Question 1 (Continued)

(d) Assuming that the debt financing costs do not change, determine ECBs new WACC based on a shift to a more highly leveraged capital structure consisting of equal weights on long-term debt and common stock. (5 marks)

Q1 Eco Cycle Berhad (ECB) is an investment holding company listed on the ACE market of Bursa Malaysia in 2015. ECB is primarily engaged in the provision of recovery and recycling of scheduled waste in accordance with Environmental Quality Act. ECB collects soiled rags, activated carbon and wood from the oil and gas, automotive and other manufacturing industries. The company has state-of-the-art scheduled waste management facilities at its plant in Rawang, Selangor, which enables it to achieve economies of scale. To widen its competitive advantage. ECB is considering to venture into the gasification technology by replacing an existing piece of equipment with a more sophisticated machine. The relevant information is as follow: Year 1 2 3 4 Esisting Machine Proposed Machine Cost = RM140,000 Cost = RM150.000 Purchased 2 years ago Installation = RM20,000 Straight line depreciation Straight line depreciation Five year usable life remaining Five year usable life expected Current market value = RM95.000 Earnings before Depreciation and Taxes RM160,000 RM170.000 RM150,000 RM170,000 RM140,000 RM170.000 RM140,000 RM170,000 RM140,000 RM170,000 This project's cost of capital is 12 percent and pays 26 percent taxes on any zains. ECB is entrusted by the Malaysian Department of Environment with treating items listed in 31 scheduled waste codes. As an ambitious company with lots of growth opportunities, the chief financial officer (CFO) of ECB closely monitors the fim's cost of capital. The CFO keeps tabs on the target capital structure of ECB's three main financing sources as long-term debt (30%). preferred stock (20%), and common stock (50%) At the present time, ECB can raise debt by selling 20-year bonds with a RM1.000 par value and a 10.5 percent annual coupon interest rate. ECB's corporate tax rate is 26 percent, and its bonds generally require an average discount of RM45 per bond and flotation costs of RM32 per bond when being sold ECB's outstanding preferred stock pays a 9 percent dividend and has a RM95-per-share par value. The cost of issuing and selling additional preferred stock is expected to be RM per share. As ECB is an aggressive firm that requires lots of cash to grow, it does not currently pay a dividend to common stockholders. To track the cost of common stock, the CFO uses the capital asset pricing model. The CFO and the firm's investment advisors believe that the appropriate risk-free rate is 4 percent and that the market's expected return equals 13 percent. Using data from 2015 through 2019. ECB's CFO estimates the fim's beta to be 1.3. Although ECB's current target capital structure includes 20 percent preferred stock, the company is considering using debt financing to retire the outstanding preferred stock, thus shifting their target capital structure to 50 percent long-term debt and 50 percent common stock. IF ECB shifts its capital mix from preferred stock to debt, its financial advisors expect its beta to increase to 1.5