SIMULATION ACTIVITY

FINANCIAL ANALYSIS
(FIN320)
BA1194A1
GROUP MEMBERS/STUDENT ID
Name Student ID

NURAISYAH BINTI DARWIS 2018275786

NOOR ELMYLZAH FARHANA 2018800812

NURUL NADIRAH BT AMIL 2018241948

NURUL WAN FAYZAH JAFFRY 2018275704

ELJOYMIRIKOSITA ELIM 2015309109

EXERCISE 12

Prepare a post-merger financial position for MERTO using the pooling of interest method.

COMMON STOCK
PV

NOSO’ AC = RM400,000/1 NOSO’ TC = RM80,000/1

= RM400,000 = RM80,000

NEW NOSO = 80,000 x 1

= 80,000 units

AC ( RM ) TC ( RM) CALCULATION POST

Current asset 50,000 70,000 + 120,000
Fixes asset 650,000 180,000 + 870,000
Total asset 70,000 250,000 950,000

Current liability 30,000 10,000 + 40,000

Long term debt 140,000 60,000 + 200,000
Common stock 400,000 80,000 (b) 480,000
Capital surplus 60,000 70,000 (c) 120,000
Retained earning 80,000 30,000 + 110,000
Total liability 700,000 250,000 950,000

b. PMCS =( SVAG + ( NOSO TC x PVAC )

= RM400,000 + ( 80,000 x 1 )

= RM480,000

c. PREMIUM = C.SURPLUS’ AC + NOSO’ TC + C.SURLUS TC – NOSO’ TC x PVAC

= RM500,000 + RM80,000 + RM70,000 – ( 80,000 x 1 )

= RM120,000

RE = RE’AC + RE’ TC

= RM80,000 + RM30,000

= RM110,000
EXERCISE 1

i. Define financial management

It is the art of managing the financial resource (such as money, human capital, and
others) effectively and efficiently in order to achieve the firm’s goal.

ii. Explain three(3) common goals of a firm

One of the common goal of a firm is maximization of profits. To make profits is
essential to provide stability and growth in operations and rewards to individuals and
institutions that contribute to the firm. But it is important to consider the above
constraints and the risk of making a decision.

Another common goal is maximization of sales. The efforts to maximize sales are in
line with the effort to maximize profits. Higher sales volume represent higher market
control and would ultimately increase profit.

Lastly is minimization of risk. The risk will act as a control factor in maximization
of profits that is the firm should ventures in activities that provide more than
associated risks.

iii. List and explain four(4) functions of the financial manager

One of the function of a financial manager is investment decision. It is about the
decision regarding the acquisition of new and disposal of existing asset.

Another function is financial decision. It is the decision regarding the appropriate

mix of funds and the availability of financing alternatives.

Lastly, another function is dividend police decision. It is the decision regarding how
much amount of earning can be distributed as dividends.

iv. Elaborate functions of financial system

The financial system plays a major role in modern societies as it moves scarce funds
in form of credit from those who save to those who borrow for consumption and
investment.

That will help to allocate financial resources in the economy by transferring it from
those who have surplus and are willing to invest, to those who has a need or a use for
that money. It determines the cost of credit and how much credit will be available in
the market.

The cost of funds or interest mechanism will serve to adjust the supply and demand
for funds in the market until it reaches a certain point of equilibrium.
v. Differentiate between money market and capital market

Money market Capital Market

Provide venue for institutions to raise Provide venue for institutions to raise
short-term funds. long-term funds.
Deals with marketable securities such as Deals with debt and equity securities such as
NCDs, REPOs, Bank Negara Bills. bonds, preferred stocks, and common stocks.
Maturity period of the securities are less than Maturities of the securities are more than 1
1 year. year or perpetuity.
The securities have low default risk. The securities have high default risk.

vi. Differentiate between primary market and secondary market.

Primary market Secondary market

Deals with newly issued securities that Deals with securities that previously issued
involve the issuer and the investors. in the primary market. The deals involve the
investors only.
Serve as a venue for issuer to raise funds. Serve as a venue for investors to trade
securities.
EXERCISE 2.

I.) STRAIGHT LINE METHOD

1. COA = PURCHASE PRICE + SHIPMENT COST + INSTALLATION COST

= RM 200,000 + RM 5,000 + RM 3,000
= RM 208,000 #
COA  SV
2. ANNUAL DEPRECIATION =
n
RM 208,000  RM 20,000
=
5
= RM 37,600 #

n BEGINNING VALUE ANNUAL ACCUMULATED BOOK

DEPRECIATION DEPRECIATION VALUE
1 RM 208,000 RM37,600 RM37,600 RM170,400
2 RM 170,400 RM37.600 RM75,200 RM132,800
3 RM132,800 RM37,600 RM112,800 RM95,200
4 RM95,200 RM37,600 RM150,400 RM57,600
5 RM57,600 RM37,600 RM188,000 RM20,000

