Documenti di Didattica
Documenti di Professioni
Documenti di Cultura
1. Value five years hence of a deposit of Rs.1,000 at various interest rates is as follows:
r = 8% FV5 = Rs.1469
2. 30 years
3. In 12 years Rs.1000 grows to Rs.8000 or 8 times. This is 23 times the initial deposit. Hence
doubling takes place in 12 / 3 = 4 years.
4. Saving Rs.2000 a year for 5 years and Rs.3000 a year for 10 years thereafter is equivalent to
saving Rs.2000 a year for 15 years and Rs.1000 a year for the years 6 through 15.
Hence the savings will cumulate to:
2000 x FVIFA (10%, 15 years) + 1000 x FVIFA (10%, 10 years)
= 2000 x 31.772 + 1000 x 15.937 = Rs.79481.
1
From the tables we find that
FVIFA (20%, 6 years) = 9.930
FVIFA (24%, 6 years) = 10.980
(5.000 – 4.411) x 2%
r = 16% + = 17.4%
(5.234 – 4.411)
8. The present value of Rs.10,000 receivable after 8 years for various discount rates (r ) are:
r = 10% PV = 10,000 x PVIF(r = 10%, 8 years)
= 10,000 x 0.467 = Rs.4,670
10. The present value of an annual pension of Rs.10,000 for 15 years when r = 15% is:
10,000 x PVIFA (15%, 15 years)
= 10,000 x 5.847 = Rs.58,470
2
The alternative is to receive a lumpsum of Rs.50,000.
Obviously, Mr. Jingo will be better off with the annual pension amount of Rs.10,000.
14. To earn an annual income of Rs.5,000 beginning from the end of 15 years from now, if the
deposit earns 10% per year a sum of
Rs.5,000 / 0.10 = Rs.50,000
is required at the end of 14 years. The amount that must be deposited to get this sum is:
Rs.50,000 / PVIF (10%, 14 years) = Rs.50,000 / 3.797 = Rs.13,165
= 15.1%
3
PVIF (12%, 4 years) + Rs.500 x PVIF (12%, 5 years) +
Rs.600 x PVIF (12%, 6 years) + Rs.700 x PVIF (12%, 7 years) +
Rs.800 x PVIF (12%, 8 years) + Rs.900 x PVIF (12%, 9 years) +
Rs.1,000 x PVIF (12%, 10 years)
= Rs.2590.9
Similarly,
PV (Stream B) = Rs.3,625.2
PV (Stream C) = Rs.2,851.1
19 A B C
20. Investment required at the end of 8th year to yield an income of Rs.12,000 per year from the
end of 9th year (beginning of 10th year) for ever:
Rs.12,000 x PVIFA(12%, ∞ )
4
= Rs.12,000 / 0.12 = Rs.100,000
To have a sum of Rs.100,000 at the end of 8th year , the amount to be deposited now is:
Rs.100,000 Rs.100,000
= = Rs.40,388
PVIF(12%, 8 years) 2.476
21. The interest rate implicit in the offer of Rs.20,000 after 10 years in lieu of Rs.5,000 now is:
Rs.5,000 x FVIF (r,10 years) = Rs.20,000
Rs.20,000
FVIF (r,10 years) = = 4.000
Rs.5,000
If the inflation rate is 8% per year, the value of Rs.26,530 10 years from now, in terms of
the current rupees is:
Rs.26,530 x PVIF (8%,10 years)
= Rs.26,530 x 0.463 = Rs.12,283
23. A constant deposit at the beginning of each year represents an annuity due.
PVIFA of an annuity due is equal to : PVIFA of an ordinary annuity x (1 + r)
To provide a sum of Rs.50,000 at the end of 10 years the annual deposit should
be
Rs.50,000
A = FVIFA(12%, 10 years) x (1.12)
Rs.50,000
= = Rs.2544
17.549 x 1.12
5
24. The discounted value of Rs.20,000 receivable at the beginning of each year from 2005 to
2009, evaluated as at the beginning of 2004 (or end of 2003) is:
Rs.20,000 x PVIFA (12%, 5 years)
= Rs.20,000 x 3.605 = Rs.72,100.
If A is the amount deposited at the end of each year from 1995 to 2000 then
A x FVIFA (12%, 6 years) = Rs.51,335
A x 8.115 = Rs.51,335
A = Rs.51,335 / 8.115 = Rs.6326
25. The discounted value of the annuity of Rs.2000 receivable for 30 years, evaluated as at the
end of 9th year is:
Rs.2,000 x PVIFA (10%, 30 years) = Rs.2,000 x 9.427 = Rs.18,854
The present value of Rs.18,854 is:
Rs.18,854 x PVIF (10%, 9 years)
= Rs.18,854 x 0.424
= Rs.7,994
26. 30 per cent of the pension amount is
0.30 x Rs.600 = Rs.180
Assuming that the monthly interest rate corresponding to an annual interest rate of 12% is
1%, the discounted value of an annuity of Rs.180 receivable at the end of each month for 180
months (15 years) is:
Rs.180 x PVIFA (1%, 180)
(1.01)180 - 1
Rs.180 x ---------------- = Rs.14,998
.01 (1.01)180
If Mr. Ramesh borrows Rs.P today on which the monthly interest rate is 1%
P x (1.01)60 = Rs.14,998
P x 1.817 = Rs.14,998
Rs.14,998
P = ------------ = Rs.8254
1.817
6
PVIFA (2%, 24) = 18.914
= 1.53%
28. The discounted value of the debentures to be redeemed between 8 to 10 years evaluated at
the end of the 5th year is:
Rs.10 million x PVIF (8%, 3 years)
+ Rs.10 million x PVIF (8%, 4 years)
+ Rs.10 million x PVIF (8%, 5 years)
If A is the annual deposit to be made in the sinking fund for the years 1 to 5,
then
A x FVIFA (8%, 5 years) = Rs.2.21 million
A x 5.867 = Rs.2.21 million
A = 5.867 = Rs.2.21 million
A = Rs.2.21 million / 5.867 = Rs.0.377 million
29. Let `n’ be the number of years for which a sum of Rs.20,000 can be withdrawn annually.
5.000 – 4.868
n=7+ ----------------- x 1 = 7.3 years
5.335 – 4.868
7
30. Equated annual installment = 500000 / PVIFA(14%,4)
= 500000 / 2.914
= Rs.171,585
31. Define n as the maturity period of the loan. The value of n can be obtained from the
equation.
32. Expected value of iron ore mined during year 1 = Rs.300 million
Expected present value of the iron ore that can be mined over the next 15 years assuming a
price escalation of 6% per annum in the price per tonne of iron
1 – (1 + g)n / (1 + i)n
= Rs.300 million x ------------------------
i-g
8
MINICASE
Solution:
2. How much money should Ramesh save each year for the next 15 years to be able to meet his
investment objective?
This means that his savings in the next 15 years must grow to :
3. How much money would Ramesh need when he reaches the age of 60 to meet his donation
objective?
46
1 2 15
9
15
1.12
1–
1.08
= 400,000
0.08 – 0.12
= Rs.7,254,962
10
Chapter 8
1. 5 11 100
P = ∑ +
t=1 (1.15) (1.15)5
Note that when the discount rate and the coupon rate are the same the value is equal to
par value.
3. The yield to maturity is the value of r that satisfies the following equality.
7 120 1,000
Rs.750 = ∑ + = Rs.100
t 7
t=1 (1+r) (1+r)
Try r = 18%. The right hand side (RHS) of the above equation is:
Rs.120 x PVIFA (18%, 7 years) + Rs.1,000 x PVIF (18%, 7 years)
= Rs.120 x 3.812 + Rs.1,000 x 0.314
= Rs.771.44
Try r = 20%. The right hand side (RHS) of the above equation is:
Rs.120 x PVIFA (20%, 7 years) + Rs.1,000 x PVIF (20%, 7 years)
= Rs.120 x 3.605 + Rs.1,000 x 0.279
= Rs.711.60
11
Thus the value of r at which the RHS becomes equal to Rs.750 lies between 18% and 20%.
Using linear interpolation in this range, we get
771.44 – 750.00
Yield to maturity = 18% + 771.44 – 711.60 x 2%
= 18.7%
4.
10 14 100
80 = ∑ +
t
t=1 (1+r) (1+r)10
82 - 80
Yield to maturity = 18% + ----------- x 2%
82 – 74.9
= 18.56%
5.
12 6 100
P = ∑ +
t
t=1 (1.08) (1.08)12
12
Bond A Bond B
The post-tax YTM, using the approximate YTM formula is calculated below
8.4 + (97-70)/10
Bond A : Post-tax YTM = --------------------
0.6 x 70 + 0.4 x 97
= 13.73%
7 + (96 – 60)/6
Bond B : Post-tax YTM = ----------------------
0.6x 60 + 0.4 x 96
= 17. 47%
7.
14 6 100
P = ∑ +
t=1 (1.08) t (1.08)14
Po = D1 / (r – g) = Do (1 + g) / (r – g)
Since the growth rate of 6% applies to dividends as well as market price, the market
price at the end of the 2nd year will be:
13
9. Po = D1 / (r – g) = Do (1 + g) / (r – g)
= Rs.12.00 (1.10) / (0.15 – 0.10) = Rs.264
10. Po = D1 / (r – g)
12. The market price per share of Commonwealth Corporation will be the sum of three
components:
C = P8 / (1.14)8
Thus,
Po = A + B + C = 5.74 + 4.89 + 13.14
14
= Rs.23.77
13. The intrinsic value of the equity share will be the sum of three components:
A: Present value of the dividend stream for the first 5 years when the
growth rate expected is 15%.
B: Present value of the dividend stream for the next 5 years when the
growth rate is expected to be 10%.
= Rs.10.81
= Rs.97.20
15
Terminal value of the proceeds from the bond = 1709.24
Define r as the yield to maturity. The value of r can be obtained from the equation
15. Intrinsic value of the equity share (using the 2-stage growth model)
(1.18)6
2.36 x 1 - ----------- 2.36 x (1.18)5 x (1.12)
6
(1.16)
= --------------------------------- + -----------------------------------
0.16 – 0.18 (0.16 – 0.12) x (1.16)6
- 0.10801
= 2.36 x ----------- + 62.05
- 0.02
= Rs.74.80
= 60 + 20
= Rs.80
16
Chapter 9
RISK AND RETURN
2 (a) For Rs.1,000, 20 shares of Alpha’s stock can be acquired. The probability distribution of the
return on 20 shares is
Expected return = (1,100 x 0.3) + (1,000 x 0.3) + (1,200 x 0.2) + (1,400 x 0.2)
17
= 330 + 300 + 240 + 280
= Rs.1,150
(b) For Rs.1,000, 20 shares of Beta’s stock can be acquired. The probability distribution of the
return on 20 shares is:
Expected return = (1,500 x 0.3) + (1,300 x 0.3) + (1,000 x 0.2) + (800 x 0.2)
= Rs.1,200
(c ) For Rs.500, 10 shares of Alpha’s stock can be acquired; likewise for Rs.500, 10
shares of Beta’s stock can be acquired. The probability distribution of this option is:
Return (Rs) Probability
(10 x 55) + (10 x 75) = 1,300 0.3
(10 x 50) + (10 x 65) = 1,150 0.3
(10 x 60) + (10 x 50) = 1,100 0.2
(10 x 70) + (10 x 40) = 1,100 0.2
18
Return (Rs) Probability
Expected return = (1,220 x 0.3) + (1,090 x 0.3) + (1,140 x 0.2) + (1,220 x 0.2)
= Rs.1,165
Option `d’ is the most preferred option because it has the highest return to risk ratio.
