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Attempt Only Five Case Study
Case 1: Zip Zap Zoom Car Company
Zip Zap Zoom Company Ltd is into manufacturing cars in the small car (800 cc) segment. It was
set up 15 years back and since its establishment it has seen a phenomenal growth in both its
market and profitability. Its financial statements are shown in Exhibits 1 and 2 respectively.
The company enjoys the confidence of its shareholders who have been rewarded with
growing dividends year after year. Last year, the company had announced 20 per cent dividend,
which was the highest in the automobile sector. The company has never defaulted on its loan
payments and enjoys a favourable face with its lenders, which include financial institutions,
commercial banks and debenture holders.
The competition in the car industry has increased in the past few years and the company
foresees further intensification of competition with the entry of several foreign car manufactures
many of them being market leaders in their respective countries. The small car segment
especially, will witness entry of foreign majors in the near future, with latest technology being
offered to the Indian customer. The Zip Zap Zoom’s senior management realizes the need for
large scale investment in up gradation of technology and improvement of manufacturing
facilities to pre-empt competition.
Whereas on the one hand, the competition in the car industry has been intensifying, on
the other hand, there has been a slowdown in the Indian economy, which has not only reduced
the demand for cars, but has also led to adoption of price cutting strategies by various car
manufactures. The industry indicators predict that the economy is gradually slipping into
recession.
Exhibit 1 Balance sheet as at March 31,200 x
(Amount in Rs. Crore)
Source of Funds Share capital 350Reserves and surplus 250 600Loans :
Debentures (@ 14%) 50 Institutional borrowing (@ 10%) 100Commercial loans (@ 12%) 250
Total debt 400Current liabilities 200
1,200
Application of Funds Fixed Assets Gross block 1,000Less : Depreciation 250Net block 750Capital WIP 190Total Fixed Assets 940Current assets : Inventory 200Sundry debtors 40 Cash and bank balance 10Other current assets 10Total current assets 260
-1200
Exhibit 2 Profit and Loss Account for the year ended March 31, 200x(Amount in Rs. Crore)
Sales revenue (80,000 units x Rs. 2,50,000) 2,000.0Operating expenditure :
Variable cost : Raw material and manufacturing expenses 1,300.0Variable overheads 100.0
Total 1,400.0Fixed cost :
R & D 20.0 Marketing and advertising 25.0Depreciation 250.0Personnel 70.0
Total 365.0 Total operating expenditure 1,765.0Operating profits (EBIT) 235.0
Financial expense : Interest on debentures 7.7Interest on institutional borrowings 11.0Interest on commercial loan 33.0 51.7
Earnings before tax (EBT) 183.3Tax (@ 35%) 64.2Earnings after tax (EAT) 119.1Dividends 70.0Debt redemption (sinking fund obligation)** 40.0Contribution to reserves and surplus 9.1
* Includes the cost of inventory and work in process (W.P) which is dependent on demand
(sales).
** The loans have to be retired in the next ten years and the firm redeems Rs. 40 crore every
year.
The company is faced with the problem of deciding how much to invest in up
gradation of its plans and technology. Capital investment up to a maximum of Rs. 100
crore is required. The problem areas are three-fold.
1 The company cannot forgo the capital investment as that could lead to reduction in its
market share as technological competence in this industry is a must and customers would
shift to manufactures providing latest in car technology.
2 The company does not want to issue new equity shares and its retained earning are not
enough for such a large investment. Thus, the only option is raising debt.
3 The company wants to limit its additional debt to a level that it can service without taking
undue risks. With the looming recession and uncertain market conditions, the company
perceives that additional fixed obligations could become a cause of financial distress, and
thus, wants to determine its additional debt capacity to meet the investment requirements.
Mr. Shortsighted, the company’s Finance Manager, is given the task of determining the
additional debt that the firm can raise. He thinks that the firm can raise Rs. 100 crore worth debt
and service it even in years of recession. The company can raise debt at 15 per cent from a
financial institution. While working out the debt capacity. Mr. Shortsighted takes the following
assumptions for the recession years.
4 A maximum of 10 percent reduction in sales volume will take place.
5 A maximum of 6 percent reduction in sales price of cars will take place.
Mr. Shorsighted prepares a projected income statement which is representative of the
recession years. While doing so, he determines what he thinks are the “irreducible minimum”
expenditures under recessionary conditions. For him, risk of insolvency is the main concern
while designing the capital structure. To support his view, he presents the income statement as
shown in Exhibit 3.
