MAF603 – DEC 2016

SUGGESTED SOLUTION (revised)

Question 1

Expected Return

i. Lux = 0.35 (31) √ + 0.40 (24) √ + 0.25 (17) √

= 24.7%

Variance

Lux = 0.35√ (31 – 24.7) 2 √ + 0.40 √ (24 – 24.7) 2 √ + 0.25 √ (17 – 24.7) 2 √
= 13.8915 + 0.196 + 14.8225
= √28.91
SD = 5.38% √
(√10 x ½ = 5 marks)

ii. Lux has the lower risk compared with May. √ The standard deviation of Lux (5.38%) is
lower than the standard deviation of May (6.26%). √
(√2 x 1 = 2 marks)

iii. Expected Return and Standard Deviation of Portfolio

Expected Return

= 0.6 √ (22) √ + 0.4 √ (24.7) √

= 23.08%

Variance

= (0.6)2 √ (6.26)2√ + 2 (0.6) (0.4) √ (6.26 √ x 5.38 x 0.2 √) + (0.4) 2√ (5.38)2

SD = √21.97
SD = 4.69%
(√10 x ½ = 5 marks)

iv. Expected Return on Portfolio (Under CAPM)

Beta portfolio

= 0.6 √ (1.6) √ + 0.4 √ (1.8) √ = 1.68

Required Return on Portfolio

= 4% √ + 1.68 (12% √ - 4% √) = 17.44%

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 MAF603 – DEC 2016

It is not correctly priced √. Since the expected return of the portfolio in (iii) is higher than
√ the CAPM’s required return, it implies that the portfolio is undervalued. √

(√10 x ½ = 5 marks)

v. The variance of the portfolio drops as more securities are added, √ which is evidence of
the diversification effect. A diversified portfolio can eliminate some but not all of the risk
of the individual securities. √ However, the portfolio’s variance can be never drop to
zero. The variance of the return on portfolio with many securities is more dependent on
the covariance between the individual securities. √

(√3 x 1 = 3 marks)

Question 2

Before the stock repurchase

i. VL = Vu + TcB
VL = RM235 million

VU = RM235 million√ – 0.25(RM140 million) √√

= RM200 million √
(√4 x ½ = 2 marks)

ii. VU = EBIT (1 - TC)

RO

RS = RO + B/S(RO – RB)(1- TC)

15% √ = RO + RM140 m/RM95 m √√ (RO - 7%) √ (1- 25%) √

RO = 10.80%

RM200 m√ = EBIT (1 – 0.25%)√

10.80% √

EBIT = RM28.8 million

OR

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 MAF603 – DEC 2016

VL = EBIT (1 - TC) + TCB

RO
RM235 m – RM35 m√ = EBIT (1 – 0.25%)√ = RM28.8 million
10.80% √

(√8 x ½ = 4 marks)

iii. RWACC = B/B+S x RB (1-TC) + S/B+S x RS

= RM140 m/RM235 m √ x 7% √ (1-25%) √ + RM95 m/RM235 m √ x 15%√

= 9.19% √

(√6 x ½ = 3 marks)

After the stock repurchase

iv. VL = RM235 m √ + 25% x RM20 m √√

= RM240 million

OR

VL = RM28.8 m (1 – 0.25) √ / 10.80% √ + 25% (RM140 m + RM20 m) √

= RM240 million

S = RM240 m – RM160 m

= RM80 million

Rs = Ro + B/S(Ro – RB)(1- Tc)

= 10.80% √ + RM160m/ RM80m √ (10.80% - 7%) √ (1-25%) √

= 16.5%

Rwacc = B/B+S x RB(1-Tc) + S/B+S x Rs

= RM160m/RM240m √ x 7% √ (1-25%) √ + RM80m/RM240m √ x 16.5% √

= 9%

(√12 x ½ = 6 marks)

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 MAF603 – DEC 2016

v. In a world with taxes, the increase in the level of debt will increase the value of the firm √
due to the increase in the tax shield.√ The cost of equity will decrease √ with leverage
because the firm pays less tax since interest is tax deductible.√ However, because debt
is tax advantaged relative to equity, the overall cost of capital declines with leverage
after the stock repurchase. √