19
(c ) Return on portfolio consisting of stocks A, B and C in equal
proportions = 1/3(0.0783 ) + 1/3(0.0917) + 1/3 (0.090)
= 0.0867 = 8.67%
4. Define RA and RM as the returns on the equity stock of Auto Electricals Limited a and Market
portfolio respectively. The calculations relevant for calculating the beta of the stock are
shown below:
RA = 15.09 RM = 15.18
∑ (RA – RA)2 = 1116.93 ∑ (RM – RM) 2 = 975.61 ∑ (RA – RA) (RM – RM) = 935.86
∑ (RM – RM) 2
= 935.86 = 0.96
975.61
Alpha = R A – βA R M
20
Equation of the characteristic line is
RA = 0.52 + 0.96 RM
RA = RF + βA (RM – RF)
= 0.10 + 1.5 (0.15 – 0.10)
= 0.175
= Rs.22.74
0.07
i.e.βA = = 1.75
0.04
We are given 0.15 = 0.09 + 1.5 (RM – 0.09) i.e., 1.5 RM = 0.195
or RM = 0.13%
Po = D1 / (r - g)
21
So D1 = Rs.39 and Do = D1 / (1+g) = 3.9 /(1.05) = Rs.3.71
Rx = Rf + βx (RM – Rf)
So Rf = 0.06 or 6%.
Original Revised
Rf 6% 8%
RM – Rf 6% 4%
g 5% 4%
βx 2.0 1.8
3.71 (1.04)
= Rs.34.45
0.152 – 0.04
Chapter 10
OPTIONS AND THEIR VALUATION
22
1. S = 100 u = 1.5 d = 0.8
The values of ∆ (hedge ratio) and B (amount borrowed) can be obtained as follows:
Cu – Cd
∆ =
(u – d) S
45 – 0 45 9
∆ = = = = 0.6429
0.7 x 100 70 14
u.Cd – d.Cu
B =
(u-d) R
-36
= = - 45.92
0.784
C = ∆S+B
= 0.6429 x 100 – 45.92
= Rs.18.37
2. S = 40 u=? d = 0.8
R = 1.10 E = 45 C=8
We will assume that the current market price of the call is equal to the pair value of the call
as per the Binomial model.
23
Cd = Max (32 – 45, 0) = 0
∆ Cu – Cd R
= x
B u Cd – d Cu S
∆ Cu – 0 1.10
= x
B -0.8Cu 40
= (-) 0.034375
∆ = - 0.34375 B (1)
C = ∆S+B
8 = ∆ x 40 + B (2)
8 = (-0.034365 x 40) B + B
8 = -0.375 B
or B = - 21.33
or
u x 40 x 0.7332 – 23.46 = 0
u = 0.8
3. Using the standard notations of the Black-Scholes model we get the following results:
ln (S/E) + rt + σ2 t/2
d1 =
24
σ√t
= 0.7675
d2 = d1 - σ √ t
= 0.7675 – 0.4
= 0.3675
Value of the call as per the Black and Scholes model is Rs.35.33.
4. σ √t = 0.2 x √ 1 = 0.2
Ratio of the stock price to the present value of the exercise price
80
= -------------------------
82 x PVIF (15.03,1)
80
= ----------------------
82 x 0.8693
= 1.122
From table A6 we find the percentage relationship between the value of the call option and
stock price to be 14.1 per cent. Hence the value of the call option is
0.141 x 80 = Rs.11,28.
25
- Stock price ……… (A)
The value of the call option gives an exercise price of Rs.85 can be obtained as follows:
σ √t = 0.2 √ 1 = 0.2
Ratio of the stock price to the present value of the exercise price
80
= ---------------------
85 x PVIF (15.03,1)
= 80 / 73.89 = 1.083
From Table A.6, we find the percentage relationship between the value of the call option and
the stock price to be 11.9%
Plugging in this value and the other relevant values in (A), we get
= Rs.3.41
ln (1.2) + 0.19
=
0.4243
= 0.8775 = 0.88
26
= 0.4532 = 0.45
B0 = V0 – S0
= 60000 – 1816
= 4184
Chapter 11
TECHNIQUES OF CAPITAL BUDGETING
27
----------- ---------- ----------
(1.14)3 (1.14)4 (1.14)5
= - 44837
= - 1,000,000
+ 100,000
(1.12)
+ 200,000
(1.12) (1.13)
+ 300,000
+ 600,000
+ 300,000
2. Investment A
28
PVIFA (15,10) = 5.019
PVIFA (16,10) = 4.883
d) BCR = PVB / I
= 194,661 / 300,000 = 0.65
Investment C
a) Payback period lies between 2 years and 3 years. Linear interpolation in this
range provides an approximate payback period of 2.88 years.
29
- 210,000
= 111,371
c) IRR (r) is obtained by solving the equation
80,000 x PVIF (r,1) + 60,000 x PVIF (r,2) + 80,000 x PVIF (r,3)
+ 60,000 x PVIF (r,4) + 80,000 x PVIF (r,5) + 60,000 x PVIF (r,6)
+ 40000 x PVIFA (r,4) x PVIF (r,6) = 210000
Investment D
a) Payback period lies between 8 years and 9 years. A linear interpolation in this
range provides an approximate payback period of 8.5 years.
8 + (1 x 100,000 / 200,000)
Comparative Table
Investment A B C D
a) Payback period
(in years) 5 9 2.88 8.5
30
d) BCR 1.13 0.65 1.53 0.88
Through a process of trial and error it can be verified that r = 9.20% pa.
4. The IRR (r) for the given cashflow stream can be obtained by solving the following equation
for the value of r.
NOTE: Given two changes in the signs of cashflow, we get two values for the
IRR of the cashflow stream. In such cases, the IRR rule breaks down.
5. Define NCF as the minimum constant annual net cashflow that justifies the purchase of the
given equipment. The value of NCF can be obtained from the equation
6. Define I as the initial investment that is justified in relation to a net annual cash
inflow of 25000 for 10 years at a discount rate of 12% per annum. The value
of I can be obtained from the following equation
31
+ 40000 x PVIF (15,4)
+ 30000 x PVIF (15,5)
= 122646 (A)
Project
P Q R
Discount rate
10% 69 40 70
15% - 66 - 142 - 135
9. NPV profiles for Projects P and Q for selected discount rates are as follows:
(a)
Project
P Q
Discount rate (%)
0 2950 500
5 1876 208
10 1075 - 28
15 471 - 222
20 11 - 382
b) (i) The IRR (r ) of project P can be obtained by solving the following
equation for `r’.
-1000 -1200 x PVIF (r,1) – 600 x PVIF (r,2) – 250 x PVIF (r,3)
+ 2000 x PVIF (r,4) + 4000 x PVIF (r,5) = 0
(ii) The IRR (r') of project Q can be obtained by solving the following equation for r'
32
-1600 + 200 x PVIF (r',1) + 400 x PVIF (r',2) + 600 x PVIF (r',3)
+ 800 x PVIF (r',4) + 100 x PVIF (r',5) = 0
Given that NPV (P) . NPV (Q); and NPV (P) > 0, I would choose project P.
NPV (P) = 11
Again NPV (P) > NPV (Q); and NPV (P) > 0. I would choose project P.
d) Project P
PV of investment-related costs
(c) Project Q
33
MIRR = 11.62%
10
(a) Project A
Project B
IRR (r'') of the differential project can be obtained from the equation
12 x PVIFA (r'', 6) = 50
i.e., r'' = 11.53%
11
(a) Project M
The pay back period of the project lies between 2 and 3 years. Interpolating in
this range we get an approximate pay back period of 2.63 years/
Project N
The pay back period lies between 1 and 2 years. Interpolating in this range we
get an approximate pay back period of 1.55 years.
34
(b) Project M
Cost of capital = 12% p.a
PV of cash flows up to the end of year 2 = 24.97
PV of cash flows up to the end of year 3 = 47.75
PV of cash flows up to the end of year 4 = 71.26
Discounted pay back period (DPB) lies between 3 and 4 years. Interpolating in this range we
get an approximate DPB of 3.1 years.
Project N
Cost of capital = 12% per annum
PV of cash flows up to the end of year 1 = 33.93
PV of cash flows up to the end of year 2 = 51.47
DPB lies between 1 and 2 years. Interpolating in this range we get an approximate
DPB of 1.92 years.
(c ) Project M
Cost of capital = 12% per annum
NPV = - 50 + 11 x PVIFA (12,1)
+ 19 x PVIF (12,2) + 32 x PVIF (12,3)
+ 37 x PVIF (12,4)
= Rs.21.26 million
Project N
Cost of capital = 12% per annum
NPV = Rs.20.63 million
Since the two projects are independent and the NPV of each project is (+) ve,
both the projects can be accepted. This assumes that there is no capital constraint.
(d) Project M
Cost of capital = 10% per annum
NPV = Rs.25.02 million
Project N
Cost of capital = 10% per annum
NPV = Rs.23.08 million
Since the two projects are mutually exclusive, we need to choose the project with the higher
NPV i.e., choose project M.
NOTE: The MIRR can also be used as a criterion of merit for choosing between the two
projects because their initial outlays are equal.
(e) Project M
Cost of capital = 15% per annum
35
NPV = 16.13 million
Project N
Cost of capital: 15% per annum
NPV = Rs.17.23 million
Again the two projects are mutually exclusive. So we choose the project with the
higher NPV, i.e., choose project N.
(f) Project M
Terminal value of the cash inflows: 114.47
MIRR of the project is given by the equation
50 (1 + MIRR)4 = 114.47
i.e., MIRR = 23.01%
Project N
Terminal value of the cash inflows: 115.41
MIRR of the project is given by the equation
50 ( 1+ MIRR)4 = 115.41
i.e., MIRR = 23.26%
36
Chapter 12
ESTIMATION OF PROJECT CASH FLOWS
1.
(a) Project Cash Flows (Rs. in million)
Year 0 1 2 3 4 5 6 7
14. NCF (200) 116.25 113.44 111.33 109.75 108.56 107.67 205
(c) IRR (r) of the project can be obtained by solving the following equation for r
-200 + 116.25 x PVIF (r,1) + 113.44 x PVIF (r,2)
37
+107.67 x PVIF (r,6) + 205 x PVIF (r,7) = 0
Through a process of trial and error, we get r = 55.17%. The IRR of the project is 55.17%.