Exhibit 3 projected Profit and Loss account
(Amount in Rs. Crore)
Sales revenue (72,000 units x Rs. 2,35,000) 1,692.0Operating expenditure
Variable cost : Raw material and manufacturing expenses 1,170.0Variable overheads 90.0
Total 1,260.0Fixed cost :
R & D --- Marketing and advertising 15.0Depreciation 187.5Personnel 70.0
Total 272.5 Total operating expenditure 1,532.5EBIT 159.5Financial expenses :
Interest on existing Debentures 7.0Interest on existing institutional borrowings 10.0Interest on commercial loan 30.0Interest on additional debt 15.0 62.0
EBT 97.5Tax (@ 35%) 34.1
EAT 63.4Dividends --Debt redemption (sinking fund obligation) 50.0*Contribution to reserves and surplus 13.4
* Rs. 40 crore (existing debt) + Rs. 10 crore (additional debt)
Assumptions of Mr. Shorsighted
6 R & D expenditure can be done away with till the economy picks up.
7 Marketing and advertising expenditure can be reduced by 40 per cent.
8 Keeping in mind the investor confidence that the company enjoys, he feels that the
company can forgo paying dividends in the recession period.
He goes with his worked out statement to the Director Finance, Mr. Arthashatra, and
advocates raising Rs. 100 crore of debt to finance the intended capital investment. Mr.
Arthashatra does not feel comfortable with the statements and calls for the company’s financial
analyst, Mr. Longsighted.
Mr. Longsighted carefully analyses Mr. Shortsighted’s assumptions and points out that
insolvency should not be the sole criterion while determining the debt capacity of the firm. He
points out the following :
9 Apart from debt servicing, there are certain expenditures like those on R & D and
marketing that need to be continued to ensure the long-term health of the firm.
10 Certain management policies like those relating to dividend payout, send out important
signals to the investors. The Zip Zap Zoom’s management has been paying regular
dividends and discontinuing this practice (even though just for the recession phase) could
raise serious doubts in the investor’s mind about the health of the firm. The firm should
pay at least 10 per cent dividend in the recession years.
11 Mr. Shortsighted has used the accounting profits to determine the amount available each
year for servicing the debt obligations. This does not give the true picture. Net cash
inflows should be used to determine the amount available for servicing the debt.
12 Net Cash inflows are determined by an interplay of many variables and such a simplistic
view should not be taken while determining the cash flows in recession. It is not possible
to accurately predict the fall in any of the factors such as sales volume, sales price,
marketing expenditure and so on. Probability distribution of variation of each of the
factors that affect net cash inflow should be analyzed. From this analysis, the probability
distribution of variation in net cash inflow should be analysed (the net cash inflows
follow a normal probability distribution). This will give a true picture of how the
company’s cash flows will behave in recession conditions.
The management recognizes that the alternative suggested by Mr. Longsighted rests on data,
which are complex and require expenditure of time and effort to obtain and interpret.
Considering the importance of capital structure design, the Finance Director asks Mr.
Longsighted to carry out his analysis. Information on the behaviour of cash flows during the
recession periods is taken into account.
The methodology undertaken is as follows :
13 Important factors that affect cash flows (especially contraction of cash flows), like sales
volume, sales price, raw materials expenditure, and so on, are identified and the analysis
is carried out in terms of cash receipts and cash expenditures.
14 Each factor’s behaviour (variation behaviour) in adverse conditions in the past is studied
and future expectations are combined with past data, to describe limits (maximum
favourable), most probable and maximum adverse) for all the factors.
15 Once this information is generated for all the factors affecting the cash flows, Mr.
Longsighted comes up with a range of estimates of the cash flow in future recession
periods based on all possible combinations of the several factors. He also estimates the
probability of occurrence of each estimate of cash flow.
Assuming a normal distribution of the expected behaviour, the mean expected
value of net cash inflow in adverse conditions came out to be Rs. 220.27 crore with standard
deviation of Rs. 110 crore.
Keeping in mind the looming recession and the uncertainty of the recession behaviour,
Mr. Arthashastra feels that the firm should factor a risk of cash inadequacy of around 5 per cent
even in the most adverse industry conditions. Thus, the firm should take up only that amount of
additional debt that it can service 95 per cent of the times, while maintaining cash adequacy.
