CWA/ICWA Final :: Valuation Management and Case Study : December 2003

*F-20(VMC)* *Revised Syllabus*
Time Allowed : 3 Hours		Full Marks : 100
Answer Question No. 1 which is compulsory carrying 20 marks and any five from the rest.
Marks

(a)

State whether the following statements are true or false:

(i)	Internal rate of return (IRR)
(ii)	Value drivers for a business are the drivers of cash flow.
(iii)	Market replacement cost method is a method of valuation under cost approach.
(iv)	Economic value added (EVA) is a measure to determine whether an investment contributes positively to the owner’s wealth.
(v)	Yield capitalization method is an example of market approach of valuation.
(vi)	Under Walter’s valuation model, the share price reflects only the present value of expected dividend in the long run.

1x6=6

(b)

Fill in the blanks:

1x10=10

(i)	______ method of valuation states that the assets of the business are worth what it would cost of replace them. (Discounted cash flow/ average cost/ Replacement cost)
(ii)	A merger of firms engaged at different stages of production but in the same industry is called ______ (horizontal merger/ vertical merger/ concentric merger)
(iii)	______ model of option valuation is used where time period and share price movements are small. (Dividend discount/ Binomial/ Black and Scholes)
(iv)	Sale of total firm, in parts, is urgently referred to as ______ (liquidation/ diverstiture/ spin-off)
(v)	The price earning ratio is calculated in case of ______ (listed companies/unlisted companies)
(vi)	A negative Economic Value Added indicates that the firm is ______ value. (destroying/ creating)
(vii)	______ is market related intangible asset. (Trademark/ Technical know-how/ Leasehold interests)
(viii)	A brand is valued as ______ asset. (tangible/ intangible)
(ix)	Value creation for a business is possible by ______ the present value of expected cash flows. (maximizing/ abnormally)
(x)	Super profit is the excess of future maintainable profits over ______ expected profits. (normally/ abnormally)

(c)

Gordon growth model using dividend capitalization is based on certain assumptions. These are—

(i)	Rate of return is, not constant . Yes/ No
(ii)	Cost of capital remains constant. Yes/No
(iii)	Cost of capital is lower than its growth rate. Yes/No
(iv)	Retained earnings represent the only source of financing.Yes/No

4x1=4

(a)

Explain the various methods of payment in case of merges and amalgamations.

(b)

Assuming no taxes and given the Earnings Before Interest and Taxes (EBIT) , interest (I) at 10% and equity capitalization rate (Ke) below:

Firms	EBIT	I (Rs.)	Ke (per cent)
X Y Z W	2,00,000 3,00,000 5,00,000 6,00,000	20,000 60,000 2,00,000 2,40,000	12 16 15 18

(i)	Calculate the total market value of each firm; and
(ii)	Determine the weighted average cost of capital for each firm.

(a)

Briefly discuss the different dividend models for valuation of shares.

(b)

A company belongs to a risk class for which the appropriate capitalization rate is 10 percent. It currently has outstanding 25,000 shares selling at Rs.100 each. The firm is contemplating the declaration of dividend of Rs. 5 per share at the end of the current financial year. The company expects to have a net income of Rs.2.5 lakhs and has a proposal for making a new investment of Rs.5 lakhs
Show that under the Modigliant and Miller assumptions, the payment of dividend does not affect the value of the firm.

Please turn over

( 2 )

F-20(VMC)
Revised syllabus

Marks

You have been provided the following financial data of two companies:

	Krishna Ltd.	Rama Ltd
Earning after taxes Equity shares outstanding Earning per share Price-earning ratio Market price per share	Rs.7,00,000 Rs.2,00,000 3.5 10 times Rs.35	Rs.10,00,000 Rs.4,00,000 2.5 14 times Rs.35

Company Rama Ltd. is acquiring the company Krishna Ltd. exchanging its shares on a one-to-one basis for company Krishna Ltd’ shares. The exchange ratio is based on the market prices of the shares of the two companies.
You are required to calculate:

(i) The EPS subsequent to merger,

(ii) Change in EPS for the shareholders of Rama Ltd and Krishna Ltd,

(iii) The market value of the post-merger firm,

(iv) The profits accruing to shareholders of both the Companies.

(a)

The financial data of G.D. Pharma is as follows:

Paid up capital (4 lakh shares)
Reserve and surplus
Profit after tax

Rs.
Rs.
Rs.

40 lakhs
180 lakhs
32 lakhs

The P/E multiple of the shares of G.D.Pharma is 7. The company has taken up an expansion project at Gaziabad. The cost of the project is Rs. 200 lakhs. It proposes to fund it with a term loan of Rs.100 lakhs from ICICI and balance by a rights issue. The rights will be priced at Rs.25 per share (Rs.15 premium).
You are required to calculate—

(i)	The value of the rights and the market capitalization of G.D. Pharma after the rights issue, and
(ii)	The Net Asset Value (NAV) of the shares after the rights share.

