Advanta Bhd. is a medium-sized manufacturing company that plans to increase capacity by purchasing new machinery at an initial basic price of RM1.5 million. The shipping costs will be RM27,000 and an additional cost of RM73,000 to modify it for special use by the firm. It will depreciate to zero over the five-year useful life using the straight-line method, but it is expected to be sold for RM65,000.
The investment is expected to increase annual sales by 6,000 units. Financial data on the additional units to be sold is as follows:
After the first year, the sales price and variable costs will increase at the inflation rate of 3% per annum.
Working capital is 15% of sales (the year prior to the anticipated sales) and will be fully recovered at the end of the project life.
The beta factor of this investment is 1.0. The company’s targeted capital structure is 60% equity and 40% debt. The cost of debt after tax is 9%. The market rate of return is 14% and the risk-free is 4%. An average-risk project has a coefficient of variation of NPV between 0.8 and 1.2.
The tax rate is 26%.
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Malton Bhd. has made the following forecast for the upcoming year based on the company’s current capitalization:
The company has RM20 million worth of debt outstanding, and all of its debt yields 10 percent. The company’s tax rate is 26 percent. The company’s price-earnings (P/E) ratio has traditionally been 12´,
The company’s investment bankers have suggested that the company recapitalize. Their suggestion is to issue enough new bonds at a yield of 10 percent to repurchase 1 million shares of common stock. Assume that the stock can be repurchased at RM40.
Assume that the repurchase will have no effect on the company’s operating income; however, the repurchase will increase the company’s dollar interest expense. Also, assume that because of the increased financial risk, the company’s price-earnings (P/E) ratio will be 11.5 after the repurchase.
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Canggih Bd. manufactures school uniforms. The company decided to re-design its school uniform for girls due to unfavourable complaints from parents. Each new dress now requires 2.2 metres of material which is 10% more material than the previous design. However, a new material has also been chosen which costs only RM2.85 per metre which is 5% cheaper than the material used on the previous dresses. In July, the total amount of material used and purchased at this price was 54,560 metres. The new design also requires a new sewing technique. As a result, all staff must undergo training. The manager of the sewing department expected each of the new dresses to take 10 minutes to make as compared to 8 minutes per dress for the old design. Canggih Bhd. has 24 staff, each of whom works 160 hours per month and is paid a wage of RM12 per hour. No labour rate variance arose in July.
The production manager at Canggih Bhd. is responsible for all purchasing and production issues that occur. Canggih Bhd. uses standard costing and usually, every time a design change takes place, the standard cost care is updated prior to production commencing. However, the company accountant responsible for updating the standards has been off sick for the last two months. Consequently, the standard cost card for the new dress has not yet been updated.
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