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SBS Corp. is considering the selection of two projects with the following internal rate of return ( IRR ) . The projects are not mutually

SBS Corp. is considering the selection of two projects with the following internal rate of return
(IRR). The projects are not mutually exclusive.
Project Initial Investment (RM) IRR (%)
Project A 25 million 16
Project B 25 million 16.5
Total financing required 50 million
SBS Board of Directors have agreed that new financing will be used to fund the projects. Currently
SBS has 30% debt in its capital structure. The beta of the company at the current level of debt is
1.2. Net profit in the previous year amounted to RM17 million. The share holders expect some
dividends to be paid from the profit. The Board of Directors will consider paying dividends from
the net profit after all financing needs of the projects are fulfilled.
The risk-free rate which is based on an annual fixed deposit rate is 3% while the expected return
of the market is 18%. SBS currently is in the 30% tax bracket. SBS made it a point to only make
investment decisions on projects with internal rate of return (IRR) higher than the cost of capital.
An investment banker has indicated that the interest rate will depend upon the percentage of debt
in the capital structure. The level of debt will also affect the beta of the company. The company is
eligible to borrow at the following interest rate.
Percentage of debt in the capital structure Interest Rate
08%
108.25%
208.75%
309%
4010%
5010.5%
Loans more than 50% of capital structure 11%
a. Determine the appropriate capital structure to finance the project.

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