Year 0 1 2 3 4 5 6 7
21. Net cash flow (140) 10.20 20.55 31.46 62.80 49.25 35.94 55.00
(17+18-19+20)
(b) NPV of the net cash flow stream @ 15% per discount rate
38
3.
(a) A. Initial outlay (Time 0)
Year 1 2 3 4 5
i. Post-tax savings in
manufacturing costs 455,000 455,000 455,000 455,000 455,000
ii. Incremental
depreciation 550,000 412,500 309,375 232,031 174,023
D. Net cash flows associated with the replacement project (in Rs)
Year 0 1 2 3 4 5
NCF (2,600,000) 620000 578750 547813 524609 2307207
39
4. Tax shield (savings) on depreciation (in Rs)
Depreciation Tax shield PV of tax shield
Year charge (DC) =0.4 x DC @ 15% p.a.
Year 1 2 3 4 5
i. Depreciation
of old machine 18000 14400 11520 9216 7373
ii. Depreciation
of new machine 100000 75000 56250 42188 31641
iii. Incremental
depreciation
( ii – i) 82000 60600 44730 32972 24268
v. Operating cash
40
flow 28700 21210 15656 11540 8494
C. Terminal cash flow (year 5)
Year 0 1 2 3 4 5
MINICASE
Solution:
a. Cash flows from the point of all investors (which is also called the explicit cost funds point of
view)
Rs.in million
Item 0 1 2 3 4 5
41
inflow 7.425 7.144 6.933 6.775 6.656
14. Terminal cash
flow 13.000
15. Net cash flow (23) 7.425 7.144 6.933 6.775 19.656
Rs.in million
Item 0 1 2 3 4 5
42
Chapter 13
RISK ANALYSIS IN CAPITAL BUDGETING
1.
(a) NPV of the project = -250 + 50 x PVIFA (13,10)
= Rs.21.31 million
Assumptions: (1) The useful life is assumed to be 10 years under all three
scenarios. It is also assumed that the salvage value of the
investment after ten years is zero.
(3) The tax rate has been calculated from the given table i.e. 10 / 35 x 100
= 28.57%.
(4) It is assumed that only loss on this project can be offset against the
taxable profit on other projects of the company; and thus the company
can claim a tax shield on the loss in the same year.
43
(c) Accounting break even point (under ‘expected’ scenario)
Fixed costs + depreciation = Rs. 45 million
Contribution margin ratio = 60 / 200 = 0.3
Break even level of sales = 45 / 0.3 = Rs.150 million
2.
(a) Sensitivity of NPV with respect to quantity manufactured and sold:
(in Rs)
Pessimistic Expected Optimistic
44
Variable costs 28000 28000 28000
Fixed costs 3000 3000 3000
Depreciation 2000 2000 2000
Profit before tax -5000 9000 37000
Tax -2500 4500 18500
Profit after tax -2500 4500 18500
Net cash flow - 500 6500 20500
NPV - 31895 (-) 5360 47711
45
= 5.8
σ12 = 0.41
σ22 = 0.56
σ32 = 0.49
4. Expected NPV
4 At
= ∑ - 25,000
t
t=1 (1.08)
5. Expected NPV
46
4 At
= ∑ - 10,000 …. (1)
t
t=1 (1.06)
A1 = 2,000 x 0.2 + 3,000 x 0.5 + 4,000 x 0.3
= 3,100
4 σ2t
σ2 (NPV) = ∑ …….. (2)
t=1 (1.06)2t
47
Substituting these values in (2) we get
490,000 / (1.06)2 + 690,000 / (1.06)4
+ 490,000 / (1.06)6 + 560,000 / (1.08)8
[ 490,000 x 0.890 + 690,000 x 0.792
+ 490,000 x 0.705 + 560,000 x 0.627 ]
= 1,679,150
σ NPV = 1,679,150 = Rs.1,296
The required probability is given by the shaded area in the following normal curve.
The required probability is given by the shaded area of the following normal
curve:
P(Z > - 0.81) = 0.5 + P(-0.81 < Z < 0)
= 0.5 + P(0 < Z < 0.81)
= 0.5 + 0.2910
= 0.7910
48
6. Given values of variables other than Q, P and V, the net present value model of Bidhan
Corporation can be expressed as:
0.5 Q (P – V) – 500
5
∑ = ------------------------------------ - 30,000
t=1 (1.1)t
Exhibit 1 presents the correspondence between the values of exogenous variables and the two
digit random number. Exhibit 2 shows the results of the simulation.
Exhibit 1
Correspondence between values of exogenous variables and
two digit random numbers
49
Exhibit 2
Simulation Results
50
31 52 1,400 61 30 58 20 -5,359
32 76 1,600 18 20 41 20 -31,896
33 43 1,400 04 20 49 20 -31,896
34 70 1,600 11 20 59 20 -31,896
35 67 1,400 35 20 26 15 -18,627
36 26 1,200 63 30 22 15 2,224
50
Variance of NPV = 1/50 ∑ (NPVi – NPV)2
i=1
51
Standard deviation of NPV = 549.481 x 106
= 23,441
7. To carry out a sensitivity analysis, we have to define the range and the most likely values of
the variables in the NPV Model. These values are defined below
** In the case of price, 20 and 30 have the same probability of occurrence viz 0.4. We
have chosen 30 as the most likely value because the expected value of the
distribution is closer to 30
The relationship between Q and NPV given the most likely values of other
variables is given by
5 5Q - 500
= ∑ - 30,000
t
t=1 (1.1)
The net present values for various values of Q are given in the following table:
52
Q 800 1,000 1,200 1,400 1,600 1,800
NPV -16,732 -12,941 -9,150 -5,359 -1,568 2,224
The relationship between P and NPV, given the most likely values of other variables is defined as
follows:
5 700 P – 14,500
= ∑ - 30,000
t=1 (1.1)t
The net present values for various values of P are given below :
P (Rs) 20 30 - 40 50
NPV(Rs) -31,896 -5,359 21,179 47,716
8. NPV -5 0 5 10 15 20
(Rs.in lakhs)
PI 0.9 1.00 1.10 1.20 1.30 1.40
6
Expected PI = PI = ∑ (PI)j P j
j=1
= 1.24
6
Standard deviation of P1 = ∑ (PIj - PI) 2 P j
j=1
= √ .01156
= .1075
The standard deviation of P1 is .1075 for the given investment with an expected PI of 1.24.
The maximum standard deviation of PI acceptable to the company for an investment with an
expected PI of 1.25 is 0.30.
53
Since the risk associated with the investment is much less than the maximum risk acceptable
to the company for the given level of expected PI, the company must should accept the
investment.
9. The NPVs of the two projects calculated at their risk adjusted discount rates are as follows:
6 3,000
Project A: NPV = ∑ - 10,000 = Rs.2,333
t
t=1 (1.12)
5 11,000
Project B: NPV = ∑ - 30,000 = Rs.7,763
t=1 (1.14)t
Project A B
PI 1.23 1.26
IRR 20% 24.3%
B is superior to A in terms of NPV, PI, and IRR. Hence the company must choose B.
10. The certainty equivalent co-efficients for the five years are as follows
αt = 1 – 0.06 t
1 α1 = 0.94
2 α2 = 0.88
3 α3 = 0.82
4 α4 = 0.76
5 α5 = 0.70
The present value of the project calculated at the risk-free rate of return is :
5 (1 – 0.06 t) At
∑
t=1 (1.08)t
7,000 x 0.94 8,000 x 0.88 9,000 x 0.82 10,000 x 0.76 8,000 x 0.70
+ + + +
2 3 4
(1.08) (1.08) (1.08) (1.08) (1.08)5
54
6,580 7,040 7,380 7,600 5,600
+ + + +
(1.08) (1.08)2 (1.08)3 (1.08)4 (1.08)5
= 27,386
MINICASE
Solution:
1. The expected NPV of the turboprop aircraft
0.65 [0.8 (17500) + 0.2 (3000)] + 0.35 [0.4 (17500) + 0.6 (3000)]
+
(1.12)2
= 2369
2. If Southern Airways buys the piston engine aircraft and the demand in year 1 turns out to be
high, a further decision has to be made with respect to capacity expansion. To evaluate the
piston engine aircraft, proceed as follows:
First, calculate the NPV of the two options viz., ‘expand’ and ‘do not expand’ at decision
point D2:
= 6600
55
Second, truncate the ‘do not expand’ option as it is inferior to the ‘expand’ option. This
means that the NPV at decision point D2 will be 6600
3. The value of the option to expand in the case of piston engine aircraft
If Southern Airways does not have the option of expanding capacity at the end of year 1, the
NPV of the piston engine aircraft would be:
0.65 [0.8 (6500) + 0.2 (2400)] + 0.35 [0.2 (6500) + 0.8 (2400)]
+
(1.12)2
4. Value of the option to abandon if the turboprop aircraft can be sold for 8000 at the end of year
1
If the demand in year 1 turns out to be low, the payoffs for the ‘continuation’ and
‘abandonment’ options as of year 1 are as follows.
56
Abandonment : 8000
Thus it makes sense to sell off the aircraft after year 1, if the demand in year 1 turns out to be
low.
0.65 [5500 +{0.8 (17500) + 0.2 (3000)}/ (1.12)] + 0.35 (500 +8000)
NPV = - 11,000 +
(1.12)
12048 + 2975
= - 11,000 + = 2413
1.12
Since the turboprop aircraft without the abandonment option has a value of 2369, the
value of the abandonment option is : 2413 – 2369 = 44
5. The value of the option to abandon if the piston engine aircraft can be sold for 4400 at the
end of year 1:
If the demand in year 1 turns out to be low, the payoffs for the ‘continuation’ and
‘abandonment’ options as of year 1 are as follows:
Abandonment : 4400
Thus, it makes sense to sell off the aircraft after year 1, if the demand in year 1 turns out to
be low.
The NPV of the piston engine aircraft with abandonment possibility is:
5915 + 1820
= - 5500 + = 1406
1.12
For the piston engine aircraft the possibility of abandonment increases the NPV
57
from 929 to 1406. Hence the value of the abandonment option is 477.
58
Chapter 14
THE COST OF CAPITAL
1(a) Define rD as the pre-tax cost of debt. Using the approximate yield formula, rD can be
calculated as follows:
14 + (100 – 108)/10
rD = ------------------------ x 100 = 12.60%
0.4 x 100 + 0.6x108
2. Define rp as the cost of preference capital. Using the approximate yield formula rp can be
calculated as follows:
9 + (100 – 92)/6
rp = --------------------
0.4 x100 + 0.6x92
= 14.68%
5. Given
0.5 x 14% x (1 – 0.35) + 0.5 x rE = 12%
Therefore rE – 14.9%
59
Using the SML equation we get
11% + 8% x β = 14.9%
6(a) The cost of debt of 12% represents the historical interest rate at the time the debt was
originally issued. But we need to calculate the marginal cost of debt (cost of raising new
debt); and for this purpose we need to calculate the yield to maturity of the debt as on the
balance sheet date. The yield to maturity will not be equal to12% unless the book value of
debt is equal to the market value of debt on the balance sheet date.