(√5 x 1 = 5 marks)

Question 3

i. NPV (Base Case)

-Initial Outlay + PV of depreciation tax shield + PV (after tax) cash flow

= -RM410,000 √ + 0.25√ (RM410,000/10 years)√ (A 4%, 10 years) √ + RM150,000 (1-0.25) √

(A 14%, 5 years) √ + RM200,000 (1-0.25) √ ( A 14%, 10-5 years) √ + RM40,000 (1-0.25) √ (A 14%, 10
years) √

= -RM410,000 + 0.25(RM410,000/10 years)(8.1109) + RM150,000(1-0.25) (3.4331) +

RM200,000(1-0.25)(5.2161-3.4331) – RM40,000 (1-0.25)(5.2161)

=-RM410,000 + RM83,136.725 + RM386,223.75 + RM267,450 – RM156,483

= RM483,293.475
(√10 X ½ = 5 marks)

ii. NPV Loan

Gross Proceed – PV (after tax) interest – PV (principal)

= RM500,000 √ – 0.08 (RM500,000) √ (1-0.25) √ (A 8%, 5 years) √ – RM500,000√ (P 8%,5

years) √

= RM500,000 – 0.08 (RM500,000) (1-0.25) (3.9927) – RM500,000 (0.6806)

= RM500,000 – RM119,781 – RM340,300

= RM39,919

Net Processing Fee/Floatation Cost

Net Floatation cost = - FC + PV FC tax shield

= -RM32,000 √ + (RM32,000/5) √√ (0.25) √ (A 4% ,5 years) √

= -RM32,000 + (RM32,000/5)(4.4518)
= -RM24,877.12

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 MAF603 – DEC 2016

APV = RM483,293.475 + RM39,919 – RM24,877.12√√√

= RM498,335.355

(√14 X ½ = 7 marks)

iii. Proceed with the purchase of the new machine √ since the APV is positive. √
(√2 X 1 = 2 marks)

iv. NPV (Govt Loan)

Gross Proceed – PV (after tax) interest – PV (principal)

= RM500,000 √ – RM500,000 (0.05) √ (1-0.25) √ (A 8%, 3 years) √ – RM500,000 √ (P8%, 3 years)

√

= RM500,000 – RM500,000 (0.05) (1-0.25)(2.5771) – RM500,000 (0.7938)

= RM500,000 – RM48,320.625 – RM396,900

= RM54,779.38

APV = RM483,293.475 + RM54,779.38

= RM538,072.855
(√6 x ½ = 3 marks)

v. Decision: Accept the project with financing from the State government √ since the
APV is positive √ and higher than borrowing using the bank loan.√
(√3 X 1 = 3 marks)

Question 4

i. Dividends per share of Elegant Bhd.

= (Total Earnings/Number of shares) x Dividend payout ratio

= (RM3,000,000/2,000,000) √ x 0.55√
= RM0.825

Required rate of return

r = D1/PO + g
= RM0.825 (1.06√)/{(RM3,000,000/2,000,000) √ (12) √ } + 0.06√
= 10.86%

The price (new growth)

P1 = D1/(r - g)
= 0.825(1.08√)/(0.1086 - 0.08) √
= RM31.15

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 MAF603 – DEC 2016

Synergy = (RM31.15 - 18) √ 2,000,000 √

= RM26,300,000
(√10 x ½ = 5 marks)

ii. The NPV of the merger to Bestasia Bhd.

= PV of Synergy – Premium paid
= RM26,300,000 √ – [(RM25 x 2,000,000 √√– RM18 x 2,000,000)] √√
= RM12,300,000

OR

NPV = Value of the target firm - cash paid

= (2 m x RM31.15) √√ – (2 m x RM25) √√
= RM12.3 m √

(√5 x 1 = 5 marks)
iii. Combined value (VAB)
= (RM25 x 3,000,000√√) + (RM18 x 2,000,000√√) + RM26,300,000
= RM75,000,000 + RM36,000,000 + RM26,300,000
= RM137,300,000

Premium paid to Elegant Bhd.