II.) DOUBLE DECLINING BALANCE METHOD

1. COA = PURCHASE PRICE + SHIPMENT COST + INSTALLATION COST

= RM 200,000 + RM 5,000 + RM 3,000
= RM 208,000 #

2. DBBM rate = (1/n) x 2

n BEGINNING rate ANNUAL ACCUMULATED BOOK

VALUE DEPRECIATION DEPRECIATION VALUE
1 RM208,000 0.4 RM83,200 RM83,200 RM124,800
2 RM124,800 0.4 RM49,920 RM133120 RM74,880
3 RM74,880 0.4 RM29,952 RM163,072 RM44,928
4 RM44,928 0.4 RM17,971.20 RM181,043.20 RM26,956.80
5 RM26,956.8 0.4 RM10782.72 RM191,825.92 RM16,174.08
0
5 RM - RM 6,956.80 RM 188,000 RM20,000
26,956.80

Adjustment : (BGV of T - SV )/ no of troubled year

= (RM 26,956.80-RM 20,000)/1

= RM 6,956.80#
 III) SUM-of-YEAR-DIGIT-Method

1. COA = PURCHASE PRICE + SHIPMENT COST + INSTALLATION COST

= RM 200,000 + RM 5,000 + RM 3,000
= RM 208,000 #

2. Dep.rate = n(n+1)/2
= 5(5+1)/2
= 15#

3. SYDM Fraction = n/dep.rate

= 5/15

n BGV COA-SV SYDM AD ACD BGV-AD

FRAC = BV
TION
1 RM 208,000 RM188,000 5/15 RM62,666.6 RM6,266.67 RM145,333.33
7
2 RM145,333.3 RM188,000 4/15 RM50,133.3 RM11,280 RM95,200
3 3
3 RM95,200 RM188,000 3/15 RM37,600 RM48,800 RM57600
4 RM57,600 RM188,000 2/15 RM25,066.6 RM73,946.67 RM32,533.33
7
5 RM32,533.33 RM188,000 1/15 RM12,533.3 RM86,480 RM20,000
3
EXERCISE 3

SELLING PRICE = RM210,000

I.) STRAIGHT LINE METHOD

COA = RM200,000+RM5,000+RM3,000
= RM 208,000
n = 5y UL = 2y
Capital gain tax rate = 28% Corporate tax rate = 32%

A. ) CAPITAL GAIN = SP-COA

=RM210,000-RM208,000
= RM2,000

B. ) CAPITAL GAIN AFTER TAX = (SP-COA) X CAPITAL GAIN TAX RATE

= (RM210,000-RM208,000) X 0.28
= RM560

C. ) BOOK VALUE
COA  SV
AD = ( )
n
RM 208,000  RM 20,000
=( )
2
=RM94,000

n BEGINNING VALUE AD ACD BOOK VALUE

1 RM 208,000 RM94,000 RM94,000 RM114,000
2 RM114,000 94,000 RM188,000 RM20,000

D. ) RD BEFORE TAX = SP-BV-CG

=RM210,000-RM20,000-RM2,000
=RM188,000

E. ) RD AFTER TAX= (SP-BV-CG) X CORPORATE TAX RATE

=(RM210,000-RM20,000-RM2,000) X 0.32
= RM60,160

F. ) TOTAL TAX LIABILITY = CG AFTER TAX + RD AFTER TAX

= RM 560 + RM 60,160
= RM60,720
II.) DOUBLE DECLINING BALANCE METHOD

n = 5y UL = 2y
Capital gain tax rate = 28% Corporate tax rate = 32%

COA = RM200,000+RM5,000+RM3,000 = RM 208,000

A.) CAPITAL GAIN = SP-COA

=RM210,000-RM208,000
= RM2,000

B. ) CAPITAL GAIN AFTER TAX = (SP-COA) X CAPITAL GAIN TAX RATE

= RM 2,000 X 0.28
= RM 560

1
C.) DEPRECIATION RATE =   x 2
 ul 
1 
=  x 2
5
= 0.4

YEAR BGV DDBM ANNUAL ACC. BOOK

rate DEPRECIATION DEPRECIATION VALUE
1 208000 0.4 83200 83200 124800
2 124800 0.4 49920 133120 74880

D ) RD BEFORE TAX = SP-BV-CG

=RM210,000-RM74,880-RM2,000
=RM133,120

E. ) RD AFTER TAX= (SP-BV-CG) X CORPORATE TAX RATE

=(RM210,000-RM74,880-RM2,000) X 0.32
= RM 42,598.40

F. ) TOTAL TAX LIABILITY = CG AFTER TAX + RD AFTER TAX

= RM 560 + RM 42,598.40
= RM43,158.40
III.) SUM-OF-YEARS-DIGIT METHOD (SYDM)

n = 5y UL = 2y
Capital gain tax rate = 28% Corporate tax rate = 32%

COA = RM200,000+RM5,000+RM3,000 = RM 208,000

A.) CAPITAL GAIN = SP-COA

=RM210,000-RM208,000
= RM2,000

B.) CAPITAL GAIN AFTER TAX = (SP-COA) X CAPITAL GAIN TAX RATE
= RM 2,000 X 0.28
= RM 560

useful life ( useful life  1 )

C.) SYDM rate =
2
5(5  1)
= 2
= 15

YEAR BGV COA-SV SYDM ANNUAL ACC. BOOK

FRACTION DEPRECIA DEPRECIA VALUE
TION TION
1 208,000 188,000 5/15 62,666.67 62,666.67 145,333.33
2 145,333.33 188,000 4/15 50,133.33 112,800 95,200

