CA FINAL

STRATEGIC FINANCIAL
MANAGEMENT

[EXPLANATIONS AND SOLUTIONS]

VOLUME - II

PROF. RAHUL DANAIT

8070 400 700 online.jkshahclasses.com

 CA – FINAL

7 CORPORATE
VALUATION

Video 1

Valuation

Pv of future Cash Inflows

ie Theoretical value of Business

Techniques
(1) **Discounted Cash flows:
Pv of future Cash inflows

(2) Net Asset value method

Assets – external Liabilities

(3) Net Realisable value method

ie Realisable value of assets

(4) Market capitalization method (Actual value of target company) :

(Applicable only to Public Company)
MPS × No. of o/s equity share

(5) Earnings Capitalization Model

(6) Fair Value of Business

(7) Chop shop method

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** In DCF method, there are 2 types of cash flows given in question

Free Cash available Dividends

for Equity (FCFE)

Already covered in
Equity valuation
chapter

(as company does

not pay dividend)

Discount @ Ke

Pv → Value of equity
component of the
business V(E)
Note: Sometimes in questions they will give you Free cash available for Firm (FCFF)

ie CF available Not only for equity shareholders
But also for debt holders

ie considered interest expenses as well as dividend

Discounting @ Ko (WACC)

PV

Value of firm [V(F)]

Consist of

V(E) V(D)
(Discounted @ Ke) (Discounted @ Kd)

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 Value of Firm V(F) = Value of Equity V(E) + Value of debt V(D)

OR
V(F) – V(D) = V(E)
OR
V(F) – V(E) = V(D)

* Synergy Benefits
Synergy can be defined as follows:
V(AB) > V(A) + V(B)
In other Words the combined value of two firms or companies shall be more
than their individual value.
Synergy is increase in performance of the combined firm over what the two
firms are already expected or required to accomplish as independent firms.
This may be result of complimentary services of economics of scale or both.

* Chop shop Method of Valuation:

→ This approach attempts to identify multi-industry companies that are
undervalued and would have more value if separated from each other.
→ In other words as per this approach an attempt is made to buy assets below
their replacement value.
→ This approach involves following 3 steps:

Step: 1 Identify firm‟s various business segments & calculate the average
capitalization ratios for firms in those industries.
Step: 2 Calculate a “theoretical” market value based upon each of average
capitalization ratios.
Step: 3 Average the „theoretical‟ market value to determine the „Chop-
shop‟ value of the firm.

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Video 2

Q.1. XYZ Ltd MPS = ` 24/share


No. of o/s equity shares

10 Lacs shares
Promoters holding → 40% → 10 Lacs × 40% → 4 Lacs shares
(i) Calculation of maximum price payable per share by PQR Ltd for every
share of XYZ Ltd.
DCF → Pv of CI
Valuations
Amount
Particulars
(` in Lacs)
For base cash flows of XYZ (M cap) 240
(24 × 10,00,000)
For Synergy benefits 80
For Savings in management costs 30
Total Maximum Value 350
÷ No. of o/s Equity shares of XYZ Ltd. 10 Lacs share
Maximum value per share `35/share

(ii) Calculation of minimum price acceptable per share to the management

of XYZ Ltd.
Market cap of Holding [4 Lacs shares × ` 24] ` 96 Lacs
Add: Pv of Loss of Incomes ` 30 Lacs
(ie remuneration to top mgmt)
Minimum total acceptable to XYZ management ` 126 Lacs
No of o/s equity shares of promoters 4 Lacs
(10 Lacs × 40%)
Minimum price per share acceptable by XYZ
management ` 31.50/share

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Video 3

Q.2. Evaluation of Simple Ltd.

PV Debt V(E)
Condition Probability
(A) (B) (A-B)
High Growth 0.2 820 L 460 L 360 L
Medium Growth 0.6 550 L 460 L 90L
Slow Growth 460 L
0.2 410 L 0
410 L
Note 1: Since the company has limited liability the value of equity cannot be
negative therefore the value of equity under slow growth will be taken as zero
because of insolvency risk & the value of debt is taken at 410 Lac.

Calculation of Weighted avg expected value of Debt & equity for simple
Ltd.
x P×x y P×y
P (Weight)
[V(D)] (`) (`) [V(E)] (`)
0.2 460 Lacs 92 Lacs 360 L 72 Lacs
0.6 460 Lacs 276 Lacs 90 L 54 Lacs
0.2 410 Lacs 82 Lacs 0 0
[V(D)] = 450 Lacs [V(E)] 126 L

Evaluation of Dimple Ltd.

V(F) V(D) V(E)
Business Condition Probability
(A) (B) (A-B)
High Growth 0.2 1050 L 65 L 985 Lacs
Medium Growth 0.6 825 L 65 L 760 Lacs
Slow Growth 0.2 590 L 65 L 525 Lacs

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Calculation of Weighted average

x P×x y P×y
P
[V(D)] (`) [V(E)] (`)
0.2 65 Lacs 13 Lacs 985 Lacs 197 Lacs
0.6 65 Lacs 39 Lacs 760 Lacs 450 Lacs
0.2 65 Lacs 15 Lacs 525 Lacs 105 Lacs
[V(D)] 65 Lacs [V(E)] 758 Lacs

For the merged entity  Expected value of

Debt [V(D)] Equity [V(E)]
(`) (`)
Simple Ltd 450 Lacs Simple Ltd 126 Lacs
Dimple Ltd 65 Lacs Dimple Ltd 758 Lacs
515 Lacs 884 Lacs

Video 4

Q.3. (i) Valuation based on Market price:

XYS‟s market capitalization
= 1.5 crores shares × ` 400/share
= ` 600 Crores
Valuation based on Discounted Cash flow → Pv of all Future CI‟s
Year CI (` in crores) DF @ 12% Pv (` in crores)
1 250 0.893 223.25
2 300 0.797 239.10
3 400 0.712 284.8
V(F) 747.15
Range of valuation is ` 600 crores to ` 747.15 crores

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Video 5

Q.4. NPAT = ` 77 Lacs Given in question

Tax rate = 30%
(i) Calculation of value of Business
Calculation of expected NP
Income statement Income statement
Particulars [Previous Years] [Coming Years]
(Amount in `) (Amount in`)
Normal Profit Before Tax 112 Lacs 112 Lacs
(+) Extra ordinary Income 8 Lacs -
(-) Extra ordinary Losses (10Lacs) -
NPBT 110 Lacs 112 Lacs
(-) Tax @ 30% 33 Lacs (33.6 Lacs)
NPAT (Given in question) 77 Lacs 78.4 Lacs

Calculation of expected NPAT p.a. due to launch of new product:

Particulars P.a. (`)
Sales 70 Lacs
(-) Material cost (20 Lacs)
(-) Labour cost (12 Lacs)
(-) Fixed cost (10 Lacs)
NPBT 28 Lacs
(-) Tax @ 30% 8.4 Lacs
NPAT 19.6 Lacs
 Total expected NPAT p.a. in coming year
= ` 78.4 Lacs + ` 19.6 Lacs
= ` 98 Lacs P.a.

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Value of Business = Total expected NPAT p.a

Capitalization rate
` 98 Lacs p.a.
Value of Business =
14%

 Value of Business = ` 700 Lacs

(ii) Calculation of market price of equity share

P/E Ratio = 10 times (given in question)
MPS = P/E Ratio × EPS
= 10 × ` 1.7

(Note 1)
= ` 17/share
Note1: Calculation of EPS
NPAT ` 98 Lacs

(-) Preference Dividend (` 13 Lacs)

[1,00,000 shares × ` 100/share × 13%]

NP for ESH ` 85,00,000

÷ No. of equity shares 50,00,000

EPS  85,00,000  ` 1.70

 50,00,000 

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Video 6

Q.5. Nishana Ltd

Calculation of PV of CI
Year CI (`) DF @ 20% Pv ( `)
0 20 Cr + 0 = 20 Cr 1 20 cr
2 10 Cr + 2 Cr = 12 Cr
3 10 Cr + 2 Cr = 12 Cr PvAF
20% for 5 35.89 cr
4 10 Cr + 2 Cr = 12 Cr yrs =
2.9906
5 10 Cr + 2 Cr = 12 Cr
5 (Terminal 50 Cr + 0 = 50 Cr 0.4018 20.09 Cr
Cash flow) (10 × 5 times)
Value of 75.98 Cr
Company

Value of Company ` 75.98 Crores

Value of Debt Value of Equity

[V(D)] [V(E)]

` 15 Crores ` 60.98 Crores

(75.98 - 15)

 Maximum amount to be paid for purchasing Nishana Ltd. is ` 60.98 Crores.