= (2,000,000√/(2,000,000+3,000,000√) x RM137,300,000) – (RM18 x 2,000,000)√
= RM54,920,000 – RM36,000,000
= RM18,920,000

NPV of the merger to Bestasia Bhd

= PV of Synergy – Premium Paid
= RM26,300,000 - RM18,920,000
= RM7,380,000 √

OR

Combined value (VAB)

= (RM25 x 3,000,000√√) + (RM18 x 2,000,000√√) + RM26,300,000
= RM75,000,000 + RM36,000,000 + RM26,300,000
= RM137,300,000

NPV = Value of the target firm - New/ (New + old shares) x VAB
= (2 m x RM31.15) √ – (2m √ / (2 m + 3 m) √√ x RM137.3 m )
= RM7.38 m

Bestasia Bhd should choose the cash offer √ as it provides a higher NPV as compared with the
share offer. √

(√10 x ½ = 5 marks)

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 MAF603 – DEC 2016

a. Cash merger √ would be preferred if the management believes that the shares are
undervalued. The argument is that the bidder would have to issue more shares if using
share swap. It would be cheaper if the acquisition is made with a cash offer.√

b. Cash merger √ would be favored if the management believes that the real synergy
benefits would be greater than what was estimated. The argument is that by paying cash
the bidder gets rid of the target shareholders and keeps the company to itself. It would not
then have to share the greater than expected synergy gains with the target shareholders.
√

(√4 x ½ = 2 marks)

v. Sources of synergy (any 3)

1) Economies of Scale √

The average cost per unit drops as the level of production increases. The merged companies
will share their central facilities such as corporate headquarters, top management and computer
systems.√

2) Economies of Vertical Integration √

The main purpose is to make coordination of closely related activities easier. For example,
forest product firms that cut timber, also own sawmills and hauling equipment.√

3) Transfer of Technology√

Technology from one company is transferred when the merger takes place. This will reduce the
cost of developing new technology. For example, an automobile manufacturer may acquire an
aircraft company if aerospace technology can improve automotive quality.√

(Any other acceptable answer)

(√6 x ½ = 3 marks)

Question 5

A. i. The benefits of international finance (any 2)

1. Tools for international trade and allows countries to specialize in producing
goods and services at which they have comparative advantage.
2. Foster relations and goodwill amongst countries.
3. Enhance the pace of increase and multiplication of wealth amongst countries.
4. Helps the financial manager to make decision to exploit opportunities at an
international level.
(√2 x 1 = 2 marks)

ii. The quoted price is the price in local currency (RM) of a foreign exchange.
Therefore, the quotation is said to be in DIRECT term. √

(√1 x 1 = 1 mark)

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 MAF603 – DEC 2016

iii. €10,000,000√/1.2550√ = £7,968,127

As the rate is quoted £1 = €X, the bank will buy € from the company at the higher
rate, so that the company receives fewer £ for each € sold. √

(√3 x 1 = 3 marks)

iv. It is likely that the effect of changes in exchange rate will benefit some companies
and hurt others. √ The net effect on the overall company depends on its net
exposure or risk. √ There are three different types of exchange rate risk: short term
exposure, long term exposure and translation exposure.

(√2 x 1 = 2 marks)

iv. Incorrect. √ Even when a company does not export or import, it might be exposed to
the threat of foreign competition in its domestic markets.√

(√ 2 x ½ = 1 mark)

v. RM depreciates against the USD.√

(√ 1 x 1 = 1 mark)

B. In an efficient market
The price of the stock will fully reflect the public information immediately and remain at
that level. √√

In an inefficient market
The price of a stock may partially reflect public information √ with some delayed response
√ or the price may over-react to the public information. √
(√5 x 1 = 5 marks)

C. There is no opportunity √ to make abnormal profits √ by investing in Jaya Communication

Bhd’s shares because the information is public information √ . In a semi strong efficient
market, this information has been incorporated in the share price. √ Thus, investors can
only expect normal profits. √
(√5 x 1 = 5 marks)

END OF SOLUTION