The Empire Rail Bhd (Empire) won a sub-contract to construct 69 kilometers railway projectof High Speed Rail mega project. The project cost is expected to be RM58 million. Below is
the optimal capital structure of Empire as at 30 June 2020:
                                                                                           RM
5% Debentures                                                           19,300,000
7% Preferred shares                                                  12,700,000
Ordinary shares at par value RM1.00                       47,500,000
Retained earnings                                                      20,500,000
                                                                                      100,000,000

 

Empire plans to use various internal and external sources of financing to fund the projectand has estimated the individual cost of capital as follows:
i. Pre-tax cost of debt is 5.35%
ii. Cost of preference shares is 6.5%
iii. Cost of internal and external equity is 19.8% and 20.5% respectively
Empire decides to limit its retained earnings available for re-investment purposes to themaximum value of 85% on retained earnings balance as at 30 June 2020. The corporate tax
rate is 24%.

 

Required:
Suggest the appropriate weighted average cost of capital (WACC) if Empire agreed toundertake the railway project. (3 marks)

3. Company Alpha is financed with $1,000 of equity and $400 of debt and intends toundertake a project in an unrelated industry. They have identified Horizon Co. as acompany in the new industry with $700 of equity and $300 of debt. Alpha Co. has aBeta of 1.3 whereas Horizon Co. has a Beta of 1.2. The risk-free rate is 4% and theaverage return on the market is 12%. The tax rate is 30%.


Required:
Calculate the project specific discount rate for Alpha Co. when entering the newindustry.


4. Card Co has in issue 8 million shares with an ex-dividend market value of $7.16 pershare. A dividend of 62 cents per share for 2013 has just been paid. The pattern ofrecent dividends is as follows:


Year                                                   2010        2011       2012      2013
Dividends per share (cents)             55.1         57.9        59.1        62.0


Card Co also has in issue 8.5% bonds redeemable in five years' time with a totalnominal value of $5 million. The market value of each $100 bond is $103.42.Redemption will be at nominal value.


Card Co is planning to invest a significant amount of money into a joint venture in anew business area. It has identified a proxy company with a similar business risk to thejoint venture. The proxy company has an equity beta of 1.038 and is financed 75% byequity and 25% by debt, on a market value basis.


The current risk-free rate of return is 4% and the average equity risk premium is 5%.Card Co pays profit tax at a rate of 30% per year and has an equity beta of 1.6.


Required:

Calculate a project-specific cost of equity for Card Co for the planned joint venture.



5.  Green Refinery Bhd (Green) is a palm oil refinery manufacturer wishes to embark intomedical supplies in view of good market outlook in the health industry. Currently, the equityto debt ratio Green is 4 to 1 with a beta value of 1.25.


Mask Protect Bhd (Mask) has been identified as a proxy company to undertake project inmedical supplies with equity beta value of 1.85 and has equity to debt ratio of 3 to 2.The rate of return of a risk-free asset is expected to be at 5%. The average return on stockmarket is 12% and the corporate tax is 24%.


Required:
Compute the suitable project specific cost of discount rate for Green in new project.
(2 marks)