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1. (a) Hong Sen Corporation is considering to setup its manufacturing unit in Malaysia and its operation will begin in January 2022.

Hong Sen has estimated to invest RM 200 million in initial investment. This investment includes the market cost of land, basic machineries, and modification cost of the machines. At the end of year 2024, when the growth rate slows down, Hong Sen intends to sell this manufacturing at a rate of 5% higher than its book value and the tax rate is 20%. To complete initial setup and to operate from the beginning of year 2022, Hong Sen will also invest an initial working capital investment of RM 10 million and the amount of working capital will increase by 10% p.a. to support the growth of sales. The fixed investment in the project (i.e. machineries and others) will be depreciated at 20% each year.

Hong Sen has estimated the demand in Southeast Asia to be 0.15 million units

p.a. and the sale will grow at a rate of 10% p.a. in the second year and third year. Each unit of its products will be sold at RM 750 and its price per unit will be kept fixed due to severe competition. Variable costs are estimated to be 30% of the total sales over the next three years. Salaries, administrative and other overhead costs are estimated to be 10% p.a. of the total sales.

Hong Sen has also estimated that the cost of debt after tax is 3% p.a. and cost of equity is 10% p.a., and these figures are assumed to be constant over the next three years. Assume that the Company has a debt-to-equity ratio of

0.45. As a new project which supports Industry 4.0 hub in Malaysia, Hong Sen is eligible for a lower corporate tax rate of 15% p.a.

1. Estimate the free cash flows to firm during the operating life of the project.

2. Calculate the net present value (NPV) and the internal rate of return (IRR) of the project.

2019 2020 2021 2022 Initial Investment in Subsidiary Basic machinery Working capital Change in working capital Total initial investment 0 RM(50,000,000) RM 10,000,000 RM( 10,000,000) RM(60,000,000) RM 10,500,000.00 RM (500,000.00) RM 11,025,000.00 RM (525,000.00) RM 11,025,000.00 Operating cash flows Demand 100,000.00 110,000.00 121,000.00 Price per unit RM 1,000 30%, 40%, 45% 100,000,000.00 110,000,000.00 121,000,000.00 Variable cost (30,000,000.00) (44,000,000.00) (54,450,000.00) 5% of sales Other overhead costs (5,000,000.00) (5,500,000.00) (6,050,000.00) RM 0 Depreciation (10,000,000.00) (10,000,000.00) (10,000,000.00) Before-tax earnings 55,000,000.00 50,500,000.00 50,500,000.00 20% Host government tax (11,000,000.00) (10,100,000.00) (10,100,000.00) After-tax earnings/Net income 44,000,000.00 40,400,000.00 40,400,000.00 20% Depreciation (10,000,000.00) (10,000,000.00) (10,000,000.00) No tax, 40% of machinery Salvage value 20,000,000.00 Free cash flow to firm RM(60,000,000) RM 53,500,000 RM 49,875,000 RM 81,425,000 Evaluation of the proposal using NPV: Subsidiary 1 o RM (60,000,000) 9.7142% FCFF 2 RM 49,875,000 9.7142% RM 41,434,035 RM 53,500,000 9.7142% RM 48,763,059 3 RM 81,425,000 9.7142% RM 61,655,134 WACC RM Present Value (60,000,000) NET PRESENT VALUE TO SUBSIDIAR Y RM 91,852,228 NPV= RM 91,852,228 78.40% IRR- 2019 2020 2021 2022 Initial Investment in Subsidiary Basic machinery Working capital Change in working capital Total initial investment 0 RM(50,000,000) RM 10,000,000 RM( 10,000,000) RM(60,000,000) RM 10,500,000.00 RM (500,000.00) RM 11,025,000.00 RM (525,000.00) RM 11,025,000.00 Operating cash flows Demand 100,000.00 110,000.00 121,000.00 Price per unit RM 1,000 30%, 40%, 45% 100,000,000.00 110,000,000.00 121,000,000.00 Variable cost (30,000,000.00) (44,000,000.00) (54,450,000.00) 5% of sales Other overhead costs (5,000,000.00) (5,500,000.00) (6,050,000.00) RM 0 Depreciation (10,000,000.00) (10,000,000.00) (10,000,000.00) Before-tax earnings 55,000,000.00 50,500,000.00 50,500,000.00 20% Host government tax (11,000,000.00) (10,100,000.00) (10,100,000.00) After-tax earnings/Net income 44,000,000.00 40,400,000.00 40,400,000.00 20% Depreciation (10,000,000.00) (10,000,000.00) (10,000,000.00) No tax, 40% of machinery Salvage value 20,000,000.00 Free cash flow to firm RM(60,000,000) RM 53,500,000 RM 49,875,000 RM 81,425,000 Evaluation of the proposal using NPV: Subsidiary 1 o RM (60,000,000) 9.7142% FCFF 2 RM 49,875,000 9.7142% RM 41,434,035 RM 53,500,000 9.7142% RM 48,763,059 3 RM 81,425,000 9.7142% RM 61,655,134 WACC RM Present Value (60,000,000) NET PRESENT VALUE TO SUBSIDIAR Y RM 91,852,228 NPV= RM 91,852,228 78.40% IRR