TEST 2 JAN 2021/MAF603

UNIVERSITI TEKNOLOGI MARA

ONLINE COMMON TEST 2

COURSE : CORPORATE FINANCE

COURSE CODE : MAF603
TEST : JAN 2021
TIME : 2 HOURS

INSTRUCTIONS TO CANDIDATES

1. This is an online test question consist of 29 Multiple Choice Questions.

2. Click "SAVE/NEXT/FINISH/SUBMIT" button for each question and after completed.

3. Answer ALL questions.

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DO NOT TURN THIS PAGE UNTIL YOU ARE TOLD TO DO SO

This examination paper consists of 3 printed pages

Instruction: Choose the most appropriate answer.

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 TEST 2 JAN 2021/MAF603

1. Which of the following statements best describes the optimal capital structure?

A. The optimal capital structure is the mix of debt, equity, and preferred stock that
maximizes the company's earnings per share (EPS).
B. The optimal capital structure is the mix of debt, equity, and preferred stock that
maximizes the company's stock price.
C. The optimal capital structure is the mix of debt, equity, and preferred stock that
maximizes the company's weighted average cost of capital (WACC).
D. None of the statements are correct.
(1 mark)

2. Which of the following does not make the firm more vulnerable to financial distress?

A. High sensitivity of the company's revenues to the general level of economic activity.
B. High proportion of fixed to variable costs.
C. Physical capital assets which are relatively illiquid and difficult to market.
D. A reduction in taxable income accomplished by claiming allowable deductions.
(1 mark)

3. Pecking order theory implies…..

A. There is a negative relationship between financial gearing and the WACC because of
the 'free lunch' effect of the tax shield.
B. There is a positive relationship between financial gearing and the WACC because of
financial distress.
C. There is no relationship between financial gearing and the WACC as there are no
'free lunch' benefits from higher gearing.
D. The level of gearing is not selected but is itself determined by other strategic
business decisions.
(1 mark)

4. Costs of financial distress emerge from incentive issues that arise as the financial
situation of the company deteriorates is ________________.

A. indirect cost.
B. direct cost.
C. agency cost.
D. institutional cost.
(1 mark)

5. If a cinema began to experience reductions in ticket sales associated with news of its
difficulty in servicing its debt (making debt payments), this would be an example of:

A. agency problems.
B. a tax-shield.
C. financial distress.
D. the pecking order view of capital structure.
(1 mark)

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6. The cost of capital for a firm when we allow for taxes, bankruptcy, and agency costs is

A. first declines and then ultimately rises with decreasing levels of financial leverage.
B. first declines and then ultimately rises with increasing levels of financial leverage.
C. first rises and then ultimately decline with increasing levels of financial leverage.
D. first rises and then ultimately decline with decreasing levels of financial leverage.
(1 mark)

7. Which of the following statements concerning capital structure theory is correct?

A. In the traditional view, there is a linear relationship between the cost of equity and
financial risk.
B. Modigliani and Miller said that, in the absence of tax, the cost of equity would remain
constant.
C. Pecking order theory indicates that preference shares are preferred to convertible
debt as a source of finance.
D. In the Static theory, the capital structure of the company is determined by a trade-off
of the valuation of the tax savings against the cost of financial distress.
(1 mark)

8. In a world with no taxes, no transaction costs, and no cost of financial distress, which of
the following statements is TRUE?

A. If a firm issues equity to redeem some of its debt, the price per share of the firm’s
stock will rise because the shares are less risky.
B. Moderate borrowing will not increase the required rate of return on a firm equity.
C. If a firm issues equity to redeem some of its debt, the price per share of the firm’s
stock will drop because the shares are less risky.
D. Minimum borrowing will not increase the required rate of return on a firm equity.
(1 mark)

9. Which of the following statement is TRUE?

A. The choice of financing, debt has an impact on the stock price.

B. The choice of financing, debt will not affect the volatility of the equity.
C. Homemade leverage refers to the use of borrowing on the corporate level.
D. Market perceives that the company needs more equity to fund capital expenditures.
(1 mark)

10. As the firm, increase its Debt to Equity ratio, __________________________________

A. the risk of equity increase, value of firm decrease.

B. the risks of equity decrease, value of firm also decrease.
C. the risk of equity increase, value of firm also increases.
D. the risk of equity decrease, value of firm increases.
(1 mark)

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 TEST 2 JAN 2021/MAF603

QUESTION 11 (i, ii, iii & iv)

11. Syukri Sdn Bhd plans to repurchase part of its common stock by issuing corporate debt.
As a result, the debt-to-equity ratio of the company is projected to rise from 50% to 60%.
The company currently has an outstanding debt of RM 9.75 million. The cost of this debt
is 12% per year. Syukri Sdn Bhd anticipates earnings before interest and tax (EBIT) of
RM4.875 million per year of perpetuity. Assume a world without taxes.