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Video 7

Q.6. (i) Calculation of Actual Purchase consideration:

Exchange Ratio = 1 : 2 (given)
Total shareholders are 70,000 share
 No of shares offered by Tiger Ltd = 70, 000 = 35,000 shares
2

Particular `
Value of Equity shares 5,25,000
(35,000 shares × `15)
External Liability settled 5,00,000
Debentures Issued 3,00,000
Less: Disposal of CA (2,00,000)
Cash (Taken over) (50,000)
Net Purchase consideration (Cash out flow) 10,75,000

(ii) Calculation of Maximum price payable → DCF


Pv of CI
Year CI (`) DF Pv (`)
1–6 5,00,000 3.684 18,42,000
6 2,00,000 0.410 82,000
Pv of CI 19,24,000
Less: Net P.C. (Cash o/f (Pv of Co) 10,75,000
NPV 8,49,000
Since NPV of the decision is positive it is advantageous to acquire
Leopard Ltd.

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Video 8

Q.7. (i) Calculation of value of C Plc

CI
=
r
£ 40, 00, 00
=
11.25%
= £ 3,55,55,556
Calculation of value of M Plc
£ 60, 00, 000
=
12.5%
= £ 4,80,00,000

Calculation of value of merged/combined entity

£ 1, 20, 00, 000
=
12%
= £ 10,00,00,000
Value of combined entity is more than the sum value of both entity
individually.
 Pv of synergy benefits
= £ 10,00,00,000 – (£ 3,55,55,556 + £ 4,80,00,000)
= £ 1,64,44,444
Total value ready to maximum pay = £ 3,55,55,556 + £ 1,64,44,444
= £ 5,20,00,000
 Max value per share = £ 5, 20, 00, 000
50, 00, 000share
= £ 10.4/share
 M Plc is ready to max pay for acquiring C PlC is £ 10.4/share

(ii) Calculation of minimum price per share


Book value per share (BVPS)
 BVPS = £ 50L  £ 247.5 Lacs
50 Lacs share
= £ 5.95
 Minimum value that C Plc would accept is £ 5.95 per share

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(iii) Floor value means least value.

Market value of C Plc = £4/share
MP is lower than book value also,
= £4 < £5.95
 Floor value is £4/share
The above floor value of £4/share will not play any role in the decision making
because book value per share £5.95/share (ie minimum price) below this no value
will be acceptable by C Plc.

Video 9

Q.8. Calculation of value of fine Toy‟s Ltd → DCF → Pv of CI

Amount
Particulars Calculation
(` in Lacs)
Operating Cash inflows (Note: 1) 7852.5
Sale of machinery `50 Lacs × 1 50
Disposal of inventories & (`100 L + ` 50L) ×1= 150
Receivable `150 Lacs
Less: Payment of fine Toy‟s (`160 L + ` 250 L) × 1 (410)
Liabilities
Less: Employee Compensation ` 90 Lacs × 1 (90)
paid
Less: Upgradation of plant ` 150 Lacs × 1 (150)
Less: Revamp of machine shop  1  34.76
 ` 50L  
 (1.20) 2 
flow ` 50 Lacs × DF (20%, 2nd yr)
Maximum Price Payable 7367.78
÷ No of o/s equity shares  560 Lacs  0.56 Lacs
 
 `1000 / share 

Maximum price payable per share  ` 367.78 Lacs  ` 13,156.75

 
 0.56 Lacs 

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Note: 1 Calculation of PV of incremental CI‟s that Timby Ltd will earn due to T/O
of Fine Toy‟s Ltd.
Post T/o CF of Incremental
CF (A) Timby CF due to
PV (` in
Year (` in cr) without T/o (A-B) DF @ 20%
Cr)
T/O (B) (` in cr)
(` in cr)
1 18 16 2 0.833
2 24 20 4 0.694
3 36 30 6 0.579
4 44 32 12 0.482
5 60 44 16 0.402 78.525
6 80 52 28 0.335
7 96 60 36 0.279
8 100 55 45 0.233
9 140 70 70 0.194
10 200 108 92 0.162
78.525
 78.525 Crores = ` 7852.5 Lacs (Converted into Lacs)

Video 10

Q.9. Ke = 12%
Kd = (Post Tax) = 6%
g = 5%
Expected free cash flow At end of yr 1 [(FCFF)1] = ` 30 Lakhs
Step 1: Calculation of Ko (using BV weights)
Value of firm = FCFF1
Ko – g

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30 Lakh 1
` 750 Lacs =
K o – 0.05

 ` 750 Lacs (Ko – 0.05) = ` 30 Lacs

 ` 750 Lacs × Ko – ` 37.5 Lacs = ` 30 Lacs
 ` 750 Lacs × Ko = ` 67.5 Lacs
` 67.5 Lacs
Ko =
` 750Lacs

Ko = 0.09 ie 9%
Step 2: Calculation of BV weights
Ko = W(E) × Ke + W(D) × Kd
9% = W(E) × 12% + W(D) × 6%
 9% = W(E) × 12% + [1–W(E)] × 6%
 9 = 12W(E) + 6 – 6 W(E)
 3 = 6 W(E)
 W(E) = 3
6
 W(E) = 0.5
W(D): 1 – W(E) = 1 – 0.5  0.5

Step 3: Calculation of MV Weights

Source Existing Weights Calculation Revised Mv weight
(BV) Valued
Equity 0.5 0.5 × 3 1.5 0.75  1.5 
 2 

Debt 0.5 0.5 0.5 0.25  0.5 

 2 

Total CE 1 2 1

Step 4: Calculation of Revised Ko (Using MV weights)

Ko = W(E) × Ke + W(D) × K(d)
 Ko = 0.75 × 12% + 0.25 × 6%
 Ko = 10.50%

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Step 5: Calculation of Revised value of Firm

FCFF1
V(F) =
Ko  g
` 30 Lacs
=
10.5% – 5%
= ` 545.45 Lacs
  Correct value of firm with market value weight taken as base is
= ` 545.45 Lacs

Video 11

Q.10. Recent FCFF(0) = ` 50,00,000

debt equity ratio = 0.25
Mv of debt = ` 1,00,00,000
Tax rate = 40%
Given in question
Ke = 16%
Kd (before Tax) = 8%
g = 5%
Value per share of the equity = ?
Step 1: Calculation of Ko
Kd (Post tax) = 8% (1 – 0.40)
= 4.8%
Calculation of Weights
Source Ratio Weights
Debt 0.25 0.2  0.25 
 1.25 

Equity 1 0.8
Total 1.25 1
Calculation of WACC (Ko)
Ko = W(E) × Ke + W(D) + Kd
= 0.8 × 16% + 0.2 × 4.8
= 13.76%
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Step 2: Calculation of value of firm

FCFF1
V(F) =
Ko – g
50 Lacs  5% of 50 Lacs
V(F) =
13.76% – 5%
V(F) = ` 599.32 Lacs

Step 3: Calculation of V(E)

Particulars Amount (in Lacs)

V(F) 599.32
(–) V(D) (100)
V(E) 499.32

Step 4: Value per equity share

Value of Equity[V(E)]
=
No.of o /s equity shares
` 499.32 Lacs
=
20 Lacs shares

= ` 24.97/share

Video 12

Q.11. Valuation of T Ltd.