D.) RD BEFORE TAX = SP-BV-CG

=RM210,000-RM95,200-RM2,000
=RM112800

E.) RD AFTER TAX= (SP-BV-CG) X CORPORATE TAX RATE

=(RM210,000-RM95,200-RM2,000) X 0.32
= RM36,096

F.) TOTAL TAX LIABILITY = CG AFTER TAX + RD AFTER TAX

= RM 560 + RM 36,096
= RM 36,656
SELLING PRICE = RM 150,000

I.) STRAIGHT LINE METHOD

COA = RM200,000+RM5,000+RM3,000
= RM 208,000
n = 5y UL = 2y
Capital gain tax rate = 28% Corporate tax rate = 32%

A) CAPITAL GAIN = SP-COA

=RM150,000-RM208,000
= (RM 58,000)

COA  SV
B.) AD = ( )
n
RM 208,000  RM 20,000
=( )
2
=RM94,000

n BEGINNING VALUE AD ACD BOOK VALUE

1 RM 208,000 RM94,000 RM94,000 RM114,000
2 RM114,000 94,000 RM188,000 RM20,000

C) RD BEFORE TAX = SP-BV-CG

=RM150,000-RM20,000-RM0
=RM130,000

D) RD AFTER TAX= (SP-BV-CG) X CORPORATE TAX RATE

=(RM150,000-RM20,000-RM0) X 0.32
= RM41,600

E) TOTAL TAX LIABILITY = CG AFTER TAX RATE + RD AFTER TAX

= 0 + 41,600
= RM41,600
II.) DOUBLE DECLINING BALANCE METHOD

n = 5y UL = 2y
Capital gain tax rate = 28% Corporate tax rate = 32%

COA = RM200,000+RM5,000+RM3,000 = RM 208,000

A.) CAPITAL LOSS = SP-COA

=RM150,000-RM208,000
= (RM58,000)
1
B.) DEPRECIATION RATE =   x 2
 ul 
1 
=  x 2
5
= 0.4

YEAR BGV DDBM ANNUAL ACC. BOOK

rate DEPRECIATION DEPRECIATION VALUE
1 208000 0.4 83200 83200 124800
2 124800 0.4 49920 133120 74880

C ) RD BEFORE TAX = SP-BV-CG

=RM150,000-RM74,880-RM0
=RM75,120

D) RD AFTER TAX= (SP-BV-CG) X CORPORATE TAX RATE

=(RM150,000-RM74,880-RM0) X 0.32
= RM 24,038.40

E) TOTAL TAX LIABILITY = CG AFTER TAX + RD AFTER TAX

= RM 0 + RM24,038.40
= RM24,038.40
III.) SUM-OF-YEARS-DIGIT METHOD (SYDM)

n = 5y UL = 2y
Capital gain tax rate = 28% Corporate tax rate = 32%

COA = RM200,000+RM5,000+RM3,000 = RM 208,000

A.) CAPITAL LOSS = SP-COA

=RM150,000-RM208,000
= (RM58,000)

useful life ( useful life  1 )

B.) SYDM rate =
2
5(5  1)
= 2
= 15

YEAR BGV COA-SV SYDM ANNUAL ACC. BOOK

FRACTION DEPRECIA DEPRECIA VALUE
TION TION
1 208,000 188,000 5/15 62,666.67 62,666.67 145,333.33
2 145,333.33 188,000 4/15 50,133.33 112,800 95,200

C.) RD BEFORE TAX = SP-BV-CG

=RM150,000-RM95,200-RM0
=RM54,800

D) RD AFTER TAX= (SP-BV-CG) X CORPORATE TAX RATE

=(RM150,000-RM95,200-RM0) X 0.32
= RM17,536

E.) TOTAL TAX LIABILITY = CG AFTER TAX + RD AFTER TAX

= RM 0 + RM 17,536
= RM 18,096
SELLING PRICE = RM 132,800

I.) STRAIGHT LINE METHOD

COA = RM200,000+RM5,000+RM3,000
= RM 208,000
n = 5y UL = 2y
Capital gain tax rate = 28% Corporate tax rate = 32%

A) CAPITAL LOSS = SP-COA

=RM132,800-RM208,000
= (RM75,200)

