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MAF603 Corporate Finance

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Case 1New waves of the Covid-19 outbreak in major parts of the world may have sparked fears of a double-dip recession,but Trendmark Auto Bhd, the official distributor of Mizda cars and spare parts in Malaysia, remainsoptimistic that the global economic growth is on track. Due to that, Trendmark Auto Bhd is considering three possible financing arrangements to raise RM100 million of new capitalfor its business.Alternative 1: Finance with only new equity.Alternative 2: Finance using 50% debt and 50% equity.Alternative 3: Finance using only new debt.The proceeds may be utilised to finance working capital requirements, investments, acquisition, capital expenditure and general corporate purposes.Currently, the capital structure consists of no debt and RM250millionin equity. There are 100millionshares of common stock currently outstanding, selling at RM2.50 per share.Expected earnings of RM200million, before interest and taxes, are expected for next period. The interest rate on any debt obtained should be 10%. Required:a)Calculate the earnings per share for each alternative.b)Determine the distribution of income between debt holders, shareholders, and the government for eachalternative.c)In view of the benefit and expense of debt funding, the corporation agreed to issue an additional debt of RM60millionresulting a debt-to-equity ratio of 1.5 primarily for the purpose of increasing its capital requirement. Byapplying Modigliani Miller Proposition, calculate the valueand the overall cost of capital of Trendmark Auto Bhd.d)Explain why debt levels vary across sectors and within industries.(Total: 12.5 marks)

3Case 2Randy Property Bhdis planning to invest in a project which would involve diversification into a new industry. Due to rising health cases nowadays, Randy Property plans to increase business focus in the industry related to healthcare that ison the diagnosis and remote monitoring of heart rhythm disorders.It will become part of Randy’s connected care business, which offers a range of platforms and devices that allow patients to stay at home while being monitored.The management of Randy Property Bhdexpected to deliver double-digit growth and improve its earnings before interestand tax to more than 20% by 2025.The finance manager of the company has analysed two companies that are identical in every respect except for their capital structure. Their market values are in equilibrium, as follows. Geared(‘000)Ungeared(‘000)Annual profit before interest and tax 1,0001,000Less interest (4,000 @ 8%) 32006801,000Less tax at 25% 170250Profit after tax 510750Market value of equity 3,9006,600Market value of debt4,1800Total market value of company 8,0806,600The total value of Geared is higher than the total value of Ungeared, which is consistent with MM. All profits after tax are paid out as dividends, and so there is no dividend growth. The beta value of Ungeared has been calculated as 1.0. The debt capital of Geared can be regarded as risk free. Required:a)Calculate the followings:i.The cost of equity to the equity holders in the geared companyii.The beta value of Geared using the asset beta formula and explain the calculated beta.b)Explain the leverage effect and the implications to companies if earnings are insufficient to cover interest obligations?c)Discussthe relationship between financial distress and capital structure,andpropose the considerations to be addressed by using debt financing

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