Ukff2013 Tutorial QS 201805 PDF

UKFF2013 Business Finance May 2018/2019
UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

LKC FACULTY OF ENGINEERING AND SCIENCE (FES)
FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)
ACADEMIC YEAR: 2018/2019
BACHELOR OF SCIENCE (HONS) ACTUARIAL SCIENCE

BACHELOR OF SCIENCE (HONS) FINANCIAL MATHEMATICS
BACHELOR OF ECONOMICS (HONS) GLOBAL ECONOMICS
YEAR 2 TRIMESTER 1
UKFF2013 BUSINESS FINANCE
TUTORIAL (Questions)
Tutorial 1
 Refer to Course Plan, brief the students on learning objectives and learning outcomes
of this course.
 Refer to Course Plan, remind students on coursework assessment (students’ group
assignment and mid-term test). Mid-Term Test will be given in WEEK 7, to monitor
students’ progress on the understanding of the lectures and tutorials from Topic 1 to
5. The duration of the test will be one (1) hour. The attendance for this test is
compulsory. The examination is CLOSED BOOK.
 Students’ group assignment will be given in Week 1 which involves the download of
financial data to examine the market efficiency for Bursa Malaysia to the extent if a
particular sector follows a random walk pattern in the Malaysian stock market.
Assignment hand-in date: Week 9, during the lecture class.
 Inform the students that they need to prepare and answer all the tutorial questions
before they attend tutorial class. Students are required to present their answers to
tutorial questions. Poor presentation and insufficient efforts in preparation will result
in poor performance in continuous assessment and final examination.
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Tutorial 2 (Topic 1)
An Introduction to Financial Management
Question 1
Identify the primary characteristics of each form of legal organization.
(a) sole proprietor; (b) partnership; (c) corporation
Question 2
Using the following criteria, specify the legal form of business that is favoured:
(a) organizational requirements and costs
(b) liability of the owners
(c) continuity of business
(d) transferability of ownership
(e) management control and regulations
(f) ability to raise capital
Question 3
What are some of the problems involved in the use of profit maximization as the
goal of the firm? How does the goal of maximization of shareholder wealth deal with
those problems?
Question 4
Describe the primary role of a Financial Manager within a firm.
Question 5
Firms often involve themselves in projects that do not result directly in profits; for
example, Maxis and Magnum frequently support public television broadcasts. Do
these projects contradict the goal of maximization of shareholder wealth? Why or
why not?
Question 6
What is agency cost? Provide two examples of agency costs.
Question 7
Maximising share price does not make sense because investors focus on short-term
results rather than long-term consequences. Give your comment.
Question 8
Discuss four (4) stakeholders to a firm, excluding its owners.
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Question 9
The manager of Hooyah Berhad receives a bonus if company profits exceed
RM1,000,000 this year. During the final week of the year, the manager changes an
accounting policy that will increase reported profits from RM950,000 to
RM1,025,000, triggering his bonus. The change in profits of RM75,000 will reverse
itself in the next year, and the accounting change has no impact on Hooyah Berhad's
cash flow. Discuss the above situation as it relates to both an agency problem and
efficient markets.
3

Financial Statements Analysis and Cash Flows
Question 1
Why doesn't an income statement provide a measure of a firm's cash flows?
Question 2
Financial Data for Springfield Power Co. as of December 31, 2016:
Inventory $300,000
Long-term debt 500,000
Interest expense 25,000
Accumulated depreciation 450,000
Cash 280,000
Net sales (all credit) 1,800,000
Common stock 900,000
Accounts receivable 325,000
Operating expense (incl. depr. exp. and
taxes) 625,000
Notes payable-current 200,000
Cost of goods sold 1,100,000
Plant and equipment 1,400,000
Accounts payable 180,000
Marketable securities 80,000
Accrued wages 45,000
Retained earnings 190,000
From the information presented above, calculate the following ratios for the
Springfield Power Co.
i. current ratio
ii. acid test ratio
iii. average collection period
iv. inventory turnover
v. gross profit margin
vi. operating profit margin
vii. net profit margin
viii. total asset turnover
Question 3
Is it possible for a company that has negative net income and negative operating
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cash flow to end the year with an increase in cash and an increase in stock price?
Explain your answer.
Question 4
Blanton Berhad increased its financial leverage during 2016 by taking out a loan
and using the proceeds to buy back common stock. At the end of 2016, the
corporation reported higher earnings per share and higher return on equity.
However, its stock price declined. Discuss why this may happen.
Question 5
How could an analyst determine whether a company's ratio is good or bad?
Question 6
Differentiate between ‘overtrading’ and ‘overcapitalisation’. Which financial ratios
could signal these conditions?
Question 7
When comparing a firm to its peers, why is it difficult to determine the industry to
which the firm belongs? Why should you be careful when comparing a firm with
industry norms?
5

Sources of Finance
Question 1
Describe the key role of a financial market and how an economy might lose out
when its financial markets are not developed.
Question 2
(a) Explain the difference between (i) public offerings and private placements, (ii)
primary markets and secondary markets, and (iii) the money market and the capital
market.
(b) Why might a large corporation want to raise long-term capital through a private
placement rather than a public offering?
Question 3
Briefly explain disadvantages for firms to go public.
Question 4
Briefly discuss the three major functions of an investment banker.
Question 5
Briefly discuss the five ways by which securities are distributed to final investors.
Question 6
Nemo Berhad has 18 million RM0.50 ordinary shares in issue. The current market
value of its shares is RM1.70 per share. The directors have decided to announce a
one for three rights issue at RM1.25 each. Suppose you hold 3,000 shares of this
firm.
(a) What, in theory, will be the ex-rights price of the shares?
(b) If you wish to sell the rights off, how much could you ask for each?
(c) Will it matter to you, if you allow the rights to lapse? Why or why not? Show
with computations.
(d) Explain any two (2) factors considered in respect to rights issues.
6

