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This case discusses a dilemma faced by Suresh Pai, an executive at a leading bank in India. One of his clients required additional working capital financing of Rs 85 lakh, bringing the total to Rs 135-250 lakh. Suresh had to evaluate the client's request and past financial data to determine if the bank could provide the financing. He found that the bank could only lend according to the second method recommended by the London Committee, which involves maintaining minimum current ratios and limiting total liabilities to a percentage of current assets. However, approval from the bank's head office would be required since the lending amount exceeded Rs 1 crore. The summary provides background on the London Committee and its recommendations regarding needs-based
This case discusses a dilemma faced by Suresh Pai, an executive at a leading bank in India. One of his clients required additional working capital financing of Rs 85 lakh, bringing the total to Rs 135-250 lakh. Suresh had to evaluate the client's request and past financial data to determine if the bank could provide the financing. He found that the bank could only lend according to the second method recommended by the London Committee, which involves maintaining minimum current ratios and limiting total liabilities to a percentage of current assets. However, approval from the bank's head office would be required since the lending amount exceeded Rs 1 crore. The summary provides background on the London Committee and its recommendations regarding needs-based
This case discusses a dilemma faced by Suresh Pai, an executive at a leading bank in India. One of his clients required additional working capital financing of Rs 85 lakh, bringing the total to Rs 135-250 lakh. Suresh had to evaluate the client's request and past financial data to determine if the bank could provide the financing. He found that the bank could only lend according to the second method recommended by the London Committee, which involves maintaining minimum current ratios and limiting total liabilities to a percentage of current assets. However, approval from the bank's head office would be required since the lending amount exceeded Rs 1 crore. The summary provides background on the London Committee and its recommendations regarding needs-based
CAPITAL SUMMARY Suman Joshi, Managing director of omega textile, was reviewing two very diferent investment proposals. The rst one is for expanding the capacity of the current pro!ect and the second is for diversifying into a new line of "usiness. #e need to nd #ACC $weighed average cost of capital% with the help of following data. &ia"ilities Amount Assets Amou nt '(uity capital )*+ ,ixed assets -++ .reference capital /++ 0nvestment /++ 1eserve and surplus 2++ Current Assets, loans and advances 3++ 4e"entures 3*+ Current lia"ilities 5 provision /++ /2++ /2++ 6mega7s target capital structure has *+ percent e(uity, /+ percent preference, and 3+ percent de"t 6mega has 1s./++ par, /+ percent coupon, annual payment, noncalla"le de"enture with 8 year to maturity. These de"entures are currently selling at 1S.//2. 6mega has 1s./++ par, 9 percent, annual dividend, preference share with residual maturity of * years. The mar:et price of these preference shares is 1s./+;. .age / Case Study Analysis 6mega7s e(uity share is currently selling at 1s.8+ per share. 0ts last dividend was 1s.2.8+ and the dividend per share is expected to grow at a rate of /+ percent in future. 6mega7s e(uity "eta is /./, the ris: free rate is - percent, and the mar:et ris: premium is estimated to "e - percent. 6mega7s tax rate is )+ percent. The new "usiness that 6mega is considering has diferent nancial characteristics than 6mega7s existing "usiness. ,irm engaged purely in such "usiness have, on an average, the following characteristics< $/%Their capital structure has de"t and e(uity in e(ual proportion. $2%Their cost of de"t is // percent. $)%Their e(uity "eta is /.*. =uestions< /. #hat sources of capital would you consider relevant for calculating the #ACC> 2. #hat is 6mega7s post?tax cost of de"t> ). #hat is 6mega7s cost of preference> 3. #hat is 6mega7s estimated cost of e(uity using dividend discount model> *. #hat is 6mega7s estimated cost of e(uity using the capital asset pricing model> ;. #hat is 6mega7s #ACC using CA.M for the cost of e(uity> -. #hat would "e your estimate cost of capital for the new "usiness> 8. #hat is the diference "etween company cost of capital and pro!ect cost of capital> .age 2 Case Study Analysis S6&@T06A< /. #hat sources of capital would you consider relevant for calculating the #ACC> All sources other than non?interest "earing lia"ilities li:e e(uity, preference share, de"enture and serves 5 surplus. Aon?interest "earing lia"ility which is given over here is current lia"ility and provision.
