(a) Determine the net investment required for the new machine and the incremental operating cash flows associated with the new machine.
 

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Q1. Eco Cycle Berhad (ECB) is an investment holding company listed on the ACE market of Bursa Malaysia in 2015. ECB is primarily engaged in the provision of recovery and recycling of scheduled waste in accordance with Environmental Quality Act. ECB collects soiled rags, activated carbon and wood from the oil and gas, automotive and other manufacturing industries. The company has state-of-the-art scheduled waste management facilities at its plant in Rawang, Selangor, which enables it to achieve economies of scale. To widen its competitive advantage, ECB is considering to venture into the gasification technology by replacing an existing piece of equipment with a more sophisticated machine. The relevant information is as follow: Existing Machine Cost = RM140,000 Purchased 2 years ago Straight line depreciation Five year usable life remaining Current market value = RM95,000 Proposed Machine Cost = RM150,000 Installation = RM20,000 Straight line depreciation Five year usable life expected Year Earnings before Depreciation and Taxes RM160,000 RM150,000 RM140,000 RM140,000 RM140,000 RM170,000 RM170,000 RM170,000 RM170,000 RM170.000 2 4 This project's cost of capital is 12 percent and pays 26 percent taxes on any gains. ECB is entrusted by the Malaysian Department of Environment with treating items listed in 31 scheduled waste codes. As an ambitious company with lots of growth opportunities, the chief financial officer (CFO) of ECB closely monitors the firm's cost of capital. The CFO keeps tabs on the target capital structure of ECB's three main financing sources as long-term debt (30%). preferred stock (20%). and common stock (50%). At the present time, ECB can raise debt by selling 20-year bongls with a RM1,000 par value and a 10.5 percent annual coupon interest rate. ECB's corporate tax rate is 26 percent, and its bonds generally require an average discount of RM45 per bond and flotation costs of RM32 per bond when being sold. ECB's outstanding preferred stock pays a 9 percent dividend and has a RM95-per-share par value. The cost of issuing and selling additional preferred stock is expected to be RM7 per share. As ECB is an aggressive fim that requires lots of cash to grow, it does not currently pay a dividend to common stockholders. To track the cost of common stock, the CFO uses the capital asset pricing model. The CFO and the firm's investment advisors believe that the appropriate risk-free rate is 4 percent and that the market's expected return equals 13 percent. Using data from 2015 through 2019, ECB's CFO estimates the firm's beta to be 1.3. Although ECB's current target capital structure includes 20 percent preferred stock, the company is considering using debt financing to retire the outstanding preferred stock, thus shifing their target capital structure to 50 percent long-term debt and 50 percent common stock. If ECB shifts its capital mix from preferred stock to debt, its financial advisors expect its beta to increase to 1.5. Q1. Eco Cycle Berhad (ECB) is an investment holding company listed on the ACE market of Bursa Malaysia in 2015. ECB is primarily engaged in the provision of recovery and recycling of scheduled waste in accordance with Environmental Quality Act. ECB collects soiled rags, activated carbon and wood from the oil and gas, automotive and other manufacturing industries. The company has state-of-the-art scheduled waste management facilities at its plant in Rawang, Selangor, which enables it to achieve economies of scale. To widen its competitive advantage, ECB is considering to venture into the gasification technology by replacing an existing piece of equipment with a more sophisticated machine. The relevant information is as follow: Existing Machine Cost = RM140,000 Purchased 2 years ago Straight line depreciation Five year usable life remaining Current market value = RM95,000 Proposed Machine Cost = RM150,000 Installation = RM20,000 Straight line depreciation Five year usable life expected Year Earnings before Depreciation and Taxes RM160,000 RM150,000 RM140,000 RM140,000 RM140,000 RM170,000 RM170,000 RM170,000 RM170,000 RM170.000 2 4 This project's cost of capital is 12 percent and pays 26 percent taxes on any gains. ECB is entrusted by the Malaysian Department of Environment with treating items listed in 31 scheduled waste codes. As an ambitious company with lots of growth opportunities, the chief financial officer (CFO) of ECB closely monitors the firm's cost of capital. The CFO keeps tabs on the target capital structure of ECB's three main financing sources as long-term debt (30%). preferred stock (20%). and common stock (50%). At the present time, ECB can raise debt by selling 20-year bongls with a RM1,000 par value and a 10.5 percent annual coupon interest rate. ECB's corporate tax rate is 26 percent, and its bonds generally require an average discount of RM45 per bond and flotation costs of RM32 per bond when being sold. ECB's outstanding preferred stock pays a 9 percent dividend and has a RM95-per-share par value. The cost of issuing and selling additional preferred stock is expected to be RM7 per share. As ECB is an aggressive fim that requires lots of cash to grow, it does not currently pay a dividend to common stockholders. To track the cost of common stock, the CFO uses the capital asset pricing model. The CFO and the firm's investment advisors believe that the appropriate risk-free rate is 4 percent and that the market's expected return equals 13 percent. Using data from 2015 through 2019, ECB's CFO estimates the firm's beta to be 1.3. Although ECB's current target capital structure includes 20 percent preferred stock, the company is considering using debt financing to retire the outstanding preferred stock, thus shifing their target capital structure to 50 percent long-term debt and 50 percent common stock. If ECB shifts its capital mix from preferred stock to debt, its financial advisors expect its beta to increase to 1.5.

Answer rating: 100% (QA)

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