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IPIM

THE INDIAN INSTITUTE OF PLANNING AND MANAGEMENT

Strategic Corporate Finance - Re-Examination Assignment

Paper Code: IIPM/FIN04/SCF004 Max. Marks: 100

General Instructions:

� The Student should submit this assignment in his/her own handwritten (not in the typed format). � The Student should submit this assignment within 2 days from the issue of the assignment. � The student should attach this assignment paper with the answered papers. � Write legibly and keep the length of the answer as per the weightage (in terms of marks)

assigned to each question. DO NOT be unduly short or long in providing the relevant details. � The student should only use the Rule sheet papers for answering the questions. � Failure to comply with the above instructions would lead to rejection of assignment.

Specific Instructions:

� There are Four Questions in this assignment. The student should answer all the questions along with their subparts. Marks are being assigned to each section of the question as well.

� Each Question carries equal marks (25 marks) unless specified explicitly

Question-1[A][15Marks]

Maharaja Ltd has announced its annual result in the recent times. You have been given following information and asked to estimate EVA of the firm. The required rate of return for the equity investor is 5% and Dividend growth rate is 3%.Take number of shares as 5000 each or Rs10.

Balance Sheet In Rs In Rs

Sources of Funds 2010 2009

Share Capital 50,000 50,000

Reserves and Surpluses 50,000 31,100

Secured Debt 20,000 20,000

Short Term Debt 20,000 20,000

Proposed Dividend 3900 Nil

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You are being asked to

(i)Explain the concept of EVA of the firm and equity.

(ii)Calculate EVA of the above firm.

(iii)Estimate Value of the firm using DDM Model?

Question-1[B][10Marks]

Hero Honda Motors is a widely held company and considering for major project expansion with the following alternatives been available:

Particulars of financing Alternatives-1 Alternative-2 Alternative-3

Share Capital 50 Lakhs 20 Lakhs 10 lakhs

14% Debentures - 20 Lakhs 15 Lakhs

Loan from Financial Institution at 18% pa

- 10 lakhs 25 lakhs

Expected rate of return by shareholders before tax is 25%.The rate of dividend of the company is not less than 20%.Corporate Taxation rate is 50%.Which of the following alternatives you would choose keeping in view the rate of return the shareholders are looking forward to? Question-2(A)[12.5 Marks]

MXP Ltd is a firm into a business of dairy products. The firm is contemplating to diversify into

other FMCG businesses and to do this it has looked to acquire one of the two firms with

following financials. You being an analyst asked to evaluate both firms using EVA. Find out

which of the two firms is most likely to create wealth for the shareholder using Economic Value

Addition for the firm concept? Justify your answer?

Other Liabilities 6100 8900

Total 150,000 130,000

Application of Funds 2010 2009

Net Fixed Assets 98,000 100,000

Current Assets 32,000 10,000

Investments 30,000 20,000

Total 150,000 130,000

Income Statement 2011

Sales 47000

Operating Exp 15000

Depreciation 2000

Interest Exp 3000

Tax 8100

Net Profit 18900

Dividend 3900

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Item RIIL Ltd RPPL Ltd

Net Worth 220 300

NOPLAT (tax adjusted Operating Profit) 65 78

Cost of Equity 17% 19%

Cost of Debt 12% 11%

Debt 100 120

Is EVA the better value to evaluate the firm who is thinking to go for an acquisition? Explain

Question-2(B)[12.5Marks]

M&M is a firm with moderate debt in its balance sheet and now being advised by its financial

consultant to move to its optimal financing mix, which is at 50% debt to capital ratio. Currently

M&M has Rs 2200 Cr of debt and Rs 7800 Cr of equity. The movement from existing capital

structure to optimal capital structure would change its credit rating from AAA to A and so its

default spread would increase from 2% to 4%. The firm effectively pays tax rate of 20%.