(i) As per P/E Ratio
MPS
P/E Ratio =
EPS

MPS= EPS × P/E Ratio

Market Capitalization = Total Earnings × P/E Ratio
= ` 50 Crores × 9

= ` 450 crores

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(ii) As per Dividend Yield model

Average Dividend Yield = 6%
Dividend = ` 40 crores
Total Dividend
Value as per → Dividend yield model =
Average Dividend yield
Rs 40 Crores
=
6%
= ` 666.67 crores
(iii) Valuation as per
(a) Dividend Growth model
Dividend
V(E) =
Ke – g
40 Crores  4% of 40crores
=
12% – 4%
= ` 520 crores
Note: Calculation of Ke as per CAPM
Ke = IRF + (Rm – IRF)
= 6% + (11% – 5%) 1.2
= 12%
(b) Book Value

This is nothing but value as per balance sheet

Given in question as ` 225 crores
 Valuation as per Book value = ` 225 crores
(c) Net Realisable Value

Particulars (` in crores)
Total value as per Balance sheet 225
Add:  In Realisable value of building 100
Less:  in Realizable value of stock (25)
Net Realisable value 300
 Value as per NRV is ` 300 crores

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Video 13

Q.12. Ke = 20%
Kd (Post tax) = 10% Given in question

FCFF1 = ` 50 Lakhs
Value of firm based BV weights = `1000 Lakhs
g = 10%
Step 1: Calculation of Ko (using BV weights)
FCFF1
Value of Firm =
Ko – g
` 50 Lakhs
` 1000 Lakhs =
K o – 0.10

 ` 1000 Lakhs (Ko – 0.10) = ` 50 Lacs

 ` 1000 Lakhs × Ko – `100 Lacs = ` 50 Lacs
   ` 1000 Lakhs × Ko = ` 150 Lacs
  Ko = ` 150 Lacs
`1000Lacs

Ko = 0.15 ie 15%

Step 2: Calculation of BV weights

Ko = W(E) × Ke + W(D) + Kd
 15% = W(E) × 20% + [1 – W(E)] × 10%
 15% = 20 W(E) + 10 – 10 W(E)
 5 = 10 W(E)
 W(E) = 5
10
 W(E) = 0.5
W(D) = 1 – W(E) = 1 – 0.5  0.5

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Step 3: Calculation of MV Weights

Source Existing weights Calculation Revised Mv Weights
(Bv) Value
Equity 0.5 0.5 × 4 2 0.8  2 

 2.5 

Debt 0.5 0.5 0.5 0.2  0.5 

 2.5 

Total (E) 1 2.5 1

Step 4: Calculation of Revised Ko (based Mv weights)

Ko = W(E) × Ke + W(D) × Kd
   Ko = 0.8 × 20 % + 0.2 × 10%
   Ko = 16 % + 2%
   Ko = 18 %

Step 5: Calculation of Revised value of firm.

FCFF1
V(F) =
Ko – g

V(F) = ` 50 Lakhs
18% – 10%
V(F) = ` 625 Lacs
 Correct value of firm based on mv weights as base is ` 625 Lacs

Video 14

Q.13 (a) (i) Calculation of value of equity for Hanky Ltd.

` 6,50, 00, 000
EPS (E0) = = `13/share
50, 00, 000

% of retained earnings = 20%

 Dividend payout ratio (1 – 0.20) = 80%
DPS (DO) = ` 13 × 80% = ` 10.4/share
D1 g=b×r
V(E) =
Ke – g g = 20% × 15%
g = 3%

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`10.4(1  3%)
=
21% – 3%
= ` 59.51
(ii) Calculation of value of equity for Shanky Ltd.
` 2, 40, 00, 000
EPS (E0) = = `16/share
15, 00, 000
Dividend payout ratio, = 1 – Retained earning ratio
= 1 – 0.80%
= 0.20
ie 20%
Do = `16 × 20%, `3 L
g = b×r
      g = 80 % × 15%
      g = 12 %
D1
 V(E) =
Ke – g
`3.2(1  0.12)
=
24% – 12%
= ` 29.87/share
(b) Calculation of value of Hanky Ltd after Take over.
D1
V(E) =
Ke – g

Hanky Ltd Shanky Ltd

Total Earnings (Eo) 6,50,00,000 2,40,00,000
(+) Growth rate + 3% +12%
Earnings (E1) 6,69,50,000 2,68,80,000

Post take over 9,38,30,000

Earning expected 0
(+) Synergy benefits 85,00,000
Total Earnings (E1) 10,23,30,000

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10,23,30,000

Retained Dividend
Earnings (65%)

` 3,58,15,500 ` 6,65,14,500

g = b×r
Total Dividend (D1)
  = 35 % × 17%
  = 5.95 %
Ke = 20%
Total D1
V(E) (Total value) =
Ke – g

V(E) = ` 6, 65,14,500
20% – 5.95%
V(E) = ` 47,34,12,811

(c) Calculation of value of Hanky (Pre-take over)

D1 (Total basis)
V(E) =
Ke – g

(10.4×50, 00, 000) + 3%

V(E) = + 3%
21% – 3%

V(E) = 5,35, 60, 000

18%

V(E) = ` 2,97,55,556

OR

No. of shares × V(E) per share [found in point(i)]

= 50,00,000 × 59.51

= ` 29,75,50,000

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Value of Hanky (pre-takeover) 47,34,12,811

Value of Hanky (Post takeover) 29,75,55,556
Value that Hanky would ready to max pay 17,58,57,255

Video 15

Two step Model


Already discussed in “EQUITY VALUATION”

Video
Video 15
16

Q.14. (i) Calculation of PV of synergy benefits (CI)

Year CI’s (` in Lacs) DF@ 20% Pv (` in Lacs)

1 50 0.8333 41.665

2 75 0.6944 52.08
3 90 0.5787 52.083
4 100 0.4823 48.23

5 105 0.4019 42.1995

5 **595 0.4019 239.1305

475.37

50% to be paid in cash only

` 278.69 Lacs

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= 105(1  0.02) = 595

D6
** P5 =
Ke – g 20% – 2%

 Cash to be paid per share = ` 278.69Lacs

10 Lacs

= ` 23.77/share
(ii) Exchange Ratio = MP of T arg et
MP of Acquirer

= 25
50
= 0.5:1
 for 10 Lacs shareholders of Kolkata  Chennai will issue
0.5
= 10 Lacs ×
1

 Chennai issued 5 Lacs share of ` 50 each

Cash paid (23.77 × 10 Lacs) ` 237.7 Lacs

Add: Value of equity share to be issued ` 250 Lacs

(50 × 5 Lacs share)

Total purchase consideration ` 487.7 Lacs

Chennai is offering to shareholders of Kolkata as  total consideration of

` 487.70 Lacs

Video 17

Q.15 (a) Calculation of Ke

Ke = IRF + (Rm – IRF)
= 5% [9% – 5%] 2
= 13%

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(b) Calculation of Annual cash flows from sking Ltd.

Sking Ltd
Sking Ltd
Particulars (before acquisition)
(after acquisition) (`)
(`)

Revenues 1,25,00,000 1,25,00,000

(-) Cash expenses 97,33,333 88,33,333

NPBDT 27,66,667 36,66,667

(-) Depreciation (6,00,000) (6,00,000)

NPBT 21,66,667 30,66,667

(-) Tax @ 40% (8,66,667) (12,26,667)

NPAT 13,00,000 18,40,000

(+) Depreciation - 6,00,000

CFAT - 24,40,000

(c) Calculation of value of Target Company:

(1) If CF‟s are expected to be received for 5 years Pv of CI

V(A)  ` 24,40,000 × PVAF (13%, 5yrs)  ` 85,82,044

(2) If CF‟s are expected to be received for 10 years

V(A)  ` 24,40,000 × PVAF (13%, 10yrs)

V(A)  ` 1,32,40,034

(3) If CF‟s are expected to be received for 15 years

V(A)  ` 24,40,000 × PVAF (13%, 15yrs)

V(A)  ` 1,57,68,204

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(d) Calculation of maximum price payable per share

(1) If CF‟s are expected to be received for 5 years.
` 85,82, 044
Value per share = = ` 34.33
` 2,50, 000 share

(2) If CF‟s are expected to be received for 10 years.

` 1, 32, 40, 034
Value per share = = ` 52.96
` 2, 50, 000 shares

(3) If CF‟s are expected to be received for 15 years.

