395 37 Solutions Case Studies 4 Time Value Money Case Solutions Chapter 4 FM

Rajiv Srivastava & Anil Misra

Financial Management, 2e

CHAPTER 4 TIME VALUE OF MONEY CASE- BHARAT ENGINEERING WORK CASE OBJECTIVE: The case study aims at showing the computation of Equated Quarterly Installments and splitting the same into the principal and interest components.

DISCUSSION POINTS: • • • •

Concept of annuity and its application in the case study What will be the cash outflows for the firm during the moratorium period of first two years The model for finding of value of annuity; value of principal; and value of interest (Reference may be made to PMT, PPMT, and IPMT formulae built-in excel) Relationship between the rate of interest and period of compounding/discounting. (The rate of interest given in the case is 12% p.a. but since it is the case of quarterly installments the equivalent quarterly rate needs to be taken for the purpose of computations. The effective rate in the case shall be taken as

12 = 3% 4

SUGGESTED APPROACH TO THE DISCUSSION QUESTIONS:

1. The value of EQI is given in Column D of tables 4-1 and 4-2. Table 4-1: Computation of Interest during the Moratorium period

Year

Quarter

Beginning Balance

(A)

(B)

(C)

1

2

1 2 3 4 1

30.00 30.00 30.00 30.00 50.00

EQI

(D) 0.00 0.00 0.00 0.00 0.00

Closing Annual Principal Interest Balance Interest

(E)

(F)

(Rs. in lakh) 0.00 -0.90 0.00 -0.90 0.00 -0.90 0.00 -0.90 0.00 -1.44

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(G) 30.00 30.00 30.00 30.00 50.00

(H)

-3.60

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50.00 50.00 50.00

0.00 0.00 0.00

0.00 0.00 0.00

-1.44 -1.44 -1.44

50.00 50.00 50.00

-5.78

Table 4-2: EQIs for the next 20 quarters for the repayment of loan

Beginning Year Quarter Balance (A) (B) (C) 3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Total

60.00 57.77 55.47 53.10 50.66 48.15 45.56 42.89 40.14 37.32 34.40 31.40 28.31 25.13 21.85 18.47 14.99 11.41 7.72 3.92

EQI (D) -4.03 -4.03 -4.03 -4.03 -4.03 -4.03 -4.03 -4.03 -4.03 -4.03 -4.03 -4.03 -4.03 -4.03 -4.03 -4.03 -4.03 -4.03 -4.03 -4.03 -80.66

Principal Interest (E)=(D)-(F) (F) (Rs. in lakh) -2.23 -1.80 -2.30 -1.73 -2.37 -1.66 -2.44 -1.59 -2.51 -1.52 -2.59 -1.44 -2.67 -1.37 -2.75 -1.29 -2.83 -1.20 -2.91 -1.12 -3.00 -1.03 -3.09 -0.94 -3.18 -0.85 -3.28 -0.75 -3.38 -0.66 -3.48 -0.55 -3.58 -0.45 -3.69 -0.34 -3.80 -0.23 -3.92 -0.12 -60.00 -20.66

Closing Balance (G)=(C)-(E) 57.77 55.47 53.10 50.66 48.15 45.56 42.89 40.14 37.32 34.40 31.40 28.31 25.13 21.85 18.47 14.99 11.41 7.72 3.92 0.00

Annual Interest (H)

-6.79

-5.62

-4.30

-2.81

-1.14

2. The interest component of EQI is given in Column (F) of the two tables given above. The sum of interest to be charged to the P&L account by Bharat Engineering has been given year-wise in column (H) of the two tables.

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Rajiv Srivastava & Anil Misra

Financial Management, 2e

CHAPTER 5 RISK AND RETURN CASE- UNITED BANK’S BUSINESS

CASE OBJECTIVE: The case aims at calculating expected return and risk. Average and standard deviation have been computed and proposed as the measure of expected return and risk respectively in the case.

SUGGESTED APPROACH TO THE DISCUSSION QUESTIONS: 1. Working capital limits for Excellent Stores have been given in Column D of the Table 5-1. The peak limit of working capital has been computed as follows:

Std. Dev × 1.5 + Average daily sales

66.42 × 1.5 + 161.71= Rs. 261350 Figures given in column D other than the peak working capital limit show the normal working capital limit.