Time Value of Money
Question 1
Your parents are complaining about the price of items today compared to what they
cost years ago. If an automobile that cost $12,000 in 1980 costs $40,000 in 2010,
calculate the annual growth rate in the automobile's price.
Question 2
You are currently 25 years of age. You have developed a lifetime budget that
includes $50,000 at age 40 for a college fund for your kids and $25,000 per year for
20 years to supplement your retirement, the first payment on your 60 th birthday
and the last payment on your 79th birthday. You open an investment account on
your 25th birthday that promises to pay 9% interest compounded annually. You
want to deposit equal annual amounts into the account every year on your birthday,
starting today (your 25th birthday) and continuing until you are 40 years old (i.e.,
the last deposit is made on your 40th birthday). How much will each deposit have to
be if you want to meet your financial goals?
Question 3
You are trying to plan for retirement in 10 years and currently you have $100,000 in
a savings account and $300,000 in stocks. In addition, you plan to add to your
savings by depositing $10,000 per year in your savings account at the end of each of
the next five years and then $20,000 per year at the end of each year for the final
five years until retirement.
(a) Assuming your savings account returns 7 percent compounded annually and
your investment in stocks will return 12 percent compounded annually, how
much will you have at the end of 10 years? (Ignore taxation).
(b) If you expect to live for 20 years after retirement, and at retirement you
deposit all of your savings in a bank account paying 10 percent, how much
can you withdraw each year after retirement (20 equal withdrawals
beginning one year after you retire) to end up with a zero balance at death?
Question 4
Bill starts a retirement fund at age 21 and plans on depositing equal annual
amounts on each birthday, starting at age 21, and ending at age 60. He wants to
have $2 million at age 60. John starts his fund on his 30th birthday. He wants to
deposit equal annual amounts on each birthday starting on his 30th birthday and
ending on his 60th birthday. John wants to have $2 million at age 60. If the
7

investment funds earn 10% per year, calculate the amounts the Bill and John
respectively will have to save each year (rounded to the nearest dollar) to meet their
goals. Comment on the difference.
Question 5
Upon retirement, your goal is to spend 5 years traveling around the world. To travel
in style will require RM 250,000 per year at the beginning of each year.
If you plan to retire in 30 years from today, what are the equal monthly payments
necessary to achieve this goal? The funds in your retirement account will compound
annually at 10%.
Question 6
A retirement home in Singapore costs $200,000 today. Housing prices in Singapore
are increasing at a rate of 4% per year. Joe wants to buy the home in 8 years when
he retires. Joe has $25,000 right now in a savings account paying 8% interest per
year. Joe wants to make eight equal annual deposits into the savings account
starting today. How much must each deposit be so Joe will have enough money in
his savings account to buy the retirement home when he retires?
Question 7
Teddy Yap invested RM2,000 in an investment fund on his 21st birthday. The fund
pays 7 percent interest compounded semiannually. Teddy is celebrating his 50th
birthday today. Teddy decides he wants to retire on his 60th birthday and he wants
to withdraw RM75,000 per year, the first withdrawal on his 60th birthday and the
last withdrawal on his 90th birthday. Teddy expects to receive RM100,000 from his
employer on his 55th birthday in recognition of his long service to the company.
Assume Teddy has not taken any money out of his investment fund since he initially
funded it on his 21st birthday, and that he will deposit the RM100,000 from his
employer into the investment fund on his 55th birthday. The investment fund will be
used to pay for Teddy’s retirement.
(a) If Teddy makes no additional deposits into his investment fund, determine
how much will be available for retirement at age 60.
(b) Since the amount in (i) is insufficient to meet his retirement goals, Teddy
decides to deposit equal annual amounts into the investment fund beginning
on his 51st birthday and ending on his 59th birthday, so that he can meet his
retirement goals. Determine how much each deposit will be.
Question 8
Your family purchased a house three years ago. When you bought the house you
financed it with a $160,000 mortgage with an 8.5 percent nominal interest rate
8

(compounded monthly). The mortgage was for 15 years. What is the remaining
balance on your mortgage today?
Question 9
On January 1, 2016, your brother's business obtained a 30-year amortized mortgage
loan for $425,000 at a nominal annual rate of 7.0%, with 360 end-of-month
payments. The firm can deduct the interest paid for tax purposes. What will the
interest tax deduction be for 2016?
9

Risk and Return
Question 1
Three assets – F, G, and H – are currently being considered by Perth Industries.
The probability distributions of expected returns for these assets are shown in the
following table.
Asset F Asset G Asset H

j Prj Return, kj Prj Return, kj Prj Return, kj
1 0.1 40% 0.4 35% 0.1 40%
2 0.2 10% 0.3 10% 0.2 20%
3 0.4 0% 0.3 -20% 0.4 10%
4 0.2 -5% 0.2 0%
5 0.1 -10% 0.1 -20%