COA  SV
B.) AD = ( )
n
RM 208,000  RM 20,000
=( )
2
=RM94,000

n BEGINNING VALUE AD ACD BOOK VALUE

1 RM 208,000 RM94,000 RM94,000 RM114,000
2 RM114,000 94,000 RM188,000 RM20,000

C) RD BEFORE TAX = SP-BV-CG

=RM132,800-RM20,000-RM0
=RM112,800

D) RD AFTER TAX= (SP-BV-CG) X CORPORATE TAX RATE

=(RM132,800-RM20,000-RM0) X 0.32
= RM36,096

E) TOTAL TAX LIABILITY = CG AFTER TAX RATE + RD AFTER TAX

= 0 + 36,096
= RM36,096
II.) DOUBLE DECLINING BALANCE METHOD

n = 5y UL = 2y
Capital gain tax rate = 28% Corporate tax rate = 32%

COA = RM200,000+RM5,000+RM3,000 = RM 208,000

A.) CAPITAL LOSS = SP-COA

=RM132,800-RM208,000
= (RM75,200)
1
B.) DEPRECIATION RATE =   x 2
 ul 
1 
=  x 2
5
= 0.4

YEAR BGV DDBM ANNUAL ACC. BOOK

rate DEPRECIATION DEPRECIATION VALUE
1 208000 0.4 83200 83200 124800
2 124800 0.4 49920 133120 74880

C ) RD BEFORE TAX = SP-BV-CG

=RM132,800-RM74,880-RM0
=RM57,920

D) RD AFTER TAX= (SP-BV-CG) X CORPORATE TAX RATE

=(RM132,800-RM74,880-RM0) X 0.32
= RM 18,534.40

E) TOTAL TAX LIABILITY = CG AFTER TAX + RD AFTER TAX

= RM 0 + RM18,534.40
= RM18,534.40
III.) SUM-OF-YEARS-DIGIT METHOD (SYDM)

n = 5y UL = 2y
Capital gain tax rate = 28% Corporate tax rate = 32%

COA = RM200,000+RM5,000+RM3,000 = RM 208,000

A.) CAPITAL LOSS = SP-COA

=RM132,800-RM208,000
= (RM75,200)

useful life ( useful life  1 )

B.) SYDM rate =
2
5(5  1)
= 2
= 15

YEAR BGV COA-SV SYDM ANNUAL ACC. BOOK

FRACTION DEPRECIA DEPRECIA VALUE
TION TION
1 208,000 188,000 5/15 62,666.67 62,666.67 145,333.33
2 145,333.33 188,000 4/15 50,133.33 112,800 95,200

C.) RD BEFORE TAX = SP-BV-CG

=RM132,800-RM95,200-RM0
=RM37600

D) RD AFTER TAX= (SP-BV-CG) X CORPORATE TAX RATE

=(RM132,800-RM95,200-RM0) X 0.32
= RM12,032

E.) TOTAL TAX LIABILITY = CG AFTER TAX + RD AFTER TAX

= RM 0 + RM 12,032
= RM 12,032
SELLING PRICE = RM 100,000

I.) STRAIGHT LINE METHOD

COA = RM200,000+RM5,000+RM3,000
= RM 208,000
n = 5y UL = 2y
Capital gain tax rate = 28% Corporate tax rate = 32%

A) CAPITAL LOSS = SP-COA

=RM100,000-RM208,000
= (RM108,000)

COA  SV
B.) AD = ( )
n
RM 208,000  RM 20,000
=( )
2
=RM94,000

n BEGINNING VALUE AD ACD BOOK VALUE

1 RM 208,000 RM94,000 RM94,000 RM114,000
2 RM114,000 94,000 RM188,000 RM20,000

C) RD BEFORE TAX = SP-BV-CG

=RM100,000-RM20,000-RM0
=RM80,000

D) RD AFTER TAX= (SP-BV-CG) X CORPORATE TAX RATE

=(RM100,000-RM20,000-RM0) X 0.32
= RM25,600

E) TOTAL TAX LIABILITY = CG AFTER TAX RATE + RD AFTER TAX

= 0 + 25,600
= RM25,600
II.) DOUBLE DECLINING BALANCE METHOD

n = 5y UL = 2y
Capital gain tax rate = 28% Corporate tax rate = 32%

COA = RM200,000+RM5,000+RM3,000 = RM 208,000

A.) CAPITAL LOSS = SP-COA

=RM100,000-RM208,000
= (RM108,000)
1
B.) DEPRECIATION RATE =   x 2
 ul 
1 
=  x 2
5
= 0.4

YEAR BGV DDBM ANNUAL ACC. BOOK

rate DEPRECIATION DEPRECIATION VALUE
1 208000 0.4 83200 83200 124800
2 124800 0.4 49920 133120 74880

C ) RD BEFORE TAX = SP-BV-CG

=RM100,000-RM74,880-RM0
=RM25,120

D) RD AFTER TAX= (SP-BV-CG) X CORPORATE TAX RATE

=(RM100,000-RM74,880-RM0) X 0.32
= RM 8,038.40

E) TOTAL TAX LIABILITY = CG AFTER TAX + RD AFTER TAX

= RM 0 + RM8,038.40
= RM8,038.40
III.) SUM-OF-YEARS-DIGIT METHOD (SYDM)

n = 5y UL = 2y
Capital gain tax rate = 28% Corporate tax rate = 32%

COA = RM200,000+RM5,000+RM3,000 = RM 208,000

A.) CAPITAL LOSS = SP-COA

=RM100,000-RM208,000
= (RM108,000)

useful life ( useful life  1 )

B.) SYDM rate =
2
5(5  1)
= 2
= 15

YEAR BGV COA-SV SYDM ANNUAL ACC. BOOK

FRACTION DEPRECIA DEPRECIA VALUE
TION TION
1 208,000 188,000 5/15 62,666.67 62,666.67 145,333.33
2 145,333.33 188,000 4/15 50,133.33 112,800 95,200

C.) RD BEFORE TAX = SP-BV-CG

=RM100,000-RM95,200-RM0
=RM4,800

D.) RD AFTER TAX= (SP-BV-CG) X CORPORATE TAX RATE

=(RM100,000-RM95,200-RM0) X 0.32
= RM1,536

E) TOTAL TAX LIABILITY = CG AFTER TAX + RD AFTER TAX

= RM 0 + RM 1,536
= RM 1,536
EXERCISE 4

i) Define risk and return.