`1,57, 68, 204
Value per share = = ` 63.07
2,50, 000 share

(e) Calculation of value of Target company assuming cash flows will be

received indefinitely without growth:
V(F) = Pv of future cash inflows
CI p.a
ie =
Ke

= ` 24, 40, 000

13%

Value of firm = ` 1,87,69,231

(f) Calculation of value of Target Company:

Year Cash flows (`) DF@13% Pv

1 24,40,400

2 26,84,000

2 ** 3,52,27,500

3,18,49,556

= 26,84, 000  5% = `3,52,27,500

D3
** P2 =
Ke – g 13% – 5%

 Value of target company ` 3,18,49,556

Strategic Financial Management 437 Corporate Valuation

 CA – FINAL

` 3,18, 49,556
Value per share = ` 127.40/share
2,50, 000

Calculation of premium paid (in %)

= Theoretical value – CMP  100
CMP
127.4 – 62
= × 100
62

= 105.48%

Video 18

Q.16 Step 1: Decision Tree

Year 0 Year 2005 Year 2006 Joint Probability

0.7 2500  0.6 × 0.7 = 0.42

P x
2000
0.3 3000  0.6 × 0.3 = 0.18
0.6
0.5 2000  0.3 × 0.5 = 0.15
0.3
x 1500
0.5 1800  0.3 × 0.5 = 0.15

0.1
0.6 1500  0.1 × 0.6 = 0.06

1200
0.4 1200  0.1 × 0.4 = 0.04

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Step 2: Calculation of expected cash Revenues for year ended 31st March
2005 & 2006
Year 2005 Year 2006
Rex(x) P P × (x) Rev(x) P P×x
2000 0.6 1200 2500 0.42 1050
1500 0.3 450 3000 0.18 540
1200 0.1 120 2000 0.15 300
1 Ʃpx = 1770 1800 0.15 270
 1500 0.06 90
Expected 1200 0.04 48
average
Revenue
1 2298

Step 3: Calculation of Expected Net Cash inflows for year ended 31 st

March 2005 & 2006:
2005 2006
Particulars
(` in Lacs) (` in lacs)
Revenues 1770 2298
(-) Operating expenses (708) (804.3)
(1770 × 40%) (2298 × 35%)
EBIT 1062 1493.7
(-) Interest (10) (10)
EBT 1052 1483.7
(-) Tax @ 30% (315.6) (445.11)
NPAT/CI/Free Cash flow 736.4 1038.59
 
D1 D2

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Step 4: Calculation of value of Company  DCF  Pv of CI

Year CI (` in Lacs) DF@15% Pv (` in Lacs)
1 736.4 0.8696
2 1038.59 0.7561
3 1454.03 (1038.59 + 40%) 0.6575
4 2035.64 (1454.03 + 40%) 0.5718
5 2849.89 (2035.64 + 40% ) 0.4972
5 ** 62697.58 0.4972
V(E) 36134.28 Lacs
D6
** P5 =
Ke – g

= 2849.89  10% of 2849.89

15% –10%

= ` 62,697.58 Lacs

Video 19

Q.17. (i) Calculation of V(E) for Minority Investment

Red Ltd
D1
V(E) =
Ke – g
3
 V(E) =
15% – 6%
 V(E) = ` 33.33/share
Yellow Ltd
Year CI DF @ 15% PV
1 2.70 0.8696 2.35
2 3.6 (2.70 + 33.33%) 0.7561 2.72
3 4.8 (3.6 + 33.33%) 0.6575 3.16
4 6.4 (4.8 + 33.83) 0.5718 3.66
4 ** 42.67 0.5718 24.39
V(E)  36.28
D5 6.4  0%
** P4 = = = ` 42.67
K e – g 15% – 0%

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(ii) Calculation of V(E) for complete takeover

* Calculation of PV of Additional Cash Flows/Synergy Benefits:

Particulars Calculation Amount

` 2,25,000
Savings in Advertisement cost `15,00,000
15%

Sell of office space ` 8,00,000 × DF(15%, 2nd yr.) ` 6,04,915

Total ` 21,04,915

This is the amount that Zed Ltd is additional ready to pay in the event of
complete T/o either Red or Yellow Ltd.
` 21, 04,915
Additional value to be paid per share =
10, 00, 000 share

= ` 21.05/share
*Value to be paid for future Dividends: PV of CI
RED Ltd
Yr CI DF @ 15% Pv

1 - - -

2 - - -

3 ` 2.5 0.6575 37.81

3 ** ` 55 0.6575

PV of the Dividend that Zed Ltd will 37.81

received on acquisition of Red Ltd.

= 2.5  10% = ` 55/share

D4
** P3 =
Ke – g 15%  10%

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Yellow Ltd
Year CI DF @ 15% Pv
1 2.7 0.8690
2 3.6 0.7561
3 4.8 0.6575
4 6.4 0.5718
5 8 (6.4 + 25%) 0.4972 56.21

6 10 (8 + 25%) 0.4323
7 12.5 (10 + 25%) 0.3759
7 ** 83.33 0.3759
`56.21

Zed Ltd is ready to max pay

after considering Future cash
flows of dividend.
D8 12.5
** P7 = = = ` 83.33/share
Ke 15%

* Calculation of Total value per share

Red Ltd: 37.81 + 21.05  ` 58.86
Yellow Ltd: 56.21 + 21.05  ` 77.26

Video 20

Q.18. (i) Calculation of Total value of Business

* Calculation of value of Business by DCF
Year CI (` in DF @ 8% Pv (` in
Lakhs) Lakhs)
1 105 0.93 97.65
2 120 0.86 103.20
3 125 0.79 98.75
4 120 0.74 88.8

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5 100 0.68 68
5 200 0.68 136
V(B) @DCF 8% 592.4 Lacs

* Calculation of value of Business using NAV.

Particulars Amount (` in Lacs)
Assets 350
(-) Liabilities (100)
Net Asset Value 250
* Therefore, Total value of Business
Fair Value = 592.4  250
2
Fair Value = ` 421.20 Lacs
(ii) Average Market price per share
570  430
= = ` 500/share
2
  No. of shares to be issued
` 421.20 Lacs
=
` 500 / share

= 0.84240 Lacs shares

ie 84240 shares
(iii) Basis of allocation
20 Lacs
20 Lacs (fully paid) = 84240 ×
25 Lacs(20  5)

= 67392 shares --------------(A)

10 Lacs (Partly paid) = 84240 × 5 Lacs
25 Lacs


(ie 5 Lacs fully paid up) = 16,848 shares ---------------(B)
A + B = 84240 share
Note 1: Ratio of distribution is 20:5
As 10 Lacs partly paid up shares are converted in 5 Lacs fully
 5 0 Lacs 
paid up  `10 / share 
 

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Video 21

Q.19. Part I Calculation of NAV:

Amount
Particular
(` in Lacs)
Assets
Land & Building 96
Plant & Machinery 100
Investments 10
Stock 20
Debtors 15
Cash as Bank 5
Total Assets 241
Less: Liabilities
Long term Debts (30)
Net Assets 216
 100  10 Lacs
÷ No. of o/s equity shares  
 10 

NAV per share 21.6

Part II Calculation of Earning Capitalized Value

Amount
Particular
(` in Lakhs)
Current Profit 64
Less: Extraordinary Income (4)
Less: Income from Investment (1)
(Unlikely to recur)
Less: Advertisement expenses (5)
Less: Depreciation (6)

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NPBT 48
Less: Tax @ 30% (14.4)
NPAT (Expected in coming year) 33.6
Capitalization Rate 15%
Earnings Capitalized value `33.6 Lacs 224 Lacs
15%
Less: Long term Debt (30 Lacs)
Value of Equity 194 Lacs
Value per share 194 Lacs `19.4
10 Lacsshares
NAV per share  Value per share as per ECM
Part III Fair value per share =
2
21.6  19.4
 Fair value =
2
 Fair value = ` 20.5/share

Video 22

Q.20. (i) Calculation Net Assets Value per share.

H Ltd: NAV = Total value of assets – Liabilities
NAV = ` 1300 Crores – ` 300 Crores
NAV = ` 1000 Crores
`1000 Crores
 NAV per share = = ` 285.71
3.5Cr shares

B Ltd: NAV = Total value of assets – Liabilities

NAV = ` 31.5 Crores – 0
NAV = ` 31.5
` 31.5
 NAV per share = = ` 48.46
0.65
Note 1: Contingent Liability of H Ltd of ` 300 Crores is assumed to be actual liability
& hence deducted from the value of total assets.

