PART 1: Concept Questions

1. Suppose a project has conventional cash flows and a positive NPV. What do you know about its
payback? Its discounted payback? Its profitability indexes? Its IRR? Explain.

Positive net present value indicates that the projected earnings generated by a project or investment. It is
assumed that an investment with a positive NPV will be profitable, and an investment with a negative NPV
will result in a net loss. The project with a zero-discount rate will also have a positive net present value
(NPV). Meanwhile, for the payback period it required the project to have payback period that is less than
the project life. In terms of the discounted payback period, it is calculated at the same discount rate as net
present value. The discounted payback period must be less than the project life for a positive net present
value. Positive net present value present that the value of future cash inflows is greater than the initial
investment cost. Profitability index must be greater than 1 positive net present value for a certain discount
rate, then it will be zero for some larger discount rate. Plus, the internal rate of return must be greater than
the required return.

2. What are the direct and indirect costs of bankruptcy? Briefly explain each.

Direct costs include lawyers’ and accountant’s fees,other professional fees and the value of the managerial
time spent in administering the bankruptcy. While indirect costs include lost sales,lost profits and the
inability of the firm to obtain credit or to issue securities except under harsh terms

3. Do you agree or disagree with the following statement? A firm’s stockholders will never want the
firm to invest in projects with negative net present values. Why?

I disagree with the statement because it is an error statement. It might be an advantageous to the
stockholders if a firm has debt. It might give advantages to stockholders for the firm to undertake risky
projects even with those projects with negative net present values. This incentive results from the fact that
most of the risk of failure is borne by bondholders. Therefore, value is transferred from the bondholders to
the shareholders by undertaking risky projects. It will be transferred to the shareholders even if the projects
have negative net present values. This incentive is even stronger when the probability and costs of
bankruptcy are high. Plus if the firm is going towards bankruptcy, it gives more benefit to the stockholders if
the firm invest in negative net present value projects. It is because a certain project will give them a better
expected return than without the project they will vote for the project.
4. What steps can stockholders take to reduce the costs of debt?

There are a few steps that the stockholders can take to reduce the cost of debt. First and foremost,
stockholder may apply the protective covenants. Protective covenant is a step where the stockholder can
make an agreement with the bondholders in order to decrease cost of debt. Negative covenants prohibit a
company from taking an action that would be prohibiting the payment of dividends in excess of earnings.
While, positive covenant specified an action that the company agrees to take or condition the company
must abide by such as agree in maintaining its working capital at a minimum level. Next, repurchase debt is
one of the steps that the shareholders can take in order to reduce the cost of debt. It can be done by
eliminating the costs of bankruptcy for example eliminate the debt from its capital structure. Lastly, the
shareholders can consolidate debt to reduce the costs of debt. The company need to take actions by merge
the existing debt, it helps in reducing the interest rate or by converting the bond into shares.

5. How does the existence of financial distress costs and agency costs affect Modigliani and Miller’s
theory in a world where corporations pay taxes?

It is can be seen through the levered company. They take a toll on the value of the levered company. The
present value of financial distress is subtracted from the value of the unlevered company and the debt tax
shield also. There will be at some point, the marginal costs of an additional debt will outweigh the marginal
tax benefits. There is an optimal level of debt where the marginal tax benefits of the debt equal the marginal
increase in financial distress and agency costs.

6. When is EAC analysis appropriate for comparing two or more projects? Why is this method
used? Are there any implicit assumptions required by this method that you find troubling? Explain.

The EAC approach is appropriate to be use when comparing mutually exclusive projects with different lives
that will be replaced when they wear out. This type of method is necessary so that the projects have
common lifespan over which they can be compared. In effect, each project is assumed to exist over an
infinite horizon of N-year repeating projects. Assume that this type of analysis is valid implies that the
project cash flows remain the same forever. Thus, ignoring the possible effects of among other things such
as inflation, changing in the economic, the increase in unreliability of cash flow estimate that occur in the
future, and the technology improvement that could alter the project cash flows.
PART 2: Problem Questions
1. The investment in project A is RM1 million, and the investment in project B is RM2 million. Both
projects have a unique internal rate of return of 20 percent. Is the following statement true or false?
“For any discount rate from 0 percent to 20 percent, project B has an NPV twice as great as that of
project A.” Explain your answer.