(a) Calculate the expected value of return, k , for each of the three assets. Which
provides the largest expected return?
(b) Calculate the standard deviation, σk, for each of the three assets’ returns.
Which appears to have the greatest risk?
(c) Calculate the coefficient of variation, CV, for each of the three assets’
returns. Which appears to have the greatest relative risk?
Question 2
A multinational company is thinking of investing in two overseas locations for a
planned expansion of its production facilities. The future returns from the
investments depend to a large extent on the economic situation of the countries
under consideration. An analysis of the expected rates of return under three
different scenarios is as follows:
Probability Expected return of country A Expected return of country B
0.3 20% 10%
0.3 10% 20%
0.4 15% 20%
(a) Calculate the mean return and the standard deviation of the returns from the
investment in each country.
(b) What would be the expected return and standard deviation of the portfolio if
the available funds were split 20% to country A and 80% to country B, and
the correlation between returns of the two countries are:
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(i) 0
(ii) +1
(iii) –1
Give your comment.
Question 3
Colours Plc. is considering two mutually exclusive investments: Black and White.
The possible net present values for both projects and the associated probabilities are
as follows:
BLACK WHITE
Probability NPV Probability NPV
0.1 RM 10 million 0.6 RM 15 million
(a) Determine the levels of risk of each investment project in RM terms.
(b) Assuming, the management is risk averse, justify the investment it should
accept.
Alternatively, the firm has an opportunity to invest in two overseas locations for a
planned expansion of its production facilities. The future returns from the
investments depend to a large extent on the economic situation of the countries
under consideration. An analysis of the expected rates of return under three
different scenarios is as follows:
Probability Expected Return of Region 1 Probability Expected Return of Region 2
0.3 30% 0.2 50%
0.4 25% 0.6 30%
0.3 20% 0.2 10%
*Assume the correlation coefficient between returns from the two countries to be 1.0.
(c) What would be the expected return and standard deviation of the portfolio if
the available funds were split 60% to Region 1 and 40% to Region 2?
(d) Should the firm consider expanding operations in both the regions? Justify.
[ICSA June 2008 BQ3]
Question 4
Mr Rich owns a portfolio consisting shares of five public listed firms. The details of
these securities and his asset allocation are provided below:
Security Number of Market Price per Beta Actual
Shares share Coefficient return
RM %
Happiness 11,000 2.00 0.75 13.00
11

Fit 25,000 1.80 0.90 14.60

Wealth 12,000 2.75 0.60 11.40
Success 16,000 1.50 1.60 20.30
Kind 20,000 2.60 1.20 16.60
The market return is 15% and risk-free investments offer 7%.
(a) Calculate the required rate of return for each security in Mr Rich’s portfolio
using the Capital Asset Pricing Model. Which securities over-performed?
(b) Determine the portfolio beta. Is this portfolio riskier than the market?
Justify.
Question 5
(i) Given the holding-period returns shown below, compute the average returns and
the standard deviations for the BP and for the market.
Month BP Market
1 1.8% 1.5%
2 –0.5 1.0
3 2.0 0.0
4 –2.0 –2.0
5 5.0 4.0
6 5.0 3.0
(ii) If BP’s beta is 2.3 and the risk-free rate is 8 percent, determine an appropriate
required return for an investor owning BP. (Note: Because the above returns are
based on monthly data, you will need to annualize the returns to make them
compatible with the risk-free rate. For simplicity, you can convert from monthly
to yearly returns by multiplying the average monthly returns by 12.)
(iii)Compare BP’s historical average return with the return you believe to be a fair
return, given the firm’s systematic risk. Indicate if BP is over- or
underperformed.
Question 6
You have RM200,000 to invest in a stock portfolio. You choose to invest in both
Stock H and Stock L, with an expected return of 13 percent in Stock H and 8
percent in Stock L.
(i) If your goal is to create a balanced portfolio with an expected return of 10.6
percent, determine the Ringgit amount that you will invest in Stock H and Stock
L respectively. [Round your Ringgit amount to 2 decimal places]
(ii) Assume Stock H has a standard deviation of 15 percent per year and stock L has
a standard deviation of 21 percent per year. The correlation between stock H
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and stock L is .32. You have a portfolio of these two stocks wherein stock L has a
portfolio weight of 60 percent. Compute the portfolio risk.
(iii)If two assets are negatively correlated, can we say that positive return is
guaranteed?
Question 7
How are total risk, non-diversifiable risk, and diversifiable risk related? Why is
non-diversifiable risk the only relevant risk?
Question 8
What impact would the following changes have on the security market line and
therefore on the required return for a given level of risk?
(a) an increase in inflationary expectations
(b) investors become less risk-averse
13

Tutorial 7 (Topic 6 and 7)

Valuation of Bonds and Stocks
Question 1
Nesta Berhad has a beta of 1.8 and has just paid a dividend of RM0.80 per share. Its
dividend is expected to grow at 5% per annum for the foreseeable future. Return on
Treasury security is 4% and risk premium for market portfolio is 10%. Is it
worthwhile to purchase Nesta Berhad’s ordinary shares at its current market price
of RM5.50 per share?
Question 2
Dhabi Sdn Bhd paid dividend of RM250,000 this year. Current return to
shareholders of companies in the same industry as Dhabi is 12%, although an
additional risk premium of 2% is applicable to Dhabi, being a smaller and non-
listed company. Dhabi has 1,000,000 authorized ordinary shares, but only 800,000
shares are currently issued and outstanding. What is the fair price for Dhabi’s
ordinary shares, if:
(a) the current level of dividend is expected to continue for the foreseeable future
(b) the dividend is expected to grow at a rate of 4% p.a. into the foreseeable
future
(c) the dividend is expected to grow at a rate of 3% p.a. for three years, and 2%
p.a. thereafter
Question 3
Home Place Hotels Inc. is entering into a 3-year remodelling and expansion project.
The construction will have a limiting effect on earnings during that time, but when
it is complete, it should allow the company to enjoy much improved growth in
earnings and dividends. Last year, the company paid a dividend of $3.40. It expects
zero growth in the next year. In years 2 and 3, 5% growth is expected, and in year
4, 15% growth. In year 5 and thereafter, growth should be a constant 10% per
year. What is the maximum price per share that an investor who requires a return
of 14% should pay for Home Place Hotel’s common stock?
Question 4
Capital market is the market for long-term securities (maturity greater than one
year), for instance ordinary shares, preferred shares, bonds (debentures/ loan
stocks) and financial leases. Harmoni Perkasa Sdn Bhd (HPSB) needs to expand
their building and property facilities.
14