2. #hat is 6mega7s post?tax cost of de"t> 4enotations< r B /+C Dv ?/++ Do ?//2 A B 8 yrs ,ormula for nding E d Current value of de"enture
F interest $.G0,A Ed, n % Hmaturity value $.G0, Ed, n % At -C //2 F /+$.G0,A -C, 8 % H /++$.G0, -C, 8 % F /+$*.9-/% H /++$+.*82% F*9.-/H*8.2 F//-.9/ At 8C //2 F /+$.G0,A 8C, 8 % H /++$.G0, 8C, 8 % F /+$*.-3-% H /++$+.*3+% F *-.3- H *3.+ F ///.3- 0nterpolation< Actu al //2 4iferen ce .age ) Case Study Analysis *.9/ at -C //-.9 / ;.33 at 8C ///.3 - F +.+- H $+.+8?+.+-%*.9/I;.33 F7.92 C
.ost tax cost of de"t F -.92$/?+.)+% F 5.54 % ). #hat is 6mega7s cost of preference> 4enotations< r B 9C Dv ?/++ Do ?/+; A B * yrs ,ormula for nding E p Current value of share
F interest $.G0,A Ep, n % Hmaturity value $.G0, Ep, n % At -C /+; F 9$.G0,A -C, * % H /++$.G0, -C, * % F 9$3./++% H /++$+.-/)% F);.9 H -/.) F/+8.2 At 8C /+; F 9$.G0,A 8C, * % H /++$.G0, 8C, * % F 9$).99)% H /++$+.;8/% .age 3 Case Study Analysis F )*.9)- H ;8./ F /+3.+) 0nterpolation< Actu al /+; 4iferenc e 2.2 at -C /+8.2 3./- at 8C /+3.+ ) F +.+- H $+.+8?+.+-%2.2I3./- F7.53 3. #hat is 6mega7s estimated cost of e(uity using dividend discount model> 4iv+ F 2.8+ .+ F8+ J F/+C E e F 4iv / I . + H g F2.8+$/./+%I8+H +./+ F +.)8* H +./+8+F +./)8* F 13.85% *. #hat is 6mega7s estimated cost of e(uity using the capital asset pricing model> 4enotations< 1m? - $1m?1f%?- K? /./ .age * Case Study Analysis EeF 1fH $1m?1,% K F - H /./$-% F 14.70% ;. #hat is 6mega7s #ACC using CA.M for the cost of e(uity>
sou!"s o# #u$% &o&o' (o$ Cos' )AC C '(uity +.* /3.- -.)* .referen ce +./ -.*) +.-*) 4e"entu re +.3 *.*3 2.2/;
10.31 9 -. #hat would "e your estimate cost of capital for the new "usiness>
Sou!" s o# #u$% Po&o' (o$ Cos' )AC C '(uity +.* /-.* 8.-* 4e"entu re +.* -.- ).8* 12.* E e F 1f H $1m?1f% K F - H $-% /.* F /-.*C 8. #hat is the diference "etween company cost of capital and pro!ect cost of capital> Company7s cost of capital is /+.)2 and pro!ect7s cost of capital is /2.;. Thus, Company7s cost of capital is less than pro!ect7s cost of capital so Suman Joshi, Managing director of omega textile shall continue with its current "usiness. .age ; Case Study Analysis CASE+ 2 )OR,IN- CAPITAL FINANCIN- SUMMARY< This case represents a dilemma of a management graduate who has "een placed in one of the leading "an:s of 0ndia. Suresh .ai faced one client who is in re(uirement of wor:ing capital nance. Suresh was the only one who could deal with this pro"lem as other executives were of diferent departments. The demand of customer was of incremental wor:ing capital nance of 1s ;+ la:h $,rom 1s /3+ la:h and 1s 2++ la:h%. Le was approaching predecessor of Suresh since many days "ut did not have any :ind of feed"ac:. Le as:ed Suresh to do his "est and provided him with various data of previous two years and also the pro!ected data for next year. Suresh has a challenging tas: of computing all the details and compute .age - Case Study Analysis the data and provide the result to the head of that "an:. Dut he nds that lending can only "e done "y following second method of Tondon committee. ,or this approval he has to get an approval from head oMce as lending amount exceeds / crore. I.&o'/$' !o$!"&'s "0/'"% 'o !/s"1 To$%o$ !o..(''""1 0n /9-3, a study group under the chairmanship of Mr. .. &. Tondon was constituted for framing guidelines for commercial "an:s for follow?up 5 supervision of "an: credit for ensuring proper end?use of funds. The group su"mitted its report in August /9-*, which came to "e popularly :nown as Tondon Committee7s 1eport. 