(b) The cost of equity has been taken as D1/P0 ( = 6/100) whereas the cost of equity is (D1/P0)
+ g where g represents the expected constant growth rate in dividend per share.
7. The book value and market values of the different sources of finance are
provided in the following table. The book value weights and the market value
weights are provided within parenthesis in the table.
(Rs. in million)
Source Book value Market value
Equity 800 (0.54) 2400 (0.78)
Debentures – first series 300 (0.20) 270 (0.09)
Debentures – second series 200 (0.13) 204 (0.06)
Bank loan 200 (0.13) 200 (0.07)
Total 1500 (1.00) 3074 (1.00)
8. Required return
based on SML Expected
Project Beta equation (%) return (%)
P 0.6 14.8 13
Q 0.9 17.2 14
R 1.5 22.0 16
S 1.5 22.0 20
Given a hurdle rate of 18% (the firm’s cost of capital), projects P, Q and R would have been
rejected because the expected returns on these projects are below 18%. Project S would be
accepted because the expected return on this project exceeds 18%.An appropriate basis for
60
accepting or rejecting the projects would be to compare the expected rate of return and the
required rate of return for each project. Based on this comparison, we find that all the four
projects need to be rejected.
9.
(a) Given
rD x (1 – 0.3) x 4/9 + 20% x 5/9 = 15%
rD = 12.5%,where rD represents the pre-tax cost of debt.
(b) Given
13% x (1 – 0.3) x 4/9 + rE x 5/9 = 15%
rE = 19.72%, where rE represents the cost of equity.
11 + (100-75)/10
rE = = 15.9%
0.6 x 75 + 0.4 x 100
61
The pre-tax cost of debentures, using the approximate formula, is :
13.5 + (100-80)/6
rD = = 19.1%
0.6x80 + 0.4x100
The average cost of capital using book value proportions is calculated below :
The average cost of capital using market value proportions is calculated below :
Equity capital
and retained earnings 14.5% 200 0.62 8.99
Preference capital 15.9% 7.5 0.02 0.32
Debentures 9.6% 40 0.12 1.15
Term loans 6.0% 80 0.24 1.44
12
62
(a) WACC = 1/3 x 13% x (1 – 0.3)
+ 2/3 x 20%
= 16.37%
(c) NPV of the proposal after taking into account the floatation costs
= 130 x PVIFA (16.37, 8) – 500 / (1 - 0.09)
= Rs.8.51 million
MINICASE
Solution:
rd (1 – 0.3) = 5.55
2.80 (1.10)
+ 0.10 = 0.385 + 0.10
80
= 0.1385 = 13.85%
7 + 1.1(7) = 14.70%
f. WACC
0.50 x 14.70 + 0.10 x 7.53 + 0.40 x 5.55
63
= 7.35 + 0.75 + 2.22
= 10.32%
64
Chapter 15
CAPITAL BUDGETING : EXTENSIONS
1. EAC
(Plastic Emulsion) = 300000 / PVIFA (12,7)
= 300000 / 4.564
= Rs.65732
EAC
(Distemper Painting) = 180000 / PVIFA (12,3)
= 180000 / 2.402
= Rs.74938
Since EAC of plastic emulsion is less than that of distemper painting, it is the preferred
alternative.
= 1 500 000 + 300 000 x PVIF (13,1) + 360 000 x PVIF (13,2)
+ 400 000 x PVIF (13,3) + 450 000 x PVIF (13,4)
+ 500 000 x PVIF (13,5) - 300 000 x PVIF (13,5)
= 2709185
Since (B) < (A), the less costly overhaul is preferred alternative.
65
4.
(a) Base case NPV
= Rs.818 182
= - 2,022,000 – 818,182
= - Rs.2,840,182
5.
(a) Base case BPV
(b) Adjusted NPV after adjustment for issue cost of external equity
66
(c) The present value of interest tax shield is calculated below :
67
Chapter 18
RAISING LONG TERM FINANCE
2.
Underwriting Shares Excess/ Credit Net
commitment procured Shortfall shortfall
68
NPo+S 4 x 220 +150
= = Rs.206
N+1 4+1
4. Po = Rs.180 N=5
a. The theoretical value of a right if the subscription price is Rs.150
Po – S 180 – 150
= = Rs.5
N+1 5+1
5 x 180 + 100
= Rs.166.7
5+1
69
Chapter 19
CAPITAL STRUCTURE AND FIRM VALUE
2. Box Cox
(b) If Box Corporation employs Rs.30 million of debt to finance a project that yields
Rs.4 million net operating income, its financials will be as follows.
70
Cost of debt 10%
Market value of equity Rs.20 million
Market value of debt Rs.30 million
Market value of the firm Rs.50 million
3. rE = rA + (rA-rD)D/E
20 = 12 + (12-8) D/E
So D/E = 2
4. E D E D
rE rD rA = rE + rD
D+E D+E (%) (%) D+E D+E
5. (a) If you own Rs.10,000 worth of Bharat Company, the levered company
which is valued more, you would sell shares of Bharat Company, resort
to personal leverage, and buy the shares of Charat Company.
(b) The arbitrage will cease when Charat Company and Bharat Company
are valued alike
71
6. The value of Ashwini Limited according to Modigliani and Miller
hypothesis is
Expected operating income 15
= = Rs.125 million
Discount rate applicable to the 0.12
risk class to which Aswini belongs
7. The average cost of capital(without considering agency and bankruptcy cost)
at various leverage ratios is given below.
D E E D
rD rE rA = rE + rD
D+E D+ E % % D+E D+E
(%)
72
1-(1-tc) (1-tpe) (1-0.55) (1-0.05)
= 1 -
(1-tpd) (1-0.25)
= 0.43 rupee
Chapter 20
CAPITAL STRUCTURE DECISION
1.(a) Currently
No. of shares = 1,500,000
EBIT = Rs 7.2 million
Interest = 0
Preference dividend = Rs.12 x 50,000 = Rs.0.6 million
EPS = Rs.2
The EPS – EBIT indifference point can be obtained by equating EPSA and EPSB
73
=
2,500,000 1,500,000
Solving the above we get EBIT = Rs.4,950,000 and at that EBIT, EPS is Rs.0.75
under both the plans
(b) As long as EBIT is less than Rs.4,950,000 equity financing maximixes EPS.
When EBIT exceeds Rs.4,950,000 debt financing maximises EPS.
2.
(a) EPS – EBIT equation for alternative A
EBIT ( 1 – 0.5)
EPSA =
2,000,000
(b) EPS – EBIT equation for alternative B
EBIT ( 1 – 0.5 ) – 440,000
EPSB =
1,600,000
(d) The three alternative plans of financing ranked in terms of EPS over varying
Levels of EBIT are given the following table
Ranking of Alternatives
3. Plan A : Issue 0.8 million equity shares at Rs. 12.5 per share.
Plan B : Issue Rs.10 million of debt carrying interest rate of 15 per cent.
(EBIT – 0 ) (1 – 0.6)
EPSA =
74
1,800,000
(EBIT – 1,500,000) (1 – 0.6)
EPSB =
1,000,000
Thus the debt alternative is better than the equity alternative when
EBIT > 3.375 million
150
=
40
= 3.75
EBIT + Depreciation
b. Cash flow coverage ratio =
Loan repayment instalment
75
Int.on debt +
(1 – Tax rate)
= 150 + 30
40 + 50
= 2
8. The debt service coverage ratio for Pioneer Automobiles Limited is given by :
5
∑ ( PAT i + Depi + Inti)
i=1
DSCR = 5
∑ (Inti + LRIi)
i=1
95.80 + 72.00
= 277.94
167.80
= 1.66
9. (a) If the entire outlay of Rs. 300 million is raised by way of debt carrying 15 per cent
interest, the interest burden will be Rs. 45 million.
Considering the interest burden the net cash flows of the firm during
a recessionary year will have an expected value of Rs. 35 million (Rs.80 million - Rs. 45
million ) and a standard deviation of Rs. 40 million .
Since the net cash flow (X) is distributed normally
X – 35
40
has a standard normal deviation
Cash flow inadequacy means that X is less than 0.
0.35
Prob(X<0) = Prob (z< ) = Prob (z<- 0.875)
40
= 0.1909
(b) Since µ = Rs.80 million, σ= Rs.40 million , and the Z value corresponding to the risk
tolerance limit of 5 per cent is – 1.645, the cash available from the operations to service the
debt is equal to X which is defined as :
X – 80
76
= - 1.645
40
X = Rs.14.2 million
Given 15 per cent interest rate, the debt than be serviced is
14.2
= Rs. 94.67 million
0.15
Chapter 21
DIVIDEND POLICY AND FIRM VALUE
3(0.5)+3(0.5) 0.15
0.5
0.12
= Rs. 28.13
0.12
3(1.00)
1.00 = Rs. 25.00
0.12
8(0.25)
0.25 = undefined
0.12 – 0.16(0.75)
8(0.50)
0.50 = Rs.100
0.12 – 0.16(0.50)
8(1.00)
1.0 =Rs.66.7
0.12 – 0.16 (0)
77
3.
P Q
• Next year’s price 80 74
• Dividend 0 6
• Current price P Q
• Capital appreciation (80-P) (74-Q)
• Post-tax capital appreciation 0.9(80-P) 0.9 (74-Q)
• Post-tax dividend income 0 0.8 x 6
• Total return 0.9 (80-P) 0.9 (74-Q) + 4.8
P Q
= 14% =14%
• Current price (obtained by solving P = Rs.69.23 Q = Rs.68.65
the preceding equation)
78
Chapter 22
DIVIDEND DECISION
1. a. Under a pure residual dividend policy, the dividend per share over the 4 year
period will be as follows:
Year 1 2 3 4
b. The external financing required over the 4 year period (under the assumption that the
company plans to raise dividends by 10 percents every two years) is given below :
Required Level of External Financing
(in Rs.)
Year 1 2 3 4
79
F. External financing
requirement 3,000 500 6,500 Nil
(E-D)if E > D or 0 otherwise
c. Given that the company follows a constant 60 per cent payout ratio, the dividend per share
and external financing requirement over the 4 year period are given below
Year 1 2 3 4
E. External financing
(D-C)if D>C, or 0 4,000 2,200 6,400 2,000
otherwise
2. Given the constraints imposed by the management, the dividend per share has to
be between Rs.1.00 (the dividend for the previous year) and Rs.1.60 (80 per
cent of earnings per share)
Since share holders have a preference for dividend, the dividend should be
raised over the previous dividend of Rs.1.00 . However, the firm has substantial
investment requirements and it would be reluctant to issue additional equity
because of high issue costs ( in the form of underpricing and floatation costs)
Considering the conflicting requirements, it seems to make sense to pay
Rs.1.20 per share by way of dividend. Put differently the pay out ratio may be
set at 60 per cent.
