CWA/ICWA Final :: Valuation Management and Case Study : December 2006

*F-20(VMC)* *Revised Syllabus*
Time Allowed : 3 Hours		Full Marks : 100
The figures in the margin on the right side indicate full marks
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)	The dividend discount model generally tends to over value stocks when the overall market is depressed. [True/False].
(ii)	When stock buy backs take place, valuation on the basis of dividend payout ratio will over estimate the value of equity in firms. (True/False)
(iii)	Whenever the required return is different from the coupon interest rate, the amount of time to maturity does not effect bond value. (True/False)
(iv)	The constant growth model assumes that dividends will grow at a constant rate but a rate that is less than the required return. (True/False)
(v)	Corporate brands and service brands are often perceived to be interchargeable. (True/False)
(vi)	For calculating the value of an equity share by yield method, it is essential to know capital employed. (True/False)

1x6

(b)

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

(i)	The factor that affect the cost of bonds to the issuer is __________ (size of offering/cost of equity capital).
(ii)	A put option provides the holder the right to ______ the underlying security. (sell/buy).
(iii)	Diversification reduces risk at ______ rate as more and more securities are added to a portfolio. (increasing/decreasing).
(iv)	A warrant is a ________ option on the equity stock of the issuing company. (call/put)

1x4=4

(c)

Attempt all the questions by selecting the correct option:

(i)

Whenever investors find that the expected return is not equal to the required return-

(a)	A market price adjustment occurs.	(Yes/No)
(b)	A market price adjustment does not occur.	(Yes/No)

(ii)

If expected return is less than the required return-

(a)	Investors sell the asset.	(Yes/No)
(b)	Investors would buy the asset.	(Yes/No)

(iii)

If the expected return is above the required return-

(a)	Investors would buy the asset.	(Yes/No)
(b)	Investors would sell the asset.	(Yes/No)

(iv)

The Beta Coefficient is measured by—

(a)	The unsystematic risk of an asset in relation to that of the market portfolio.
(b)	The non-diversifiable risk of an asset in relation to that of the market portfolio.
(c)	The market risk of a security in relation to that of the market portfolio.
(d)	The systematic risk of an asset in relation to that of the unsystematic risk of an asset.

2x5=10

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( 2 )

F-20(VMC)
Revised syllabus

Marks

(v)

Which of the following not an assumption of Gordon growth model using dividend capitalization?

(a)	Retained earnings represent the only source of financing.
(b)	Rate of return is variable.
(c)	Cost of capital remains constant and is greater than growth rage.
(d)	The company has perpetual life.

(a)

Discuss how effectively shareholder value analysis indicates the creation of economic value for shareholders.

(b)

The following data relates to Morning Glory Ltd.

Profit and Loss data
	20 x 1 Rs. in lakh	20 x 2 Rs. in lakh
Turnover Pre-tax accounting Profit Taxation Profit after Tax Dividends Retained Earnings	1990 420 126 294 100 194	2360 530 160 370 120 250

Balance Sheet Data
	20 x 1 Rs. in lakh	20 x 2 Rs. in lakh
Fixed Assets Net Current Assets Finance by Shareholders funds Medium and long term Bank loans	740 800 1540 1190 350 1540	960 1000 1960 1440 520 1960

Pre-tax accounting profit is taken after deducting the economic depreciation of the company's fixed assets (also the depreciation used for tax purposes).
Additional Information:

(i)	Economic depreciation was Rs. 190 lakh in 20 x 1 and Rs. 210 lakh in 20 x 2.
(ii)	Interest expenses were Rs. 26 lakh in 20 x 1 and Rs. 36 lakh in 20 x 2.
(iii)	Other non-cash expenses were Rs. 64 lakh in 20 x 1 and Rs. 72 lakh in 20 x 2.
(iv)	The tax rate in 20 x 1 and 20 x 2 was 30%.
(v)	Morning Glory Ltd. has non-capitalized leases valued at Rs. 70 lakh in each year 20 x 0.20 x 2.
(vi)	The company's pre-tax cost of debt was estimated as 7% in 20 x 1 and 8% in 20 x 2.
(vii)	The company's cost of equity was estimated as 14% in 20 x 1 and 16% in 20 x 2.
(viii)	The target capital structure is 75% equity and 25% debt.
(ix)	Balance sheet capital employed at the end of 20 x 0 was Rs. 1390 lakh.
Estimate the economic value added for Morning Glory Ltd. for 20 x 1 and 20 x 2.