Required:

i. Calculate the market value of Syukri Sdn Bhd after the repurchase of its common
stock.

A. RM 28.00 million
B. RM 39.25 million
C. RM 36.975 million
D. RM 29.25 million
(2 marks)

ii. Calculate the required return on equity (RS) before the repurchase of its common
stock.
(Round up to the nearest percentage)

A. 25%
B. 19%
C. 16%
D. 17%
(2 marks)

iii. Compute the required return on equity (RS) after the repurchase of its common stock.

A. 19.47%
B. 20.76%
C. 17.84%
D. 18.63%
(1 marks)

iv. Assume that Syukri Sdn Bhd need to pay a corporate tax rate at the rate of 25%.
Calculate the overall cost of capital (Rwacc) before the repurchase of its common stock?

A. 9.32%
B. 14.06%
C. 12.50%
D. 15.00%
(1 marks)

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12. The financial performance of Novascotia Ltd indicates declining trend for the past few
years with earnings before interest and tax (EBIT) reducing to RM35 million. The firm’s
unlevered cost of capital is 20%. The net present value of bankruptcy and agency cost
are RM45 million and RM60 million respectively. If Novascotia Ltd has a market value of
RM200 million, the present value of tax shield on debt is ____________.

A. RM175 million
B. RM200 million
C. RM130 million
D. RM305 million
(2 marks)

13. The capital structure of Sunrise Bhd is equally financing between debt and equity. The
post-tax cost of borrowing on the outstanding debt is 5% per annum. Sunrise Bhd
predict that the firm will improve its earnings next year. Thus, the shareholder expects
the firm will provide the required rate of return (RS) at 15%. The corporate tax rate is
25%. If the value of firm is currently valued at RM1,125 million, determine the earning
after interest and tax of Sunrise Bhd:

A. RM140.63 million
B. RM84.36 million
C. RM37.51 million
D. RM112.48 million
(2 marks)

14. A firm's overall cost of capital could help the company to make decision. Which of the
following is the correct decision?

A. Research and Development Decision

B. Investment Decision
C. Marketing Decision
D. Business Decision
(1 mark)

15. Issue ordinary shares at market price RM10.00 per share. The flotation cost associated
with the issuance is 4% of the market price. Hexagon is expected to pay a dividend of
RM1.188 per share next year as compared to RM1.10 per share last year. Hexagon
assumed the dividend to grow at a constant rate of 8% per annum. Calculate the cost of
internal equity for Hexagon.

A. 19.88%
B. 18.77%
C. 19.19%
D. 17.22%
(1 mark)

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 TEST 2 JAN 2021/MAF603

16. The 12% preferred stocks can be issued at a premium of 20% from its market value. The
dividend is paid based on the par value. The par value of the preferred stock is RM100
and the issuing cost is RM4. The current share price of the preferred stock is RM120.
Calculate the cost of preferred stock.

A. 8.89%
B. 9.01%
C. 8.57%
D. 8.77%
(1 mark)

17. Tiffany Co. has issued a 5% corporate bond at a premium of 10% from the par value of
RM1,000. The floatation cost is 5% of the issued value. The corporate bonds can be
redeemed at a maturity period of 10 years at par value. Tiffany Co. pays 25%
corporation tax. What is the best estimate of the cost of these loan notes?

A. 4.01%
B. 3.34%
C. 5.25%
D. 8.62%
(1 mark)

18. A 6% irredeemable loan notes of a nominal value of RM200. The market price is RM95
and flotation cost incurred in the company is RM25. A company that pays corporation tax
at a rate of 25%. What is the cost of capital for these loan notes?

A. 12.9%
B. 13.2%
C. 12.4%
D. 14.8%
(1 mark)

19. Empire plans to use various internal and external sources of financing to fund the project
and has estimated the individual cost of capital as follows:

i. After tax cost of debt is 4.07% (Weightage: 0.193)

ii. Cost of preference shares is 6.5% (Weightage: 0.127)
iii. Cost of internal and external equity is 19.8% and 20.5% respectively (Weightage:
0.68)

Empire decides to limit its retained earnings available for re-investment purposes to the
maximum value of 85% on retained earnings balance which is RM 20,500,000. The
project cost is expected to be RM58 million. What is the weighted marginal average cost
of capital for Empire?
A. 15.551%
B. 12.332%
C. 17.229%
D. 14.234%

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(1 mark)

20. The overall (weighted average) cost of capital is composed of a weighted average of
__________.

A. the cost of common equity and the cost of debt

B. the cost of common equity and the cost of preferred stock
C. the cost of preferred stock and the cost of debt
D. the cost of common equity, the cost of preferred stock, and the cost of debt
(1 mark)

21. Following assumptions is required when using the capital asset pricing model to estimate
the cost of equity for project appraisal EXCEPT?