(a) HPSB chooses to raise the external funds for this purpose by issuing 20 year
bonds. HPSB pays RM110 in annual interest, with a face value of RM1,000. The
required rate of return is 9 percent. Determine the value of this bond.
(b) Re-examine the value of this bond. Revise on the value changed if the required
return (k) increases to 12 percent.
(c) Generalize the relationship between the bond values with required rate of return
as examined from part (a) and (b) under the annual payment assumptions.
(d) Alternatively, HPSB chooses to issue new common stocks in order to finance
their expansion. HPSB latest annual dividend of RM1.25 a share was paid
yesterday and maintained its historic 7% annual rate of growth. You plan to
purchase the stock today as the dividend growth rate will increase to 8% for the
next three years and the selling price of the stock will be RM40.00 at the end of
that time. Determine the fair price or the intrinsic value you will be willing to
pay for the HPSB stock if you require a 12% return.
(e) Re-examine the maximum price you should be willing to pay for the HPSB stock
if you believe that the 8% growth rate can be maintained indefinitely and you
require a 12% return.
Question 5
Calculate the yield-to-maturity (YTM) and current yield for each of the bonds
below:
Par Value Market Price Coupon rate (%) Years to maturity
Bond
A RM1,000 RM820 9% annually 8
B RM100 RM108 2.5% semiannually 5
C RM500 RM560 12% annually 12
(Note: For YTM calculation, use the approximate formula)
Question 6
Harmoni Perkasa Sdn Bhd (HPSB) sells at RM32 per share, and Ms.Sally, the CEO
of this company estimates that the latest 12-month earnings are RM4 per share with
a dividend payout of 50 percent.
(a) Determine the HPSB’s current P/E ratio.
(b) If an investor expects earnings to grow by 10 percent a year, re-examine the
projected price for the next year if the P/E ratio remains unchanged.
(c) Sally analyzes the data and estimates that the payout ratio will remain the same.
Assuming that the expected growth rate of dividends is 10 percent and an
investor has a required rate of return of 16 percent, analyse whether this stock is
worth to buy.
15

(d) If the interest rates are expected to decline, assess the likely effect will have on
HPSB’s P/E ratio.
(e) Differentiate the dividend yield and the dividend payout ratio. Justify with
reasons which dividend information is more reliable for current shareholders
and potential investors.
Question 7
The Rapid Growth Berhad is expecting a period of intense growth and has decided
to retain more of its earnings to help finance that growth. As a result it is going to
reduce its annual dividend by 10 percent a year for the next three years. After that,
it will maintain a constant dividend of RM0.70 a share. Last month, the company
paid RM1.80 per share. Calculate the value of this stock if the required rate of
return is 13 percent.
Question 8
Identify three prominent theories that attempt to explain the term structure of
interest rates. The yield curve in 2009 was very low, with short-term rates close to
zero and long-term rates below 5 percent. What factors contributed to such low
interest rates?
Question 9
Given the following information on ABC Corporation’s bonds:
Coupon rate = 9%
Current yield = 9.62%
Call premium = 12.25%
Par value = $1,000
Years to call = 6 years
Years to maturity = 11 years
If the bond pays coupons semiannually, compute its yield-to-call (YTC) by using
financial calculator.
Question 10
You are considering an investment in a U.S. Treasury bond but you are not sure
what rate of interest it should pay. Assume that the real risk-free rate of interest is
1.0%; inflation is expected to be 1.5%; the maturity risk premium is 2.5%; and, the
default risk premium for AAA rated corporate bonds is 3.5%. What rate of interest
should the U.S. Treasury bond pay? What rate of interest should the U.S. corporate
bond pay?
16

Cost of Capital
Question 1
Ruffles Incorporated reported net earnings of RM4.2 million last year. It paid a
dividend of RM1.26 per share for the 1 million shares outstanding. The firm’s
capital structure includes 40% debt and 60% common share. The tax rate is 28%.
(a) If Ruffles shares are trading at RM40 and dividends are expected to grow at
6%, determine the cost of financing with retained earnings.
(b) If underwriting and floatation costs are RM7.00 per share, what is the cost of
issuing new shares to the firm?
(c) The firm can issue 10%, 5- year bonds at a premium at RM1,200 each. What
is the cost of debt financing, if flotation cost is RM25 per bond? Face value of
the bond is RM1,000 each. (Note: use trial and error method to find yield to
maturity)
(d) Calculate Ruffles Inc.’s weighted average cost of capital?
Question 2
As the Finance Director for Ginger Bread Berhad, you have been asked to estimate
the firm’s weighted average cost of capital. Using the information below, perform
the necessary calculations, using market values.
Capital Structure:
11% bonds (redeemable in 5 years) RM80,000
*Ordinary Shares (RM0.25 par) RM90,000
**9% Preference Shares (RM1 par) RM50,000
Retained Earnings RM145,000
Note: The above are all in book values.
 Current dividend, to be paid soon is RM0.20 per share. Dividends are
expected to grow at 5% per year.
 The interest rate on short-term bank borrowings stands at 12.6%.
 Stock market prices as at 30 June 2007 (all ex-dividend); *RM1.76 and
**RM0.67 respectively.
 Bond market price as at the 30 June 2007 (all ex-interest); RM950.
Assume a corporate tax of 28%.
Question 3
The capital structure for Nealon, Inc., follows:
Nelaon, Inc., Balance Sheet
Percentage of
Type of financing future financing
17

Bonds (8%, $1,000 par, 16-year maturity) 38%

Preferred stock (5,000 shares outstanding, $50 par,
$1.50 dividend) 15%
Common stock 47%
Total 100%
Flotation costs are (a) 15 percent of market value for a new bond issue, (b) $1.21 per
share for common stock, and (c) $2.01 per share for preferred stock. The dividends
for common stock were $2.50 last year and are projected to have an annual growth
rate of 6 percent. The firm is in a 34 percent tax bracket.
Market prices are $1,035 for bonds, $19 for preferred stock, and $35 for common
stock. There will be sufficient internal common equity funding (i.e., retained
earnings) available such that the firm does not plan to issue new common stocks.
What is the weighted average cost of capital if the firm financing are in the above
mentioned proportions?
Question 4
Using the data for each firm shown in the following table, calculate the cost of
retained earnings and the cost of new common stock using the constant-growth
valuation model.
Current Dividend Projected Under- Flotation

