ANSWER ALL QUESTIONS

SECTION A - CASE STUDY (40 marks)

Here is the condensed 2020 Statement of Financial Position for SEDAP Beverage Company

CONDENSED STATEMENT OF FINANCIAL POSITION FOR SEDAP BEVERAGE COMPANY

2020 

Current assets                                                                      RM4,000,000

Net fixed assets                                                                   RM6,000,000

Total assets                                                                        RM10,000,000

Current liabilities

Long-term debt (1200 bonds)

Preferred stock (10000 shares)

Common stock(26,000 share @

RM100)

Retained earnings

Total common equity

Total liabilities & equity

1,800,000

2,400,000

500,000

2,600,000

2,700,000 

RM5,300,000 

RM10,000,000 

SEDAP’s earning per share last year were  RM3.70. The common stocks sells for RM58.00, last year’s dividend was RM2.50, and flotation cost of RM2 would be required to sell new common stock. Security analysis are projecting that the common dividend will grow at an annual rate of 9%. SEDAP’s preferred stock pays a dividend of RM3.50 per share, and its preferred stock sells for RM30.00 per share with a flotation cost of 5%. The firm can issue long-term debt with a 25-year life, a RM1,000 par value a 10% coupon rate and pay interest semi-annually and sell at RM990. Tax rate is 35%. The market risk premium is 5%, the risk-free rate is 6%, and SEDAP’s beta is 1.80. In its cost of capital calculations, the company only long-term; hence, it disregards current liabilities for calculating its WACC.

a) Calculate the cost of capital component, that is, the after-tax cost of debt, the cost preferred stock, the cost of equity from retained earnings, and the cost of newly issued common. (Hint: Use the DCF method to find the cost of common stock and CAPM for retained earnings.)

(20 marks)

b) Calculate Weighted Average Cost of Capital

(12 marks)

c) Should the company use the WACC as the hurdle rate for each of its projects? Explain

(8 marks) (Total; 40 marks)

SECTION B (60 MARKS)

QUESTION 1(20 MARKS)

a)  Accessories Corporation owns a portfolio consisting of the following stocks:

Stock           Percentage of            Beta               Expected Return

Portfolio

Total Investment   RM100,000

The risk free rate is 7%. The expected return on the market portfolio is 15.5% i)   Calculate the expected return of your portfolio

(3 marks)

ii)  Calculate the portfolio beta

(3 marks)

iii)  The CAPM shows that expected returns for particular asset depend on three factors. Discuss these factors.

(4 marks)

b)  Possible outcomes for three investment alternatives and their probabilities of occurrence are given below. Rank the three alternatives in terms of risk from lowest to highest

Failure       Acceptable Successful

Alternative 1

Alternative 2

Alternative 3

(10 marks)

(Total: 20 marks)

QUESTION 2 (20 MARKS)

a)       NASHORA Company is considering a project with the following cash flows

Year              Cash Flow

0                   (RM20,000)

1                   RM 3,000

2                   RM 4,000

3                   RM 5,000

4                   RM 6,000

5                   RM 7,000

(i)        In capital budgeting, payback method is considered as an easy method. Nevertheless, it suffers from two serious problems. Discuss these problems.

(4 marks)

(ii)       Calculate the payback period and the discounted payback period of the

proposed NASHORA Company project if the discount rate is 6%?

(4 marks)

(iii)      Calculate the net present value of the proposed NASHORA Company

project if the discount rate is 6%.

(3 marks)

(iv)      Calculate the IRR of the proposed NASHORA Company project.

(3 marks)

b)     What are the assumptions and predictions of the trade-off theory? How can agency problems lead to a target leverage ratio?

(6 marks)