Case

The economic environment has become increasingly volatile since the economic downturn hit Southeast Asian countries from 1997 to 1999. The most affected financial sector has had a significant impact on the growth and finances of other companies that rely heavily on bank funds. Interest rates also skyrocketed at the time, creating a heavy financial burden on borrowers and small and medium enterprises (SMEs).

As the economic downturn recovered in the early 2000s, a retired electronics factory engineer began to take steps to own a consumer goods factory. Starting with the idea and effort to produce plastic-based products such as waste plastics, boxes and kitchen utensils, Ir Mohd Helmi began to venture into the production sector of food packs that are seen to be more able to survive in any economic situation better and the potential of the product that can be marketed to all over the world.

Armed with an initial capital of RM1.5 million obtained from Bank Pembangunan Desa, he opened a small factory with a production capacity of 500,000 units of food packs per month. The company, named Budi Sejati Sdn Bhd (BSSB), started the business by employing 8 operating employees and 3 marketing staff. While the technical aspect was handled by Ir Mohd Helmi himself with his partner, Hj Abdullah Saari. The growth of the business was accelerating as companies began to receive continuous orders from SME firms in the food sector and small snack food producers in Selangor and Kuala Lumpur. The company's financial report for 2019 shows that BSSb has accumulated funds of RM35 million in the form of cash, equity and retained earnings reserves.

Currently, BSSB, which operates in Teluk Panglima Garang, is known as one of the strong medium-sized companies and has a market share of plastic food packaging packs of around seven percent (7%) of all similar product manufacturers in Malaysia. Following the government-recommended awareness campaign on the use of environmentally friendly plastic packaging and environmental responsibility, the demand for perishable and recyclable food packaging plastic packs is growing rapidly. BSSB strives to improve their production capacity to meet the current needs of the industry and the environment of its customers.

The management of BSSB submitted a plan to implement a project to increase the production capacity of their plant in Teluk Panglima Garang through two methods as follows;

Proposal 1: Expansion of the Production Capacity of Existing Factories

BSSB will allocate RM15.0 million to procure new environmentally friendly and high-capacity processing machines by January 2020. Once acquired, production will increase by 40 per cent and production costs will be saved by 30 per cent.

The company's accountant reported that to obtain the machine, BSSB had two other alternatives, either buying the machine on a bank loan or leasing the machine from the lessor company, Opic Leasing Sdn Bhd through the finance lease method.

If the management chooses to buy through bank financing, the company can obtain the RM15.0 million loan from Firstline Bank Berhad with a repayment period of 5 years, at an interest rate of 8 per cent per annum. The bank also offers an advantage to RPSB by requiring that the loan only be repaid in annual instalments.

If the purchase on credit is used, the depreciation of the machine will use the reduced balance method for 4 years at annual rates of 33%, 45%, 15% and 7% over the useful life of the machine. BSSB will also bear the cost of machine maintenance of RM800,000 and insurance expenses of RM200,000 annually. By the end of the 5th year, the company is expected to dispose of the machine. The company's accountant estimated that the machine would be resold to a third party for RM3.0 million. Currently, BSSB uses a corporate tax rate of 27% in calculating their income, costs and expenses.

The finance department of BSSB also suggested another alternative to obtain the machine, which is through the leasing approach. If BSSB uses this alternative, the machine will be acquired under a lease contract from Opic Leasing Sdn Bhd with an annual lease payment of RM3.9 million for 5 years. The annual lease payment is also included in the cost of machine maintenance (RM800,000 per year). The offer is given by Opic Leasing Sdn Bhd also includes an option for BSSB to buy the machine at the end of the 5th year for RM1.5 million. Some of the advantages of leasing have also been presented by the company's accountants as additional information and reference by top management.

Proposal 2: Acquisition of Nine-Star Plastic Sdn Bhd (NSP)

The management of BSSB would also like to consider the potential to take over a high-tech plastic manufacturing company that is facing financial and management problems, namely Nine-Star Plastic Sdn. Bhd. (NSP). NSP is a product manufacturing plant that is similar to BSSB and operates in Bukit Raja Klang.

Based on the information obtained during the preliminary negotiations that were done at the end of 2019, the acquisition price offered to BSSB is RM46 million. After acquiring NSP, BSSB companies are expected to be able to increase production of their products by 35% and increase market share by another 5%. BSSB will also own all high-quality NSP machines and factories valued at RM35 million at current book value. All the equipment will also be able to be used properly for at least 8 years. Based on the information obtained during the preliminary negotiations that were done at the end of 2019, the acquisition price offered to BSSB is RM46 million. After acquiring NSP, BSSB companies are expected to be able to increase production of their products by 35% and increase market share by another 5%. BSSB will also own all high-quality NSP machines and factories valued at RM35 million at current book value. All the equipment will also be able to be used properly for at least 8 years.

Through the acquisition of NSP, BSSB company accountants report that they have the potential to earn additional annual cash flows as described in below. The accountant also explained that cash flow after 2026 is expected to increase steadily at a rate of 6% per annum.

Expected Additional Cash Flows as of 31 December 202x (After Acquisition) Year Additional Cash Flows (RM) 2022 6.5 million 2023 7.2 million 2024 6.0 million 2025 9.0 million 2026 7.4 million The projected risk level of NSP companies after acquisition in early 2021 is 0.95 (Beta = 0.95), while the forecasted financial market information at the same time is as follows; Risk -free rate of return (k* ) 2.0% Inflation premium (IP) 1.5% Market rate of return (kM) 11.5%