Capital Asset

1. Plaggio Ltd. needs to replace its production machinery to meet its increase in production. The following information relates to three offers for the capital expenditure on the machinery. You are required by the managing director to recommend one of the three tenders.


Tenders A B C
Cost RM310,000 RM280,000 RM380,000
Expected life 5 years 5 years 4 years
Scrap value expected RM10,000 RM30,000 RM20,000
Expected cash inflow RM RM RM
End of the year:
1 90000 100000 155000
2 110000 100000 165000
3 85000 80000 95000
4 80000 80000 100000
5 75000 60000
The company requires a minimum return on its cost of capital of 12%.
(a) Calculate the payback period for each tender.    (6 marks)
(b) Calculate the Accounting rate of return using the straight line method for depreciation.   (9 marks)
(c) Calculate the Net Present Value (NPV) of each tender.   (9 marks)
(d) Calculate the internal rate of return for each tender.   (9 marks)
(e) State which tender should be accepted under each appraisal method, stating some of the advantages and disadvantages of each method.   (7 marks)
(Total 40 marks)
2. The Finance Manager of Plaggio Ltd. believes that the cost of capital of a firm influences firm value and that it is very much related to the capital structure policy of a firm. The capital structure of a firm consists of debt and equity. To determine the cost of capital of the firm, he has collected the following information:
i) The firm’s capital structure comprises of 30 per cent debt and 70 per cent equity.
ii) The firm has bonds outstanding with 20 years to maturity; 12 per cent annual coupon rate; face value of RM1,000; and the current bond price is RM1,252
iii) The firm uses Capital Asset Pricing Model (CAPM) to compute the cost of equity with the risk free rate at 2.5 per cent per annum, stock beta of 1.6 and market return of 12% per annum.
iv) The firm pays tax at a rate of 30 per cent.
(a) Determine the firm’s after-tax cost of debt. Why is the after-tax cost of debt used in the computation of cost of debt and not the before-tax
cost?   (6 marks)
(b) Compute the firm’s cost of equity and its weighted average cost of capital (WACC) using the table approach   (10 marks)
(c) Explain any TWO (2) factors that are generally beyond a firm’s control that could affect the firm’s cost of capital.   (4 marks)
(d) Discuss any four methods of raising funds and discuss their advantages and disadvantages    (20 marks)
(Total 40 marks)

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