CONFIDENTIAL 1 AC/FEB 2021/MAF603

UNIVERSITI TEKNOLOGI MARA

FINAL EXAMINATION

COURSE : CORPORATE FINANCE

COURSE CODE : MAF603
EXAMINATION : FEBRUARY 2021
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 :

i) the Question Paper

ii) one page Appendix 1 (Formulae Sheet)
iii) a two-page Appendix 2 (Present Value Table)
iv) 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
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QUESTION 1

The Finance Manager of Mekar Indah Bhd proposes two risky securities and risk-free
securities for investment consideration which are currently traded at the stock exchange. The
following information shows the estimated returns of the two securities; Pluto Bhd and Venus
Bhd in different economic condition.

State of economy Recession Normal Boom

Probability 0.30 0.40 0.30
Estimated return (%)
Pluto Bhd -12 13 18
Venus Bhd 11 10 8

The expected returns and standard deviation of the market are 6.30% and 8.13% respectively.
The covariance between Pluto Bhd and the market is 93.25 while the covariance between
Venus Bhd and the market is 58.21.

Mekar Indah Bhd plans to bid for auction the Malaysian Treasury Bills issued by the
government which offers the rate of return at 4%.

Required:

a. Calculate the expected return, standard deviation and beta of the following securities:

i. Pluto Bhd
ii. Venus Bhd
iii. Malaysian Treasury Bills
(10 marks)

b. Applying the Capital Asset Pricing Model (CAPM) and assuming its hold true:

i. Evaluate whether the above portfolio are correctly priced or otherwise

ii. Advise the choice of option of investment for Mekar Indah Bhd
( 5 marks)

c. Explain on the Beta implying in (a) above with regard to systematic risk.
(2 marks)

d. Mr Danial and Mr Rayyan are childhood friends. Mr Danial is an active investor in AAA’s
stock under banking sector. Based on his findings, he believed that the returns from the
banking sector can raise up to 60 percent in the coming year. In addition, it is impossible
to get similar kind rate of return in any portfolio holding. He suggests to Mr Rayyan to
put all his fund into AAA’s stock.

Comment on Mr Danial’s suggestion from the investor’s risk perspective.

(3 marks)
(Total: 20 marks)

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QUESTION 2

A. Senko Bhd (Senko) is a company producing plastic kitchenware in Kluang. At present,

the capital structure of the firm is considered at optimal level. The following is the extract
of Statement of Financial Position Senko concerning its outstanding debt and equity.

Owner’s equity: RM RM
Common shares (250,000 units) 2,100,000
Preference shares 630,000
Retained earnings 630,000 3,360,000

Non-current liabilities:
10% Bond 840,000

Current liabilities:
Payables 560,000
Short-term borrowings 840,000 1,400,000
Total liabilities & equities 5,600,000

Senko expects to raise RM3.8 million for its new project named MOONLIGHT in Johor
Bahru. The Finance Director has suggested several options to raise the needed capital
such as follows:

1. Issue a 5-years’ redeemable bond, selling at RM995. The bonds will be redeemed
at RM1,010. The cost of issuing this bond is estimated at 2% of its issue price.
The par value of the bond is RM1,000.

2. The market price of the preference shares is RM12.00 per share and the flotation
cost on the new issue of preference shares is RM2.50 per share. The preference
shareholders are expecting to receive a dividend of RM1.20 per share.

3. The common shares are currently selling at RM8.40 per share. A new issue of
shares will incur a flotation cost of 5% of its market price. Next year expected
dividend is RM2.00 per share with a dividend yield of 2.3% and expected growth
rate of dividend is 3%.

Senko decides to distribute the next year expected dividend per share from the existing
retained earnings to the holder of 250,000 units common shares whilst the remaining
balance of retained earnings is to be utilized in the new project. The corporate tax rate
is 25%.

Required:

a. Calculate the cost of:

i. After tax bond

ii. Preference shares
iii. Internal equity
iv. External equity
(8 marks)

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b. If Senko Bhd agreed to undertake the MOONLIGHT project, suggest the

appropriate firm’s weighted average cost of capital.
(4 marks)

c. With reference to (b) above, determine the number of common shares to be issued
by Senko Bhd upon utilizing the retained earnings available.
(2 marks)

B. Twinkle Design Bhd (Twinkle) is an interior designer company and currently is planning
to embark into manufacturing miniature building replicas. Total capital of Twinkle is
RM2,500,000. 20% of the capital is from the issuance of Bonds. The beta value of this
company is 1.2. After-tax cost of debt for this company is 8%.