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(ii) Part II: Earnings Capitalization value (ECV)

H Ltd:
Future maintainable Profits
ECV =
Ke
` 300Crores
ECV =
8%
ECV = ` 3750 Crores
` 3750 Crores
Value per shares =
3.5Crores shares
= ` 1071.43
B Ltd:
Future maintainable Profits
ECV =
Ke
` 10 Crores
ECV =
8%
ECV = `125 Crores
Value per shares = ` 125 Crores
0.65Crores
= `192.31/share
(iii) Part III:Calculation of Fair value per share
Fair Value of B Ltd
Exchange Ratio =
Fair Value of H Ltd

Calculation of Weights
Valuation Model Ratio Weights
NAV 1 0.25
EL 3 0.75
4 1
For H Ltd:
0.25 × NAV per share + 0.75 × EC valuation
= 0.25 × 285.71 + 0.75 × 1071.43
Fv per share = 875/share

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For B Ltd:
0.25 × NAV per share + 0.75 × EC valuation per share
= 0.25 × 48.46 + 0.75 × 192.31
Fv per share = `156.35

Part IV Calculation of Share exchange Ratio based on FV per share

FV of B Ltd
SER =
FV of H Ltd
156.35
=
875
= 0.1787:1
ie for every of 1 share of B Ltd, H Ltd will issue it‟s own 0.1782 share
 For 0.65 crores of B Ltd  H Ltd will issue
65 Lacs shares × 0.1787 = 11,61,550 shares

Video 23

Chop shop Method

Q.21. (i) Calculation of value of Telecom Business:
Based on Turnover
` 5000 crores × 1.65 = `8,250 Crores
Based on Assets
` 1250 Crores × 3 = ` 3750 Crores
Based on NOPAT:
` 1000 Crores × 12 = ` 12000 Crores
Average Value
` 8250 Crores  ` 3750 Crores  ` 12000 Crores
3

= `8000 Crores

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 CA – FINAL

(ii) Calculation of value of Real estate

Based on Turnover
` 4000 crores × 1.4 = ` 5600 Crores
Based of Assets
` 2000 crores × 4 = ` 8000 Crores
Based on NOPAT
` 500 crores × 9 = ` 4500 Crores
Average Value
` 5600 Crores  ` 8000 Crores  ` 4500 Crores
3
= ` 6033.33 Crores

(iii) Calculation of value of Toys Business

Based on Turnover
` 1000 crores × 0.7 = ` 700 Crores
Based of Assets
` 1000 crores × 2 = ` 2000 Crores
Based on NOPAT
` 400 crores × 11 = ` 4400 Crores
Average Value
` 4400 Crores  ` 2000 Crores  ` 700 Crores
3
= ` 2366.67 Crores
Total value of Business
Particulars ` in crores
Telecom Business 8000
(+) Real Estate business 6033.33
(+) Toys business 2366.67
Total 16,400
According to chop shop method, the value of T Ltd is ` 16400 Crores.

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Video 24

Q.22. (i) Calculation of value of consumer wholesale business.

Based on Sales
` 22500 × 0.85 = ` 191250

Based of Assets
` 60,0000 × 0.7 = ` 4,20,000

Based on Operating Income

` 75000 × 9 = ` 6,75,000

Average Value
` 19,1250  ` 4, 20, 000  ` 6, 75, 000
3
= ` 428750

(ii) Calculation of value of consumer Retail Business

Based on Sales
` 720000 × 1.2 = ` 8,64,000

Based of Assets
` 50,0000 × 0.7 = ` 3,50,000

Based on Operating Income

` 1,50,000 × 8 = ` 12,00,000

Average Value
` 8, 64, 000  ` 3,50, 000  ` 12, 00, 000
3
= ` 8,04,666.67

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 CA – FINAL

(iii) Calculation of value of General Business centers.

Based on Sales
` 25,00,000 × 0.8 = ` 20,00,000

Based of Assets
` 40,00,000 × 0.7 = ` 28,00,000

Based on Operating Income

` 7,00,000 × 4 = ` 28,00,000

Average Value
` 20, 00, 000  ` 28, 00, 000  ` 28, 00, 000
3
= ` 25,33,333.33
Total value of Business
Particulars `
Wholesale 4,28,750
Retail 8,04,666.67
General 25,33,333.33
Total 37,66,750
 According to chop shop method, the value of cranberry ` 37,66,750

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Video 25

Q.23. (i) Impacts of Financial Restructuring:

Amount
Particulars Calculation
(` in Lacs)

Reduction in Equity share 50 Lacs shares × 8 400

Reduction in Preference shares Capital 50

Waiver of Debt interest 12

Waivers from Trade Creditors 300 × 20% 60

Appreciation in Land & Building (350-150) 200

Total Benefits 722

Benefits to be utilized for

Amount
Particulars Calculation
(` in Lacs)

Write off preliminary Expenses 15

Write off cost of issue to debentures 7

Write off P & L Debit balance 480

Revaluation of Plant & Machinery 200 L – 150 L 50

Provision for Bad & doubtful debt. 5

Total 557

  Capital Receive = ` 722 Lacs – ` 557 Lacs

= ` 165 Lacs

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(ii) Balance Sheet Post Restructuring of XYZ Ltd.

Amount Amount
Liabilities (` in Assets (` in
Lacs) Lacs)
Equity share of `2 each 200 Land & Building 350
[100 L + (50 × 2)]
100 Lacs
9% Preference shares 50 Plant & Machinery 150
Capital Reserve 165 Furniture & Fixtures 60
10% debentures 100 Inventory 60
Loan from Bank 60 Sundry Debtors (50 -5) 45
Trade Creditors (300 – 60) 240 Cash at Bank (Bal figures) 150
815 815

Video 26

Free cash for firm (FCFF)

v/s Or v/s
Free cash for Equity (FCFE)
Sales/Revenue xx
(-) Operating Expentiure (xx)
EBIT (NOP) xx
(-) Interest (xx)
EBT xx
(-) Tax @ x % (xx)
EAT xx
(+) Depreciation xx
CFAT xx
(-) Investment in FA/Capital Budget (xx)
(-) Investment in CA/Working Capital (xx)
Strategic Financial Management 452 Corporate Valuation
 CA – FINAL

FCFE xx

Discounted @ Ke &
grow at constant rate
of g for perpetually
then
FCFF1
V(E) :
Ke – g

V(E) + V(D) = V(F)

FCFF

ie that cash profit or that cash flow which is available to distribution not only
for equity shareholder but also for debentures holders.
While calculating FCFE, we have already, taken into consideration the interest
amount paid so whatever available after that will be paid to equity shareholder.
 For calculating FCFF Don‟t take interest amount during calculation.
Sales/Revenue xx
(-) Operating expenses (xx)
EBIT (NOP) xx
(-) Int. 0
EBT xx
(-) Tax @ x % (xx)
EAT but excluding interest xx
(+) Depreciation xx
xx
(-) Investment in FA/CB (xx)
(-) Investment in WC/CA (xx)
Strategic Financial Management 453 Corporate Valuation
 CA – FINAL

FCFE xx

Discounted @ Ko &
growing @ constant rate
of g for infinite period.
V(F) = V(E) + V(D)
V(E) = V(F) – V(D)
V(E) : FCFF1
KO – g

Conclusion
Only difference between FCFF and FCFE is interest payment made to debt
holder.

Video 27

Q.24. 1. Calculation of ke:

For High Growth Period (1st 4 Years):
Ke = IRF + [RM – IRF]β
= 10% + 6%  1.15
= 16.9%
For Stable Growth Period:
Ke = IRF + [RM – IRF]β
= 9% + 5%  1
= 14%

2. Calculation of kd:
For High Growth Period (1st 4 Years):
Kd = Interest Rate (1 – t)
= 13% (1-0.3)
= 9.1%

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 CA – FINAL

For Stable Growth Period:

Kd = Interest Rate (1 – t)
= 12.86% (1-0.3)
= 9%

3. Calculation of ko:
For High Growth Period (1st 4 Years):
Ko = W(E)  ke + W(D)  kd
= 0.5  16.9% + 0.5  9.1%
= 13%

Ko = W(E) x ke + W(D) x kd
= 0.6  14% + 0.4  9%
= 12%
Calculation of Forecasted Free Cash for Firm:
Particulars Year Year 2 Year 3 Year 4 Terminal
1 Year

Revenue 2,400 2,880 3,456 4,147.20 4,561.92

EBIT 360 432 518.4 622.08 684.29

(-) Tax @ 30% (108) (129.6) (155.52) (186.62) (205.29)

EAT 252 302.40 362.88 435.46 479.00

(+) Depreciation 240 288 345.60 414.72 -

(-) Capital Expenditure (336) (403.2) (483.84) (580.61) -

(-) Working Capital Investment (100) (120) (144) (172.80) (103.68)

FCFF 56 67.2 80.64 96.77 375.32

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Calculation of PV of FCFF:

Year Cash Flow Discounting Rate DF PV

1 56 13% 0.8850 49.56

2 67.2 13% 0.7831 52.63

3 80.64 13% 0.6931 55.89

4 96.77 13% 0.6133 59.35

4 18766 12% 0.6133 11,509.54

11,726.97

P4 = CF5/(ko-g) = 375.32/(12% - 10%) = 18,766

Video 28

Q.25. Calculation of Free Cash for Firm:

Terminal
Particulars Year 1 Year 2 Year 3
Year
Revenues 9,000 10,800 12,960 13,996.8
EBIT 2,700 3,240 3,888 4,199.04
EAT 1,890 2,268 2,721.6 2,939.33
(-) Capital Expenditure (Net of (172.5) (198.38) (228.13) -
Depreciation)
(-) Working Capital Investment (375) (450) (540) (259.20)
FCFF 1,342.5 1,619.62 1,953.47 2,680.13

Calculation of PV of FCFF:

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Year Cash Flow DF@15% PV

1 1,342.5 0.8696 1,167.44
2 1,619.62 0.7561 1,224.59
3 1,953.47 0.6575 1,284.41
3 38,287.57 0.6575 25,174.08
28,850.52
P3 = CF4/(ko-g) = 2,680.13/(15% - 8%) = 38,287.57

Video 29

Q.26. 1. ke = 16%
Kd = Interest Rate (1-t)
= 12% (1-0.3)
= 8.4%
WACC = W(E) x ke + W(D)  kd
= 0.6 x 16% + 0.4 x 8.4%
= 12.96% say 13%

2. Calculation of Depreciation:
Opening Depreciation
Year (+) Additions Total
Balance @15%

1 17 0.50 17.50 2.63

2 14.87 0.80 15.675 2.35

3 13.32 2.00 15.32 2.30

4 13.02 2.50 15.52 2.33

5 13.19 3.50 16.69 2.50

6 14.19 2.50 16.69 2.50

7 14.19 1.50 15.69 2.35

8 13.34 1.00 14.34 2.15

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3. Calculation of Investment in Fixed Assets and Current Assets:

Additional Existing Used Used Additional
Investment Total
Year Investment Investment for for Balance Investment
in FA Investment
in CA in CA FA CA Required

1 0.50 1.60 2.10 3 0.50 1.60 0.90 0

2 0.80 0.40 1.20 0.9 0.80 0.40 (0.30) 0.30

3 2.00 1 3.00 0 2 1 (3) 3

4 2.50 1.4 3.90 0 2.50 1.4 (3.9) 3.9

5 3.50 1.6 5.1 0 3.50 1.6 (5.1) 5.1

6 2.50 (0.8) 1.7 0 2.50 (0.8) (1.7) 1.7

7 1.50 (0.6) 0.9 0 1.50 (0.6) (0.9) 0.9

8 1.00 (0.6) 0.4 0 1.00 (0.6) (0.4) 0.4

4. Calculation of PV of FCFF:
Year Year Year Year Year Year Year Year
Particulars
1 2 3 4 5 6 7 8

Sales 8.00 10.00 15.00 22.00 30.00 26.00 23.00 20.00

(-) Variable Expenses 3.20 4.00 6.00 8.80 12.00 10.40 9.20 8.00

(-) Fixed Expenses 1.60 1.60 1.60 1.60 2.00 2.00 2.00 2.00

(-) Advertisement Expenses 0.50 1.50 1.50 3.00 3.00 3.00 1.00 1.00

(-) Depreciation 2.63 2.35 2.30 2.33 2.50 2.50 2.35 2.15

EBIT 0.07 0.55 3.60 6.27 10.50 8.10 8.45 6.85

(-) Tax @ 30% 0.02 0.16 1.08 1.88 3.15 2.43 2.53 2.06

EAT 0.05 0.39 2.52 4.39 7.35 5.67 5.92 4.79

(+) Depreciation 2.63 2.35 2.30 2.33 2.50 2.50 2.35 2.15

(-) Investment in Capital 0 0.30 3.00 3.90 5.10 1.70 0.90 0.40
Expenditure/ Working Capital

FCFF 2.68 2.44 1.82 2.82 4.75 6.47 7.37 6.54

X DF@13% 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376

PV 2.371 1.911 1.261 1.729 2.579 3.106 3.132 2.46

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Total present value of first 8 years = $ 18.549 million

P8 = CF10/(ko-g) = (6.54 + 5%)/(13% - 5%) = 85.8375

PV = 85.8375 x 0.376 = $ 32.2749 million

Therefore, Value of Firm = $ 18.549 million + $ 32.2749 million = $50.8239 million
Therefore, Value of Equity = $50.8239 million – $ 8 million = $ 42.8239 million

Video 30

Economic Value Added = [EBIT (1 – t)] – [Total Capital Employed  WACC]

Video 31

Q27. (i) Working for calculation of WACC

Orange Grape Apple
Total debt 80,000 50,000 20,000
Post tax Cost of debt 10.4% 8.45% 9.75%
Equity Fund 20,000 50,000 80,000

WACC
Orange: (10.4  0.8) + (26  0.2) = 13.52%
Grape: (8.45  0.5) + (22  0.5) = 15.225%
Apple: (9.75  0.2) + (20  0.8) = 17.95%

(ii) Orang Grape Apple

e
WACC 13.52 15.225 17.95
EVA [EBIT (1-T)-(WACC x Invested 2,730 1,025 -1,700
Capital)]

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Alternatively, it can also be computed as follows:

Orange Grape Apple
Net Income (`) 8,970 12,350 14,950
Pre Tax Income (`) (A) 13,800 19,000 23,000
Debt Amount (`) 80,000 50,000 20,000
Interest (`) (B) 12,800 6,500 3,000
EBIT (`) 26,600 25,500 26,000
Tax 35% (`) 9,310 8,925 9,100
EAT 17,290 16,575 16,900
Less: WACC X Invested Capital 13,520 15,220 17,950
EVA (`) 3,770 1,355 -1,050

(iii) Orange would be considered as the best investment since the EVA of
the company is highest and its weighted average cost of capital is the
lowest

(iv) Estimated Price of each company shares

Alternatively, it can also be computed as follows:
Orange Grape Apple
EBIT (`) 25,000 25,000 25,000
Interest (`) 12,800 6,500 3,000
Taxable Income (`) 12,200 18,500 22,000
Tax 35% (`) 4,270 6,475 7,700
Net Income (`) 7,930 12,025 14,300
Shares 6,100 8,300 10,000
EPS (`) 1.3 1.448795 1.43
Stock Price (EPS x PE Ratio) (`) 14.30 15.94 15.73
Since the three entities have different capital structures they would
be exposed to different degrees of financial risk. The PE ratio should
therefore be adjusted for the risk factor.

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 CA – FINAL

Alternative Answer
Orange Grape Apple
Net Income (Given) (`) 8,970 12,350 14,950
Shares 6,100 8,300 10,000
EPS (`) 1.4705 1.488 1.495
Stock Price (EPS x PE Ratio) (`) 16.18 16.37 16.45

(iv) Market Capitalisation

Estimated Stock Price (`) 14.30 15.94 15.73
No. of shares 6,100 8,300 10,000
Estimated Market Cap (`) 87,230 1,32,302 1,57,300

Video 32

Q28. Financial Leverage = PBIT/PBT

1.5 = PBIT / (PBIT – Interest)

1.5 = PBIT / (PBIT – 40)

1.5 (PBIT – 40) = PBIT
1.5 PBIT – 60 = PBIT
1.5 PBIT – PBIT = 60
0.5 PBIT = 60
60
Or PBIT =
0.5
= ` 120lakhs

NOPAT = PBIT – Tax = `120 lakhs (1 – 0.30)

= `84 lakhs.