Risk is commonly defined as a chance of bad consequences happens. For our purpose,
it is anything that may deviate the actual return from the expected return. For
example, if you forecast that your company will get RM1,000,000 of profits next
year and due to the presence risk, you may find that the actual income will be less
than expected. Return, on the other hand is the payoff from an investment or effort or
for foregoing current consumption. In essence, it is the compensation for taking the
risks. The basic rule states that higher uncertainty reflects higher risks, and
consequently higher return is required by investors to compensate for absorbing the
associated risks.

ii) State the basic rule of the relationship between risk and return.
Recall the basic relationship between risk and return, the higher the risk the higher the
return. They are positively correlated. For the same degree of risk, we must choose
the one that provides the highest return. For the same degree of return, we want the
one with the least risk. Under normal circumstances, we assume that investors are risk
adverse and will always prefer investment with lower risks per unit of return.
iii) Define systematic risks. List and explain three (3) types of systematic risks.
The systematic risk is non-diversifiable risks that cannot be eliminated no matter how
many securities are held in investment portfolio. These risks occur outside the
company for externality and beyond the financial manager’s direct control. When
looking at risk inherent in stock investment, stocks normally do not have the same
degree of non-diversifiable risk as it depends on the variability of the security’s
returns in relation to the market returns. The degree of systematic risk is measured by
beta coefficients.

Three (3) types of systematic risks are:

1) Market Risk
Market risk is the result of the investors’ expectation towards the price of the
company’s securities in the market, or the customers’ expectation towards the price of
the company’s products in the market. For example, if the investor expects that the
price of the company’s shares will to go up in the near future, he or she will buy the
shares now in expectation of higher return.

2) Interest Rate Risk

Interest rate is the price mechanism for supply and demands for funds in the market,
and therefore any fluctuations or movements in the current interest rate represent risk
to both investors and firms alike. Higher interest rate will increase the interest expense
and hence, lowering the company’s profit and reduce the value of return received by
investors.

3) Purchasing Power Risk

The purchasing power risk relates to the increasing inflation rate; that is the
purchasing power of the consumers will decline due to rapid increase in prices. It will
lead to lower sales for the company as well as the profits, especially those that are
dealing with non-durable goods. The effect, however, will be lesser on companies that
produce basic needs’ products, such as foods, drinks, and textiles compared to luxury
goods’ manufactures.
 iv) Define unsystematic risks. List and explain three (3) types of unsystematic risks.
On the other hand, unsystematic risk is a diversifiable risk that is unique only to a
particular company. These are the risks that occur inside or within the company, and
thus within the financial manager’s control. As word of cautions, risks cannot be
eliminated but can be reduced to some extend with proper mix of securities in the
investment portfolios.

Risk in a well-diversified portfolio is much lower than the risk of the security held in
isolation. The lower risk results from holding securities that have negative correlation
that reduces the impact of certain negative events. To eliminate the diversifiable risk
totally, is quite impossible as it requires investors to hold securities that have a perfect
negative correlation in their portfolios. The upcoming materials with give some
insight of how unsystematic risks are measured.

Three (3) types of unsystematic risks are:

1) Business Risks
The risks are caused due to the mismanagement of the company’s asset. A normal
company may comprise of several departments, such as the personnel, marketing,
production, and etceteras. All these departments must be able to cooperate with each
other so as the company can achieve its stated objectives. A failure to manage any of
the assets and/or one of the departments in the company will leads to lower
performances and hence lower profits. For example, if management of the production
department is poor, the output produced by the company will be lower. This leads to
lower sales and consequently lower profits.

2) Financial Risk
It is caused by the improper financing mix used by the company to finance its
investment activities. For example, if the firm depends too much on debts, it will have
to incur higher amount of interest expense and increase the firm risks of insolvency.
The company is perceived to be highly risky by the investors if the company has too
much fix obligations of principal and interest payments on debt. This leads to future
difficulty in the event that the company is trying to raise more funds externally.
3) Operational Risk
Operational risks are the business process risks failing due to human errors. This risk
will change from industry to industry. It occurs due to breakdowns in the internal
procedures, people, policies and systems. Besides, in operational risk it also have the
types which are model risk, people risk, legal risk and political risk.

The meaning of types of operational risk is as follows:

Model risk is involved in using various models to value financial securities. It is due
to probability of loss resulting from the weaknesses in the financial-model used in
assessing and managing a risk.

People risk arises when people do not follow the organization’s procedures, practices
and/or rules. That is, they deviate from their expected behaviour.

Legal risk arises when parties are not lawfully competent to enter an agreement
among themselves. Furthermore, this relates to the regulatory-risk, where a
transaction could conflict with a government policy or particular legislation (law)
might be amended in the future with retrospective effect.

