CONFIDENTIAL

AC/JAN 2013/MAF620/FMC570

UNIVERSITI TEKNOLOGI MARA

FINAL EXAMINATION

COURSE

CORPORATE FINANCE

COURSE CODE

MAF620/FMC570

EXAMINATION

JANUARY 2013

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.
Please check to make sure that this examination pack consists of:
i)
ii)
iii)

the Question Paper

a two-page Appendix 1 (Present Value Table)
an Answer Booklet - provided by the Faculty

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

This examination paper consists of 6 printed pages
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AC/JAN 2013/MAF620/FMC570

QUESTION 1
Sun World Bhd is considering investing its excess funds in one of the following two
companies. The following table shows the estimated returns of the two securities for next
year and the related probabilities.
State of economy
Recession
Normal
Boom

Probability
0.30
0.50
0.20

Estimated return (%)

May Bhd
June Bhd
10
-11
9
12
7
17

The expected returns and standard deviation of the market are 5.9% and 8.23%
respectively. The covariance between May and the market is 92.21 while the covariance
between June and the market is -7.61.
Required:
a)

Calculate the expected return and standard deviation of May Bhd and June Bhd.
Which security should the company choose? Why?
(9 marks)

b)

Calculate and comment on the beta of each security.

(4 marks)

c)

Assume the capital asset pricing model (CAPM) holds true. If the Treasury Bill rate is
3%, calculate the required return of each security. In which security should the
company invest in?
(3 marks)

d)

Management may make decisions which are often in conflict with their shareholders'
interest. Explain two (2) control mechanisms that shareholders can use to cause
management to act in the shareholders' best interest.
(4 marks)
(Total: 20 marks)

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AC/JAN 2013/MAF620/FMC570

QUESTION 2
A.

Chendana Berhad and Dupa Berhad are identical in all respects except that Chendana
Berhad is more levered than Dupa Berhad. Chendana Berhad's debt obligation
requires the firm to make RM8 million in payments. Dupa Berhad's debt obligations
are RM4.9 million.
Both companies expect that the probability next year of an expansion is 70 percent
and of a recession is 30 percent. If an expansion occurs, each firm will have earnings
before interest and taxes (EBIT) of RM15 million. On the other hand, if a recession
occurs, each firm will have EBIT of RM7 million.
Required:
a)

B.

Assume a one-period model and no taxes. The shareholders and bondholders in

these firms are risk-neutral and they discount the firm's cash flows at 12 percent.
i)

Calculate the value of Chendana Berhad and Dupa Berhad. (Show

calculations of each firm's equity and debt values).
(10 marks)

ii)

Is it true that Dupa Berhad should have a higher value than Chendana
Berhad as Dupa Berhad has less debt, and therefore less bankruptcy risk?
Comment.
(3 marks)

In the real world, financial distress can lead to conflict of interest between stockholders
and bondholders. Discuss the three (3) kinds of selfish investment strategies that
stockholders use to gain benefits and hurt the bondholders. Why are these strategies
costly?
(7 marks)
(Total: 20 marks)

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AC/JAN 2013/MAF620/FMC570

QUESTION 3
A.

Indicate whether the following statements are true or false. Provide a brief explanation
for your answer.
i)

"The desire for current income is not a valid explanation for adopting a high
dividend payout because investors can always create homemade dividends by
selling a portion of their stocks".

ii)

"Empirical research has found that there are significant increases in stock price
on the day an initial dividend is announced".

iii)

"A firm with weak cash flows can boost its share price by raising its dividend in
the longer term".
(9 marks)

B.

In the context of the efficient market hypothesis (EMH), explain what it means for a
stock market to be efficient. Describe two (2) examples when the stock market price
reaction may be called inefficient.
(5 marks)

C.

Explain Research on Mutual Funds and the evidence this research provides. Which
form(s) of EMH does it support or prove?
(3 marks)

D.

