Question

(Khaleef is appointed as a financial analyst for the NASHORA Bhd. The director has asked him to analyse two proposed capital investments, Project NAS dan Project HORA. Each project has a cost of RM2,000,000. NASHORA Bhd will used a mix of capital structure (40% of debt and 60% of equity) to finance their project’s cost. NASHORA will issuing a-10years bond with 10% coupon rate and selling price at RM750. Tax rate = 30%. Meanwhile, a 4%-risk free rate, risk premium of 3% and 2.0 for company beta. The project’s expected net cash flows are as follows:) Tahun Aliran Tunai Bersih Dijangka Expected Net Cash Flows Year Project NAS Project HORA 0 -RM24,890,000 -RM13,500,000 1 12,950,000 7,230,000 2 10,923,000 8,100,000 3 8,231,000 8,629,000 4 7,242,000 5,238,900

(Management requires a minimum return of 15% in order for the project to be acceptable. The discount rate for projects of this level of risk is 10%. Management 3 requires projects with this type of risk to have a minimum payback of 1.5 years. Assuming the projects are mutually exclusive and ignoring the issue of scale, what should NASHORA Bhd do? Include calculations for the payback method, t net present value and internal rate of return in your analysis. Which project should the company consider, if any?) (i) Kira Kos modal NASHORA (Calculate NASHORA’s cost of capital). (5 markah/marks) (ii) Kira tempoh bayar balik untuk setiap projek. (Calculate each project’s payback period.) (5 markah/marks) (iii) Kira Nilai Kini Bersih untuk setiap projek (Calculate net present value for each project.) (5 markah/marks) (iv) Kira kadar pulangan dalaman (IRR). (Calculate internal rate of return (IRR) for each project. ) (5 markah/ marks) (v) Projek mana akan dipilih? Mengapa? (Which project be selected?

Answer 1

Part i)

Assume face or redemption value = 1,000; Coupon = 1,000*10% = 100; Current value = 750; tax rate = 0.3

Cost of debt after tax (Kd) = {[Coupon*(1-tax rate)]+[redemption value-current value]/10years}/[(redemption value+current value)/2] = {[100*(1-0.3)]+[1000-750]/10}/[(1000+750)/2] = {(100*0.7)+(250/10)}/(1750/2) = (70+25)/875 = 95/875 = 10.86%

Risk free rate=4%; Risk premium=3%; Beta=2

Cost of equity (Ke) = Risk free rate+(Risk premium*Beta) = 4%+(3%*2) = 4%+6% = 10%

NASHORA’s cost of capital = (40%*Kd)+(60%*Ke) = (40%*10.86%)+(60%*10%) = 4.34%+6% = 10.34%

Part ii)

Year	Cashflow NAS	Cumulative cashflow NAS	Cashflow HORA	Cumulative cashflow HORA
0	(24,890,000)	(24,890,000)	(13,500,000)	(13,500,000)
1	12,950,000	(11,940,000)	7,230,000	(6,270,000)
2	10,923,000	(1,017,000)	8,100,000	1,830,000
3	8,231,000	7,214,000	8,629,000	10,459,000
4	7,242,000	14,456,000	5,238,900	15,697,900

Payback period for project 1 = Year in which less negative cumulative cashflow+(Low negative cumulative cashflow/cashflow in next year) = 2+(1017000/8231000) = 2+0.12 = 2.12years

Payback period for project 2 = Year in which less negative cumulative cashflow+(Low negative cumulative cashflow/cashflow in next year) = 1+(6270000/8100000) = 1+0.77 = 1.77years

Part iii)

Year	Cashflow NAS	Cashflow HORA	Present value factor @ 10%	Discounted cashflow NAS (Cashflow*PVF)	Discounted cashflow HORA (Cashflow*PVF)
0	(24,890,000)	(13,500,000)	1.0000	(24,890,000.00)	(13,500,000.00)
1	12,950,000	7,230,000	1/1.1 = 0.9091	11,772,845.00	6,572,793.00
2	10,923,000	8,100,000	0.9091/1.1 = 0.8265	9,027,859.50	6,694,650.00
3	8,231,000	8,629,000	0.8265/1.1 = 0.7514	6,184,773.40	6,483,830.60
4	7,242,000	5,238,900	0.7514/1.1 = 0.6831	4,947,010.20	3,578,692.59
				7,042,488.10	9,829,966.19

Net present value of project 1 = ΣDiscounted cashflow NAS = 7,042,488.10

Net present value of project 2 = ΣDiscounted cashflow HORA = 9,829,966.19

Part iv)

IRR for project 1 = 24.09%

IRR for project 2 = 41.54%

Part v)

	Payback period	NPV	IRR
Project 1	2.12 years	7,042,488.10	24.09%
Project 2	1.77 years	9,829,966.19	41.54%
Which project should select?	Project 2	Project 2	Project 2
Why	Project 2 payback period is least among other project	Project 2 gives higher NPV	Project 2 gives higher IRR

Finally select project 2 which has year 0 cashflow of -RM13,500,000