Fajar Bhd is in the business of producing electronic gadgets. In early 2020, it has undertaken market research at a cost of RM 2,000,000 in order to forecast the future cash flows of an investment project with an expected life of four years, as follows
Fajar Bhd is in the business of producing electronic gadgets. In early 2020, it has undertaken market research at a cost of RM 2,000,000 in order to forecast the future cash flows of an investment project with an expected life of four years, as follows: Year 1 2 3 4 Sales revenue (RM 000) 12,500 25,700 68,900 45,300 Costs (RM 000) 5,000 10,000 25,000 17,500 These forecast cash flows are before taking account of general inflation of 4.% per year. The capital cost of the investment project, payable at the start of the first year, will be RM 20,000,000. The investment project will have zero scrap value at the end of the fourth year. The level of working capital investment at the start of each year is expected to be 10% of the sales revenue in that year. In order to determine the viability of the project, the management of Fajar Bhd want to determine the suitable cost of capital to determine the viability of the project. The equity beta of Fajar Bhd is 0.9 and the company has issued 10 million ordinary shares. The market value of each ordinary share is RM 7.50. The company is also financed by 7% bonds with a nominal value of RM 100 per bond, which will be redeemed in seven years' time at nominal value. The bonds have a total nominal value of RM 14 million. Interest on the bonds has just been paid and the current market value of each bond is RM 107.14. Fajar Bhd plans to invest in a project which is different to its existing business operations and has identified a company in the same business area as the project, Hajar Bhd. The equity beta of Hajar Bhd is 1. 2 and the company has an equity market value of RM 54 million. The market value of the debt of Hajar Bhd is RM 12 million. The risk-free rate of return is 4% per year and the average return on the stock market is 11% per year. Both companies pay corporation tax at a rate of 20% per year. Auction 1 Question 1 a) Determine the current weighted average cost of capital of Fajar Bhd. Explain the assumption made in arriving at the weighted average cost of capital of Fajar Bhd Note: There are 15 marks available for calculations and 5 marks available for the assumption (20 Marks) b) Advice on the management on the suitability of the project of the investment project using relevant investment appraisal method. Justify on the use of the method used. (Ignore Taxation) Note: There are 20 marks available for calculations and 10 marks available for the recommendation and justification