The board of directors of Twinkle will approve this project if the cost of the project does
not exceed the expected return from the project, which is estimated at 17%. MiniCas
Bhd has been identified as the proxy company with equity beta value of 1.5. A quarter
of MiniCas capital comprises of debts, valued at RM500,000.

The rate of return of a risk-free asset is expected to be 5%. The average return on the
market is 12%, while the market risk premium is 7%. The corporate tax rate is 25%.

Required:

Advise the board of directors whether Twinkle should approve or reject this project.
(Support your answer with calculation.)
(6 marks)
(Total: 20 marks)

QUESTION 3

QQ Bhd is a company involving in agriculture industry in Malaysia. The firm building a

presence in the sustainable palm oil sector with activities such as milling, plantations and
production of biomass clean energy.

The company’s annual perpetual earnings before interest and tax is RM600,000. QQ Bhd is
entitled a pioneer-status for a period of 5 years and the status will expires early next year. On
the expiration of the pioneer-status, QQ Bhd will pay a corporate tax at 25%.

The company’s debt outstanding is RM450,000 and currently have 5 million unit of ordinary
shares issued and fully paid-up in the market. The par value is RM1.00 per share. The interest
rate and unlevered cost of equity are 10% and 15% respectively.

Required:

a. In a current year, calculate the following items for QQ Bhd:

i. The value of firm

ii. The value of equity
iii. The cost of equity
iv. Market price per share
(5 marks)

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b. For next year, QQ Bhd is planning to issue an additional debt of RM50,000 and the
proceeds are used to repurchase the existing 1 million units of its ordinary shares in the
market. Assuming the corporate tax rate and other information remain unchanged,
calculate the following items:

i. The value of QQ Bhd

ii. The firm’s debt to equity ratio
iii. The new market price per share
(5 marks)

c. Discuss the effect of Modigliani - Miller Proposition I and II, if a firm reduce its level of
gearing in a world with taxes environment.
(4 marks)

d. When a firm has debt and there is a probability of bankruptcy due to financial distress,
conflicts of interest may arise between stockholders and bondholders.

i. Explain three (3) strategies to reduce the conflicts that would benefit the
stockholders but may affect the bondholders.
ii. Discuss the impact of the strategies in (i) above to the firm and stockholders.

(6 marks)
(Total: 20 marks)

QUESTION 4

A. Hood Bhd (Hood) is a growing company in electronics industry eagerly looking for
business expansion locally and overseas market. Hood is taking into consideration a
possible merger with Adam Bhd, a low-cost production company to enhance its
competitive edge in the industry. The management of Hood forecasts that the acquisition
of Adam Bhd would create synergies from the economies of scale, results in overall
reduction of operating costs and thus increase its after-tax cash flows by RM1.7 million
and RM800,000 respectively. Information pertaining to both companies prior to the
acquisition exercise is as follows:

Hood Bhd Adam Bhd

Price-earnings ratio 5 2
Shares outstanding (units) 2.2 million 1.5 million
Earnings per share RM2.00 RM2.50
Cost of capital all equity firm 8%

Hood proposes to offer 1,000,000 unit of shares of merged entity in exchange for all
shares held by the shareholders of Adam Bhd. Both companies have no outstanding
debt obligation. The relevant discount rate for all cash flows is based on the cost of
capital all equity firm. Assume all cash flows above are perpetuities.

Required:

a. Calculate the net present value (NPV) of the acquisition.

(7 marks)

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b. Advise whether shareholders of Hood Bhd should proceed with the acquisition
proposal.
(2 marks)

c. Based on answer in (b) above, suggest the best financing option that Hood Bhd
would choose if the firm offers to buy shares of Adam Bhd at a premium of 20%
over its current market price.
(3 marks)

B. The following excerpt from the “The Malaysian Reserve” news portal online dated 10
February 2020:

UEM Sunrise-EcoWorld merger unlikely

UEM Sunrise Bhd rose 3.6% last Friday after a news report of a possible merger
between the property developer and Eco World Development Group Bhd, but an
analyst does not see the synergy of the combined firm. An analyst said the rise in
UEM Sunrise’s share price was related to the speculation of a possible merger is on
the card.