market price growth dividend per pricing cost per
Firm per share rate share next year per share share
A $50.00 8% $2.25 $2.00 $1.00
B 20.00 4 1.00 0.50 1.50
C 42.50 6 2.00 1.00 2.00
D 19.00 2 2.10 1.30 1.70
Question 5
Federico Berhad has the following capital structure:
Book Value Market Value
Debt RM500 RM550
Preferred Stock RM100 RM120
Common Equity RM1,400 RM4,330
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New corporate bonds can be issued at par if they have a coupon of 7%. The current
yield on newly-issued preferred stock is 6%. Risk free rate is 3% and market risk
premium is 5%. If Federico Berhad has a stock beta of 2.0 and a corporate tax of
25%, what is the company’s weighted average cost of capital?
Question 6
Last year BF Inc. had $50 million in total assets. Management desires to increase its
plant and equipment during the coming year by $12 million. The company plans to
finance 40 percent of the expansion with debt and the remaining 60 percent with
equity capital. Bond financing will be at a 9 percent rate and will be sold at its par
value. Common stock is currently selling for $50 per share, and flotation costs for
new common stock will amount to $5 per share. The expected dividend next year for
BF Inc. is $2.50. Furthermore, dividends are expected to grow at a 6 percent rate far
into the future. The marginal corporate tax rate is 34 percent. Internal funding
available from additions to retained earnings is $4,000,000.
(a) What amount of new common stock must be sold if the existing capital structure
is to be maintained?
(b) Calculate the weighted cost of capital at an investment level of $12 million.
Question 7
Cemerlang Berhad has determined its optimal capital structure, which is composed
of the following sources and target market value proportions:
Source of capital Target Market Proportions
Long-term debt 30%
Preferred stock 5%
Common stock equity 65%
Debt: The firm can sell a 20-year, RM1,000 par value, 9 percent bond for RM980. A
flotation cost of 2 percent of the face value would be required in addition to the
discount of RM20.
Preferred Stock: The firm has determined it can issue preferred stock at RM65 per
share par value. The stock will pay an RM8 annual dividend. The cost of issuing and
selling the stock is RM3 per share.
Common Stock: The firm's common stock is currently selling for RM40 per share.
The dividend expected to be paid at the end of the coming year is RM5.07. Its
dividend payments have been growing at a constant rate for the last five years. Five
years ago, the dividend was RM3.45. It is expected that to sell, a new common stock
issue must be underpriced at RM1 per share and the firm must pay RM1 per share
in flotation costs.
The firm's marginal tax rate is 40 percent. Calculate the firm's weighted average
cost of capital assuming the firm has exhausted all retained earnings.
19

Analysis and Impact of Leverage
Question 1
Famous Caterer Berhad (FCB) has an expected sales of RM20 million. Fixed
operating costs are RM2.5 million, and the variable cost ratio is 65%. It has an
outstanding RM12 million, 8% bank loan and an outstanding shares of 1 million
ordinary shares (RM1 par). Assume corporate tax rate is 28%.
(a) What is FCB’s degree of operating leverage at a sales level of RM20 million?
(b) What is FCB’s current degree of financial leverage?
(c) What is the combined leverage of FCB?
(d) Forecast FCB’s earnings per share if sales drop to RM15 million.
(e) What information does the degree of financial leverage provide in decision
making?
Question 2
Footwear, Inc., manufactures a complete line of men’s and women’s shoes for
independent merchants. The average selling price of its finished product is $85 per
pair. The variable cost for this same pair of shoes is $58. Footwear, Inc., incurs
fixed costs of $170,000 per year.
(a) What is the break-even point in pairs of shoes for the company?
(b) What is the dollar sales volume the firm must achieve to reach the break-
even point?
(c) What would be the firm’s profit or loss at the following units of production
sold: 7,000 pairs of shoes? 9,000 pairs of shoes? 15,000 pairs of shoes?
(d) Find the degree of operating leverage for the production and sales levels
given in the part (c).
Question 3
Northwestern Savings and Loan has a current capital structure consisting of
$250,000 of 16% (annual interest) debt and 2,000 shares of common stock. The firm
pays taxes at the rate of 40%.
(a) Using EBIT values of $80,000 and $120,000, determine the associated
earnings per share (EPS).
(b) Using $80,000 of EBIT as a base, calculate the degree of financial leverage
(DFL).
(c) Rework parts (a) and (b) assuming that the firm has $100,000 of 16%
(annual interest) debt and 3,000 shares of common stock.
20

Question 4
The following information pertains to the Classic Burger Restaurant chain:
Sales $600,000
Variable costs 300,000
Total contribution margin 300,000
Fixed costs 100,000
EBIT 200,000
Interest expense 50,000
Earnings before taxes 150,000
Taxes (30%) 45,000
Net income $105,000
(a) If sales increase by 10%, what will be the new level of EPS if the firm has 10,000
shares outstanding?
(b) What is the percentage increase in EPS? Explain the difference between the
percentage increase in sales and the percentage increase in EPS.
Question 5
Welker Products sells small kitchen gadgets for $14 each. The gadgets have a
variable cost of $4 per unit, and Welker Products' fixed operating costs are $220,000
per year. Welker Products' capital structure includes 55% debt and 45% equity.
Annual interest expense is $25,000, and the corporate tax rate is 35%.
(a) Calculate the break-even point in units.
(b) If Welker Products sells 25,000 units, calculate the firm's EBIT and net income.
(c) If sales increase ten percent from 25,000 units to 30,000 units, estimate the firm's
expected EBIT and net income.
(d)Does Welker Products use operating leverage and/or financial leverage? Explain.
21