80
Hence
Dt = 0.7 x 0.6 x 3.00 + (1-0.7)1.20
= Rs.1.62
These simplify to
b ≥ 76/84
b ≥ 2
81
Chapter 23
Debt Analysis and Management
240,000,000
(c) Tax savings on tax-deductible expenses
Tax rate[Call premium+Unamortised issue cost on
the old bonds] 9,200,000
0.4 [ 15,000,000 + 8,000,000]
Initial outlay i(a) – i(b) – i(c) 15,800,000
82
(iii) Present Value of the Annual Cash Savings
Present value of an 8-year annuity of 3,100,000 at a
discount rate of 9 per cent which is the post –tax cost
of new bonds 3,100,000 x 5.535 17,158,500
124,800,000
(b) Net proceeds of the new issue
Gross proceeds 120,000,000
Issue costs 2,400,000
117,600,000
(c) Tax savings on tax-deductible expenses 3,120,000
Tax rate[Call premium+Unamortised issue costs on
the old bond issue]
0.4 [ 4,800,000 + 3,000,000]
Initial outlay i(a) – i(b) – i(c) 4,080,000
83
Present value of a 5 year annuity of 672,000 at
as discount rate of 9 per cent, which is the post-tax 2,614,080 cost of
new bonds
4.913
84
1 120 100.0 0.131 0.131
2 120 83.2 0.109 0.218
3 120 69.5 0.091 0.273
4 120 57.8 0.076 0.304
5 1120 450.2 0.592 2.960
3.886
Maturity YTM(%)
1 12.36
2 13.10
3 13.21
4 13.48
5 13.72
Graphing these YTMs against the maturities will give the yield curve
1,00,000
- 1 = 12.36 %
89,000
To get the forward rate for year 2, r2, the following equation may be set up :
12500 112500
99000 = +
(1.1236) (1.1236)(1+r2)
85
Solving this for r2 we get r2 = 13.94%
To get the forward rate for year 3, r3, the following equation may be set up :
To get the forward rate for year 4, r4 , the following equation may be set up :
113,500
+
(1.1236)(1.1394)(1.1349)(1+r4)
To get the forward rate for year 5, r5 , the following equation may be set up :
13,750
+
(1.1236)(1.1394)(1.1349)(1.1454)
113,750
+
(1.1236)(1.1394)(1.1349)(1.1454)(1+r5)
86
Chapter 25
HYBRID FINANCING
Stock price 40
= = 1.856
PV (Exercise price) 25/(1.16)
The ratio of the value of call option to stock price corresponding to numbers
0.495 and 1.856 can be found out from Table A.6 by interpolation. Note the
table gives values for the following combinations
1.75 2.00
Since we are interested in the combination 0.495 and 1.856 we first interpolate
between 0.450 and 0.500 and then interpolate between 1.75 and 2.00
1.75 2.00
87
Then, interpolation between 1.75 and 2.00 gives
Chapter 24
LEASING, HIRE PURCHASE, AND PROJECT FINANCE
88
also reflects the net
cash flow)(1-t) -294 266 266 266 266 560
6.Discount factor at
13 per cent 1.000 0.885 0.783 0.693 0.613 0.543
7.Present value(5x6) -294 -235.4 208.3 184.3 163.1 304.1
The interest payment of Rs. 720,000 is allocated over the 3 years period using
the sum of the years digits method as follows:
Year Interest allocation
366
1 x Rs.720,000 = Rs.395,676
666
222
2 x Rs.720,000 = Rs.240,000
666
78
3 x Rs.720,000 = Rs.84,324
666
Rs.2,000,000 + Rs.720,000
= Rs.906,667
3
89
The lease rental will be as follows :
Rs. 560,000 per year for the first 5 years
Rs. 20,000 per year for the next 5 years
The cash flows of the leasing and hire purchse options are shown below
5 336,000 10 12,000
= -∑ − ∑ = - 1,302,207
t=1 (1.10)t t=6 (1.10)t
90
20,023 215,017
+
(1.10.9 (1.10)10
= - 1,369,383
Since the leasing option costs less than the hire purchase option , Apex should choose the
leasing option.
Chapter 26
WORKING CAPITAL POLICY
Average inventory
1 Inventory period =
Annual cost of goods sold/365
(60+64)/2
= = 62.9 days
360/365
(80+88)/2
= = 61.3 days
500/365
(40+46)/2
= = 43.43 days
360/365
(110+120)/2
2. Inventory period = = 56.0 days
750/365
91
(140+150)/2
Accounts receivable = = 52.9 days
period 1000/365
(60+66)/2
Accounts payable = = 30.7 days
period 750/365
2,940,000
92
Cash balance A predetermined amount = 100,000
93
Chapter 27
CASH AND LIQUIDITY MANAGEMENT
1. The forecast of cash receipts, cash payments, and cash position is prepared in the
statements given below
1. Purchases 60 60 60 60 80 80 80
2. Payment of accounts 60 60 60 60 80 80
payable
3. Cash purchases 3 3 3 3 3 3
4. Wage payments 25 25 25 25 25 25
5. Manufacturing
expenses 32 32 32 32 32 32
6. General, administrative
94
& selling expenses 15 15 15 15 15 15
7. Dividends 30
8. Taxes 35
9. Acquisition of
machinery 80
1. Opening balance 28
2. Receipts 129.0 137.4 150.0 235.0 179.0 203.0
3. Payments 135.0 135.0 215.0 135.0 155.0 220.0
4. Net cash flow(2-3) (6.0) 2.4 (65.0) 100.0 24.0 (17.0)
5. Cumulative net cash flow (6.0) (3.6) (68.6) 31.4 55.4 (38.4)
6. Opening balance +
Cumulative net cash flow 22.0 24.4 (40.6) 59.4 83.4 66.4
7. Minimum cash balance
required 30.0 30.0 30.0 30.0 30.0 30.0
8. Surplus/(Deficit) (8.0) (5.6) (70.6) 29.4 53.0 36.4
2. The projected cash inflows and outflows for the quarter, January through March, is shown below
.
Inflows :
Sales collection 50,000 55,000 60,000
Outflows :
Purchases 22,000 20,000 22,000 25,000
Payment to sundry creditors 22,000 20,000 22,000
Rent 5,000 5,000 5,000
Drawings 5,000 5,000 5,000
Salaries & other expenses 15,000 18,000 20,000
Purchase of furniture - 25,000 -
95
Total outflows(2to6) 47,000 73,000 52,000
Given an opening cash balance of Rs.5000 and a target cash balance of Rs.8000, the
surplus/deficit in relation to the target cash balance is worked out below :
3. The balances in the books of Datta co and the books of the bank are shown below:
(Rs.)
1 2 3 4 5 6 7 8 9 10
Books of Datta
Co:
Opening 30,00 46,00 62,00 78,000 1,10,00 1,26,0 1,42,0 1,58,0 1,74,0
Balance 0 0 0 94,000 0 00 00 00 00
Add: Cheque 20,00 20,00 20,00 20,000
received 0 0 0 20,000 20,000 20,000 20,000 20,000 20,000
Less: Cheque 4,000
issued 4,000 4,000 4,000 4,000 4,000 4,000 4,000 4,000 4,000
Closing 46,00 62,00 78,00 94,000 1,10,0 1,26,00 1,42,0 1,58,0 1,74,0 1,90,0
Balance 0 0 0 00 0 00 00 00 00
Books of the
Bank:
96
Opening 30,00 30,00 30,00 30,000 30,000 30,000 50,000 70,000 1,06,0
Balance 0 0 0 90,000 00
Add: Cheques - - - - - 20,000 20,000 20,000
realised 20,000 20,000
Less: Cheques - - - - - - - -
debited 4,000 4,000
Closing 30,00 30,00 30,00 30,000 30,000 50,000 70,000 90,000 1,06,0 1,22,0
Balance 0 0 0 00 00
From day 9 we find that the balance as per the bank’s books is less than the balance as per Datta
Company’s books by a constant sum of Rs.68,000. Hence in the steady situation Datta Company has
a negative net float of Rs.68,000.
So,
2 x 1200 x 2,500,000
C = = Rs.346,410
0.05
5.
3 3 bσ2
RP = + LL
4I
UL = 3 RP – 2 LL
97
UL = 3RP – 2LL = 3 x 149,695 – 2 x 100,000
= Rs.249,085
Chapter 28
CREDIT MANAGEMENT
1. Δ RI = [ΔS(1-V)- ΔSbn](1-t)- k ΔI
ΔS
ΔI = x ACP x V
360
Δ S = Rs.10 million, V=0.85, bn =0.08, ACP= 60 days, k=0.15, t = 0.40
360
= Rs. 207,500
So ΔS
Δ I = (ACPN – ACPo) +V(ACPN)
360 360
98
ΔS=Rs.1.5 million, V=0.80, bn=0.05, t=0.45, k=0.15, ACPN=60, ACPo=45, So=Rs.15 million
Hence ΔRI = [1,500,000(1-0.8) – 1,500,000 x 0.05] (1-.45)
360 360
= 123750 – 123750 = Rs. 0
So ΔS
ΔI = (ACPo-ACPN) - x ACPN x V
360 360
12,000,000 1,200,000
+ 0.15 (24-16) - x 16 x 0.80
360 360
= Rs.79,200
So ΔS
ΔI = (ACPN –ACPo) + x ACPN x V
360 360
99
Rs.50,000,000 Rs.6,000,000
- 0.15 (40-25) + x 40 x 0.75
360 360
= - Rs.289.495
Rs.40,000,000
Value of receivables = x 38
360
= Rs.4,222,222
Assuming that V is the proportion of variable costs to sales, the investment in
receivables is :
Rs.4,222,222 x V
6. 30% of sales are collected on the 5th day and 70% of sales are collected on the
25th day. So,
ACP = 0.3 x 5 + 0.7 x 25 = 19 days
Rs.10,000,000
Value of receivables = x 19
360
= Rs.527,778
Investment in receivables = 0.7 x 527,778
= Rs.395,833
50 10
ΔI= (24-20) + x 24 x 0.85
360 360
= Rs.1.2222 million
Δ RI = [ 10,000,000 (1-.85) – 380,000 ] (1-.4) – 0.12 x 1,222,222
100
= Rs.525,333
Customer pays(0.95)
Grant credit Profit 1500
Customer pays(0.85)
Grant credit Customer defaults(0.05)
Profit 1500 Refuse credit
Loss 8500
Customer defaults(0.15)
Loss 8500
Refuse credit
The expected profit from granting credit, ignoring the time value of money, is :
MINICASE
Solution:
Present Data
• Sales : Rs.800 million
• Credit period : 30 days to those deemed eligible
• Cash discount : 1/10, net 30
• Proportion of credit sales and cash sales are 0.7 and 0.3. 50 percent of the credit customers
avail of cash discount
• Contribution margin ratio : 0.20
• Tax rate : 30 percent
101
• Post-tax cost of capital : 12 percent
• ACP on credit sales : 20 days
∆S
where ∆ I = x ACP x V
360
50,000,000
- 0.12 x x 20 x 0.8
360
∆ RI = [∆S(1 – V) - ∆Sbn] (1 – t) – R ∆ I
So ∆S
where ∆I = (ACPn – ACPo) + V (ACPn)
360 360
800,000,000 50,000,000
- 0.12 (50 – 20) x + 0.8 x 50 x
360 360
= 7,000,000 – 8,666,667
= - Rs.1,666,667
102
where ∆ I = savings in receivables investment
So ∆S
= (ACPo – ACPn) – V x ACPn
360 360
800,000,000 20,000,000
= (20 – 16) – 0.8 x x 16
360 360
Chapter 29
INVENTORY MANAGEMENT
1.
a. No. of Order Ordering Cost Carrying Cost Total Cost
Orders Per Quantity (U/Q x F) Q/2xPxC of Ordering
Year (Q) (where and Carrying
(U/Q) PxC=Rs.30)
Units Rs. Rs. Rs.
