3. Decision tree analysis shows how different decisions in a project life affect its value. As a financial analyst, conduct the analysis on this project using the following information: P Year 0 Year 1 (RM450) A- RM800 0.60 Year 2 AI- RM500 0.30 Year 3 Alb - RM400 0.70 A2 - RM900 0.70 Alc-(RM300) A2a - RM600 A2b - (RM500) 0.30 0.50 0.50 B- 0.40 RM600 B1 - RM700 B2 - RM200 B2-(RM300) 0.50 0.25 0.25 Note: P: Probability of event. (b) (c) Construct the decision tree. (1 mark) Calculate the expected net present value (NPV) of this project using cost of capital at 12%. (4 marks) Calculate the expected NPV, if cost of capital increase to: (1) Cost of capital increase to 15%. (4 marks) (ii) Initial investment increase by 10%, with no changes in the cost of capital (4 marks) From your answers in (b) and (c), what can you conclude about this project? (d) 4 Below is the selected financial data for Syarikat Bersatu Berhad and Syarikat Karisma Berhad. As a financial consultant, you are required to analyse the level of riskiness of these companies. Selling price per unit Variable cost per unit Fixed cost per annum Unit sold Financing Syarikat Bersatu Berhad RM36 RM30 RM80 000 1 600 000 units RM120 000 of 10% bonds 160 000 shares 26% Syarikat Karisma Berhad RM90 RM40 RM150 000 50 000 units RM180 000 of a 12% loan 300 000 shares 26% Shares outstanding Corporate tax rate (a) (b) Calculate the degree of operating leverage (DOL), degree of financial leverage (DFL) and degree of combined leverage (DCL) for these companies. (8 marks) What is the earning per share (EPS) for the two companies if sales increase by 25%? (2 marks) If sales were to decline, which company will suffer the largest relative decline in profitability? State your reason. (2 marks) Based on the information given, explain how the company will be able to reduce the business risk and financial risk. (3 marks) (d) 5. The managers of Classic Auto Incorporated plan to manufacture Product X. The necessary equipment will cost a total of RM3 940 000, with installation cost of RM50 000 and shipping expense of RM10 000. The equipment will be depreciated using a five year modified accelerated cost recovery system (MACRS) life: Rounded Depreciation Percentages by Recovery Year Using MACRS for First Four Property Classes Percentage by recovery year Recovery year 3 years 5 years 7 years 10 years 1 33% 20% 14% 10% 2 45 32 25 18 3 15 19 18 14 4. 7 12 12 12 5 12 9 9 6 5 9 8 7 9 7 8 4 6 9 6 10 6 11 4 Total 100% 100% 100% 100% Projected sales in annual units for the next 5 years are 300 per year. If sales price is RM27 000 per unit, variable costs are RM18 000 per unit, and fixed costs are RM1 200 000 annually. The equipment is sold for salvage value for RM500 000 at the end of Year 5. Net working capital increased by RM600 000 at the beginning of the project (Year O) and is reduced back to its original level in the final year. The required rate of return for the project is 12%, and the marginal tax rate of the company is 30%. (a) What is the total initial investment of this project? (2 marks) (b) Calculate the annual incremental operating cash inflows of the project. (7 marks) ) Calculate the terminal value of this project. (2 marks) (d) Should Classic Autos proceed with the project based on the net present value (NPV)? Why? (2 marks) (e) Discuss the strength of using scenario analysis as compared to sensitivity analysis. (2 marks) 8 Part C: (10 marks) Instruction: Answer one question only. 6. The objectives of a company's dividend policy should be consistent with the overall objective of maximization of shareholder wealth. Paying dividend will increase shareholder wealth only when cash value of the dividend share price and expected dividend share price are higher than its market price before the dividend was announced (DI + P > Po). Using relevant theories, explain the impact of dividend on the value of the firm. (10 marks) 7. The traditional approach argues that an optimal capital structure does exist for companies. By using an appropriate diagram, explain the traditional view of capital structure. (10 marks) 8. Using a diagram, explain the characteristics of business risk and financing risk by relating the operating leverage and financial leverage of a company. (10 marks) 