Capital Budgeting Cash Flows
Question 1
(a) In general, a project's cash flows will fall into one of three categories. What are
these categories?
(b) How do sunk costs affect the determination of cash flows associated with an
investment proposal?
Question 2
Garcia’s Truckin’ Inc. is considering the purchase of a new production machine for
$200,000. The purchase of this machine will result in an increase in earnings before
interest and taxes of $50,000 per year. To operate this machine properly, workers
would have to go through a brief training session that would cost $5,000 after tax.
In addition, it would cost $5,000 after tax to install this machine properly. Also,
because this machine is extremely efficient, its purchase would necessitate an
increase in inventory of $20,000. This machine has an expected life of 10 years, after
which it will have no salvage value. Finally, to purchase the new machine, it
appears that the firm would have to borrow $100,000 at 8 percent interest from its
local banks, resulting in additional interest payments of $8,000 per year. Assume
simplified straight-line depreciation and that this machine is being depreciated
down to zero, a 34 percent marginal tax, and a required rate of return of 10 percent.
(a) What is the initial outlay associated with this project?
(b) What are the annual after-tax cash flows associated with this project for years 1
through 9?
(c) What is the terminal cash flow in year 10 (what is the annual after-tax cash flow
in year 10 plus any additional cash flows associated with termination of the
project)?
(d) Should this machine be purchased?
Question 3
A firm is considering the following three separate situations.
Situation A Build either a small office building or a convenience store on a parcel
of land located in a high-traffic area. Adequate funding is available, and both
projects are known to be acceptable. The office building requires an initial
investment of $620,000 and is expected to provide operating cash inflows of $40,000
per year for 20 years. The convenience store is expected to cost $500,000 and to
provide a growing stream of operating cash inflows over its 20-year life. The initial
operating cash inflow is $20,000, and it will increase by 5% each year.
22

Situation B Replace a machine with a new one that requires a $60,000 initial
investment and will provide operating cash inflows of $10,000 per year for the first 5
years. At the end of year 5, a machine overhaul costing $20,000 will be required.
After it is completed, expected operating cash inflows will be $10,000 in year 6;
$7,000 in year 7; $4,000 in year 8; and $1,000 in year 9, at the end of which the
machine will be scrapped.
Situation C Invest in any or all of the four machines whose relevant cash flows are
given in the following table. The firm has $500,000 budgeted to fund these machines,
all of which are known to be acceptable. Initial investment for each machine is
$250,000.
Operating cash inflows
Year Machine 1 Machine 2 Machine 3 Machine 4
1 $50,000 $70,000 $65,000 $90,000
2 70,000 70,000 65,000 80,000
3 90,000 70,000 80,000 70,000
4 -30,000 70,000 80,000 60,000
5 100,000 70,000 -20,000 50,000
For each situation, indicate:

(a) Whether the projects involved are independent or mutually exclusive.
(b) Whether the availability of funds is unlimited or capital rationing exists.
(c) Whether accept-reject or ranking decisions are required.
(d) Whether each project’s cash flows are conventional or nonconventional.
Question 4
Covol Industries is developing the relevant cash flows associated with the proposed
replacement of an existing machine tool with a new, technologically advanced one.
Given the following costs related to the proposed project, explain whether each
would be treated as a sunk cost or an opportunity cost in developing the relevant cash
flows associated with the proposed replacement decision.
(a) Covol would be able to use the same tooling, which had a book value of
$40,000, on the new machine tool as it had used on the old one.
(b) Covol would be able to use its existing computer system to develop programs
for operating the new machine tool. The old machine tool did not require
these programs. Although the firm’s computer has excess capacity available,
the capacity could be leased to another firm for an annual fee of $17,000.
(c) Covol would have to obtain additional floor space to accommodate the larger
new machine tool. The space that would be used is currently being leased to
another company for $10,000 per year.
23

(d) Covol would use a small storage facility to store the increased output of the
new machine tool. The storage facility was built by Covol 3 years earlier at a
cost of $120,000. Because of its unique configuration and location, it is
currently of no use to either Covol or any other firm.
(e) Covol would retain an existing overhead crane, which it had planned to sell
for its $180,000 market value. Although the crane was not needed with the
old machine tool, it would be used to position raw materials on the new
machine tool.
Question 5
DuPree Coffee Roasters, Inc., wishes to expand and modernize its facilities. The
installed cost of a proposed computer-controlled automatic-feed roaster will be
$130,000. The firm has a chance to sell its 4-year-old roaster for $35,000. The
existing roaster originally cost $61,000 and was being depreciated using MACRS
table and a 7-year recovery period. DuPree pays taxes at a rate of 40% on ordinary
income and capital gains.
(a) What is the net book value of the existing roaster?

(b) Calculate the after-tax proceeds of the sale of the existing roaster.
(c) Calculate the change in net working capital using the following figures:
24

Anticipated Changes in Current

Assets and Current Liabilities
Accruals -$20,000
Inventory 50,000.00
Accounts payable 40,000.00
Accounts receivable 70,000.00
Cash 0
Notes payable 15,000.00
(d) Calculate the initial investment associated with the proposed new roaster.
Question 6
Ultra Berhad (UB) has a proposed contract with Spltra Berhad. The initial
investment in land and equipment will be RM120,000. Of this amount, RM70,000 is
subject to five-year Industrial Building Allowance/Capital Allowance – Purchased
Assets depreciation (Year 1: 20%; Year 2: 32%; Year 3: 19.2%; Year 4: 11.5%;
Year 5: 11.5%; Year 6: 5.8%). The balance is in non-depreciable property. The
contract covers six years; at the end of six years the non-depreciable assets will be
sold for RM50,000. The depreciated assets will have zero resale value.
The contract will require an additional investment of RM55,000 in working capital

at the beginning of the first year and, of this amount, RM25,000 will be returned
after six years.
The investment will produce RM50,000 in income before depreciation and taxes for
each of the six years. The company is in a 40 percent tax bracket and has a 10
percent cost of capital.
Determine the cash flow for this investment. Use the net present value method to
explain whether this investment should be undertaken.
25


