Reference no: EM133169368

Question - Ali Berhad is a KL-based manufacturing company. The company has a weighted average cost of capital of 10%, and is financed partly by equity (cost 12%) and partly by debt capital (cost 8%). The company is considering acquiring Granvi Berhad, a design company. The acquisition of Granvi Berhad would cost RM10m, however the acquisition is expected to yield additional annual profits of RM2m before interest charges. The company expects to finance the investment with a further loan at a cost of 8% per annum. As a result of this additional borrowing, the company expects its cost of equity to rise to 15%. The company pays out all profits as dividends, which are currently RM3.6m a year. You may assume the traditional view of WACC and gearing.

Required -

a. Calculate the effect of acquiring Granvi Berhad on the value of Ali Berhad's equity.

b. Calculate the extent to which the change in the value of Ali Berhad's equity is caused by:

i. The NPV of the project at the current WACC

ii. The method of financing

c. Briefly explain why the company's cost of equity would increase as the company increases its total borrowing.