Do empirical studies support or reject the notion that corporate insiders earn abnormal
returns on their trades? What forms of market efficiency are supported or rejected?
(3 marks)
(Total: 20 marks)

QUESTION 4
Kejora Bhd is considering a RM10 million project that will last five years. The straight line
depreciation method is used. The cash inflows for the project are RM3.5 million per year for
the first two years and RM4.5 million per year for the remaining years. This project is
expected to have a salvage value of RM0.5 million at the end of the project's life.
Kejora Bhd can obtain a five-year commercial bank loan at 8% interest per year but the
company will only borrow 40% of the project's value. The bank will charge a processing fee
of 1 % of the loan amount. The fee is payable upfront, and is to be amortized over the term of
the loan. The terms of agreement require the company to settle principal payments of
RM800,000 at the end the second year and the balance in the fifth year.
The corporate tax rate is 25 percent. The risk-free rate is 6 percent and the applicable
unlevered cost of capital is 20 percent.

Hak Cipta Universiti Teknologi MARA

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AC/JAN 2013/MAF620/FMC570

Required:
a)

Determine whether or not Kejora Bhd should undertake the project if it is 100-percent
equity financed.
(6 marks)

b)

Calculate the Adjusted Present Value (APV) of the project. Advise the firm whether or
not Kejora Bhd should undertake the project with debt financing from the commercial
bank.
(10 marks)

c)

Assume that the Melaka State Government is willing to offer 40% of the project's value
through a non-amortized government loan at 5% interest rate for 3 years with no
processing cost. The repayment of the principal is a lump sum at the end of the loan
term. Advise Kejora Bhd on which financing option is the best for the company.
(4 marks)
(Total: 20 marks)

QUESTION 5
The shareholders of Apple Bhd have voted in favour of a buyout offer from Maddox Bhd.
Information about each firm is given below:
Price-earnings ratio
Number of Shares outstanding
Earnings
Dividends

Maddox Bhd
15
1,200,000
RM2,400,000
RM720,000

Apple Bhd
10.8
660,000
RM696,000
RM348.000

Securities analysts expect that the earnings and dividends of Apple Bhd will grow at a
constant rate of 5 percent each year. It is estimated that the acquisition will create
economies of scale for Apple that will increase its growth rate to 7 percent per year.
Required:
a)

Determine the value of Apple Bhd to Maddox Bhd.

(6 marks)

b)

Calculate the present value of the synergy from the merger.

(2 marks)

c)

If Maddox were to offer RM20 in cash for each share of Apple, what would the NPV of
the acquisition be?
(2 marks)

d)

Determine the maximum price Maddox should be willing to pay for each share of Apple
Bhd.
(2 marks)

Hak Cipta Universiti Teknologi MARA

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CONFIDENTIAL

AC/JAN 2013/MAF620/FMC570

e)

If Maddox Bhd were to offer 300,000 of its shares in exchange for the outstanding
stock of Apple Bhd, what would the NPV be?
(4 marks)

f)

Calculate the after-acquisition stock price of Maddox if the stock offer had been used.
(2 marks)

g)

Should the acquisition be attempted? If so, should it be a cash offer or stock offer?
(2 marks)
(Total: 20 marks)

END OF QUESTION PAPER

Hak Cipta Universiti Teknologi MARA

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CONFIDENTIAL
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Table A-2: Present Value of an Annuity of RM1 per period for n Period
Period

