131012470 1971 4877-1264 101506590431 0349 0284 0188 0128 0057 0027 25 375129532330 1842-1460 1160 0923 0588 0378 0304 0245 0160 0105 0048 0021 ‘WILN3GLINOD (b) b XIGNSdd¥ eos4viweloz NOrIOVYeIvIN IBojouyoy pIsIeAIUN eIdID EH AWILNAGIINOS ‘Table A-2: Present Value of an Annuity of RM1 per period forn Periods Period 4% ___5% __6% __7% __8% __9% 10% 12% 14% 15% 16% ‘18% ~~ 20% +~—-24% +~—-28% 1 0.9615 0.9524 0.9434 0.9346 0.9259 0.9174 0.9097 0.8929 0.8772 0.8696 0.8621 0.8475 0.8333 0.8065 0.7613 2 1.8861 1.8594 1.8334 1.8080 1.7833 1.7591 1.7355 1.6901 18467 1.6257 16052 15656 1.5278 1.4568 1.3016 3 2.7751 2.7232 2.6730 2.6243 25771 2.6313 2.4869 2.4018 2.3216 2.2832 22459 21743 21065 1.9613 1.8684 4 36299 3.5460 3.4651 3.3872 3.3121 3.2397 3.1699 3.0373 29137 28550 27982 26901 25887 2.4043 2.2410 5 44518 4.3295 4.2124 4.1002 3.9927 3.8897 3.7908 3.6048 3.4331 3.3522 32743 3.1272 29906 27454 25320 & 5.2421 5.0757 4.9173 4.7685 46229 4.4859 4.3553 4.1114 3.8887 3.7845 3.6847 3.4976 3.3255 3.0205 2.7594 7 6.0021 5.7864 6.5824 5.3893 5.2064 5.0330 4.8684 4.5638 4.2883 4.1604 4.0386 38115 3.6046 3.2423 2.9370 8 6.7327 6.4632 6.2098 5.9713 5.7466 5.5348 5.3349 4.9676 46389 4.4873 43436 4.0776 38372 34212 3.0758 9 7.4363 7.1078 6.8017 6.5152 6.2469 5.9952 5.7590 5.3282 4.9464 4.7716 46065 43030 4.0310 35655 3.1842 10 81109 7.7217 7.3601 7.0236 6.7101 64177 6.1446 5.6502 5.2161 5.0188 48332 44941 4.1925 3.6819 3.2680 11 8.7605 8.3064 7.8869 7.4987 7.1300 6.8052 6.4951 5.9377 5.4527 5.2337 5.0286 4.6560 4.3271 3.7757 3.3351 12 9.3851 8.8633 8.3838 7.9427 7.5361 7.1607 6.8137 6.1944 5.6603 5.4206 5.1971 47932 4.4302 3.8514 3.3868 13 9.9856 9.3936 8.8527 8.3577 7.9038 7.4869 7.1034 6.4235 5.8424 5.5831 5.3423 49095 4.5327 3.9124 3.4272 14 10.563 9.8986 9.2950 8.7455 8.2442 7.7862 7.3667 6.6282 6.0021 57245 54675 5.0081 46106 39616 3.4587 15 11.1184 10.38 9.7122 9.1079 8.5595 8.0607 7.6061 6.8109 6.1422 5.8474 55755 5.0916 46755 4.0013 3.4834 16 14.652 10.838 10.106 9.4466 8.8514 8.3126 7.8237 6.9740 6.2651 5.9542 5.6685 5.1624 4.7296 4.0333 3.5026 17 12.168 11.274 10.477 9.7632 9.1216 8.5436 8.0216 7.1196 6.3729 6.0472 5.7487 5.2223 4.7746 4.0591 3.5177 18 12.659 11.69 10.628 10.059 9.3719 8.7556 8.2014 7.2497 6.4674 6.1280 5.8178 52732 4.8122 4.0799 3.5294 19 13-134 12.085 11.158 10.336 9.6036 8.9501 6.3649 7.3658 6.5504 6.1982 5.8775 53162 4.8435 4.0967 3.5386 20° 13.59 12.462 11.47 10.5940 9.8181 9.1285 8.5136 7.4694 6.6231 6.2593 5.9288 5.3527 4.8696 41103 3.5458 21 14.029 12.821 11.764 10.836 10.017 9.2922 8.6487 7.5620 6.6870 6.3125 5.9731 5.3837 4.8913 4.1212 3.5514 22 14.481 13.1630 12.042 11.061 10.201 9.4424 8.7715 7.6446 6.7429 6.3587 6.0113 5.4099 4.9094 41300 35558 23 14.867 13.489 12.303 11.272 10.371 9.5802 8.8832 7.7184 6.7921 6.3988 6.0442 5.4321 4.9245 41371 3.5592 24 18.2470 13.799 12.55 11.469 10.529 9.7066 8.9847 7.7843 6.8351 6.4338 6.0726 5.4509 4.9371 41428 3.5619 25 16.622 14.094 12.783 11.654 10.675 9.8226 90770 7.8431 6.8729 6.3641 6.0971 5.4669 4.9476 41474 3.5640 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