Capital Budgeting Techniques
Question 1
Clean & Clear Berhad is considering to invest in a developmental research project.
The investment opportunities Project A and Project B, are mutually exclusive and
have the following estimated cash flows
Year Project A Project B
0 -$125,000 -$125,000
1 $62,500 $22,500
2 $62,500 $22,500
3 $25,000 $75,000
4 $25,000 $75,000
(a) Compute the internal rates of returns for both the projects using trial and
error approach.
(b) Compute the net present value of both projects given a 10% cost of capital
for the firm.
(c) If the firm is able to reinvest the cash flows from the projects and earn a 10%
annual rate of return, which project has the highest expected rate of return?
(d) Which project should the firm adopt? Why?
Question 2
Healthy Food Inc. is considering switching its manually operated machine with a
new automated machine. Although the existing unit has 5 more years of service life,
its operating costs are fairly high compared to its revenue.
The new automated machine costs RM2.5 million. An additional RM100,000 is
needed for transportation and installation. The new machine is expected to generate
incremental revenues of RM2 million with an incremental overhead cost of
RM700,000 per year. It will be depreciated on a straight line method over 5 years to
a salvage value of RM200,000.
(a) If the firm’s cost of capital is 12%, calculate the following:
(i) Payback period
(ii) Net Present Value
(iii) Internal Rate of Return (using trial and error approach)
(b) Advice the management on whether it should go ahead with this investment
or not. Justify.
Question 3
The B.T.Knight Corporation is considering two mutually exclusive pieces of
26

machinery that perform the same task. The two alternatives available provide the
following set of after-tax net cash flow.
YEAR EQUIPMENT A EQUIPMENT B

0 -$20,000 -$20,000
1 12,590 6,625
2 12,590 6,625
3 12,590 6,625
4 6,625
5 6,625
6 6,625
7 6,625
8 6,625
9 6,625
Equipment A has an expected life of three years, whereas equipment B has an
expected life of nine years. Assume a required rate of return of 15 percent.
(a) Calculate each project’s net present value.
(b) Are these projects comparable?
(c) Compare these projects using replacement chains and EAAs. Which project
should be selected? Support your recommendation.
Question 4
The integrated Pavilion Kuala Lumpur development will culminate and expand
with a RM120 million ﬁve-star hotel — the Royale Pavilion Hotel, that will begin
construction in March, 2014 and is expected to be completed in June 2017. The 329
rooms of Royale Pavilion Hotel owned by Harmoni Perkasa Sdn Bhd (HPSB), is one
of the four major components of Pavilion Kuala Lumpur, which opened for business
since September 2007. The three other major completed components are a retail
mall, a 20-storey office tower, and two blocks of condos.
In considering this expansion, HPSB’s finance staff has obtained the following
information: HPSB is required to purchase RM120 million of initial investment in
land and equipment today (t = 0). Of this amount, RM700,000 is depreciated over
useful life of four years, subject to four-year Industrial Building Allowance or
Capital Allowance – Purchased Assets depreciation (Year 1: 25%; Year 2: 38%;
Year 3: 20%; Year 4: 17%). The balance is in non-depreciable property. This
expansion will require the company to increase its net operating working capital by
RM600,000 today. This net operating working capital will be recovered at the end of
four years. The new five-star hotel’s operating costs are expected to be 60 percent of
the company’s annual sales. This expansion on its hotel project will increase the
27

company’s sales. Room rates have yet to be determined, but the projected revenues
upon completion are:
Year 1: RM40.0 million
After the fourth year, the equipment will be obsolete, and will no longer provide any
additional incremental sales to the company. The equipment is expected to have a
salvage value of RM900,000 at the end of four years. However, this expansion has
suspended on its hotel project, pending advice from the authorities following a freak
accident where a crane hook fell and killed a driver near the construction site at
Pavilion shopping complex who was in a traffic jam at Raja Chulan road. Suppose
the company will receive RM150,000 before-tax rental income each year (payable at
year end) from the shop lots that is currently being rented out at Pavilion shopping
complex.
Due to the suspension notice of all works and businesses until further advice from
relevant authorities, the company will no longer receive this rental income. In
addition, HPSB will also make use of one of its old equipment that it bought at RM1
million six years ago to facilitate the previous construction. The old equipment has
not been in use for a few years and is kept in the firm’s warehouse. In order to
bring it to use, the equipment will need to be overhauled. The cost of overhauling
(catch up) is estimated to be RM110,000 today (t = 0).
The company’s corporate tax rate is 28 percent and the company’s other divisions
are expected to have positive tax liabilities throughout the project’s life. The
project’s WACC is 12 percent.
Determine the net present value (NPV) of this expansion project and its internal
rate of return (IRR). Appraise and decide whether the expansion of new ﬁve-star
hotel — the Royale Pavilion Hotel should be accepted.
Question 5
Bersih Products (BP) manufactures a variety of household products. The company
is considering introducing a new detergent. The company’s finance manager has
collected the following information about the proposed product.
- The project has an anticipated economic life of 4 years.
- The company will have to purchase a new machine to produce the detergent.
The machine has an up-front cost of RM2 million. The machine will be
depreciated on a straight-line basis over 4 years. The company anticipates that
the machine will last for four years, and that after four years, its salvage value
will equal zero.
- If the company goes ahead with the proposed product, it will have an effect on
28

the company’s net operating working capital. At the outset, inventory will
increase by RM140,000 and accounts payable will increase by RM40,000. The
net operating working capital will be recovered after the project is completed.
- The detergent is expected to increase sales revenue by RM1 million the first
year, RM2 million the second year, RM2 million the third year, and RM1 million
the final year. Each year the operating costs (not including depreciation) are
expected to equal 50 percent of sales revenue.
- The company’s interest expense each year will be RM100,000.
- The new detergent is expected to reduce the after-tax cash flows of the
company’s existing products by RM100,000 a year.
- The company’s overall Weighted Average Cost of Capital (WACC) is 10
percent. However, the proposed project is riskier than the average project for
BP; the project’s WACC is estimated to be 12 percent.
- The company’s tax rate is 26 percent.
Determine the Net Present Value (NPV) of this new project and its Internal Rate of
Return (IRR). Appraise and decide whether the project should be accepted.
29