The New Straits Times’ reported UEM Sunrise may buy-over Eco World in a share
swap deal that could see the latter’s substantial shareholder Eco World, Tan Sri Liew
Kee Sin, ending up with a 15% to 20% stake in the former.

“But the speculated merger between UEM Sunrise and Eco World is unlikely to
happen now, but more probable in the future. From what I know, UEM Sunrise does
not have any plans to merge with Eco World. It’s probably from Khazanah’s side
which wants to divest its assets. Eco World’s gearing is so high. I’m not sure what
they can offer to one another,” the analyst said.

Meanwhile, Eco World saw 59.5 million shares traded last Friday and closed two sen
or 3.10% higher to 67 sen. Eco World when contacted regarding the news said it is
unable to comment on speculations. UEM Sunrise also said it was unable to
comment on the matter at present.

(Source: extracted from https://themalaysianreserve.com/2019/09/23)

Required:

Based on the above report:

a. State two (2) reasons for the possible failure of mergers exercise between UEM
Sunrise Bhd and EcoWorld.
(2 marks)

b. If this merger materialized in the future, recommend the suitable method of

payment made by UEM Sunrise Bhd if its shares is overvalued. Why?
(2 marks)

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c. Suggest any three (3) defensive tactics before or pre-mergers talk to hinder
potential mergers and acquisitions by a potential bidder.
(4 marks)
(Total: 20 marks)

QUESTION 5

A. Roxy Ltd, a Scottish company from United Kingdom has made a sale of corn oil supplies
to Cherish & Co in US for a sales value of USD$10 million. Thus, Roxy Ltd will receive
payment from Cherish & Co in the next three months. Roxy Ltd has entered in a three
(3) months forward contract to hedge the company against the exchange rate risk.

The three months forward rate $/£ is 1.4310 ± 0.0005.

Required:

i. Compute the amount receipt by Roxy Ltd in pound sterling (£) under forward
contract.
(2 marks)

ii. Briefly explain how forward rate agreement can help a borrowing firm from
unfavorable interest rate movement.
(2 marks)

B. A Korean firm importing goods from a Chinese manufacturer. The Korean firm has a
strong opinion that Yuan rate (¥) will fall next month. The payment of ¥150,000 is due in
one month’s time. Current exchange rate is ₩1 = ¥0.0058 and next month’s rate is
expected to be at ₩1 = ¥0.007

Required:

i. Describe the strategy of payment that should be undertaken by a Korean firm.

(2 marks)

ii. Based on the strategy in (i) above, calculate the total saving or loss the Korean
firm will receive if Yuan fall.
(3 marks)

C. Price of a cup of Starbuck coffee in United States (US) is $USD3.59. The inflation rate
in US is reported at 2% whilst Malaysia has reported an inflation rate of 1%. Assuming
that the US dollar and Malaysian Ringgit are at Purchasing Power Parity, and the current
spot rate is $USD1.00 for every MYR4.20 (spot rate quoted in US Dollar):

Required:

Calculate the price of a Starbuck coffee in Malaysia in future spot rate.

(3 marks)

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D. The following excerpt from the website “The Balance.Com” on article entitled “US Trade
Deficit with China and Why It’s So High!!” updated 12 October 2020.

US Trade Deficit with China and Why It’s So High

The U.S. trade deficit with China in 2019 was $345.6 billion. That's 18% less than
2018's $418.9 billion deficit. The trade deficit exists because U.S. exports to China
were only $106.6 billion while imports from China were $452.2 billion. A lot of these
imports are from U.S. manufacturers that send raw materials to China for low-cost
assembly. Once shipped back to the United States, they are considered imports.
China produces goods at lower cost and most economists agree that China’s
competitive pricing is a result of relaxing its peg on Yuan ( ¥) value in 2016. In effort to
manage the deficit, President Donald Trump began imposing tariffs on China imports
in 2018.

Read more at https://www.thebalance.com/u-s-china-trade-deficit-causes-effects-and-solutions

Required:

Based on the above report:

i. Explain the situation balance of payment between US and China in the

international trades.
(2 marks)

ii. Discuss the impact of the imbalance trade to the currency value of both countries;
US Dollar ($) and China Yuan (¥).
(3 marks)

iii. Recommend three (3) mechanisms that could be implemented by countries facing
with trade deficits like the U.S. country.
(3 marks)
(Total: 20 marks)

END OF QUESTION PAPER

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