Question 1

Subang Folding Box Berhad is considering purchasing a new gluing machine. The gluing machine costs RM50,000 and requires installation costs of RM2,500. This outlay would be partially offset by the sale of an existing gluer.

The existing gluer originally cost RM30,000 and is four years old. It is being depreciated under straight line method and can currently be sold for RM15,000. The existing gluer has a remaining useful life of two years. If held until year six, the existing machine's market value would be zero.

Over its five-year life, the new machine should reduce operating costs (excluding depreciation) by RM17,000 per year. Training costs of employees who will operate the new machine will be a one-time cost of RM5,000 which should be included in the initial outlay. The new machine will be depreciated under straight line method and estimated disposal value is RM10,000. The firm has a 12 percent cost of capital and a 40 percent tax on ordinary income and capital gains.

Required:

a)Calculate the initial cash outflow associated with replacing the older machine with the new one?

(3 Marks)

b)Calculate the net present value if the company decided to but the new gluing machine?

(6 Marks)

c)Should Subang Folding Box Berhad replace the old machine?

(1 Mark)

(Total: 10 Marks)

Answer:

Question 2

Oren Manis Berhad has a capital structure that consists of RM2 million of debt, and RM11 million of common equity, based upon current market values from its 2,000,000 shares. The company's yield to maturity on its bonds is 7%, and investors require a 14% return on common stock.

a)If the marginal tax rate is 28%, what is the company's WACC?

(2 Marks)

b)If Oren Manis Berhad were to generate an EBIT of RM15,000,000 this year, calculate the company earning per share (EPS) and its price per share (P₀).

(3 Marks)

c)Oren Manis Berhad can increase its debt by RM8.0 million and using the new debt to buy back the shares at current price.Its interest rate on the new debt will be the same as its earlier debt and its costs of new equity will rise from 14% to 17%.EBIT will remain constant.Should Oren Manis Berhad change its capital structure?

(5 Marks)

(Total: 10 Marks)