Question

You have been appointed as the Finance Manager of Shangpuri Hotel Bhd. As a finance manager, you are evaluating Project PJ10B, an investment project, and TWO (2) other additional projects namely Project Bee and Project Cee. You are required to deliver a comprehensive report explaining the application of numerous financial practices for valuing investment projects for the board of directors’ strategic decision. Your finance department has forecasted cash flows to assess the viability of Project PJ10B, Project Bee, and Project Cee incorporating risk into the calculations.

Additional information:

1. Current dividend for Shangpuri Hotel Bhd’s ordinary stock is RM2.50 and dividend growth rate is 6%.

2. Shangpuri Hotel Bhd is planning to issue new ordinary stock at RM50 with a flotation cost of 9%.

3. The company’s bond is paying a 6% coupon payment. Corporate tax stood at 30%.

4. Shangri Hotel Bhd’s capital structure comprising of 40% debt and 60% common stock.

Information related to Project PJ10B

The cost of this investment is RM1,200,000.

The investment is estimated to effectively contribute for 3 years. Ignore the residual value.

Depreciation for the Project PJ10B is subject to a straight-line method.

Further, yearly cash inflow is estimated at $900,000 and cash outflow RM400,000 per year. Cash inflow and outflow in entitle for tax benefit.

Finance department estimates discount factor at 7.0%.

Information related to Project Bee

1. Cost of this investment is RM120,000

2. Finance department estimates discount factor at 8.0%.

3. Ignore tax and depreciation.

Economy	Probability	Cash Flow
Good	0.30	RM20,000.00
Normal	0.50	RM30,000.00
Bad	0.20	RM40,000.00

Information related to Project Cee

1. Cost of this investment is RM120,000

2. Finance department estimates discount factor at 8.0%.

3. Ignore tax and depreciation.

Economy	Probability	Cash Flow
Good	0.30	RM50,000.00
Normal	0.50	RM30,000.00
Bad	0.20	RM20,000.00

Required:

QUESTION 1

a. Calculate the cost of new ordinary stock for Shangpuri Hotel Bhd. The current dividend for the ordinary stock is $2.50 and the dividend is expected to grow at 6%.

b. Explain THREE (3) advantages and THREE (3) disadvantages of equity financing.

c. Calculate cost of debt for Shangpuri Hotel Bhd

d. Explain THREE (3) advantage and THREE (3) disadvantages of debt financing.

e. Calculate the weighted average cost of capital for the company

f. Explain FIVE (5) uses of WACC.

QUESTION 2

a. Calculate NPV for Project PJ10B based on discount factor of Shangpuri Hotel Bhd.

b. Calculate NPV for Project PJ10B based on WACC of Shangpuri Hotel Bhd.

c. Calculate IRR for Project PJ10B

d. Explain FIVE (5) conflicts between NPV and IRR

QUESTION 3

a. Calculate expected Annual Cash flow from Project Bee

b. Calculate expected Annual Cash flow from Project Cee

c. Calculate NPV and IRR from Project Bee assuming discount factor stood at 8% & Project Bee’s life span is 6 years.

d. Calculate NPV and IRR from Project Cee assuming discount factor stood at 8% & Project Cee’s life span is 6 years.

QUESTION 4

a. Provide overall recommendation to Shangpuri Hotel Bhd Board of Directors on the viability of

             i. Project PJ10B.

ii. Project Bee.

iii. Project Cee.

(15 marks

b. Prepare an executive summary

Answer 1

Answer 1

(a) Cost of Equity = D1/Po + g

Where D1 = Dividend per share at the end of the year

Do = Current Dividend

g= Growth Rate

Po = Current Market Price

Do = 2.50     g = 6% or 0.06    Po = 50 - (0.09*50) = 45.5

D1 = Do(1+g) = 2.5(1+0.06) = 2.65

Ke = (D1 / Po) + g = 2.65/45.5 + 0.06 = 0.1138 = 11.38%

Answer B -

Advantages of Equity Financing

1) It is less risky as no fixed annual payment is needed as in case of debt financing

2. It is best source for financing long term projects in which cash flows may occur in the later years.

3. It is more useful in case of company having credit problems.

Disadvantages

1. It is more costly as it involves higher risk for investor and there is no tax benefit

2. By equity financing the ownership is distributed.

3. By loss of control, there may be some potemtial conflicts.

Answer c

Cost of debt = 4.2%

Kd (after tax) = Int rate *(1-tax rate) Kd is the cost of debt

                      = 0.06*(1-0.30) = 0.042 or 4.2%

Answer d

Advantages of Debt Financing

1. Since debt can be repaid at any time , there is no loss of control.

2. Tax benefit is there as interest is a tax deductible item

3. The cost of financing ie interest is fixed.

Disadvantages of Debt Financing

1. It is not suitable for long term projects.

2. Some fixed assets may have to be secure as collateral.

3. A good credit rating is required to obtain debt financing.

Answer e

WACC = Kd(% of Debt) + Ke (% of Equity)

           =   0.042*(0.40) + 0.1138(0.6) = 0.0168 + 0.06828 = 0.0851 or 8.51%

Answer f

Uses of WACC

1. To evaluate the projects with different risk by assigning different risk adjected WACC

2. To evaluate the projects with the same risk

3. To calculate the NPV, PI of the project.

4. To calculate the Economic Value Added (EVA) of the company

5. It can be used for valuation of company.