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Weighted Average Cost of Capital (WACC)

= 14%  (300 / 700) + (1 – 0.30)  (10%)  (400 / 700)
= 10%
EVA = NOPAT – (WACC  Total Capital)
EVA = `84 lakhs – 0.10  ` 700 lakhs
EVA = ` 14 lakhs

Video 33

Q29. (a) Determination of Economic Value Added (EVA)

$ Million
EBIT 180.00
Less: Taxes @ 35% 63.00
Net Operating Profit after Tax 117.00
Less: Cost of Capital Employed [W. No.1] 72.60
Economic Value Added 44.40

(b) Determination of Market Value Added (MVA)

$ Million
Market value of Equity Stock [W. No. 2] 500
Equity Fund [W. No. 3] 425
Market Value Added 75

Working Notes:
(1) Total Capital Employed
Equity Stock $ 100 Million
Reserve and Surplus $ 325 Million
Loan $ 180 Million
$ 605 Million
WACC 12%
Cost of Capital employed $ 605 Million  12% $ 72.60 Million

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(2) Market Price per equity share (A) $ 50

No. of equity share outstanding (B) 10 Million
Market value of equity stock (A) х (B) $ 500 Million
(3) Equity Fund
Equity Stock $ 100 Million
Reserves & Surplus $ 325 Million
$ 425 Million

Video 34

Q30. EVA = Income earned – (Cost of capital  Total Investment)

Total Investments
Particulars Amount
Working capital ` 20 lakhs
Property, plant, and equipment ` 80 lakhs
Patent rights ` 40 lakhs
Total ` 140 lakhs

Cost of Capital 15%

EVA = ` 12 lakh – (0.15  ` 140 lakhs)
= ` 12 lakh – ` 21 lakh
= -` 9 lakh Thus Herbal Gyan has a negative EVA of ` 9 lakhs.

Video 35

Q31. Cost of Equity as per CAPM

ke = Rf + β x Market Risk Premium
= 8.5% + 1.36  9%
= 8.5% + 12.24%
= 20.74%

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Cost of Debt
kd = 11%(1 – 0.30)
= 7.70%
E D
WACC =  k 0   k e   kd 
ED ED
125 40
= 20.74   7.70 
165 165
= 15.71 + 1.87
= 17.58%

Taxable Income = ` 25,00,000/(1 - 0.30)

= ` 35,71,429 or ` 35.71 lakhs

Operating Income = Taxable Income + Interest

= ` 35,71,429 + ` 4,40,000
= ` 40,11,429 or ` 40.11 lacs

EVA = EBIT (1-Tax Rate) – WACC  Invested Capital

= ` 40,11,429 (1 – 0.30) – 17.58%  ` 1,65,00,000
= ` 28,08,000 - ` 29,00,700
= (` 92,700)

Video 36

Q32. (i) Taxable income = Net Income /(1 – 0.40)

or, Taxable income = ` 15,00,000/(1 – 0.40)
= ` 25,00,000
Again, taxable income = EBIT – Interest
or,
EBIT = Taxable Income + Interest
= ` 25,00,000 + ` 15,00,000
= ` 40,00,000

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(ii) EVA = EBIT (1 – T) – (WACC  Invested capital)

= ` 40,00,000 (1 – 0.40) – (0.126  ` 1,00,00,000)
= ` 24,00,000 – ` 12,60,000
= ` 11,40,000

` 11,40,000
(iii) EVA Dividend =
2,50,000
= ` 4.56
If Delta Ltd. does not pay a dividend, we would expect the value of the
firm to increase because it will achieve higher growth, hence a higher
level of EBIT. If EBIT is higher, then all else equal, the value of the firm
will increase.

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SOLUTIONS FOR
ADDITIONAL
QUESTIONS
FOR SELF PRACTICE

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Q33. The levered beta of the company will be = 1.8[1 + (1-0.3)*40/60)]

= 2.64

The adjusted EBITDA would be 90 –10 – 20 = 60

The EV will be multiple of 5 on the 60 obtained above = 300

The Cost of equity in accordance with CAPM = r (f) + β (Rm – Rf)

= 5% + 2.64 (11% - 5%)
= 20.84%
The WACC = Cost of Equity + Cost of Debt
= 20.84 (60/100) + 12.0 (1-0.3) (40/100)
= 15.864

Finally, the future cash flows can be discounted at the WACC obtained above
as under –
Y1 Y2 Y3
Future Cash flows 100 120 150
Discount factor 0.863 0.745 0.643
PVs of cash flows 86.30 89.40 96.45
VALUE OF THE FIRM 272.15

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Q.34.

(In ` Thousands)

Year 1 2 3 4 5

Fixed Assets 13000.00 16900.00 21970.00 28561.00 28561.00

(25% of sales)

Current Assets 7800.00 10140.00 13182.00 17136.60 17136.60

(15% of sales)

Total Assets 20800.00 27040.00 35152.00 45697.60 45697.60

Current Liability 1300.00 1690.00 2197.00 2856.10 2856.10

Equity and Reserves 19500.00 25350.00 32955.00 42841.50 42841.50

(In ` Thousands)

Sales (30% yoy) 52000.00 67600.00 87880.00 114244.00 114244.00

PBT 15% 7800.00 10140.00 13182.00 17136.60 17136.60

PAT 70% 5460.00 7098.00 9227.40 11995.62 11995.62

Depreciation 15% 1500.00 1950.00 2535.00 3295.50 4284.15

Addition to Fixed Assets 4500.00 5850.00 7605.00 9886.50 4284.15

Increase in Current Assets 1800.00 2340.00 3042.00 3954.60 0

Operating Cash Flow 660.00 858.00 1115.40 1450.02 11995.62

Present value factor @ 14% 0.877 0.769 0.675 0.592 0.519

Present value of cash flows 579.28 659.80 752.90 858.41 6225.73

@14%

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(In ` Thousands)
Total for first 4 years (A) 2850.39
Residual value (11995.62/0.14) 85683
Present value of Residual value 50731
[85683/(1.14)4] (B)
Total Shareholders value (C) = (A) +(B) 53581.39
Pre strategy value (4200/0.14) (assuming 30000.00
Perpetual Cash Flow)(D)
Value of strategy (C) – (D) 23581.39
Conclusion: The strategy is financially viable.

Q35.
Projected Balance Sheet Year 1 Year 2 Year 3 Year 4
Fixed Assets (40%) of Sales 96,000 1,15,200 1,49,760 1,94,688
Current Assets (20%) of Sales 48,000 57,600 74,880 97,344
Total Assets 1,44,000 1,72,800 2,24,640 2,92,032
Equity 1,44,000 1,72,800 2,24,640 2,92,032
Projected Cash Flows:-
Year 1 Year 2 Year 3 Year 4
Sales 2,40,000 2,88,000 3,74,400 4,86,720
PBT (10%) of sale 24,000 28,800 37,440 48,672
PAT (70%) 16,800 20,160 26,208 34,070
Depreciation 8,000 9,600 11,520 14,976
Addition to Fixed Assets 24,000 28,800 46,080 59,904
Increase in Current 8,000 9,600 17,280 22,464
Assets
Operating cash flow (7,200) (8,640) (25,632) (33,322)

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P V of Projected Cash Flows:-

Present value of Projected Cash Flows:-
Cash Flows PV at 5% PV
-7,200 0.870 -6,264.00
-8,640 0.756 -6,531.84
-25,632 0.658 -16,865.86
-29,661.70
33,322
Residual Value =
0.15
= -2,22,147
Present value of Residual value = -2,22,147/(1.15)3
= -2,22,147/1.521 = -1,46,065.00
Total shareholders’ value = -29,661.70 - 1,46,065 = -1,75,726.70
Pre strategy value = 14,000 / 0.15 = 93,333.33
Value of strategy = -1,75,726.70 - = – 2,69,060.03
93,333.33
Conclusion: The strategy is not financially viable

Q36. As per Firm Cash Flow Approach

(i) Computation of tax rate
EBIT = ` 245 lakh
Interest = ` 218.125 lakh
PBT = ` 26.875 lakh
PAT = ` 17.2 lakh
Tax paid = ` 9.675 lakh
Tax rate = ` 9.675 /26.875
= 0.36
= 36%

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(ii) Computation for increase in working capital

Working capital (2009) = ` 44 lakh
Increase in 2010 = ` 44  0.08 = ` 3.52 lakh
It will continue to increase @ 8% per annum.

(iii) Weighted average cost of capital

Present debt = ` 1934 lakh
Interest cost = ` 218.125 lakh / ` 1934 = 11.28 %
Equity capital = 75 lakh  ` 66 = ` 4950 lakh
4950 1934
KC   16%   11.28 1  0.36 
1934  4650 1934  4950
= 11.51 + 2.028 = 13.54

(iv) As capital expenditure and depreciation are equal, they

will not influence the free cash flows of the company.

