CONFIDENTIAL AC/APR 2009/MAF620/FMC570

Example: Capital Structure for Basic Understanding

QUESTION 3

Aman Sentosa Berhad has 4 million ordinary shares with a market price of RM10 per share. It
also has RM100 million perpetual debt with a pre-tax cost of 6%. The firm’s cost of equity is
18% and the company tax rate is 25%.

Required:

a. Determine the value of Aman Sentosa Berhad.

(1 mark)

b. Determine the rate of return required by the shareholders if the firm were financed
entirely with equity.
(2 marks)

c. Calculate the firm’s earnings before interest and taxes (EBIT).

(3 marks)

d. Suppose the firm plans to issue additional RM10 million debt and use the proceeds to
buy back 1 million units of its ordinary shares, calculate the following after the
restructuring:

i. Value of Aman Sentosa Berhad.

ii. The firm’s cost of equity.
iii. The firm’s overall cost of capital.
iv. The market price of its ordinary shares.
(6 marks)

e. Suppose instead of part (d) above, the firm changes its capital structure by issuing
RM10 million in additional shares and uses the proceeds to redeem its debt, calculate
the following after the restructuring:

i. Value of Aman Sentosa Berhad.

ii. The firm’s cost of equity.
iii. The firm’s overall cost of capital.
iv. The market price of its ordinary shares.
(5 marks)

f. Explain the differences in your answers (if any) in parts, d(i)(ii)(iii) with parts e(i)(ii)(iii).

(3 marks)

g. Suggests three (3) assumptions used in the Modigliani Miller Propositions with corporate
taxes

(3 marks)
(Total: 23 marks)