Table 5-1: Working Capital limits and Interest calculations

Week

(A) 1 2 3 4 5 6 7 8 9 10 11 12

Sales of Kwality Stores for the previous year (B) (Rs. In 000) 135.00 400.00 196.00 258.00 354.00 120.00 78.00 96.00 364.00 223.00 198.00 146.00

Projected Sales for Excellent Stores for the coming year

Working capital limit

Interest

(C) = B X 0.75 (Rs. In 000) 101.25 300.00 147.00 193.50 265.50 90.00 58.50 72.00 273.00 167.25 148.50 109.50

(D) (Rs. In 000) 161.71 261.35 161.71 193.50 261.35 161.71 161.71 161.71 261.35 167.25 161.71 161.71

(E) (Rs) 40,428 71,085 40,428 50,209 71,085 40,428 40,428 40,428 71,085 42,132 40,428 40,428

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13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52

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188.00 225.00 165.00 144.00 98.00 113.00 149.00 256.00 274.00 356.00 389.00 162.00 165.00 123.00 91.00 332.00 229.00 298.00 335.00 146.00 198.00 173.00 228.00 263.00 194.00 225.00 239.00 322.00 398.00 146.00 122.00 189.00 236.00 294.00 336.00 198.00 233.00 155.00 95.00 162.00

141.00 168.75 123.75 108.00 73.50 84.75 111.75 192.00 205.50 267.00 291.75 121.50 123.75 92.25 68.25 249.00 171.75 223.50 251.25 109.50 148.50 129.75 171.00 197.25 145.50 168.75 179.25 241.50 298.50 109.50 91.50 141.75 177.00 220.50 252.00 148.50 174.75 116.25 71.25 121.50

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161.71 168.75 161.71 161.71 161.71 161.71 161.71 192.00 205.50 261.35 261.35 161.71 161.71 161.71 161.71 249.00 171.75 223.50 251.25 161.71 161.71 161.71 171.00 197.25 161.71 168.75 179.25 241.50 261.35 161.71 161.71 161.71 177.00 220.50 252.00 161.71 174.75 161.71 161.71 161.71

40,428 42,594 40,428 40,428 40,428 40,428 40,428 49,747 53,901 71,085 71,085 40,428 40,428 40,428 40,428 67,286 43,517 59,440 67,978 40,428 40,428 40,428 43,286 51,363 40,428 42,594 45,824 64,978 71,085 40,428 40,428 40,428 45,132 58,517 68,209 40,428 44,440 40,428 40,428 40,428

Rajiv Srivastava & Anil Misra

Average weekly sales Std. Deviation Expected interest income Std. deviation of interest income

Financial Management, 2e

431.23

161.71

88.57

66.42

48,069.97

11,484.76

Normal working capital limit has been computed as the higher of weekly sales and 50% of the average weekly sales for two weeks but subject to an upper limit equal to the peak working capital value. That is if sales is higher than the 50% of the average weekly sales for two weeks then the sales value becomes the normal working capital limit provided it is less than peak limit. If sales is higher than the peak working capital limit also then bank’s financing for peak working capital gets limited up to peak working capital only. 2. Expected interest income is the average of the interest income computed above as Rs. 48,069.97 3. Standard deviation of interest income is Rs, 11,484.76.

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Rajiv Srivastava & Anil Misra

Financial Management, 2e

CHAPTER 6 VALUATION AND MANAGEMENT OF BONDS CASE- NATURE CARE INDIA LTD.

CASE OBJECTIVE: The case has following objectives: • •

Computation of intrinsic value of bond Computing the various types of yields on bonds that investors take into account while deciding about investing in them

DISCUSSION POINTS: • • • •

What are the variables that determine the intrinsic value of bonds? How does intrinsic value help in investment decisions How are the different types of yields on bonds computed? What is their relevance in investment decisions? What is the impact of calling the bonds by the issuing company (at par and at premium) before maturity the following on the value and yields of bonds?

SUGGESTED APPROACH TO THE DISCUSSION QUESTIONS: Facts of the case: • • • • • •

Face Value of NCD = Rs. 100 Duration of NCD = 9 years Coupon rate = 10.20% Periodicity of coupon payment = annual Redemption value = Rs. 100 Discount rate = 12%

1. Intrinsic value calculation is shown in table 6-1

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Rajiv Srivastava & Anil Misra

Financial Management, 2e

Table 6-1: Computing the value of a 9-year non-convertible debenture with annual coupon payments

Coupon No.

Coupon payment Present value (Rs.) (Rs.)

