DFF is a listed company operating in property industry. The CEO was informed about the governments plan

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Question:

DFF is a listed company operating in property industry. The CEO was informed about the government’s plan to develop a piece of land and he is interested in bidding the project. The estimated after-tax cost of development is RM1.4 billion, where 30% will be payable upfront as deposit, and the balance will be payable based on the stage of completion at the end of each year. It is estimated that the project will be 60% completed in the first year and the project will be completed fully in the second year.

Upon completion, the property is expected to yield RM200 millions of rental income before tax annually. The incremental fixed costs including the depreciation is RM90 million per year. Due to the uncertainty of the economy, no growth is estimated for the rental income and costs. The property that is subject to depreciation and industrial building allowance is costing at RM700 million out of the RM1.4 billion cost of development.

DFF’s accounting policy to set 5% straight-line depreciation on real property assets. The tax law allows the buildings in this project to claim industrial building allowance at 10% initial allowance and 3% annual allowance starting from the first year of completion (straight-line basis). This project is assumed to sustain thereafter and all the properties will not be sold or demolished. The current corporate tax rate is 24% and the tax are assumed to be paid at the same year when it incurs.

The CFO would like to propose a suitable financing method to finance the new project. Currently, there are two options available, namely a long-term borrowing or rights issue. The cost of capital is estimated to be 10% regardless of which financing method is used.

The summarized latest (current) financial statements are presented below:

Statement of Profit and Loss
Revenue	4,600	6,500
Cost of goods sold	(3,000)	(4,500)
Operating expenses	(1,200)	(1,400)
Operating profit	400	600
Finance cost	(220)	(313)
Net profit before tax	180	287
Tax	(27)	(54)
Net profit after tax	153	233
Statement of Financial Position
Non-current assets	13,000	15,000
Inventories	2,000	2,300
Trade and other receivables	1,800	2,200
Cash and cash equivalents	2,100	3,200
Trade and other payables	(2,500)	(3,000)
	16,400	19,700
Share capital (par value of RM1 per share)	4,500	5,200
Retained profits	4,000	4,100
Other equity reserves	2,200	1,600
Long term liabilities	5,700	8,800
	16,400	19,700