0ts main recommendations related to norms for inventory and receiva"les, the approach to lending, style of credit, follow ups 5 information system. 0t was a landmar: in the history of "an: lending in 0ndia. #ith acceptance of ma!or recommendations "y 1eserve Dan: of 0ndia, a new era of lending "egan in 0ndia. To$%o$ !o..(''""2s "!o.."$%/'(o$s1 Drea:ing away from traditional methods of security oriented lendingN the committee en!oyed upon the "an:s to move towards need "ased lending. The committee pointed out that the "est security of "an: loan is a well functioning "usiness enterprise, not the collateral. M/3o "!o.."$%/'(o$s o# '4" !o..(''"" 5"" /s #o00o5s1 /. Assessment of need "ased credit of the "orrower on a rational "asis on the "asis of their "usiness plans. .age 8 Case Study Analysis 2. Dan: credit would only "e supplementary to the "orrower7s resources and not replace them, i.e. "an:s would not nance one hundred percent of "orrower7s wor:ing capital re(uirement. ). Dan: should ensure proper end use of "an: credit "y :eeping a closer watch on the "orrower7s "usiness, and impose nancial discipline on them. 3. #or:ing capital nance would "e availa"le to the "orrowers on the "asis of industry wise norms $prescri"e rst "y the Tondon Committee and then "y 1eserve Dan: of 0ndia% for holding diferent current assets, viO. R/5 ./'"(/0s ($!0u%($6 s'o"s /$% o'4"s ('".s us"% ($ ./$u#/!'u($6 &o!"ss. Stoc: in .rocess. ,inished goods. Accounts receiva"les. *. Credit would "e made availa"le to the "orrowers in diferent components li:e cash creditN "ills purchased and discounted wor:ing capital, term loan, etc., depending upon nature of holding of various current assets. ;. 0n order to facilitate a close watch under operation of "orrowers, "an: would re(uire them to su"mit at regular intervals, data regarding their "usiness and nancial operations, for "oth the past and the future periods M"'4o%s o# 0"$%($61 There are ) methods of lending money to the "orrowers. The "elow mentioned is the 2 nd method of lending money. 0n order to ensure that the "orrowers do enhance their contri"utions to wor:ing capital and to improve their current ratio, it is necessary to place them under the second method of lending recommended "y the Tondon committee which would give a minimum current ratio of /.))</. The "orrower will have to provide a minimum of 2*C of total current assets .age 9 Case Study Analysis from long?term funds. Lowever, total lia"ilities inclusive of "an: nance would never exceed -*C of gross current assets. As many of the "orrowers may not "e immediately in a position to wor: under the second method of lending, the excess "orrowing should "e segregated and treated as a wor:ing capital term loan which should "e made repaya"le in installments. To induce the "orrowers to repay this loan, it should "e charged a higher rate of interest. ,or the present, the group recommends that the additional interest may "e xed at 2C per annum over the rate applica"le on the relative cash credit limits. This procedure should "e made compulsory for all "orrowers $except sic: units% having aggregate wor:ing capital limits of rs./+ lacs and over. 7/!8 'o !/s"1 ,rom "orrowers le we nd that the limits sanctioned to him are su"!ect to the following norms< P0n assessing the wor:ing capital advance the "an: will follow the average holding levels prevalent in their industry, which as updated on +/?+3?2+// are as follows< Maximum holding level for raw material and stores< ) months of consumption. #or: in process< +.