1

10.20

9.11

2

10.20

8.13

3

10.20

7.26

4

10.20

6.48

5

10.20

5.79

6

10.20

5.17

7

10.20

4.61

8

10.20

4.12

9

10.20

3.68

Redemption 10

32.20 Rs 86.55

100.00 Value of the bond

2. The YTM calculations are given in Table 6-2

Coupon No.

0 1 2 3 4 5 6 7 8 9 10

Purchase and Redemption (Rs) (100.00)

100.00

Coupon Payment (Rs) 10.20 10.20 10.20 10.20 10.20 10.20 10.20 10.20 10.20 10.20

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Total Cash flow (Rs) (100.00) 10.20 10.20 10.20 10.20 10.20 10.20 10.20 10.20 10.20 110.20

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Financial Management, 2e

IRR of annual cash flow

10.20%

Since the issue price and the redemption value are same the YTM (10.20%) is same as the coupon rate. 3.

Table 6-3: Computation of yield to call for investors if they put the NCD at 10% premium at the end of 5th year

Coupon No.

0 1 2 3 4 5

Purchase and Redemption (Rs) (100.00)

Coupon payment (Rs)

Total Cash flow (Rs)

10.20 10.20 10.20 10.20 10.20

(100.00) 10.20 10.20 10.20 10.20 120.20

110.00 IRR of annual cash flow

110.00 22.85%

4. Nature care with a credit rating of AAA for its NCD is offering a coupon rate of 10.20%. This is at a premium over the yield that the investors can get by investing in available options with similar risk. Since it offers a premium of 1.1%-1.25% over the other two bond offerings with AAA credit rating (by LIC Housing Finance and Rural Electrification Corpn.) during the period it is surely more rewarding for the investors.

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Rajiv Srivastava & Anil Misra

Financial Management, 2e

CHAPTER 7 SHARES AND THEIR VALUATION CASE- EURO CERAMICS LTD.

CASE OBJECTIVE: The case is aimed at highlighting the subjectivity involved the process of stock valuation. It is this subjectivity that is responsible for the diversity of opinions with respect to the intrinsic value of scrip and makes some investors bullish vis-à-vis a stock while others bearish towards the same. The case is aimed at initiating the discussion that may lead to discovery of multiple prices.

DISCUSSION POINTS: • •

• •

The different parameters that are used in relative valuation (P/E, P/B multiples etc.) Which one of the available relative valuation metrics should be used in a given scenario? (The instructor may highlight the two most prominent measures in this regard-P/E and P/B) The concept of leading and lagging P/E Is it intrinsic value arrived at reliable? (the instructor may highlight the method of arriving at the intrinsic value using multiple drivers by assigning weights to them)

SUGGESTED APPROACH TO THE DISCUSSION QUESTIONS: 1. Since data on multiples other than P/E is not available the P/E shall be used for relative valuation. Using the industry P/E the intrinsic value ranges between Rs. 103 and 397.17. The price based on the average P/E multiple for the industry comes to 267.15. The Seen in this light the issue price of Rs. 165 seems to be justified as at this level the P/E of the firm works out to be 9.26 which seems to be reasonable. But merely basing the judgment on the P/E ratio, that too industry P/E, may lead to a misleading price. It is always better to use more than one relative valuation method and also to compare the results arrived at with the cash flow based valuation. Different investors basing their judgment of fair value on the different multiples are likely to get multiple results. Which one of them is a correct value is anybody’s guess as the markets value a stock based on not only the past financial performance. Future projections and qualitative and nonquantifiable issues also play a vital role in the process. Since the case study is based on real life case the extent of oversubscription can be looked at to justify the issue price.

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Financial Management, 2e

2. Additional earnings of 6.07 lakh need to be made by the firm to ensure that its existing level of EPS (17.81) is maintained.

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Rajiv Srivastava & Anil Misra

Financial Management, 2e

CHAPTER 10: VALUATION AND CORPORATE GOVERNANCE CASE- AMARA RAJA BATTERIES

CASE OBJECTIVE: The case study is aimed at making the valuation of the firm using the Discounted Cash Flow (DCF) approach. In the process the computation of Free Cash Flow to Equity (FCFE) and Free Cash Flow to Firm (FCFF) have also been arrived at. The case also covers the valuation using the relative valuation approach.

DISCUSSION POINTS: • • •

What is FCFE and how is it computed. (The instructor may highlight the adjustments made to PAT to arrive at FCFE) The concept of. How it is computed and what is the difference between FCFF and FCFE? How is the valuation of firm done using the DCF approach and relative valuation method?