To maintain an annual dividend of 10 per cent, an additional Rs. 35 crore has to be kept
aside. Hence, the expected available net cash inflow is Rs. 185.27 crore (i.e. Rs. 220.27 – Rs. 35
crore)
Question:
Analyse the debt capacity of the company.
CASE – 2 GREAVES LIMITED
Started as trading firm in 1922, Greaves Limited has diversified into manufacturing and marketing of high technology engineering products and systems. The company’s mission is “manufacture and market a wide range of high quality products, services and systems of world class technology to the total satisfaction of customers in domestic and overseas market.”
Over the years Greaves has brought to India state of the art technologies in various engineering fields by setting up manufacturing units and subsidiary and associate companies. The sales of Greaves Limited has increased from Rs 214 crore in 1990 to Rs 801 crore in 1997. The sales of Greaves Limited has increased from Rs 214 crore in 1990 to Rs 801 crore in 1997. Profits before interest and tax (PBIT) of the company increased from Rs 15 crore to Rs 83 crore in 1997. The market price of the company’s share has shown ups and downs during 1990 to 1997. How has the company performed? The following question need answer to fully understand the performance of the company:
Exhibit 1
GREAVES LTD. Profit and Loss Account ending on 31 March (Rupees in crore)
1990 1991 1992 1993 1994 1995 1996 1997
Sales
Raw Material and Stores
Wages and Salaries
Power and fuel
Other Mfg. Expenses
Other Expenses
Depreciation
Marketing and Distribution
Change in stock
214.38
170.67
13.54
0.52
0.61
11.85
1.85
4.86
1.18
253.10
202.84
15.60
0.70
0.49
15.48
1.72
5.67
3.10
287.81
230.81
18.03
1.11
0.88
16.35
1.52
5.14
4.93
311.14
213.79
37.04
3.80
2.37
25.54
4.62
5.17
0.48
354.25
245.63
37.96
4.43
2.36
31.60
5.99
9.67
- 1.13
521.56
379.83
48.24
6.66
3.57
41.40
8.53
10.81
5.63
728.15
543.56
60.48
7.70
4.84
45.74
9.30
12.44
11.86
801.11
564.35
69.66
9.23
5.49
48.64
11.53
16.98
- 5.87
Total Op Expenses 202.72 239.40 268.91 291.85 338.77 493.41 672.20 731.75
Operating Profit
Other Income
Non-recurring Income
11.61
2.14
1.30
13.70
3.69
2.28
18.90
4.97
0.10
19.29
4.24
10.98
15.48
7.72
16.44
28.15
14.35
0.46
55.95
11.35
0.52
69.36
13.08
1.75
PBIT 15.10 19.67 23.97 34.51 39.64 42.98 65.67 82.64
Interest 5.56 6.77 11.92 19.62 17.17 21.48 28.25 27.54
PBT 9.54 12.90 12.05 14.89 22.47 21.50 37.42 55.10
Tax
PAT
Dividend
3.00
6.54
1.80
3.60
9.30
2.00
4.90
7.15
2.30
0.00
14.89
4.06
4.00
18.47
7.29
7.00
14.50
8.58
8.60
28.82
12.85
15.80
39.30
14.18
Retained Earnings 4.74 7.30 4.85 10.83 11.18 5.92 15.97 25.12
Exhibit 2
GREAVES LTD. Balance Sheet (Rupees in crore)
1990 1991 1992 1993 1994 1995 1996 1997
ASSETS
Land and Building
Plant and Machinery
Other Fixed Assets
Capital WIP
Gross Fixed Assets
Less: Accu. Depreciation
Net Tangible Fixed Assets
Intangible Fixed Assets
3.88
11.98
3.64
0.09
19.59
12.91
6.68
0.21
4.22
12.68
4.14
0.26
21.30
14.56
6.74
0.19
4.96
12.98
4.38
10.25
23.57
15.79
7.78
0.05
21.70
33.49
5.18
11.27
71.64
19.84
51.80
4.40
30.82
50.78
6.95
34.84
123.39
25.74
97.65
22.03
39.71
75.34
8.53
14.37
137.95
33.90
104.05
22.45
42.34