Political risk occurs due to changes in government policies. Such changes may have
an unfavourable impact on an investor. It is especially prevalent in the third-world
countries.
EXERCISE 5

i) Calculate the expected value, standard deviation and coefficient variation for both
project.

PROJECT C
STATE OF PROBABILITY ACTUAL EXPECTED VARIANCE
ECONOMY RETURN RETURN ( P X ( AR-TER)2
( P X AR )
Boom 0.2 30 0.2 x 30 = 6 0.2 X ( 30 -34)2 = 3.2
Nornal 0.5 50 0.5 x 50 = 25 0.5 X (50 -34)2 = 128
Recession 0.3 10 0.3 x 10 = 3 0.3 X (10-34)2 = 172.8
 TER = 34  TV = 304

STANDARD DEVIATION COEFFICIENT OF VARIATION

SD = TV SD
CV =
= 304 TER
= 17.44 17.44
=
34
= 0.51

PROJECT D
STATE OF PROBABILITY ACTUAL EXPECTED VARIANCE
ECONOMY RETURN RETURN ( P X ( AR-TER)2
( P X AR )
Boom 0.2 50 0.2 X 50 = 10 0.2 X ( 50-26.5)2 =
110.45
Nornal 0.5 30 0.5 X 30 = 15 0.5 X ( 30-26.5)2 =
6.13
Recession 0.3 5 0.3 X 5 = 1.5 0.3 X (5-26.5)2 =
138.68
 TER = 26.5  TV = 255.26

STANDARD DEVIATION COEFFICIENT OF VARIATION

SD = TV SD
CV =
= 255.26 TER
= 15.98 15.98
=
26.5
= 0.60

ii. The company should invest in Project C because of the lowest coefficient of
variation which means by risk.
EXERCISE 6

i) Calculate he after tax cost of debt, the breaking point, and the weighted average
cost of capital (WACC)

STEP 1:
Sources Financing Limit Cost of Capital (%)
Kb = 4%
Debt RM0 – RM1000,000 Tax rate = 25%
*kbat = kb (1-0.25)
= 0.04(1-0.25)
= 0.03 @ 3%
Kb = 6%
RM1,010,000 – Tax rate = 25%
RM4,000,000 *kbat= kb(1-0.25)
= 0.06(1-0.25)
=0.045 @ 4.5%
Kb = 7.5%
More than RM4,000,000 Tax rate = 25%
*kbat= kb(1-0.25)
=0.075(1-0.25)
=0.0563 @ 5.63%

Preferred Stock RM0 – RM2,000,000 8%

More than RM2,000,000 10%

RM0 – 5,000,000 11.9%

Common Stock
More than RM5,000,000
12.6%
STEP 3:
Component 1st financing limit weight Breakpoint
of capital (RM) (RM)

RM2,500,000
Bond RM1,000,000 0.40

Preferred RM2,000,000 0.10 RM20,000,000

Stock

Common RM5,000,000 0.50 RM10,000,000

Stock

STEP 4 :
1st Range RM0 – RM2,500,000
2nd Range RM2,500,001– RM10,000,000
3rd Range RM10,000,001-RM20,000,000
4th Range More than RM20,000,000

STEP 5:
1ᶳᶧ Range ( 0 – 2,500,000 )
Sources Range limit Weight Cost of capital WACC(%)
Debt 0 – 1,000,000 0.40 3% 1.2 %
Preferred Stock 0 –250,000 0.10 8% 0.8%
Common Stock 0 – 1,250,000 0.50 11.9 % 5.95 %
TOTAL WACC = 7.95%
2 ᵑᵈ Range ( 2,500,001 – 10,000,000 )
Sources Range limit Weight Cost of capital WACC(%)
Debt 1,000,001 – 4,000,000 0.40 4.5% 1.8 %
Preferred 250,001 – 1,000,000 0.10 8% 0.8%
Stock
Common 1,250,001 – 5,000,000 0.50 11.9% 6.3 %
Stock
TOTAL WACC = 8.9%

3 ᵈ Range (10,000,001-20,000,000 )
Sources Range limit Weight Cost of Capital WACC(%)
Debt 4,000,001-8,000,000 0.40 5.63 % 2.25%
Preferred Stock 1,000,001-2,000,000 0.10 8% 0.8%
Common Stock 5,000,001-10,000,000 0.50 12.6 % 6.3 %
TOTAL WACC = 9.35%

4th Range (More than 20,000,000

Sources Range limit Weight Cost of Capital WACC(%)
Debt >8,000,000 0.40 5.63% 1.8%
Preferred Stock >2,000,000 0.10 10 % 1%
Common Stock >10,000,000 0.50 12.6 % 6.3 %
TOTAL WACC = 9.1%
EXERCISE 7

STEP 1:

Sources Financing Limit (RM) Cost of Capital (%)

Debt Kbat=kb(1-tax rate)

RM0-RM200,000 = 10%(1-0.25)
=0.075 @ 7.5%

More than RM200,000 Kbat=kb(1-tax rate)