The NPV rule says to go for the project that has a higher net present value. What happens if you have one
project that has a lower present value but a higher discount rate and the other one has a higher present
value but a lower discount rate? Which project would you choose?
- The discount rate is simply a measure of how risky an investment is, so the NPV calculation takes
riskiness into account (as long as you have assigned the proper discount rate to each investment - a big if). 
So all other things being equal, you are still better off choosing the investment with the highest NPV, no
matter the discount rate. 
In the example you provided, the less risky project has a higher NPV, which would immediately bias you in
favor of it (again, assuming you had calculated the discount rates accurately).  In a real-world situation,
there are other factors to consider, such as possible follow-on investments that you can't value at the time
of the initial investment, agreements with suppliers and customers, and public perceptions of the firm,
among others, which might sway the decision. 
In the real world, the NPV of a project is just the starting point in the decision-making over an investment,
not the end.  I have seen negative NPV projects get approved and positive NPV projects abandoned due to
a host of non-financial factors that NPV doesn't even begin to consider.
- The discount rate doesn't matter. In fact, notice that the higher the discount rate, the lower the PV of cash
flows because the denominator of your discount factor formula is larger. Based solely on the NPV rule, if
the NPV is > 0, then take on the project, all else equal. You are indifferent when NPV=0. If NPV<0, don't do
the project.
- The higher the Discount rate NPV will be lower and reach zero at IRR. SO IRR is the maximum return
(discount rate) that the NCF can support. Ignore the conventional rule to stick on with NPV as a criterion.
NPV is only an unutilized NCF and fully utilized it will be zero (that is IRR). IRR is the best criterion and not
NPV
2. An investment project provides cash inflows of RM970 per year for eight years. What is the
project payback period if the initial cost is RM4,100 (4.2268)? What if the initial cost is RM6,200
(6.3917)? What if it is RM8,000 (8.247 years)?
0 4,100 6,200 8,000
1 970 970 970
2 970 970 970
3 970 970 970
4 970 970 970
5 970 970 970
6 970 970 970
7 970 970 970
8 970 970 970
Payback Period = 4,100 6,200 8,000
¿ ¿ ¿
970 970 970
Initial Outlay ¿ 4.23 years ¿ 6.39 years ¿ 8.25 years
Annual Cahflows

3. Ash plans to open a self-serve insurance center in a storefront. The kiosk equipment will cost
RM190,000, to be paid immediately. Ash expects aftertax cash inflows of RM65,000 annually for
seven years, after which he plans to scrap the equipment and retire to the beaches of Bora-Bora.
The first cash inflow occurs at the end of the first year. Assume the required return is 15 percent.
What is the project’s PI? Should it be accepted?

Year Cash Flows (CF) PVCF 15% Cumulative CF

0 -190,000
1 65,000 65,000¿ 1.151 56,521.74
2 65,000 65,000¿ 1.152 49,149.34
3 65,000 65,000¿ 1.153 42,738.56
4 65,000 65,000¿ 1.154 37,163.96
5 65,000 65,000¿ 1.155 32,316.49
6 65,000 65,000¿ 1.156 28,101.29
7 65,000 65,000¿ 1.157 24,435.91
∑PVCF= 270,427.29

∑ PVCF
 Profitability Index¿
Initial Outlay

270,427.29
¿
190,000
 = 1.42

(Accepted, because the profitability index is greater than 1)

Results

Profitability Index (PI) :  1.4233

Net Present Value (NPV) :  RM 80,427.29

Expected Cash Flows :  RM 270,427.29

Profitability Index (PI) : RM 270,427.29 / 190,000 = 1.4233

PI > 1 ⇒ Accept the project

4. Pharma Restaurant is considering the purchase of a RM12,000 dough maker. The dough maker
has an economic life of five years and will be fully depreciated by the straight-line method. The
machine will produce 1,900 waffle per year, with each costing RM2.20 to make and priced at RM5.
Assume that the discount rate is 14 percent and the tax rate is 34 percent. Should Pharma make the
purchase?

IO : RM12,000

n:5

Sale Per Year(Unit) : 1,900 Unit

Variable Cost : RM2.20 x 1,900 = 4180

Selling Price : RM5 x 1,900 = 9500

Disc. Rate : 14%, Tax : 34%

Year 0 1 2 3 4 5
Sales 1,900x5 1,900x5 1,900x5 1,900x5 1,900x5
=9,500 =9,500 =9,500 =9,500 =9,500
(-) Variable 1,900x2.20 1,900x2.20 1,900x2.20 1,900x2.20 1,900x2.20
Cost =4,180 =4,180 =4,180 =4,180 =4,180
(-) Fixed 0 0 0 0 0
Cost
Depreciation 12,000/5 12,000/5 12,000/5 12,000/5 12,000/5
=2,400 =2,400 =2,400 =2,400 =2,400
 EBIT 2,920 2,920 2,920 2,920 2,920
Taxes 2,920x0.34 2,920x0.34 2,920x0.34 2,920x0.34 2,920x0.34
=992.80 =992.80 =992.80 =992.80 =992.80
Net income 1,927.20 1,927.20 1,927.20 1,927.20 1,927.20
OCF 4,327.20 4,327.20 4,327.20 4,327.20 4,327.20

Projected Cash Flows

Year 0 1 2 3 4 5
Initial Outlay (12,000) - - - - -
OCF 4,327.20 4,327.20 4,327.20 4,327.20 4,327.20
CF (12,000) 4,327.20 4,327.20 4,327.20 4,327.20 4,327.20

Using Financial Calculator: -12,000 CF 0 , 4,327.20 CF 1, 4,327.20 CF 2, 4,327.20 CF 3 , 4,327.20 CF 4,