(b)

Sunny Ltd is studying the possible acquisitions of Rainy Ltd and the following information is available:

	Sunny Ltd	Rainy Ltd
Profit after tax Equity shares outstanding P/E multiple	Rs.3,00,000 Rs.50,000 3	Rs.75,000 Rs.10,000 2

If the merger takes place by exchange of equity shares based on market price, what is the EPS of the new firm?

(a)

Banana Leaf is a popular restaurant in South India, owned and runf by Radhaswamy , a star chef specializing in South Indian cuisine. You are interested in buying the restaurant and have been provided the following data:

The restaurant can seat 100 diners. It has two seatings for lunch and one seating for dinner. It fills 80% of its seats at lunch and 70% of its seats at dinner. The restaurant remains open for 340 days a year for the pu blic. The average price of a lunch is Rs.40 and the average price of a dinner is Rs.50. The cost of food is approximately 30% of the price if the meal. There are 25 employees on the staff of the restaurant and the payroll amounts to Rs.10 lakhs a year. The annual rent for the space used by the Banana Leaf is Rs.2,40,000.

The restaurant is expected at present to grow 6% a year for 3 years and 3% a year after that. You estimate the un levered beta of publicity by trader restaurants to be 0.70. the average debt to capital ratio for these firms is 10%. The risk free rate is 8% and the market risk premium is 5.5%.

You are required to estimate the value of the Banana Leaf (assume the tax rate is 40% and the cost of borrowing is 9%)

(b)

S.K. Lab a pharmaceutical company in Western India was expected to have revenues of Rs.50 lakhs in 2003., and report net income of Rs.9 lakhs in that year.

The firm had a book value of assets is Rs.110 lakhs and a book value of equity of Rs.58 lakhs at the end of 2002. its market value, then was Rs.85 per share.

The firm was expected to maintain sales in its niche product, a multivitamin tablet, and grow at 5% a year in the long term, primarily by expanding into the genetic during market. The beta of S.K Lab treated in Mumbai Stock Exchange was 1.25.

The return on 10 year GOI bond in India in 2002 was 7% and the risk premium for stocks over bond is assumed to be 3.5%.

Do you consider the market price as the fair value of the shares of S.K. Lab?

Please turn over

( 3 )

F-20(VMC)
Revised syllabus

Marks

Nav Udyog. A venture capital fund has specialized in providing bridge finance to young technocrafts in Biotechnology sector. The fund has received an investment proposal from Intellect Ltd., a Bio-tech firm, to finance its recent project with equity investment of Rs.10 crore. The firm is an existing profit making organization with a dividend track record of 3 years. The current EPS of the company is Rs.5. the expected growth on EPS for the next year is as follows:

Growth in EPS(%)	Probability
0 25 35 40	0.20 0.30 0.40 0.10

The venture fund reckons that the P/E ratio for this induatry will be as follows:

P/E ratio	Probability
8 9 12	0.30 0.40 0.30

The fund finaces every project for 1 year. The fund invests only ion those projects where the probability of getting target return of 35% is atleast 75%. The fund is expected to dispose of its investment at industry PIE ratio.
What should be the price at which Nav Udyog would make the investment?

Funtime Ltd. a toy manufacturing company, has aggressive plans for expanding its market share. To get faster market access the management of the company has decided in favour of take over. The research wing og Funtime Ltd. has undertaken a detailed study of prospective takeover targets and finally identified Giggle Ltd., a company based in Baroda. Funtime Ltd. has already collected the following relevant information about Gigle Ltd. it is now to access the value of Giggle’s to start negotiation for the take over.

Balance sheet of Giggle Ltd as on 31st March,2002
Liabilities	Amount	Assets	Amount
Share capital Reserves Term loan: IDBI Other Current Liabilities	80 6 100 20 300 506	Land Buildings Plant and machinery Other fixed assets Gross fixed assets Less: Accumulated depreciation Add: capital WIP Total fixed assets Inventories Receivables Other	4 40 100 6 150 64 86 16 102 120 160 124 506

Capital expenditure of Rs.86 lakhs will be incurred in 2003 and Rs.280 lakhs in 2004.

Other Information:	(Rs. In lakhs)
Particulars	2002	2003	2004	2005	2006	2007
Net sales Raw materials cost Power Employee related cost Administrative expenses Depreciation	1,100 480 20 56 21 10	1,160 500 23 61 24 14	1,600 660 32 80 32 41	2,100 880 43 88 37 42	2,400 940 44 100 39 42.4	2,500 960 48 110 41 42.8

The tax rate for the company is 30%. There is no charge on deferred taxes. The stock is currently trading at Rs.25 per share. The cost of equity is 20%.
Bank finance carries an interest rate of 20%. Based on the information given use the discounted cash flow approach to value Giggle Ltd.

Note:

Additional capital (issued at par)
Term loan

Rs.260 lakhs
Rs.220 lakhs

__________