* months of cost of production ,inished goods< 2 months of cost of sales 1eceiva"les< ) months of net sales Trade credit< 2 months purchase or the actual credit period en!oyed whichever is higher The level of CA may "e set at ) percent of the rest of the CA.7 =</ The holding levels for raw materials, wor: in process, nished goods, de"tors and creditors as seen from "orrowers own pro!ections. .age /+ Case Study Analysis =< 2 M.D, under the second method of lending as per the norms set "y the "an: =< ) whether to recommend any increase in the present wor:ing capital limit of 1s. /3+ lacs or not and if the latter, how to explain the reasons to the client and the course of action desired "y the "an:. So0u'(o$1 A$s5" 11+ Computation of Lolding level of 1aw material F1aw Material 0nventory91aw Material Consumption F;+I/8+Q/2 F3 Month Computation of Lolding level of #or: in progress F #or: in .rogress 0nventory9 Cost of .roduction F2+I)8+Q/2 F+.;)/* Month Computation of Lolding level of ,inish good consumption period F ,inish JoodI C6JS F*+I)8+Q/2 F/.*- Month 4e"tors conversion period F 4e"tors I Credit Sales F23+ I -++ Q /2 F 3.// Months Creditors 4eferral .eriod F Creditors I Credit .urchase F/)+ I /9+ Q /2 .age // Case Study Analysis F8.2/ Months A$s5"1 2 MP7F C('"(/ :; To$%o$ !o..(''"" As per the Tondon committee M.D, $Maximum .ossi"le Dan: ,inance% the value of the current assets must "e 2*C of the total current assets. So this criteria is satised "y the availa"le data for pro!ected year. S"!o$% M"'4o% o# L"$%($6 @nder this method, it was thought that the "orrower should provide for a minimum of 2*C of total current assets out of long?term funds i.e., owned funds plus term "orrowings. A certain level of credit for purchases and other current lia"ilities will "e availa"le to fund the "uild up of current assets and the "an: will provide the "alance $M.D,%. Conse(uently, total current lia"ilities inclusive of "an: "orrowings could not exceed -*C of current assets. Lere current lia"ility inclusive of "an: "orrowings is not exceeding -* C of current assets. As "oth the conditions are satised "y the client7s data Dan: can provide extra wor:ing capital of ;+ lacs. Answer: 3 Here, we have two option through which we can increase in working capital or not. As per the Companys Standard. We can not increase in working capital. Because we can not satisfy the criteria of companys standard. As per companys standard holding level for raw material is 3 months of consumption But as per projection it is months. !o it is not good for firm. Working process is ".# months of cost of production $ut as per projection it is ".% month Which is not good for company, finished goods is & months of cost of sales and as per projection it is '.#(. .age /2 Case Study Analysis Here company can get $enefit in )reditors *eferral +eriod. Because as per companys standard credit period is & months of purchase $ut as per projection it is ,.&' -onths. !o company can enjoy credit of , months. Which is $eneficial for the company. As per second method of Tondon committee, We can accept the increment. /nder this method, it was thought that the $orrower should provide for a minimum of � of total current assets out of long1term funds i.e., owned funds plus term $orrowings. A certain level of credit for purchases and other current lia$ilities will $e availa$le to fund the $uild up of current assets and the $ank will provide the $alance -a2imum permissi$le $anking finance 3-+B45. )onse6uently, total current lia$ilities inclusive of $ank $orrowings could not e2ceed (#0 of current assets. Here, company can fulfill all the criteria of tendon )ommittee and through which company can increase in working capital. .age /)