3. Decision tree analysis shows how different decisions in a project life affect its value. As a financial analyst, conduct the analysis on this project using the following information: P Year 0 Year 1 (RM450) A- RM800 0.60 Year 2 AI- RM500 0.30 Year 3 Alb - RM400 0.70 A2 - RM900 0.70 Alc-(RM300) A2a - RM600 A2b - (RM500) 0.30 0.50 0.50 B- 0.40 RM600 B1 - RM700 B2 - RM200 B2-(RM300) 0.50 0.25 0.25 Note: P: Probability of event. (b) (c) Construct the decision tree. (1 mark) Calculate the expected net present value (NPV) of this project using cost of capital at 12%. (4 marks) Calculate the expected NPV, if cost of capital increase to: (1) Cost of capital increase to 15%. (4 marks) (ii) Initial investment increase by 10%, with no changes in the cost of capital (4 marks) From your answers in (b) and (c), what can you conclude about this project? (d) 4 Below is the selected financial data for Syarikat Bersatu Berhad and Syarikat Karisma Berhad. As a financial consultant, you are required to analyse the level of riskiness of these companies. Selling price per unit Variable cost per unit Fixed cost per annum Unit sold Financing Syarikat Bersatu Berhad RM36 RM30 RM80 000 1 600 000 units RM120 000 of 10% bonds 160 000 shares 26% Syarikat Karisma Berhad RM90 RM40 RM150 000 50 000 units RM180 000 of a 12% loan 300 000 shares 26% Shares outstanding Corporate tax rate (a) (b) Calculate the degree of operating leverage (DOL), degree of financial leverage (DFL) and degree of combined leverage (DCL) for these companies. (8 marks) What is the earning per share (EPS) for the two companies if sales increase by 25%? (2 marks) If sales were to decline, which company will suffer the largest relative decline in profitability? State your reason. (2 marks) Based on the information given, explain how the company will be able to reduce the business risk and financial risk. (3 marks) (d) 5. The managers of Classic Auto Incorporated plan to manufacture Product X. The necessary equipment will cost a total of RM3 940 000, with installation cost of RM50 000 and shipping expense of RM10 000. The equipment will be depreciated using a five year modified accelerated cost recovery system (MACRS) life: Rounded Depreciation Percentages by Recovery Year Using MACRS for First Four Property Classes Percentage by recovery year Recovery year 3 years 5 years 7 years 10 years 1 33% 20% 14% 10% 2 45 32 25 18 3 15 19 18 14 4. 7 12 12 12 5 12 9 9 6 5 9 8 7 9 7 8 4 6 9 6 10 6 11 4 Total 100% 100% 100% 100% Projected sales in annual units for the next 5 years are 300 per year. If sales price is RM27 000 per unit, variable costs are RM18 000 per unit, and fixed costs are RM1 200 000 annually. The equipment is sold for salvage value for RM500 000 at the end of Year 5. Net working capital increased by RM600 000 at the beginning of the project (Year O) and is reduced back to its original level in the final year. The required rate of return for the project is 12%, and the marginal tax rate of the company is 30%. (a) What is the total initial investment of this project? (2 marks) (b) Calculate the annual incremental operating cash inflows of the project. (7 marks) ) Calculate the terminal value of this project. (2 marks) (d) Should Classic Autos proceed with the project based on the net present value (NPV)? Why? (2 marks) (e) Discuss the strength of using scenario analysis as compared to sensitivity analysis. (2 marks) 8 Part C: (10 marks) Instruction: Answer one question only. 6. The objectives of a company's dividend policy should be consistent with the overall objective of maximization of shareholder wealth. Paying dividend will increase shareholder wealth only when cash value of the dividend share price and expected dividend share price are higher than its market price before the dividend was announced (DI + P > Po). Using relevant theories, explain the impact of dividend on the value of the firm. (10 marks) 7. The traditional approach argues that an optimal capital structure does exist for companies. By using an appropriate diagram, explain the traditional view of capital structure. (10 marks) 8. Using a diagram, explain the characteristics of business risk and financing risk by relating the operating leverage and financial leverage of a company. (10 marks)