(v) Computation of free cash flows upto 2012

2010 2011 2012 2013 2014
Year
` ` ` ` `
EBIT (1-t) 169.34 182.89 197.52 213.32 230.39 lakh
4 lakh lakh lakh lakh
Increase in 3.52 3.80 4.10 4.43 4.78 lakh
working capital lakh lakh lakh lakh
Debt repayment - - - - 1934 × 0.30
= 580.2 lakh
Free cash flows 165.82 179.09 193.41 208.89 -354.59
4 lakh lakh lakh lakh lakh
PVF @ 13.54% 0.8807 0.7757 0.6832 0.6017 0.53
PV of free cash flow 146.04 138.92 132.14 125.69 -187.93
@ 13.54% lakh lakh lakh lakh lakh
Present value of free cash flows upto 2014 = ` 354.86 lakh

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(vi) Cost of capital (2014 Onwards)

Debt = 0.7  ` 1934
= ` 1353.80 lakh
Equity = ` 4950 lakh
4950 1353.80
KC   16%   11.28 1  0.36 
4950  1353.80 4950  1353.80
= 12.56 + 155%
= 14.11%

(viii) Continuing value

5
240.336  1 
=  
0.1411  0.06  1.1354 

= ` 1,570.556 lakh
(a) Value of the firm = PV of free cash flows upto 2014 + continuing value
= ` 354.86 lakh + ` 1,570.556 lakh
= ` 1925.416 lakh

(b) Value per share = (Value of Firm – Value of Debt)/ Number of Shares
(Value of Firm – Value of Debt)
=
75 lakh
= ` 7.622<` 66 (present market price)

Alternatively, following value can also be considered

= (Value of Firm – Value of Debt)/No. of Shares
= (` 1925.416 lakh - ` 1934)/75 lakh
= - ` 0.1145 or ` 0
Thus, share has zero value, and hence overvalued.

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Answer as per Equity Cash Approach

(i) Computation of tax rate
EBIT = ` 245 lakh
Interest = ` 218.125
PBT = ` 26.875 lakh
PAT = ` 17.2 lakh
Tax Paid = ` 9.675 lakh
Tax rate = ` 9.675/26.875 = 0.36 = 36%
(ii) Computation for increase in working capital
Working capital (2009) = ` 44 lakh
Increase in 2010 = ` 44 lakh  0.08
= ` 3.52 lakh
(iii) As capital expenditure and depreciation are equal, they will not
influence the free cash flows of the company.

(iv) Computation of free cash flows upto 2014

2010 2011 2012 2013 2014
Year
` lakh ` lakh ` lakh ` lakh ` lakh
EBIT 245.000 264.600 285.768 308.629 333.319
Less Interest 218.125 218.125 218.125 218.125 152.688
EBT 26.875 46.475 67.643 90.504 180.631
Tax 9.675 16.266 24.351 32.581 65.027
EAT 17.200 30.209 43.292 57.923 115.604
Increase in working 3.52 3.80 4.10 4.43 4.78
capital
Debt repayment - - - - 1934 × 0.30 =
580.20
Free cash flows 13.68 26.409 39.192 53.493 -469.376
PVF @ 16% 0.8621 0.7432 0.6407 0.5523 0.4761
PV of free cash flow 11.794 19.627 25.110 29.544 -223.470
Present value of free cash flows upto 2014 = - ` 137.395 lakh

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(v) Continuing value

5
117.473 *  1 
=  
0.16 – 0.06  1.16 

= *(115.604 – 4.78) (1.06)

(a) Value of the Equity = PV of free cash flows upto 2014 + continuing value
= - `137.395 lakh + `559.304 lakh
= `421.909 lakh
Value of Equity
(b) Value per share =
Number of Shares
` 421.909 lakh
=
` 75lakh
= 5.62< `66 (present market value)
Q37. Working Notes :
Calculation of Interest Payment on 9% Debentures
PVAF (9%,6) = 4.486
` 22.50
Annual Installment = = ` 5.0156 crore
4.486

Balance Interest Principal

Installment Balance
Year Outstanding (` Repayment
(` Crore) (` Crore)
(` Crore) Crore) (` Crore)

1 22.5000 2.025 5.0156 2.9906 19.5094

2 19.5094 1.756 5.0156 3.2596 16.2498

3 16.2498 1.462 5.0156 3.5536 12.6962

4 12.6962 1.143 5.0156 3.8726 8.8236

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Statement showing Value of Equity

2013-14 2014-15 2015-16 2016-17
Particulars
(` Crore) (` Crore) (` Crore) (` Crore)
EBIT 48.0000 57.0000 68.0000 82.0000
Interest on 9% Debentures 2.0250 1.7560 1.4620 1.1430
Interest on 8% Loan 12.8000 12.8000 12.8000 12.8000
EBT 33.1750 42.4440 53.7380 68.0570
Tax* @35% 11.6110 14.8550 18.8080 23.8200
EAT 21.5640 27.5890 34.9300 44.2370
Dividend @12.5% of EAT* 2.6955 3.4490 4.3660 5.5300
18.8685 24.1400 30.5640 38.7070
Balance b/f Nil 18.8685 43.0085 73.5725
Balance c/f 18.8685 43.0085 73.5725 112.2795
Share Capital 82.5000 82.5000 82.5000 82.5000
101.3685 125.5085 156.0725 194.7795
*Figures have been rounded off.
In the beginning of 2013-14 equity was ` 82.5000crore which has been
grown to ` 194.7795 over a period of 4 years. In such case the
compounded growth rate shall be as follows:
(194.7795/82.5000)¼ - 1 = 23.96%
This growth rate is slightly higher than 20% as projected by Mr. Smith.
If the condition of VenCap for 18 shares is accepted the expected share
holding after 4 years shall be as follows:
No. of shares held by Management 6.00 crore
No. of shares held by VenCap at the starting stage 2.25 crore
No. of shares held by VenCap after 4 years 4.05 crore
Total holding 6.30 crore

Thus, it is likely that Mr. Smith may not accept this condition of VenCap as
this may result in losing their majority ownership and control to VenCap.
Mr. Smith may accept their condition if management has further
opportunity to increase their ownership through other forms.

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Q38. Creditors would convert ` 10,00,000 in debt to equity by accepting

` 1,000,000/` 20 = 50,000 shares of stock.
The remaining ` 500,000 of debt would generate interest of
` 500,000  0.12 = ` 60,000
Repayment of principal would be reduced by two thirds to ` 25,000 per
year. The result is as follows:
Income and Cash Flow Capital
EBIT ` 80,000 Debt ` 500,00
Interest 60,000 Equity ` 1,700,00
EBT ` 20,000 2,200,000
Tax 3,000
EAT ` 17,000
Depreciation 50,000
Principal repayment (25,000)
Cash Flow ` 42,000
After the restructuring there will be a total of (35,000+50,000)85,000
shares of equity stock outstanding.
The original shareholders will still own 35,000 shares (approximately
41%), while the creditors will own 50,000 shares (59%).
Hence the creditors will control the company by a substantial majority.

Q39. (i) Value of Firm

Cash Flow PV
Year PVF
(` in lakhs) (` in lakhs)
1 1760 0.833 1466.08
2 480 0.694 333.12
3 640 0.579 370.56
4 860 0.482 414.52
5 1170 0.402 470.34
PV of Cash flows upto year 5 3054.62
If PV of Terminal Value is considered with the growth rate (at the end
of 5 th year)

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Now, PV (at the beginning of the year)

= `92,340 x 0.402 = `37,120.68 Lakhs
So, Present Value of the firm
= `3054.62 + `37120.68
= `40175.30 Lakhs

(ii) Value per share

= Value of Firm – Value of Debt / No of shares
= (40175.30 – 3620)/151.50
= ` 241.29

(iii) Takeover bid of ` 225 per share seems to be not a good offer as it is
lesser than the intrinsic value i.e. value per share of ` 241.29.

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Q40.
Price Earnings Ratio 6
Market Price Per Share 24
EPS 4
Number of Shares 5,00,000
Profit After Pref. Dividend ` 20,00,000
Pref. Dividend ` 9,00,000
Profit After Tax ` 29,00,000
29,00,000 ` 43,93,939
Profit before tax
1  0.34
Less: Extraordinary income ` 24,00,000
Add: Extraordinary losses ` 9,00,000
Existing Profit from Old Operations ` 28,93,939
Profit from new product (`
Lakhs)
Sales 150
Less: Material costs 40
Labour costs 34
Fixed costs 24 (98) ` 52,00,000
` 80,93,939
Less: Taxes @ 34% ` 27,51,939
Future Maintainable Profit after taxes ` 53,42,000
Relevant Capitalisation Factor 0.10
Value of Business (` 53,42,000/0.10) ` 5,34,20,000
or ` 5.342
crore



Strategic Financial Management 478 Corporate Valuation