Dividend Policy
Question 1
Describe the three divergent views of dividend policy's effect on share price.
Question 2
BF Berhad decides to cut its dividend from RM2 per share to RM1.50 per share.
Give two rationales and/or theories to explain why this action may cause the stock
price to decrease and two rationales and/or theories to explain why this action may
cause the stock price to increase.
Question 3
Identify three reasons why a firm might buy back its own common stock shares.
Question 4
Dryden, Corp. has 500,000 shares of common stock outstanding, a P/E ratio of 11,
and $900,000 earnings available for common stockholders. The board of directors
has just voted a 5:2 stock split.
(a) If you had 100 shares of stock before the split, how many shares will you have
after the split?
(b) What was the total value of your investment in Dryden stock before the split?
(c) What should be the total value of your investment in Dryden stock after the
split?
(d) In view of your answers to (b) and (c) above, why would a firm's management
want to have a stock split?
Question 5
Cyberco Corporation has 5 million shares of stock outstanding. Cyberco's after-tax
profits are $15 million and the corporation's stock is selling at a price-earnings
multiple of 10, for a stock price of $30 per share. Cyberco management issues a 25%
stock dividend.
(a) Calculate Cyberco's earnings per share before and after the stock dividend.
(b) Suppose an investor owns 100 shares of Cyberco before the stock dividend. Use
the price earnings multiple to estimate the value of the investor's holdings both
before and after the dividend.
(c) Comment on the results of the stock dividend for current shareholders.
Question 6
Identify and explain three different dividend policies. Which is most common?
30

Question 7
Trevor Co.'s future earnings for the next four years are predicted below:
Year 1 $900,000
Year 2 $1,200,000
Year 3 $850,000
Year 4 $1,350,000
Assuming there are 500,000 shares outstanding, what will the yearly dividend per
share be if the dividend policy is
(a) a constant payout ratio of 40%
(b) stable dollar dividend targeted at 40% of the average earnings over the four-
year period
(c) small, regular dividend of $0.75 plus a year-end extra of 40% of profits
exceeding $1,000,000
31


Working Capital Management
Question 1
If sales are projected to be 10,000 units and the order cost/order is $50 and the
carrying cost/unit is $300, using the EOQ Model:
(a) Calculate the optimal quantity to be ordered.
(b) What is the total inventory cost?
Question 2
Persie Berhad has determined the following inventory information and
relationships:
Orders can be placed only in multiples of 300 units
Annual unit usage is 600,000 units (assume a 50-week/year in calculation)
The carrying cost is 10% of the purchase price of the goods. The purchase price is
RM6 per unit, ordering cost is RM85 per order. The desired safety stock is 6,000
units, excluding the delivery-time stock. Delivery time is 5 weeks
Given these information:
(a) What is the Economic Order Quantity (EOQ) level?
(b) At what inventory level should a reorder be made?
Question 3
A textile manufacturer has cloth that has a RM14 per yard carrying cost per year.
This cloth is used at a rate of 25,000 yards per year, and ordering costs are RM10
per order.
(a) Calculate the economic order quantity for this cloth.
(b) Determine the annual inventory costs for this firm if it orders in the quantity
calculated in (a).
Question 4
VG Enterprises wishes to determine the economic order quantity (EOQ) for a
critical and expensive inventory item that is used in large amounts at a relatively
constant rate throughout the year. The firm uses 450,000 units of the item annually,
has order costs of $375 per order, and its carrying costs associated with this item are
$28 per unit per year. The firm plans to hold safety stock of the item equal to 5 days
of usage, and it estimates that it takes 12 days to receive an order of the item once
placed. Assume a 365-day year.
(a) Calculate the firm’s EOQ for the item of inventory described above.
(b) What is the firm’s total cost based upon the EOQ calculated in part (a)?
(c) How many units of safety stock should VG hold?
32

(d) What is the firm’s reorder point for the item of inventory being evaluated?
(Hint: Be sure to include the safety stock.)
Question 5
What three actions can a firm take to minimize its net working capital?
Question 6
Rapid Products wishes to evaluate its cash conversion cycle (CCC). Research by one
of the firm’s financial analysts indicates that on average the firm holds items in
inventory for 65 days, pays its suppliers 35 days after purchase, and collects its
receivables after 55 days. The firm’s annual sales (all on credit) are about $2.1
billion, its cost of goods sold represent about 67 percent of sales, and purchases
represent about 40 percent of cost of goods sold. Assume a 365-day year.
(a) What is Rapid Products’ operating cycle (OC) and cash conversion (CCC)?
(b) How many dollars of resources does Rapid have invested in (i) inventory, (ii)
accounts receivable, (iii) accounts payable, and (iii) the total CCC?
(c) If Rapid could shorten its cash conversion cycle by reducing its inventory
holding period by 5 days, what effect would it have on its total resource investment
found in part b(iv)?
(d) If Rapid could shorten its CCC by 5 days, would it be best to reduce the
inventory holding period, reduce the receivable collection period, or extend the
accounts payable period? Why?
33

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UKFF2013 Business Finance May 2018/2019

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ACADEMIC YEAR: 2018/2019

BACHELOR OF SCIENCE (HONS) ACTUARIAL SCIENCE

UKFF2013 BUSINESS FINANCE

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Asset F Asset G Asset H

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Fit 25,000 1.80 0.90 14.60

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Tutorial 7 (Topic 6 and 7)

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Bonds (8%, $1,000 par, 16-year maturity) 38%

Current Dividend Projected Under- Flotation

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Tutorial 10 (Topic 10)

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For each situation, indicate:

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(a) What is the net book value of the existing roaster?

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Anticipated Changes in Current

The contract will require an additional investment of RM55,000 in working capital

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Tutorial 11 (Topic 11)

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YEAR EQUIPMENT A EQUIPMENT B

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Tutorial 12 (Topic 12)

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Tutorial 13 (Topic 13)

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