4,327.20 CF 5 , 4,327.20 CF 6 , 14 I/Y, CPT NPV 2855.63, IRR 23.52

PART 3: Capital Structure Heineken’s MiniCase

Heineken Malaysia Berhad (HEIM) is a major producer of beer and stout in Malaysia and has been listed on
the Main Board of Bursa Malaysia since 1965. Among the brands they produce, and market are Tiger Beer,
Guinness, Heineken, Anchor Smooth, Anchor Strong, Kilkenny, Anglia Shandy, Malta, Paulaner,
Strongbow, and Sol. As reporting in their latest’s annual report, there were substantial changes in the
operating environment, primarily driven by the historic election of a new Government. And there were
significant changes within Heineken Malaysia itself, both in the approach to business as well as in the
leadership. Among the changes introduced by the new Government that impact the entire corporate sector
was the re-introduction of the Sales and Services Tax (SST) in September 2018 to replace the Goods and
Services Tax (GST).
The Heineken is currently is 100% equity financed with 15 million shares outstanding, and the latest share
price is traded in Main Board: Stock Code (3255) is RM75.50 per share. The chairman, Dato’ Seri Idris Jala
propose to purchase a shopping mall building that cost RM66 million and then lease out to the possible
tenants to increase their profitability. This planning is expected to increase the Heineken’s earning before
interest and tax by RM18 million in perpetuity. You, as the chief financial officer, reviewed the Heineken
capital structure and determined that the current cost of capital is 12 percent, and the corporate tax is 13.5
percent. After considering the possible opportunity with the Kenanga Investment Bank Bhd, the firm in view
of issuing bonds at par value with 7 percent coupon rate.
Questions
1. If the chairman would like to maximize the total market value, in general, would you recommend
the chairman to issue equity or debt to finance the purchase of the shopping mall building?

I would like to recommend the chairman to issue debt to finance the 60million purchase. This is because, by
issuing debt, the interest payment is tax deductible. The debt in capital structure will decrease the firm’s
taxable income and also by issuing debt will create tax shield which will increase the overall of the firm’s
value.

2. Prepare the statement of financial position before the announcement of the purchase plan

Market value of equity: RM 75.50 X RM 15,000,000

= RM 1,132,500,000

Rm 1,132,500,000 Rm 1,132,500,000
Assets Equity

Total Assets Rm 1,132,500,000 Debt & Equity Rm 1,132,500,000

3. Assume the chairman would like to issue equity to finance the purchase of the shopping mall building;

a) Calculate the net present value of the purposed plan.

IO : RM 66,000,000
EBIT : RM 18,000,000

EAT : RM 18,000,000 X (1-0.135) = RM 15,570,000

NPV : -RM 66,000,000 + (RM 15,570,000/0.12)

= RM63,750,000

b) Prepare the statement of financial position after the announcement of the purchase plan and calculate
the number of shares that the Heineken needs to issue in order to finance the purchase.

Old Assets(RM15,000,000 RM 1,132,500,000 Equity RM 1,132,500,000

X RM75.50)

NPV RM 63,750,000 Debt & Equity RM 1,132,500,000

RM 1,196,250,000

New price per share = RM1,196,250,000 / RM15,000,000 = RM79.75/Shares

No. of shares to issue to finance the purchase = RM 66,000,000 / RM79.75 = 827586.21 shares
 c) Prepare the statement of financial position after the equity issue but before the purchase plan has
been made. Calculate the number of shares of stocks outstanding in the market, and the share price
of the Heineken.

Non Profitable Project)

NPV of the project : RM 0

Share Price : RM 1,132,500,000/RM15,000,000 = RM75.50

No. of shares : RM 66,000,000/RM75.50 = 874,172.19

Total no. of share outstanding : RM 15874172.19

Equity : RM 1,132,500,000 + RM 66,000,000 = RM1,198,500,000

Profitable project)

NPV of the project : RM 63,750,000

Share Price : RM 1,196,250,000 / RM15,000,000 = RM79.75

No. of shares : RM 66,000,000 / RM79.75= 827,586.21

Total no. of share outstanding : RM 15,827,586.21

Equity : RM1,196,250,000+ RM 66,000,000 = RM1,262,250,000

Issuance of equity before purchase

Cash RM 66,000,000 Equity RM 1,262,250,000

Old asset(RM15,000,000 RM 1,132,500,000

X RM75.50)

NPV of plant RM 63,750,000

TOTAL ASSET RM 1,262,250,000

d) Prepare the statement of financial position after the purchase plan has been made

After the purchase

PV of project = RM 15,570,000/0.12 = RM 129,750,000

 Old RM 1,132,500,000 Equity RM 1,262,250,000
asset(RM15,000,000 X
RM75.50)

PV of the project RM 129,750,000

TOTAL ASSET RM 1,262,250,000 EQUITY RM 1,262,250,000

4. Assume the chairman would like to issue bond to finance the purchase of the shopping mall
building.

a) Calculate the market value (VL) of the Heineken

VL = VU + (Tc x D)

Vu = RM 1,262,250,000 + 0.135(RM66,000,000)

VL = RM 1,262,250,000 + RM8,910,000

VL = RM 1,271,160,000

b) Prepare the statement of financial position after the bonds are issued and the shopping mall
building purchased. Calculate the share price of the Heineken, upon completion of the purchase

5. Would you recommend equity or debt financing to maximize the per share stock price of the
Heineken’s equity?

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