2 UF 2x250x200
103
b. Economic Order Quantity (EOQ) = =
PC 30
2UF = 58 units (approx)
2. a EOQ =
PC
U=10,000 , F=Rs.300, PC= Rs.25 x 0.25 =Rs.6.25
2 x 10,000 x 300
EOQ = = 980
6.25
10000
b. Number of orders that will be placed is = 10.20
980
Note that though fractional orders cannot be placed, the number of orders
relevant for the year will be 10.2 . In practice 11 orders will be placed during the year. However,
the 11th order will serve partly(to the extent of 20 percent) the present year and partly(to the
extent of 80 per cent) the following year. So only 20 per cent of the ordering cost of the 11th
order relates to the present year. Hence the ordering cost for the present year will be 10.2 x
Rs.300
2 x 6,000 x 400
EOQ = = 490 units
20
U U Q’(P-D)C Q* PC
Δπ = UD + - F- -
Q* Q’ 2 2
6,000 6,000
= 6000 x .5 + - x 400
490 1,000
104
= 30,000 + 2498 – 4600 = Rs.27898
2 x 5000 x 300
EOQ = = 707 units
6
If 1000 units are ordered the discount is : .05 x Rs.30 = Rs.1.5 Change in
profit when 1,000 units are ordered is :
5,000 5,000
Δπ = 5000 x 1.5 + - x 300
707 1,000
If 2000 units are ordered the discount is : .10 x Rs.30 = Rs.3 Change in profit
when 2,000 units are ordered is :
LT
(Days)
DUR 5(0.6) 10(0.2) 15(0.2)
(Units)
105
*
Note that if the DUR is 4 units with a probability of 0.3 and the LT is 5 days with
a probability of 0.6, the requirement for the combination DUR = 4 units and LT =
5 days is 20 units with a probability of 0.3x0.6 = 0.18. We have assumed that the
probability distributions of DUR and LT are independent. All other entries in the
table are derived similarly.
The normal (expected) consumption during the lead time is :
20x0.18 + 30x0.30 + 40x0.12 + 40x0.06 + 60x0.10 + 80x0.04 + 60x0.06 + 90x0.10 +
120x0.04 = 46.4 tonnes
a. Costs associated with various levels of safety stock are given below :
1 2 3 4 5 6 7
[3x4] [(1)x1,000] [5+6]
106
0 13.6 54,400 0.16
33.6 134,400 0.04 43,296 0 43,296
43.6 174,400 0.10
73.6 294,400
*
Safety stock = Maximum consumption during lead time – Normal
consumption during lead time
So the optimal safety stock= 13.6 tonnes
Reorder level = Normal consumption during lead time + safety stock
K= 46.4 + 13.6 = 60 tonnes
7.
Item Annual Usage Price per Annual Ranking
(in Units) Unit Usage Value
Rs. Rs.
107
1,35,200
108
14 12 1,200 133,250 98.6 80.0
15 13 900 134,150 99.2 86.7
7 14 600 134,750 99.7 93.3
8 15 450 135,200 100.0 100.0
15 135,200
Chapter 30
WORKING CAPITAL FINANCING
Therefore, the annual per cent interest cost for the given credit terms will be as
follows:
a. 0.01 360
x = 0.182 = 18.2%
0.99 20
b. 0.02 360
x = 0.367 = 36.7%
0.98 20
c. 0.03 360
x = 0.318 = 31.8%
109
0.97 35
d. 0.01 360
x = 0.364 = 36.4%
0.99 10
2.
a.
0.01 360
x = 0.104 = 10.4%
0.99 35
b. 0.02 360
x = 0.21 = 21%
0.98 35
c. 0.03 360
x = 0.223 = 22.3%
0.97 50
d. 0.01 360
x = 0.145 = 14.5%
0.99 25
3. The maximum permissible bank finance under the three methods suggested by
The Tandon Committee are :
110
Chapter 31
WORKING CAPITAL MANAGEMENT :EXTENSIONS
Zi = aXi + bYi
where Zi = discriminant score for the ith account
Xi = quick ratio for the ith account
Yi = EBDIT/Sales ratio for the ith account
σx 2. dy − σ xy . dx
b =
σx 2 . σ y 2 − σ xy . σ xy
111
The basic calculations for deriving the estimates of a and b are given
the accompanying table.
112
X1 = = = 0.8947
15 15
1 0.8311
σx =
2
∑(Xi –X) =
2
= 0.0346
n-1 25-1
1 1661.76
σy =
2
∑(Yi – Y) =
2
= 69.24
n-1 25-1
1 10.0007
σxy = ∑(Xi-X)(Yi-Y) = = 0.4167
n-1 25-1
113
Zi = 6.079 Xi + 0.1089 Yi
1 7.1046
2 6.7373
3 7.4720
4 6.6918
5 5.6938
6 9.4728
7 8.0847
8 7.9378
9 6.8514
10 6.7018
11 7.1426
12 8.9231
13 7.7554
14 7.8870
15 9.2498
16 5.7090
17 5.4405
18 3.8398
19 5.7292
20 5.1571
21 5.7038
22 5.1265
23 4.7946
24 3.3890
25 4.4097
Good(G)
Account Number Zi Score or
Bad (B)
24 3.3890 B
18 3.8398 B
25 4.4097 B
114
23 4.7946 B
22 5.1265 B
20 5.1571 B
17 5.4405 B
5 5.6938 G
21 5.7038 B
16 5.7090 B
19 5.7292 B
4 6.6918 G
10 6.7018 G
2 6.7373 G
9 6.8514 G
1 7.1046 G
11 7.1426 G
3 7.4720 G
13 7.7554 G
14 7.8870 G
8 7.9378 G
7 8.0847 G
12 8.9231 G
15 9.2498 G
6 9.4728 G
From the above table, it is evident that a Zi score which represents the mid-point between the
Zi scores of account numbers 19 and 4 results in the minimum number of misclassifications . This Zi
score is :
5.7292 + 6.6918
= 6.2105
2
Given this cut-off Zi score, there is just one misclassification (Account number 5)
115
Chapter 4
ANALYSING FINANCIAL PERFORMANCE
Net profit
1. Return on equity =
Equity
1
= 0.05 x 1.5 x = 0.25 or 25 per cent
0.3
Debt Equity
Note : = 0.7 So = 1-0.7 = 0.3
Total assets Total assets
116
2. PBT = Rs.40 million
PBIT
Times interest covered = = 6
Interest
So PBIT = 6 x Interest
PBIT – Interest = PBT = Rs.40 million
6 x Interest = Rs.40 million
Hence Interest = Rs.8 million
3. Sales = Rs.7,000,000
Net profit margin = 6 per cent
Net profit = Rs.7000000 x 0.06 = 420,000
Tax rate = 60 per cent
420,000
So, Profit before tax = = Rs.1,050,000
(1-.6)
Interest charge = Rs.150,000
1,200,000
Times interest covered ratio = = 8
150,000
4. CA = 1500 CL = 600
Let BB stand for bank borrowing
CA+BB
= 1.5
CL+BB
1500+BB
= 1.5
600+BB
BB = 120
1,000,000
5. Average daily credit sales = = 2740
365
160000
ACP = = 58.4
117
2740
If the accounts receivable has to be reduced to 120,000 the ACP must be:
120,000
x 58.4 = 43.8days
160,000
Current assets
6. Current ratio = = 1.5
Current liabilities
Inventories
1.5 - = 1.2
800,000
Inventories
= 0.3
800,000
Inventories = 240,000
Sales
=5 So Sales = 1,200,000
2,40,000
7. Debt/equity = 0.60
118
Equity = 50,000 + 60,000 = 110,000
So Debt = 0.6 x 110,000 = 66,000
Hence Total assets = 110,000+66,000 = 176,000
Total assets turnover ratio = 1.5
So Sales = 1.5 x 176,000 = 264,000
Gross profit margin = 20 per cent
So Cost of goods sold = 0.8 x 264,000 = 211,200
Day’s sales outstanding in accounts receivable = 40 days
Sales
So Accounts receivable = x 40
360
264,000
= x 40 = 29,333
360
So Inventory = 42,240
Cash + 29,333
= = 1.2
66,000
So Cash = 49867
Balance Sheet
Equity capital 50,000 Plant & equipment 54,560
Retained earnings 60,000 Inventories 42,240
Debt(Current liabilities) 66,000 Accounts receivable 29,333
Cash 49,867
119
176,000 176,000
Sales 264,000
Cost of goods sold 211,200
5,000,000+15,000,000+20,000,000+2,500,000
=
15,000,000+10,000,000+5,000,000
42,500,000
= = 1.42
30,000,000
12,500,000 + 30,000,000
= = 1.31
10,000,000 + 22,500,000
15,100,000
= = 3.02
5,000,000
120
(vi) Average collection period =
Net sales/Accounts receivable
365
= = 57.6 days
95,000,000/15,000,000
PBIT 15,100,000
(x) Earning power = = = 20.1%
Total assets 75,000,000
The comparison of the Omex’s ratios with the standard is given below
Omex Standard
Current ratio 1.42 1.5
Acid-test ratio 0.75 0.80
Debt-equity ratio 1.31 1.5
Times interest covered ratio 3.02 3.5
Inventory turnover ratio 3.6 4.0
Average collection period 57.6 days 60 days
Total assets turnover ratio 1.27 1.0
Net profit margin ratio 5.4% 6%
Earning power 20.1% 18%
Return on equity 15.7% 15%
MINICASE
Solution:
121
(a) Key ratios for 20 X 5
12.4
Current ratio = = 0.93
13.4
8.8 + 6.7
Debt-equity ratio = = 0.98
6.5 + 9.3
57.4
Total assets turnover ratio = = 1.96
[(34 – 6.6) + (38 – 6.7)] / 2
3.0
Net profit margin = = 5.2 percent
57.4
5
Earning power = = 17.0 percent
[(34 – 6.6) + (38 – 6.7)] / 2
3.0
Return on equity = = 20.2 percent
(13.9 + 15.8) / 2
Net profit
3.0 –
Net sales
57.4
Return on
total assets
10.2%
122
Net sales
57.4
+
Average total
assets Average
29.35 net current
assets 54.0
Average
other assets
2.55
123
• Tax - - - -
• Profit after tax 2.6 3.0 7 5
Balance Sheet
124
• Profit after tax 2.6 3.0 100 115
Balance Sheet
(f) The qualitative factors relevant for evaluating the performance and prospects of a
company are as follows:
125
• To what extent are the company’s revenues tied to one key product?