92.49
8.87
13.92
157.62
42.56
115.06
20.04
43.07
104.45
10.35
14.36
172.23
53.87
118.86
21.11
Net Fixed Assets 6.89 6.93 7.83 56.20 119.68 126.50 135.10 139.97
Raw Materials
Finished Goods
Inventory
Accounts Receivable
Other Receivable
Investments
Cash and Bank Balance
Current Assets
Total Assets
LIABILITIES AND CAPITAL
Equity Capital
Preference Capital
Reserves and Surplus
5.26
29.37
34.63
38.16
32.62
3.55
8.36
117.32
124.21
9.86
0.20
27.60
6.91
33.72
40.63
53.24
40.47
14.95
8.91
158.20
165.13
9.86
0.20
32.57
7.26
38.65
45.91
67.97
49.19
15.15
12.71
190.93
198.76
9.86
0.20
37.42
21.05
53.39
74.44
93.30
24.54
27.58
13.29
233.15
289.35
18.84
0.20
100.35
28.13
52.26
80.39
122.20
59.12
73.50
18.38
353.59
473.27
29.37
0.20
171.03
44.03
58.09
102.12
133.45
64.32
75.01
30.08
404.98
531.48
29.44
0.20
176.88
53.62
69.97
123.59
141.82
76.57
75.07
33.46
450.51
585.61
44.20
0.20
175.41
50.94
64.09
115.03
179.92
107.31
76.45
48.18
526.89
666.86
44.20
0.20
198.79
Net Worth 37.66 42.63 47.48 119.39 200.60 206.52 219.81 243.19
Bank Borrowings
Institutional Borrowings
Debentures
Fixed Deposits
Commercial Paper
Other Borrowings
Current Portion of LT Debt
14.81
4.13
4.77
12.31
0.00
2.33
0.00
19.45
3.43
16.57
14.45
0.00
3.22
0.00
26.51
9.17
19.99
15.03
0.00
3.10
0.08
24.82
38.09
4.56
14.08
0.00
3.18
0.12
55.12
38.76
4.37
15.57
15.00
17.08
15.08
64.97
69.69
4.37
17.75
0.00
1.97
0.02
70.08
89.26
2.92
20.81
0.00
2.36
1.49
118.28
63.60
1.49
19.29
0.00
2.57
1.57
Borrowings 38.35 57.12 73.72 84.61 130.82 158.73 183.94 203.66
Sundry Creditors
Other Liabilities
Provision for tax, etc.
Proposed Dividends
Current Portion of LT Dept
37.52
5.70
3.18
1.80
0.00
49.40
10.16
3.82
2.00
0.00
59.34
10.70
5.14
2.30
0.08
77.27
3.59
0.31
4.06
0.12
113.66
1.42
4.40
7.29
15.08
148.13
1.99
7.70
8.58
0.02
153.63
1.70
12.19
12.85
1.49
179.79
3.04
21.43
14.18
1.57
Current Liabilities 48.20 65.38 77.56 85.35 141.85 166.42 181.86 220.01
TOTAL LIABILITIES
Additional information:
Share premium reserve
Revaluation reserve
Bonus equity capital
124.21
8.51
165.13
8.51
198.76
8.51
289.35
47.69
8.91
8.51
473.27
107.40
8.70
8.51
531.67
107.91
8.50
8.51
585.61
93.35
8.31
23.25
666.86
93.35
8.15
23.25
Exhibit 3
GREAVES LTD.Share Price Data
1990 1991 1992 1993 1994 1995 1996 1997 Closing share price (Rs)
Yearly high share price (Rs)
Yearly low share price (Rs)
Market capitalization (Rs crore
EPS (Rs)
Book value (Rs)
27.19
29.25
26.78
65.06
4.79
35.64
34.7
4
45.2
8
21.6
1
67.7
121.27
121.27
34.36
236.56
9.73
42.54
66.67
126.33
48.34
274.84
1.93
57.75
78.34
90.00
42.67
346.35
2.66
40.61
71.67
100.01
68.34
316.87
7.16
64.98
47.5
90.00
45.00
210.02
5.03
45.35
48.25
85.00
43.75
213.34
9.01
50.73
7
6.82
37.2
2
Questions
16 How profitable are its operations? What are the trends in it? How has growth affected the profitability of the company?
17 What factors have contributed to the operating performance of Greaves Limited? What is the role of profitability margin, asset utilisation, and non-operating income?
18 How has Greaves performed in terms of return on equity? What is the contribution of return on investment, the way of the business has been financed over the period?
?