SUGGESTED APPROACH TO THE DISCUSSION QUESTIONS: 1. Table 10-1: Computation of FCFE Free Cash Flow to Equity (FCFE) PAT Add: Depreciation Less: Increase in CAPEX Less: CAPEX funded by debt CAPEX funded by equity Less: Increase in working capital Free Cash Flow to Equity (FCFE)

Mar 02

Mar 03

Mar 04

Mar 05

Mar 06

18.22 8.41 ---------------------

7.40 11.70 10.26 -3.62 13.88 3.17 2.05

1.39 12.31 3.70 5.14 -1.44 15.67 -0.53

8.69 13.63 9.22 8.42 0.80 15.82 5.70

23.84 14.70 27.01 14.57 12.44 13.70 12.40

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Rajiv Srivastava & Anil Misra

Financial Management, 2e

2. Table 10-2: Computation of FCFE for year 2007 Free Cash Flow to Equity (FCFF) PBDIT Less: Interest Less: Tax Less: CAPEX funded by debt Less: CAPEX funded by equity Less: Increase in working capital FCFE

Mar-07 91.29 3.09 25.15 15.20 79.80 34.29 -51.04

The above calculations in table 10-2 have been made based on following assumptions: • •

•

The debt-equity ratio remains at 2006 level (16% debt and 84% equity) The growth rate in sales during the high growth phase (2007-12) has been taken as 35%. This has been used to project the sales for year 2007 onwards. Sales for 2007 have thus been estimated as Rs. 528.78 crores. NCA to sales ratio for 2007 remains constant at 2006 levels (25.01%). Working capital for the year 2007 has been taken as 25.01% of the projected sales (i.e. 25.01% of 528.78 crores = 34.29 crores)

It may be noted that FCFE in year 2007 is negative. This is due to a high growth that the company is facing. Companies witnessing high growth phase reinvest heavily in capacity expansion of the business that brings down its FCFE. In case of Amara Raja CAPEX in the year 2007 has gone up significantly by 95 crores. 3. & 4. Table 10-3: Computation of FCFE for year 2008-12

Free Cash Flow to Equity (FCFF) PBDIT Less: Interest Less: Tax Less: CAPEX funded by debt Less: CAPEX funded by equity Less: Increase in working capital FCFE Terminal Value Net Cash Flows

Mar-08

Mar-09

Mar-10

Mar-11

Mar-12

97.23 3.09 26.79 15.20 79.80 46.30 -58.74 -----58.74

131.26 3.09 36.16 15.20 79.80 62.50 -50.29 -----50.29

177.20 3.09 48.82 15.20 79.80 84.37 -38.88 -----38.88

239.22 3.09 65.90 15.20 79.80 113.90 -23.48 -----23.48

322.94 3.09 88.97 15.20 79.80 153.77 -2.69 826.86 824.17

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Financial Management, 2e

PV Factor at 20.30% PV of Net Cash Flows Value of the Firm (Rs. In crores) Value per share (Rs. 209.98 crores/113.9 shares)

0.831 -48.83

0.691 -34.75

0.574 -22.33 209.98

0.477 -11.21

0.397 327.11

I85.35

The above calculations have been done based on the following assumptions: • 35% growth on the top line is maintained for the next 5 years (2008-12). After the 5th year the growth rate gets normalized and settles down at 5%. • PBDIT to sales ratio for the period 2008-12 is assumed to remain constant at 2007 level 0f 13.62% • Tax to PBDIT ratio to remain constant at 25.26% • Debt-equity ratio remains constant at 2006 levels. Hence interest outflow remains constant at 3.09 crores Cash Flows (FCFE) have been discounted at cost of equity. Cost of equity has been computed using the CAPM model as follows: 6.5%+12%X 1.15 = 20.30 For the period beginning from 2013 beta has been assumed to have come down to 0.80 and thus cost of equity has come down to 16.1%. This 16.1% has been used for discounting the terminal cash flow.

5.

The value of share arrived at by HDFC using the relative valuation method comes to around Rs. 453 which is not the same as the value arrived (Rs. 185) at using the DCF approach. It may be pointed out that the valuation depends on the assumptions made in cash flow computations. With the assumptions changing value also changes. The value arrived at by two professional varies due to these assumptions. That is why valuation process involves subjectivity. It is due to the different perceptions and assumptions that lead to different values the position of the shareholders vis-à-vis a stock varies.

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