A. Efficient capital markets

B. Well diversified investors
C. Future periods are consistent with the present
D. Companies are well diversified
(1 mark)

22. Thinker Bhd has issued Ordinary Share capital of RM10 million, made up of 20 million
ordinary shares. The Ordinary shares of Thinker is currently selling 20% above its par
value. Any issuance of new shares will result in issuing cost of 10% of its market value.
The most recent dividend was RM0.05 and the annual growth rate of dividend is
expected to be 2%. Calculate the internal cost of Thinker share capital?

A. 11.44%
B. 10.50%
C. 12.20%
D. 10.33%
(2 mark)

23. Bliss Bhd is currently evaluating a mega landscaping project where the total cost is
RM500,000. After evaluating the firm’s capital structure, the retained earnings are not
sufficient to cover the cost of investment. Current weightage of financing for equity is
75% and the retained earnings available for reinvestment is RM300,000. Bliss proposed
to pay next year dividend of RM0.50 per share and the growth rate is 5%. If the cost of
external common equity of Bliss is 15%, calculate the number of new shares to be
issued to finance the project assuming no floatation cost.

A. 15,000
B. 40,000
C. 60,000
D. 75,000
(2 mark)

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 TEST 2 JAN 2021/MAF603

24. Wonderful Bhd is about to issue a 5% preference shares to finance the proposed project
of manufacturing kids’ educational toys. The issuance of new preference shares will
result in floatation cost of RM0.20 per share, which is equivalent to 10% of the current
market value of the preference shares. The preference share is currently selling at a
premium of 25%. Calculate the cost of preference shares.

A. 5.00%
B. 5.55%
C. 4.00%
D. 4.44%
(2 mark)

25. The following is the optimal capital structure of Felicia Bhd:

Common Equity 70%

Preference Shares 20%
Debt 10%

The cost of internal equity is 10%, cost of external equity is 11%, cost of debt is 8% and
cost of preference shares is 12%. Felicia intends to invest in a new project and after
calculation, the overall cost of equity is 10.9%. which of the following is the possible
combination of retained earnings and cost of project?

Retained Earnings (RM) Cost of project (RM)

A. 3.5 million (all retained earnings available for 6 million
reinvestment)
B. 5.0 million (75% retained earnings available for 5 million
reinvestment)
C 4.0 million (all retained earnings available for 5 million
. reinvestment)
D 4.0 million (70% retained earnings available for 3.9 million
. reinvestment)
(2 mark)

26. Consider the following statements:

Statement 1: Floatation cost result in a lower cost of capital.

Statement 2: Floatation cost is normally incurred by a firm when issuing new securities.

Which one of the following combinations (true/false) relating to the above statements is
correct?

Statement 1 Statement 2
A. True True
B. True False
C False True
.
D False False
.

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(1 mark)

27. Aladdin Bhd involved in food and beverage industry. The firm plan to venture into a new
project in different industry (healthcare). The debt to asset ratio of Aladdin is 1 to 3 with a
beta of 1.5. For the purpose of computation of project specific cost, a proxy company
(Wilson Bhd) has been identified. Wilson is an unlevered firm with a beta of 1.2. The
expected market return is 10% and the market risk premium is 6%. Assume tax rate is
25%, calculate Aladdin cost for the new project.

A. 13.0%
B. 13.9%
C. 16.4%
D. 18.4%
(1 mark)

28. Nabata Bhd, a sport equipment manufacturer is engaged a consultant in evaluating a

new project. The consultant advises Nabata to use the firm’s current weighted average
cost of capital (‘WACC’) to appraise the potential project. Which of the following
statement is true relating to the investment?

Statement 1: The financing plan for the project will not affect Nabata’s current capital
structure
Statement 2: The project is related to the manufacturing of sports equipment
Statement 3: The project is big relative to the size of Nabata

A. 1 and 2 only
B. 2 and 3 only
C. 1 and 3 only
D. 1, 2 and 3
(1 mark)

29. Consider the following statements:

Statement 1: The beta of an all-equity firm is equity beta.

Statement 2: The equity beta of proxy company is ungeared to derive the asset beta
that capture the financial risk of proxy company.

Which one of the following combinations (true/false) relating to the above statements is
correct?

Statement 1 Statement 2
A. True True
B. True False
C False True
.
D False False
.
(1 mark)

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TEST 2 JAN 2021/MAF603

TOTAL: 40 MARKS

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