= 13%(1-0.25)
=0.0975 @ 9.75%

Preferred Stock RM0-RM300,000 8%

More than RM300,000 10%

 D1  
Kc=    g  x100
 SP  FC  
−
Common Stock  3.78  
 32  3.84   0.08 x100
  

= 21.42%

 D1  
Kre=    g  x100
 SP  

 3.78  
=    0.08 x100
 32  
=19.81%
STEP 2:
Component of Capital Book Value (RM) Weight (%)

350,000
Wb= = 0.35
Bond 350,000 1,000,000

200,000
Preferred Stock 200,000 Wp = =0.2
1,000,000

450,000
Wce= =0.45
Common Stock 450,000 1,000,000

TOTAL BOOK VALUE

= 1,000,000

STEP 3:
Component of Financing Unit Weight Breaking Point
Capital (RM)

Bond 350,000 0.35 Bpb= 1,000,000

Preferred Stock 200,000 0.2 Bpp = 1,000,000

STEP4:
1st nancing range 0-1,000,000
2nd range More than 1,000,000
ii) Weighted average cost of capital (WACC)

STEP 5:
1st range (0-1,000,000)
Sources Weight Cost of Capital WACC(%)

Bond 0.35 7.5% 2.63%

Preferred Stock 0.20 8% 1.60%

Common Stock 0.45 19.81% 8.91%

TOTAL WACC 13.14%

Sources Weight Cost of Capital WACC(%)

Bond 0.35 9.75% 3.41%

Preferred Stock 0.20 10% 2%

Common Stock 0.45 21.42% 9.64%

TOTAL WACC 15.05%

iii) Weighted marginal cost of capital (WMCC) curve.

Projects IRR % Initial Investments Accumulated Cost

(in RM) RM(‘000)
Mulan 12 350,000 350,000
Aurora 15 400,000 750,000
Sofia 13 550,000 1,300,000
Amber 10 600,000 1,900,000

WMCC CURVES

Iv.) So, the company should choose the project Aurora due to they have IRR >
WMCC.
EXERCISE 8

Fixed Cost (FC) RM50,000

Sales (Units) 20,000
Selling Price (P) RM10
EBIT RM70,000

i) Variable cost per unit

Operating Profit = Q (p-v) – FC
70,000 = 20,000 (10-v) – 50,000
70,000 + 50,000 = 200,000 – 20,000v
120,000 – 200,000 = -20,000v
v = 4 units

ii) Breakeven points in units and ringgit

FC
BEP (in units) = BEP (u ) 
P V
50,000
= BEP (u ) 
10  4
= 8,333 Units

FC
BEP (in RM) = BEP ( RM ) 
V 
1  
P
50,000
= BEP (RM ) 
 4
1  
 10 
= RM83,333.33

iii) DOL at sales level of 20,000 units

TV = V x Q
= 4 x 20,00
= 80,000

TOTAL SALES = P x Q
= 10 x 20,000
= 200,000

SALES  TV
DOL =
SALES  TV  FC
200,000  80,000
=
200,000  80,000  50,000
= 1.71times
EXERCISE 9

STEP 1:
Capital Structure Current cost of capital

Debt Cost of bond = 160,000 x 10%

= 16,000

Common Stock Cost of common share

172,000
=
( 4  0)
=43,000

STEP 2:
FTBR = RM1,000,000

STEP 3:
PLAN 1
CAPITAL CURRENT COST NEW COST TOTAL
STRUCTURE

Common Stock 43,000 NOSO = 10,000 43,000 + 10,000

= 53,000

Bond 16,000 0 16,000

Preferred Stock − − −

STEP 4:
PLAN 2
CAPITAL CURRENT COST NEW COST TOTAL
STRUCTURE

Bond 16,000 = 600,000 x 6% = 16,000 + 36,000

= 36,000 = 52,000

Preferred Stock − − −

Common Stock 43,000 0 43,000

STEP 5: i) Corporate tax = 30%

PLAN 1 PLAN 2

(EBIT – Interest) (1 – tax rate) - DPS (EBIT – Interest) (1 – tax rate) - DPS
NOSO = NOSO

( EBIT  16,000)(1  0.30)  0 ( EBIT  52,000)(1  0.3)  0

53,000 = 43,000

( EBIT  16,000)(0.7)  0 = ( EBIT  52,000)(0.7)  0

53,000 43,000

0.7 EBIT  11200  0 = 0.7 EBIT  36,400  0

53000 43000

0.7EBIT-11200(43,000) = 0.7EBIT-36,400(53,000)

30,100EBIT-481,600,000 = 37100EBIT-1,929,200,000

30100EBIT-37100EBIT = 1,929,200,000-481,600,000

7000EBIT = 1,447,600,000

EBIT = 1,447,600, 000

7000

EBIT = 206,800
iii) 20,000,000

PLAN 1
(20,000,000  16,000)(1  0.3)  0
=
53,000
19,984,000(0.7)
=
53,000
= RM263.94

PLAN 2
(20,000,000  52,000)(1  0.3)  0
=
43,000
19,948,000(0.7)
=
43,000
= RM324.73

So, the company should adopt Plan 2 because due to higher EBIT.
EXERCISE 10
Briefly explain four (4) reasons for merging.