Existing Optimal

Beta 1.2 1.5

Credit Rating AAA A

Default Spread 2% 4%

Risk Free Rate 8% 8%

Market Expected Return 15% 15%

(i)Does capital structure is at optimal level if M&M changes its debt to capital ratio from 22% to

50%?[7.5Marks]

(ii) Explain the concept of Optimal Capital Structure along with appropriate examples ?

[5Marks]

Question3(A)[12.5M arks]

UB Inc. is examining its capital structure with the intent of arriving at an optimal debt ratio. It currently has no debt and has a beta of 1.5. The riskless interest rate is 9%.

Your research indicates that the debt rating will be as follows at different debt levels;

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D/(D+E) Rating Interest Rate

0% AAA 10% 10% AA 10.5% 20% A 11% 30% BBB 12% 40% BB 13% 50% B 14% 60% CCC 16% 70% CC 18% 80% C 20% 90% D 25%

The firm currently has 1 million shares outstanding at $20 per share (tax rate =40%).

You are required to determine the optimal capital structure ratio for the company. Question3(B)[12.5]

RIL is a firm into multiple segments whereas RPL Ltd is into a single business. You being an analyst asked to evaluate both firms using EVA. You are given following information to judge the firm. Find out which of the two firms is most likely to create wealth for the shareholder using Economic Value Addition for the firm concept? Justify your answer?

Item RIL Ltd RPL

Ltd

Net Worth 250 300

NOPLAT (tax adjusted Operating Profit) 65 78

Cost of Equity 17% 19%

Cost of Debt 12% 11%

Debt 100 120

Is EVA the better value to evaluate the firm RIL Ltd who is into multiple segments? Explain

Question-4(A)[10 Marks]

Time warner is considering sale of its publishing division. The division has earnings before interest, taxes and depreciation of Rs.550 million in the most recent year (depreciation was Rs.150), growing at an estimated 5% a year. (You can assume that depreciation grows at the

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same rate). The return on capital in the division is 15% and the corporate tax rate is 40%. If the cost of capital for the division is 9%, estimate the following: (i)Value / FCFF multiple.

(ii)Value / EBIT multiple.

(iii)Value / EBITDA multiple.

Question-4(B)[15Marks]

A large profit making company is considering installation of a machine to process the waste produced by one of its existing manufacturing process and convert it into a marketable product. At present, the waste is being removed, for disposal by a contractor against payment of INR 50 lacs per annum. This arrangement will continue for next four years. The contract can be terminated upon installation of aforesaid machine, on payment of a compensation of INR 30 lacs before the processing operation starts. This compensation is not allowed as deduction for tax purposes. The machine required for carrying out the processing, costing INR 200 lacs will be financed by a loan repayable in four installments, commencing from end of year 1. Interest rate is 16 percent per annum. At end of the 4th year, the machine can be sold for INR 20 lacs and the cost of dismantling and removal will be INR 15 lacs. Sales and direct costs of the product emerging from waste processing, for 4 years are estimated as under:

Year 1 2 3 4

Sales 322 322 418 418

Material Consumption 30 40 85 85

Wages 75 75 85 100

Other expenses 40 45 54 70

Factory overheads 55 60 110 145

Depreciation (as per Income Tax Rules)

50 38 28 21

Initial stock of materials required before commencement of the processing operations is INR 20 Lacs at the start of year 1. The stock levels of materials to be maintained at the end of year 1, 2, and 3 will be INR 55 lacs and stocks at end of year 4 will be nil. The storage of materials will utilize space which would otherwise have been rented out at INR 10 lacs per annum. Labour costs include wages of 40 workers, whose transfer to this process will reduce ideal time payments of INR 15 lacs in year 1 and INR 10 lacs in year 2. Factory overheads include apportionment of general factory overheads, except to the extent of insurance charges of INR 30 lacs per annum, payable on this venture. The company’s tax rate is 50 percent. Present value factors for 4 years are as under:

Year 1 2 3 4

PV factor at 15% .870 .756 .658 .572

Advise management on the desirability of installing the machine for processing the waste. All

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calculation should form part of the answer.

………………………………………………ALL THE

BEST………………