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( 3 )

F-20(VMC)
Revised syllabus

Marks

Sumangal Developer a leading promoter and land developer intends to construct luxary apartments this year or a year hence. The company has already acquired a vacant land in a residential area. Mr. Mounif the technical director along with Mr. Chitto finance director has worked out the following data to decide on when to construct the apartments:

Current interest rate = 12%

Current value of an apartment = Rs. 20 lakh.

Value of an apartment a year from now:

Rs. 26 lakh under unfavourable conditions.

Rs. 16 lakh under unfavourable conditions.

Constructon costs (this year as well as next year).

For a 8 unit building = Rs. 90 lakh.

For a 12 unit building = Rs. 120 lakh.

You are required to estimate the value of land using option pricing model approach and decide whether Sumangal Developer has to construct in the current year or next year, a 8 unit building or a 12 unit building.

Laxmi Private Limited is negoriating to sell their business to a public limited company. The following is a summarised extract from the Balance Sheet as on 31st March, 2006 of Laxmi Private Ltd:

		Rs.
Capital, 1000 shares of Rs. 1,000 each Free Reserve		10,00,000 2,00,000 12,00,000
Fixed assets at depreciated cost		6,40,000
Current Assets (—) Current Liabilities	Rs. 7,20,000 1,60,000
		5,60,000 12,00,000

The profits of Laxmi Private Ltd, for the last five years it has been in existence, after eliminating any extraneous or non-recurring debits and credits, were Rs. 90,000; Rs. 1,30,000; Rs. 1,15,000; Rs. 2,40,000 and Rs. 2,75,000. A return of 10% on the capital employed is considered to be reasonable in this particular business and it is expected that future requirements as to capital will not vary materially from the capital employed as on 31st March.

Ignoring any extraneous factors that may affect the position, suggest the amount that should reasonably be paid to the private company for the goodwill for acquiring the company, by giving details of how you work-out this amount and any assumption you consider it necessary to make.

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( 4 )

F-20(VMC)
Revised syllabus

Marks

(a)

Explain why synergy might exist when one company merges with or takes over another company.

(b)

The total values both equity and debt of two companies Sun Ltd. and Moon Ltd. are expected to fluctuate according to the state of the economy.

Economic State

Probability Recession Slow growth Rapid growth

Total Values:
Sun Ltd (Rs. in lakh)
Moon Ltd. (Rs. in lakh) 0.15
126
189 0.65
165
240 0.20
225
360

Sun Ltd. currently has Rs. 135 lakh of debt, and Moon Ltd. Rs. 30 lakh of debt.
If the two companies were to merge and assuming that no operational synergy occurs as a result of the merger, calculate the expected value of debt and equity of the merged company.
Explain the reasons for any difference that exists from the expected values of debt and equity if they do not merge.

(a)

Why do firms 'Manage Earnings'? How do firms manage earnings?

(b)

ABC Consulting Ltd. is a firm that specializes in offering management consulting services to software companies. ABC Ltd. reported operating income (EBIT) of Rs. 102 lakh and net income of Rs. 45 lakh in the most recent year. However the firms expenses include the cost of recruiting new consultants and the cost of training which amounts to Rs. 20 lakh. A consultant who joints ABC Consulting Ltd. stays with the firm, on an average, for 4 years.
Recruitment and training expenses are amortizable over 4 years. Over the past 4 years they are:

Year	Trainings, Recruitment Expenses (Rs. in lakh)
Current — 1 — 2 — 3 — 4	20 16 15 12 10

Assuming a linear amortization Schedule (over 4 years) —
Estimate:

(i)	The value of human capital asset and the amount of training and recruitment expenses amortization this year:

(ii)	The adjustment to operating income.

The following information pertains to M/s. XY Ltd:

Earning of the company
Dividend pay-out ratio
Number of shares outstanding
Equity capitalization rate
Rate of return on investment

Rs. 5,00,000
60%
1,00,000
12%
15%

(a)

What would be the market value per share as per Walter's model?

(b)

What is the optimum dividend pay-out ratio according to Walter's model and the market value of company's share at the pay-out ratio?

(a)

What are the methods of payment in mergers and amalgamations?

(b)

What is the method of valuation of unlisted shares as per SEBI guidelines?

__________