4%
0.9615
1.8861
2.7751
3.6299
4.4518

5%
0.9524
1.8594
2.7232
3.5460
4.3295

6%
0.9434
1.8334
2.6730
3.4651
4.2124

7%
0.9346
1.8080
2.6243
3.3872
4.1002

8%
0.9259
1.7833
2.5771
3.3121
3.9927

9%
0.9174
1.7591
2.5313
3.2397
3.8897

10%
0.9091
1.7355
2.4869
3.1699
3.7908

12%

14%

15%

16%

18%

20%

24%

28%

1
2
3
4
5

0.8929
1.6901
2.4018
3.0373
3.6048

0.8772
1.6467
2.3216
2.9137
3.4331

0.8696
1.6257
2.2832
2.8550
3.3522

0.8621
1.6052
2.2459
2.7982
3.2743

0.8475
1.5656
2.1743
2.6901
3.1272

0.8333
1.5278
2.1065
2.5887
2.9906

0.8065
1.4568
1.9613
2.4043
2.7454

0.7813
1.3916
1.8684
2.2410
2.5320

6
7
8
9
10

5.2421
6.0021
6.7327
7.4353
8.1109

5.0757
5.7864
6.4632
7.1078
7.7217

4.9173
5.5824
6.2098
6.8017
7.3601

4.7665
5.3893
5.9713
6.5152
7.0236

4.6229
5.2064
5.7466
6.2469
6.7101

4.4859
5.0330
5.5348
5.9952
6.4177

4.3553
4.8684
5.3349
5.7590
6.1446

4.1114
4.5638
4.9676
5.3282
5.6502

3.8887
4.2883
4.6389
4.9464
5.2161

3.7845
4.1604
4.4873
4.7716
5.0188

3.6847
4.0386
4.3436
4.6065
4.8332

3.4976
3.8115
4.0776
4.3030
4.4941

3.3255
3.6046
3.8372
4.0310
4.1925

3.0205
3.2423
3.4212
3.5655
3.6819

2.7594
2.9370
3.0758
3.1842
3.2689

11
12
13
14
15

8.7605
9.3851
9.9856
10.563
11.1184

8.3064
8.8633
9.3936
9.8986
10.38

7.8869
8.3838
8.8527
9.2950
9.7122

7.4987
7.9427
8.3577
8.7455
9.1079

7.1390
7.5361
7.9038
8.2442
8.5595

6.8052
7.1607
7.4869
7.7862
8.0607

6.4951
6.8137
7.1034
7.3667
7.6061

5.9377
6.1944
6.4235
6.6282
6.8109

5.4527
5.6603
5.8424
6.0021
6.1422

5.2337
5.4206
5.5831
5.7245
5.8474

5.0286
5.1971
5.3423
5.4675
5.5755

4.6560
4.7932
4.9095
5.0081
5.0916

4.3271
4.4392
4.5327
4.6106
4.6755

3.7757
3.8514
3.9124
3.9616
4.0013

3.3351
3.3868
3.4272
3.4587
3.4834

16
17
18
19
20

11.652
12.166
12.659
13.134
13.59

10.838
11.274
11.69
12.085
12.462

10.106 9.4466
10.477 9.7632
10.828 10.059
11.158 10.336
11.47 10.5940

8.8514
9.1216
9.3719
9.6036
9.8181

8.3126
8.5436
8.7556
8.9501
9.1285

7.8237
8.0216
8.2014
8.3649
8.5136

6.9740
7.1196
7.2497
7.3658
7.4694

6.2651
6.3729
6.4674
6.5504
6.6231

5.9542
6.0472
6.1280
6.1982
6.2593

5.6685
5.7487
5.8178
5.8775
5.9288

5.1624
5.2223
5.2732
5.3162
5.3527

4.7296
4.7746
4.8122
4.8435
4.8696

4.0333
4.0591
4.0799
4.0967
4.1103

3.5026
3.5177
3.5294
3.5386
3.5458

21
22
23
24
25

14.029
14.451
14.857
15.2470
15.622

12.821
13.1630
13.489
13.799
14.094

11.764
12.042
12.303
12.55
12.783

10.017
10.201
10.371
10.529
10.675

9.2922
9.4424
9.5802
9.7066
9.8226

8.6487
8.7715
8.8832
8.9847
90770

7.5620
7.6446
7.7184
7.7843
7.8431

6.6870
6.7429
6.7921
6.8351
6.8729

6.3125
6.3587
6.3988
6.4338
6.3641

5.9731
6.0113
6.0442
6.0726
6.0971

5.3837
5.4099
5.4321
5.4509
5.4669

4.8913
4.9094
4.9245
4.9371
4.9476

4.1212
4.1300
4.1371
4.1428
4.1474

3.5514
3.5558
3.5592
3.5619
3.5640

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10.836
11.061
11.272
11.469
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