• To what extent does the company rely on a single supplier?
• What percentage of the company’s business is generated overseas?
• How will competition impact the company?
• What are the future prospects of the firm?
• What could be the effect of the changes in the legal and regulatory environment?
Chapter 5
BREAK-EVEN ANALYSIS AND LEVERAGES
1. a. EBIT = Q(P-V)-F
= 20,000(10-6)-50,000 = Rs.30,000
2. EBIT = Q(P-V)-F
EBIT=Rs.30,000 , Q=5,000 , P=Rs.30 , V=Rs.20
So, 30,000 = 5,000(30-20)-F
So, F = Rs.20,000.
Q(P-V)
3. DOL =
126
Q(P-V)-F
400(1,000-600)
DOL(Q=400) = = 2.67
400(1,000-600)-100,000
600(1,000-600)
DOL(Q=600) = = 1.71
600(1,000-600)-1,00,000
4. DOL(Q=15000) = 2.5
EBIT(Q=15000) = Rs.3,00,000
127
Pre-tax income must be Rs.60,000
= Rs.100,000
1-.4
Hence the number of units to be sold to earn an after-tax income of Rs.60,000
is :
50,000 + 100,000
Q = = 30,000 units
12-7
6. P-V
= 0.30 P-V = Rs.6 F=20,000
P
20000 6
Q = = 3,333 P = = Rs.20
6 0.30
10,000
7. (a) P = Rs.30 ,V=Rs.16, F=Rs.10,000 Q = = 714.3 bags
30-16
128
10,000
Q = = 588.2 bags
33-16
8. A B C D
Selling price per unit Rs.10 Rs.16.66 Rs.20 Rs.10
Variable cost per unit Rs.6 Rs.8.33 Rs.12 Rs.5
Contribution margin per unit Rs.4 Rs.8.33 Rs.8 Rs.5
Contribution margin ratio 0.4 0.5 0.4 0.5
Total fixed costs Rs.16000 Rs.100000 Rs.160000 Rs.60000
Break-even point in units 4000 12000 20000 12000
Break-even sales(Rs.) Rs.40000 Rs.200000 Rs.400000 Rs.120000
Net income(loss)before tax Rs.30000 Rs.80000 Rs.(40000) Rs.40000
No.of units sold 11500 21600 15000 20000
129
5000 8,000 6,000
x Rs.10 + x Rs.20 + x Rs.40 = Rs.23.68
19000 19000 19000
10. EBIT
DFL =
Dp
EBIT – I -
T
at Q = 20000
EBIT= 20000(Rs.40-Rs.24)=Rs.320,000
Rs.320,000
DFL(Q=20,000) =
Rs.10,000
Rs.320,000-Rs.30,000 -
(1-.5)
= 1.185
(Rs.60,000-Rs.10,000)(1-.4)-Rs.5,000
Firm A : = Rs.1.9
10,000
(Rs.130,000-Rs.20,000)(1-.5)-Rs.5,000
Firm B : = Rs.4.17
12,000
(Rs.80,000-Rs.40,000)(1-.6)-Rs.10,000
Firm C : = Rs.0.40
15,000
F+I
(c) BEP =
P–V
130
Rs.40,000 + Rs.10,000
Firm A : = 10,000 units
Rs.20 – Rs.15
Rs.70,000 + Rs.20,000
Firm B : = 4,500 units
Rs.50 – Rs.30
Rs.100,000 + Rs.40,000
Firm C : = 2,333 units
Rs.100 – Rs.40
Q(P-V)
(d) DOL =
Q(P-V)-F
20,000(Rs.20-Rs.15)
Firm A : = 1.67
20,000(Rs.20-Rs.15)- Rs.40,000
10,000(Rs.50-Rs.30)
Firm B : = 1.54
10,000(Rs.50-Rs.30)-Rs.70,000
3,000(Rs.100-Rs.40)
Firm C : = 2.25
3,000(Rs.100-Rs.40)-Rs.100,000
EBIT
(e) DFL =
Dp
EBIT – I -
(1-T)
Rs.60,000
Firm A : = 1.44
Rs.5000
Rs.60,000-Rs.10,000 -
(1-.4)
Rs.130,000
Firm B : = 1.30
131
Rs.5,000
Rs.130,000-Rs.20,000 -
(1-.5)
Rs.80,000
Firm C : = 5.333
Rs.10,000
Rs.80,000-Rs.40,000-
(1-.6)
(f) DTL = DOL x DFL
Chapter 6
FINANCIAL PLANNING AND BUDGETING
1. The proforma income statement of Modern Electronics Ltd for year 3 based on the per cent
of sales method is given below
132
Depreciation 6.75 68.85
Operating profit 2.90 29.58
Non-operating surplus/deficit 1.07 10.91
Earnings before interest and taxes 3.96 40.39
Interest 1.24 12.65
Earnings before tax 2.72 27.74
Tax 1.00 10.20
Earnings after tax 1.72 17.54
Dividends (given) 8.00
Retained earnings 9.54
2. The proforma income statement of Modern Electronics for year 3 using the
the combination method is given below :
133
Earnings before tax 49.86
Tax 1.00 10.20
Earnings after tax 39.66
Dividends (given) Budgeted 8.00
Retained earnings 31.66
3. The proforma balance sheet of Modern Electronics Ltd for year 3 is given below
ASSETS
Fixed assets (net) 40.23 410.35
Investments No change 20.00
134
Miscellaneous expenditure & losses No change 14.00
961.70
LIABILITIES :
Share capital :
Equity No change 150.00
Reserves & surplus Proforma income 160.66
statement
Secured loans:
Term loans No change 175.00
Bank borrowings No change 199.00
Current liabilities :
Trade creditors 17.33 176.77
Provisions 5.03 51.31
961.7
A L
4. EFR = - ∆S – m S1 (1-d)
S S
800 190
= - 300 – 0.06 x 1,300 (1-0.5)
1000 1000
= 183 – 39 = Rs.144.
Sales 1,300
Profits before tax 195
Taxes 117
135
Profit after tax (6% on sales) 78
Dividends 39
Retained earnings 39
Liabilities Assets
1,040 1,040
A L
5. (a) EFR = - ∆S – m S1 (1 –d)
S S
150 30
= - x 80 – (0.625) x 240 x (0.5)
160 160
Liabilities Assets
136
225.00 225.00
(d)
A L
EFR 20X1= - ∆S – mS1 (1 – d)
S S
150 30
= - 20 – 0.0625 x 180 x 0.5
160 160
= 9.38
168.75 33.75
= - x 20 –0.0625 x 220 x 0.5
180 180
= 8.75
187.31 37.46
= - x 20 – 6.88
200 200
= 8.11
137
EFR 20X4 = - x 20 – 0.0625 x 240 x 0.5
220 220
= 7.49
225.00 225.00
(0.05)(1+g)(0.4)
(0.8-0.5) - =0
g
(0.05)(1+g)(0.4)
i.e. 0.3 - =0
g
A L
7. (a) EFR = - ∆S – mS1 (1-d)
S S
320 70
= - x 100 – (0.05) (500) (0.5)
400 400
138
= Rs.50
CA
≥ 1.25
STL +SCL
1285.125
or STL =
1.25
i.e STL ≤ Rs.102.50
borrowings , we have :
∆ STL = STL (20X1) – STL (20X1) = 102.50 – 60.00 = 42.50
139
∆ LTL = LTL (20X1)- LTL (20X1) = 130.00 – 80.00 = 50.00
Hence, the suggested mix for raising external funds will be :
Short-term borrowings 42.50
Long-term loans 7.50
Additional equity issue --
50.00
A L
8. EFR = - ∆ S – m S1 (1-d)
S S
A S
Therefore, mS1(1-d) – - ∆S represents surplus funds
S S
Given m= 0.06, S1 =11,000, d= 0.6 , L= 3,000 S= 10,000 and
surplus funds = 150 we have
A 3,000
(0.06) 11,000 (1-0.6) - - 1,000 = 150
10,000 10,000
A – 3,000
= (0.06) (0.4) (11,000) – 150 = 114
10
d = 0.466
The dividend payout ratio must be reduced from 60 per cent to 46.6 per cent
140
(c) .05 = A/E = 3.33
1.4 -.05 (1-0.6) A/E
m (1-0.6) 2.5
(d) .06 = m = 7.92 per cent
1.4 – m (1-0.6) x 2.5
The net profit margin must increase from 5 per cent to 7.92 per cent
Chapter 32
CORPORATE VALUATION
Tax on EBIT
Tax provision on income statement 26 32
+ Tax shield on interest expense 9.6 11.2
- Tax on interest income (4) (6)
141
- Tax on non-operating income (2) (4)
Tax on EBIT 29.6 33.2
2. Televista Corporation
0 1 2 3 4 5
Base year
142
5. Working capital 400 480 576 691 829 912
6. ∆Working capital 80 96 115 138 83
7. FCFF 11 13 16 19 273
(3-4-6)
273 273
Horizon value = = = 7690
0.1355 – 0.10 0.0355
143
ke = 11 + 1.1 x 6 = 17.6%
ka = 0.44 x 9.8 + 0.56 x 17.6 = 14.2%
The FCFF for years 1 to 11 is calculated below. The present value of the
FCFF for the years 1 to 10 is also calculated below.
