CWA/ICWA Final :: Valuation Management and Case Study : December 2005

*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)

Attempt all the questions by selecting the correct option:

2x5=10

(i)

P/E rises when

(a)	Growth rises, discount rate falls , reinvestment rate is flat.
(b)	Growth falls, discount rate falls, reinvestment rate rises.
(c)	Growth exceeds, discount rate and reinvestment rate falls short of growth
(d)	Discount rate falls and reinvestment rate rises.

(ii)

which of the following statements is generally descriptive of efficient markets?

(a)	Inefficiency is not consistent with discounted cash flow valuation.
(b)	The stock market ‘always’ (nearly so) gets it right (that is the true value of the asset)
(c)	Investors can’t beat the market unless they have better information about the value of the asset.
(d)	Trading oriented strategies can beat the market.

(iii)

If growth is 10%, return on new investment is 20% and discount rate is 15%, then P/E is

(a)

1000

(b)

100

(c)

(d)

Not defined.

(iv)

Shareholders can align managers with enterprise goals by

(a)	Requiring more frequent and detailed reporting of operations.
(b)	Replacing debt with equity, thus forcing managers to invest inhigh-yield operational assets.
(c)	Establishment of Management By Objectives princilple.
(d)	Reviewing management’s hiring choices.

(v)

How does economic profit grow:

(a)	Increase in invested capital	(c)	Increase in shareholder’s return expectations
(b)	Increase in cost of capital	(d)	Decrease in shareholder’s return expectations.

(b)

State whether the following statements are true or false:

(i)	Organizational capital is a primary component of intellectual capital	(True/False)
(ii)	The PS ration becomes higher as riskness of a firm decreases	(True/False)
(iii)	Increase in strike price increases the value of call option.	(True/False)
(iv)	Zero coupon bonds do not make periodic interest payments.	(True/ False)

1x4=4

(c)

Fill in the blanks by filling the appropriate word given in brackets:

(i)	Land and Building is an example of _____asset. (Real/Financial)
(ii)	The risk in holding a Government bond is _____ the risk associated with a debenture issued by a company (More than/Less than)
(iii)	Since equity is a call option on the value of the firm, an increase in the variance in the firm value will lead to an _____ in the value of equity. (Increase/decrease)
(iv)	Investors expectations and the market appraisal of the performance of a firm is measured by _____(Earnings per share/ Return on equity ratio)
(v)	Dividend discount model is a specific case of _____ valuation. (Equity/Bond/ both equity and bond)
(vi)	If inflation is expected to go up in future periods, shorter term rates will be _____ than longer term rates. (Higher/ Lower)

1x6=6

(a)

Discuss various aspects of computation of economic value added and its application in business planning and valuation.

(b)

Explain the difference between financial and operating synergy?

(a)

Halfway online, an internet service provider has 1 million existing subscribers. Each subscriber is expected to remain for 3 years. Halfway expects to generate Rs.100 net after-tax cash flow (subscription revenue costs of providing service) per subscriber each year. Halfway has a cost of capital of 15%. Furthermore, assume that Halfway expects to add 100000 subscribers each year for the next 10 years and that the value added by eacj subscriber will grow from the current level in the inflation rate of 3% every year. The cost of adding a new subscriber is Rs.100 currently, assumed to be growing at the inflation rate.

Based on the information given, find out the firm and the value per existing subscriber.
(Note: Rs. 1 million = Rs. 10,00,000)

(b)

Why are sector specific multiples used by analysts?

Please turn over

( 2 )

F-20(VMC)
Revised syllabus

Marks

The following information is given for Glow-Health Ltd. a leading pharmaceutical company:

Year	After tax earnings (Rs in lakhs)	Dividends (Rs in lakhs)	Issued shares in lakh	Price per share In paise
2000 2001 2002 2003 2004	129.3 138.6 148.95 201.60 222.90	51.75 54.30 56.40 77.40 79.95	270 270 270 360 360	540 615 518 689 672

Year
2000
2001
2002
2003
2004

All share index
4646
4950
4268
3915
3458

Inflation rate
6%
5%
4%
3%
3%

Glow health’s cost of equity is estimated to be 12%.

(a)

Explain with numerical workings, the current dividend policy of Glow-Health Ltd and also discuss whether or not this appears to be successful.

(b)

Identify and consider additional information that might assist managers of Glow-Health in assessing whether the dividend policy has been successful.

(c)

Evaluate whether or not the company’s share price at the end of year 2001 was that might have been expected from the Dividend Growth Model. Briefly discuss the validity of your findings.

(a)

Laxmi Enterprise is to acquire a personal computer complete with multi-media kit and a printer. Its price is Rs.60,000. laxmi Enterprise can borrow Rs.60,000 from Punjab National bank at 12 % interest per annum to finance the purchase. The principal sum is to be repaid in 5 equal installments. Laxmi Enterprise can also have the computer on lease for 5 years and seeks your advice to know the maximum lease rent per year payable at the end of each year.
You collect the following additional information:

(i)	Interest on bank loan is payable at the end of each year.
(ii)	The full cost of the computer will be written off over the effective life of computer on a straight line basis. This is allowed for tax purposes.
(iii)	At the end of year 5, the computer may be sold fot Rs.1500 through second-hand dealer who will charge 8% commission on the sale proceeds.
(iv)	The company’s effective tax rate is 30%.
(v)	The cost of capital is 11%.
Suggest the maximum lease rental for Laxmi Enterprise.

(b)

What are the possible causes of horizontal and vertical merges?

What are the SEBI guidelines for valuation of unlisted share?

(a)

What is index futures and what are its salient features?

(b)

The settlement price of sensex futures contract on a particular day was Rs.4,600, Rs.8,000. The multiple of each contract is 50.
The settlement prices on the following four days were as follows:

Day
1
2
3
4
5

Settlement Price Rs.
4700
4500
4650
4750
4700

Calculate the mark to market cash flows and the daily closing balances in the accounts of
(a) an investor who has gone long , and
(b) an investor who has gone short at 4600
Calculate net profit (loss) on each of the contracts.

The Finance Director of Green Field Ltd is investing a potential Rs. 250 lakh investment. The investment would be in a bio-tech project a way fro, existing mainstream activities of computer hardware manufacture. Rs.60lakh of investment would be financed by internal funds., Rs.90 lakh by long-term loans and Rs.100 lakh by right issue. The investment is expected to generate pre-tax net cash-flows of approximately Rs.50 lakh a year, for a period of 10 years. The residual value at the end of the year 10 is forecast to be Rs.50 lakh after tax. Government loan of Rs.40 lakh out of total 90 lakh is also available. This will cost 2% below the company’s normal cost of long term debt finance which is 8%.

Green Field Ltd’s financial gearing is 60% equity and 40% debt by market value and its equity bets is 0.85. The average equity bets in computer hardware industry is 1.2, and average gearing 50% debt and 50% equity by marke value.

The risk free rate is 5.5% per annum and the market is 12% per annum. Issue costs are estimated to be 1% for debt financing (excluding subsidized loan) and 4% for equity financing.
The corporate tax is 30%.
(Issue costs are not tax deductible).

(a)

Estimate the adjusted present value of the proposed investment.

(b)

Explain the circumstances under which Adjusted Present Value (APV) might be a better method of evaluating a capital investment than Net Present Value (NPV).

__________