The key motivation for most mergers are to increase the combined firms’ values to
benefits the shareholder that is to maximize the shareholders’ wealth. In order to
achieve this, the following must exist in the proposed merger which is an increase in
the level of expected cash flows and dividend. Next, a reduction in risk and therefore
the required rate of return. Thirdly, the acquired firm is undervalued. Lastly, the
acquiring firm is overvalued.

In the efficient financial market such as ours, condition 3 and 4 rarely exist, as the
market will adjust itself to reflect the firm’s true value. Thus, the focus is on the first
two factors that deal with risk and return trade offs of merger activity. In reality, many
mergers occurred in the market place are not clearly directed toward increasing
operating efficiency, but rather to gain market power or dominant. Other things being
equal, the real reasons for merging are:

1. Synergy: It refers to economies of scale and operating economies that result from
combining two companies together. Economies of scale provide efficient production
facilities, raising of capital, setting up research and development facility, or marketing
center. Operating economies could take form of eliminating duplication of activities
such as production, marketing, financial and personnel facilities.
2. Tax consideration : A highly profitable firm may acquire smaller company with
large amount of accumulated tax losses to shelter its own income, and therefore
reduce its tax liability.
3. Diversification : This effort helps to stabilize the firm’s earnings and reduce the
overall risk of the firm by involving in business activities that has negative correlation
with its current business.
4. Maintaining control : Some firms make use of merger to reduce the chances of
their firm being taken over. Such move may involve issuing large amount of debt in
acquiring another firm, and thus make it less attractive for potential take over. This is
known as defensive merger.
EXERCISE 11
i) Calculate the post-merger earnings per share for the acquiring company.
STEP 1:
SMIDEX CO = A
MALTA CO = T
STEP 2:
Smidex Company (A) Malta Company (T)
EPS (T ) RM6 RM2
ERE 
EPS ( A)
2
=
6
=0.33

STEP 3:
Smidex Company (A) Malta Company(T)
NOSO= 600,00 80,000
NOSO (A) = NOSO (T) =
Value of common stock 3 2
Par value = 200,000 shares = 40,000 shares
***
EPS (T )
ERE 
EPS ( A)
2
=
6
=0.33

New NOSO = ERE × NOSO (T)

= 0.33× 40,000
= 13,200 shares

STEP 4:

Post merger EPS (A) =

EPS (A)  NOSO (A)  EPS (T)  NOSO (T)
NOSO (A)  New NOSO

=
6 X 200,000  2 X 40,000
200,000  13200
=RM6.004
Post merger EPS (T) = Post merger EPS (A) × ERE
= 6 × 0.33
= RM 1.98

Pre merger EPS Post merger EPS

Smidex RM 6 Increase to RM 6.004 Acceleration
Company (A) in EPS
Malta Company RM 2 Decrease to RM 1.98 Dilution in
(T) EPS
ii) Prepare a post-merger balance sheet under the purchase method. Show all
calculation.
Smidex Malta Company Post Merger
Company (T) Balance Sheet
(A) (RM)
(RM)
Current 200,000 20,000 220,000
assets
Fixed 800,000 130,000 930,000
Asset
Goodwill Purchase price (PP) = MP (A) × 280,000
New NOSO
= 20 × 20,000
= RM 400,000
Goodwill = PP + (TL-T)
= 400,000  30,000  150,000
= RM 280,000
Total 1,430,000
Assets

Current 70,000 5,000 75,000

liabilities
Long 100,000 25,000 125,000
term debt
New value of common stock
Common 600,000 80,000 660,000 C  = New NOSO x PV(A)
stock = 20,000 × 3
= RM 60,000

Total value of common stock =

Value of common stock (A) + C
= 600,000 + 60,000
= RM 660,000
 Capital 100,000 30,000 440,000 New value of capital surplus (D)
surplus = PP - C
= 400,000 - 60,000
= RM 340,000

Total value of capital surplus =

Value of capital surplus (A) + D
= 100,000 + 340,000
=RM 440,000
Retained 130,000 10,000 130,000
earnings
Total
Liabilitie 1,430,000
s
EXERCISE 12

Prepare a post-merger financial position for MERTO using the pooling of interest method.

COMMON STOCK
PV

NOSO’ AC = RM400,000/1 NOSO’ TC = RM80,000/1

= RM400,000 = RM80,000

NEW NOSO = 80,000 x 1

= 80,000 units

AC ( RM ) TC ( RM) CALCULATION POST

Current asset 50,000 70,000 + 120,000
Fixes asset 650,000 180,000 + 870,000
Total asset 70,000 250,000 950,000

Current liability 30,000 10,000 + 40,000

Long term debt 140,000 60,000 + 200,000
Common stock 400,000 80,000 (b) 480,000
Capital surplus 60,000 70,000 (c) 120,000
Retained earning 80,000 30,000 + 110,000
Total liability 700,000 250,000 950,000

b. PMCS =( SVAG + ( NOSO TC x PVAC )

= RM400,000 + ( 80,000 x 1 )

= RM480,000

c. PREMIUM = C.SURPLUS’ AC + NOSO’ TC + C.SURLUS TC – NOSO’ TC x PVAC

= RM500,000 + RM80,000 + RM70,000 – ( 80,000 x 1 )

= RM120,000

RE = RE’AC + RE’ TC

= RM80,000 + RM30,000

= RM110,000