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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. In Rs 2009 50,000 31,100 20,000 20,000 Nil

Balance Sheet Sources of Funds Share Capital Reserves and Surpluses Secured Debt Short Term Debt Proposed Dividend

In Rs 2010 50,000 50,000 20,000 20,000 3900

2 Other Liabilities Total Application of Funds Net Fixed Assets Current Assets Investments Total 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? 8900 6100 150,000 130,000 2010 98,000 32,000 30,000 150,000 2009 100,000 10,000 20,000 130,000 Income Statement Sales Operating Exp Depreciation Interest Exp Tax Net Profit Dividend 2011 47000 15000 2000 3000 8100 18900 3900

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 Share Capital 14% Debentures Loan from Financial Institution at 18% pa Alternatives-1 50 Lakhs Alternative-2 20 Lakhs 20 Lakhs 10 lakhs Alternative-3 10 lakhs 15 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?

3 Item Net Worth RIIL Ltd RPPL Ltd 220 300 78 19% 11% 120

NOPLAT (tax adjusted Operating Profit) 65 Cost of Equity Cost of Debt Debt 17% 12% 100

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;

4 D/(D+E) 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% Rating AAA AA A BBB BB B CCC CC C D Interest Rate 10% 10.5% 11% 12% 13% 14% 16% 18% 20% 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?


RIL Ltd RPL Ltd 250 300 78 19% 11% 120

Net Worth

NOPLAT (tax adjusted Operating Profit) 65 Cost of Equity Cost of Debt Debt 17% 12% 100

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

5 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 Sales Material Consumption Wages Other expenses Factory overheads Depreciation (as per Income Tax Rules) 2 322 30 75 40 55 50 322 40 75 45 60 38 3 418 85 85 54 110 28 4 418 85 100 70 145 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 companys tax rate is 50 percent. Present value factors for 4 years are as under: Year PV factor at 15% 1 .870 2 .756 3 .658 4 .572

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

6 calculation should form part of the answer.