Multisoft Limited
Period Growth EBIT Tax EBIT Cap. Dep. ∆WC FCFF D/E Beta WACC PV Present
rate (%) rate (1-t) exp. % Factor value
(%)
0 90 100 60
1 40 126 6 118 140 84 26 36 1:1 1.3 17.6 .850 30.6
2 40 176 12 155 196 118 39 38 1:1 1.3 17.2 .726 27.6
3 40 247 18 203 274 165 50 44 1:1 1.3 16.7 .622 27.4
4 40 346 24 263 384 230 70 39 1:1 1.3 16.3 .535 20.8
5 40 484 30 339 538 323 98 26 1:1 1.3 15.8 .462 12.0
6 34 649 30 454 721 432 132 33 0.8:1 1.1 14.2 .405 13.4
7 28 830 30 581 922 553 169 43 0.8:1 1.1 14.2 .354 15.4
8 22 1013 30 709 1125 675 206 53 0.8:1 1.1 14.2 .310 16.7
9 16 1175 30 822 1305 783 239 61 0.8:1 1.1 14.2 .272 16.9
10 10 1292 30 905 1436 862 263 68 0.8:1 1.1 14.2 .238 16.6
11 10 1421 30 995 1580 948 289 74 0.5: 1.1 13.7 476
1.0
673.4
The present value of continuing value is :
FCF11 74
x PV factor 10 years = x 0.238 = 476
k–g 0.137 – 0.100
144
MINI CASE
Solution:
Solution: 1 2 3 4 5 6
1. Revenues 950 1,000 1,200 1,450 1,660 1,770
2. PBIT 140 115 130 222 245 287
3. NOPAT = PBIT 91 74.8 84.5 144.3 159.3 186.6
(1 – .35)
4. Depreciation 55 85 80 83 85 87
5. Gross cash flow 146 159.8 164.5 227.3 244.3 273.7
6. Gross investment 100 250 85 100 105 120
in fixed assets
7. Investment in net 10 15 70 70 70 54
current assets
8. Total investment 110 265 155 170 175 174
9. FCFF (5) – (8) 36 (105.2) 9.5 57.3 69.3 99.6
0.4 1.0
WACC = x 12 x (1 – 0.35) + {8 + 1.06 (8)}
1.4 1.4
= 14%
99.6 (1.10)
Continuing Value = = 2739.00
0.14 – 0.10
2739
Present value of continuing value = = 1249
6
(1.14)
= 72.4
Firm value = 72.4 + 1249 = 1321.4
145
Chapter 33
VALUE BASED MANAGEMENT
146
=
B k–g
r - .10
2 =
k - .10
r - .10 = 2k - .20
r = 2k - .10
r/k = 2 - (.10/k)
4.
I = Rs.200 million
r = 0.40
c* = 0.20
T = 5 years
200 (0.40 – 0.20) 5
Value of forward plan =
0.20 (1.20)
= Rs.833.3 million
147
2. Costs 1,400 1,400 1,400 1,400 1,400
3. PBDIT 600 600 600 600 600
4. Depreciation 200 200 200 200 200
5. PBIT 400 400 400 400 400
6. NOPAT 240 240 240 240 240
7. Cash flow (4+6) 440 440 440 440 440
8. Capital at charge 1,000 800 600 400 200
9. Capital charge (8x0.14) 140 112 84 56 28
10. EVA (6-9) 100 128 156 184 212
5 440
NPV = ∑ - 1000 = 440 x 3.433 – 1000 = 510.5
t
t=1 (1.14)
EVAt
NPV = ∑ = 100 x 0.877 + 128 x 0.769 + 156 x 0.675 + 184 x 0.592 +
t
(1.14) 212 x 0.519
= 510.3
881,600 881,600
Annuity amount = =
PVIFA14%, 4yrs 2.914
= Rs.302,540
7. Investment : Rs.2,000,000
Life : 10 years
148
Cost of capital : 15 per cent
Salvage value : 0
2,000,000
Economic depreciation =
FVIFA(10yrs, 15%)
2,000,000
= = 98,503
20.304
8. Investment : Rs.5,000,000
Life : 5 years
Cost of capital : 12 per cent
Salvage value : Nil
5,000,000
Economic depreciation =
FVIFA(5yrs, 12%)
5,000,000
= = Rs.787,030
6.353
80 80
Economic depreciation = = = Rs.5.828 million
149
FVIFA(8, 15%) 13.727
Year 1 Year 4
• Profit after tax 11.618 11.618
• Depreciation 10.000 10.000
• Cash flow 21.618 21.618
• Book capital100 70
(Beginning)
• ROCE 11.62% 16.59%
• ROGI 21.62% 21.62%
• CFROI 15.79% 15.79%
150
Chapter 34
MERGERS, ACQUISITIONS AND RESTRUCTURING
1. The pre-amalgamation balance sheets of Cox Company and Box Company and the post-
amalgamation balance sheet of the combined entity, Cox and Box Company, under the ‘pooling’
method as well as the ‘purchase’ method are shown below :
Share capital 20 5 25 20
(face value @ Rs.10)
Reserves & surplus 10 10 20 10
Share premium 15 2.5 17.5 17.5
Debt 45 17.5 42.5 77.5
2 x 100,000 + 2 x100,000
100,000 + ER x 100,000
151
NPV to Beta = Cash Compensation – PVB = Rs.1 million
b) NPV to Ajeet
= Benefit - Cost
= 4 - 1.75 = Rs.2.25 million
Rs.1.20 (1.05)
Rs.12 =
k - .05
If the growth rate of Unibex rises to 7 per cent as a sequel to merger, the intrinsic value
per share would become :
1.20 (1.07)
= Rs.15.11
0.155 - .07
Thus the value per share increases by Rs.3.11 Hence the benefit of the
acquisition is
2 million x Rs.3.11 = Rs.6.22 million
152
(b) (i) If Multibex pays Rs.15 per share cash compensation, the cost of the
merger is 2 million x (Rs.15 – Rs.12) = Rs.6 million.
(ii) If Multibex offers 1 share for every 3 shares it has to issue 2/3 million
shares to shareholders of Unibex.
0.667
α = = 0.1177 or 11.77 per cent
5+0.667
6. The expected profile of the combined entity A&B after the merger is shown in the last column
below.
A B A&B
Number of shares 5000 2000 6333
Aggregate earnings Rs.45000 Rs.4000 Rs.49000
Market value Rs.90000 Rs.24000 Rs.114000
P/E 2 6 2.33
S1 (E1+E2) PE12
ER1 = - +
S2 P1S2
12 (36+12) 8
= - + = 0.1
8 30 x 8
153
ER2 =
(PE12) (E1+E2) - P2 S2
9 x 12
= = 0.3
9 (36+12) - 9 x 8
Equating ER1 and ER2 and solving for PE12 gives, PE12 = 9
When PE12 = 9
ER1 = ER2 = 0.3
Thus ER1 and ER2 intersect at 0.3
0 10.2 16.7
+ + +
(1.15)5 (1.15)6 (1.15)7
= - Rs.20.4 million
The horizon value at the end of seven years, applying the constant growth model is
FCF8 18
V4 = = = Rs.257.1 million
0.15-0.08 0.15 – 0.08
1
PV (VH) = 257.1 x = Rs.96.7 million
7
(1.15)
154
- 20.4 + 96.7 = Rs.76.3 million
MINICASE
Solution:
(a)
Modern Pharma Magnum Drugs Exchange
Ratio
Book value per share 2300 650 65
= Rs.115 = Rs.65
20 10 115
Earnings per share 450 95 9.5
= Rs.22.5 = Rs.9.5
20 10 22.5
Market price per share Rs.320 Rs.102 102
320
Exchange ratio that gives equal weightage to book value per share, earnings per share, and market
price per share
65 9.5 102
+ +
115 22.5 320 0.57 + 0.42 + 0.32
= = 0.44
3 3
(b) An exchange ratio based on earnings per share fails to take into account the
following:
(i) The difference in the growth rate of earnings of the two companies.
(ii) The gains in earnings arising out of merger.
(iii) The differential risk associated with the earnings of the two companies.
155
= = Rs.22.5
20
20 + ER X 10
Equating this with Rs.22.5, we get
Thus the maximum exchange ratio Modern Pharma should accept to avoid initial dilution of EPS is
0.54
(d) Post-merger EPS of Modern Pharma if the exchange ratio is 1:4, assuming no
synergy gain:
450 + 95
= Rs.24.2
20 + 0.25 x 10
(e) The maximum exchange ratio acceptable to the shareholders of Modern Pharma if
the P/E ratio of the combined entity is 13 and there is no synergy gain
- 20 (450 + 95) 13
= + = 0.21
10 320 x 10
(f) The minimum exchange ratio acceptable to the shareholders of Magnum Drugs if
the P/E ratio of the combined entity is 12 and the synergy benefit is 2 percent
P2S1
ER2 =
(P/E12) (E1 + E2) (1 + S) – P2S2
156
102 x 20
=
12 (450 + 95) (1.02) – 102 X 10
= 0.36
(g) The level of P/E ratio where the lines ER1 and ER2 intersect.
157
Chapter 37
INTERNATIONAL FINANCIAL MANAGEMENT
46.50 – 46.00 12
= x = 4.3%
46.00 3
2. 100
100 (1.06) = x 1.07 x F
1.553
106 x 1.553
F = = 1.538
107
A forward exchange rate of 1.538 dollars per sterling pound will mean indifference between
investing in the U.S and in the U.K.
3. (a) The annual percentage premium of the dollar on the yen may be calculated with
reference to 30-days futures
105.5 – 105 12
x = 5.7%
105 1
158
(b) The most likely spot rate 6 months hence will be : 107 yen / dollar
5807.6 4633.6
+ +
(1.18)5 (1.18)6
= Rs.3406.2 million
159
The dollar NPV is :
3406.2 / 46 = 74.05 million dollars
F 1 + .015
=
1.60 1 + .020
F = $ 1.592 / £
6. Expected spot rate a year from now 1 + expected inflation in home country
=
Current spot rate 1 + expected inflation in foreign country
So, the expected spot rate a year from now is : 72 x (1.06 / 1.03) = Rs.72.04
(1.01)2
= 170 x = 163.46 yen / £
(1.03)2
9. (i) Determine the present value of the foreign currency liability (£100,000) by using
90-day money market lending rate applicable to the foreign country. This works
out to :
160
£100,000
= £ 98522
(1.015)
(ii) Obtain £98522 on today’s spot market
(iii) Invest £98522 in the UK money market. This investment will grow to
£100,000 after 90 days
10. (i) Determine the present value of the foreign currency asset (£100,000) by using
the 90-day money market borrowing rate of 2 per cent.
100,000
= £98039
(1.02)
(ii) Borrow £98039 in the UK money market and convert them to dollars in the spot
market.
(iii) Repay the borrowing of £98039 which will compound to £100000 after 90 days
with the collection of the receivable
11. A lower interest rate in the Swiss market will be offset by the depreciation of the US
dollar vis-à-vis the Swiss franc. So Mr.Sehgal’s argument is not tenable.
161
Chapter 40
CORPORATE RISK MANAGEMENT
1. (a) The investor must short sell Rs.1.43 million (Rs.1 million / 0.70) of B
(b) His hedge ratio is 0.70
(c) To create a zero value hedge he must deposit Rs.0.43 million
The dividend yield on a six months basis is 2 per cent. On an annual basis it is
approximately 4 per cent.
3. Futures price
= Spot price + Present value of – Present value
(1+Risk-free rate)1 storage costs of convenience yield
5400
= 5000 + 250 – Present value of convenience yield
1
(1.15)
162
163
164