Advanced Financial Management B.

com 5th Semester

BAPU DEGREE COLLEGE

(Affiliated Bengaluru City University)

ADVANCED FINANCIAL MANAGEMENT

Course Manual for Undergraduate Students
Bengaluru City University
B.com 5th Semester

Compiled By
Prof Punith Kumar H S M.com (Ph.D.)
Assistant Professor Commerce & Management

(For Internal Circulations only)

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Unit 1
Introduction and Fundamental Tools of Finance
Meaning of Financial Management – Goals of Financial Management - Analysis of Financial Statements – DU
PONT ANALYSIS; Time Value of Money – Compounding, Discounting, Annuity and Perpetuity; Weighted
Average Cost of Capital – CAPM based calculation. Beta – Un-levering and Re-levering

Unit blue print

Sl no Topics Concept Marks allotted
1. Meaning definition of FM Theory 2 Marks
2 Goals Financial Management Theory 2/5/15 Marks
3 Analysis of Financial Statement Theory 5 marks
4 Dupont analysis Theory 5 marks
5 Time value of money Meaning Theory & 2 marks
Compounding Technique / Future Value Practical
Discounting Technique / Present Value Questions 5 marks
6 CAPM Model Theory 5 Marks
7 How to calculate Beta Simple Problems Practical 2 marks 5 marks
Question
8 Un-levering and Re-levering Theory 2 marks
9 Weighted average cost of capital Practical 15 Marks

Introduction to Finance
Finance is the life blood of any business, just as circulation of blood is essential in the human body for
maintaining life; Finance is very essential for smooth running of the business.
A company needs enough funding to execute their plans and support their operations, and these
finances can be obtained from various sources such as bank loan, venture capital, own funds, investors
fund etc.
Once the funds are obtained it used for procuring assets, managing various costs in routine operations
such as payment of rent, salaries buying inventory or for expansion of business.
DEFINITION:
According to Gutman and Dougal, financial management means, “the activity concerned with the
planning, raising, controlling and administering of funds used in the business.” It is concerned with the
procurement and utilisation of funds in the proper manner.
Financial management: According to wheeler “Financial management is that business activity which
is concerned with the acquisition and conservation of capital funds in meeting the financial needs and
overall objectives of the firm".
Meaning:
It refers to that part of the management activity which is concerned with the planning & controlling of
firm's financial resources. It deals with finding out various sources for raising funds & most appropriate
use of such funds.

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Meaning of Finance:
It is the science and art of managing money or other assets. Finance implies to procuring, investing
funds and managing the profits or losses.
Business finance:
It is that business activity which is concerned with the acquisition and conservation of capital funds in
meeting financial needs and overall objectives of a business enterprise.
Finance function:
It refers to action performed by a finance department that involves acquiring and utilizing funds of a
business. In other words, It refers to the raising of funds and their effective utilization.
AIMS OF FINANCE FUNCTION:
1. Acquiring Sufficient funds: The main objective of financial function is to estimate the financial
needs of the business and then finding out suitable sources for long term investment than long term
sources like issue of shares, debentures, long term loans etc, may be preferred. It funds are required for
working capital purposes then short-term sources like bank credit, trade credit, factoring etc, may be
used.
2. Proper utilization of funds: Though raising of funds is important but their effective utilization is
more important. The funds should be used in a way that maximum benefit is derived from them. The
returns must be more than their expected cost.
3. Increasing profitability: The planning and control of finance function aims at increasing
profitability of the concern, it is true that money generates money. To increase profitability, sufficient
funds will have to be invested. It should be ensured that funds do not remain idle at any point of time.
When funds are used effectively it will lead to increase in profitability.
4. Maximising the firm's value: Finance function also at maximising the value of the firm. The value
of the firm is determined by its profitability. The value of the firm is also influenced by the other factor,
such as sources funds, cost of capital, money market conditions, the demand for product etc. In order
to maximize the value a firm need to have sustainable growth and strong earnings.
5. Budgeting and controlling: Through the preparation of various budget statements to estimate the
financial requirements of a stipulated period to control the costs in the organisation for long survival
is another finance function of the organisation.
6. Dividend pay-out: It refers to profit planning and allocation is disposable profit is the major function
of finance. The rate of dividend declared and the stability of dividend is very imp maintaining residual
profits to meet future contingencies is also a key function of finance.
OBJECTIVES Or GOALS OF FINANCIAL MANAGEMENT:
The basic objectives of financial management can be classified into 2 categories namely:
(a) Basic objective or Goal
(b) Other objective or Goal
(a) Basic objective or Goal: The basic objective of financial management are:
Punith Kumar H S M.com (Ph.D.)
Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

1. Profit management
2. Wealth management
1. Profit management:
Profit is the main aim of every economic activity. A business being an economic institution must earn
profit to cover its costs and provide funds for a growth. No business can survive without earning profit.
Profit maximisation denotes the maximum profit to be earned by an organisation in a given time period.
Argument for profit maximization
1. When profit earning is the main objective of the business than, profit maximization should be its
main objective.
2. Profitability is a barometer for measuring efficiency and economic prosperity of a business
enterprise.
3. Profits are the main sources of finance for the growth and development of a business.
4. A business will be able to survive under unfavorable situations like recession, depression, severe
competition etc only if it has some past earnings.
5. Profitability is essential for fulfilling social needs also.
6. Profit maximization attracts the investors to invest their savings in securities of the firm.
7. Profit maximization indicates the efficient use of funds of the business concern.
8. The goodwill of the firm is based on profitability.
9. Profit maximization ensures maximum returns to the proprietor, fair remuneration to employees
and prompt payment to creditors of the company.

Arguments against profit maximization:

1. The term profit is vague and it cannot be precisely defined. It means different things for different
people. i.e., it is not clear whether it is accounting profit or economic profit or profit before tax or
profit after tax.
2. Another limitation of this approach is that it ignored the time value of money i.e., under this
approach income of different years get equal weight but in fact the value of a Rupees today will be
greater than value of Rupees after 1 year.
3. It does not take into consideration the risk of the prospective earnings stream.
4. Profit maximization encourages corrupt practices to increase the profit.
5. The effect of dividend policy on the market price of shares is also not considered in the objective
of profit maximization.
6. Profit maximization attracts cutthroat competition.
7. Huge amount of profit may invite government intervention.
8. It does not consider the element of risk

2. Wealth maximization:
Wealth maximization is the process of increasing shareholders wealth by way of maximising the
market value of firm’s common stock.

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

When business enterprises try to maximise the wealth of their firm, they are actually trying to increase
their stock price. As the price goes up, the value of the firm increases and the net worth of the individual
who owns the stock increases.
Arguments for wealth maximization:
1. Serves interest of society: When a business enterprise attempts to maximise it's stock value its
actually benefits the society as most stock ownership is held by relatively small segment of society
consisting of the individuals.
2. Benefits customers: to increase the market value of stock a business enterprise must strive to
accomplish efficient, low-cost business model that produce high quality goods and services at the
lowest possible cost. This leads to new technological development and new products.
3. Considers timing of benefits risk: in taking an investing decision management should choose that
project for investment, which will give maximum return to shareholders will a minimum risk.
4. Benefits employees: companies that successfully increase stock prices also grow and add more
employees, thus benefits society. This results in firm’s ability to satisfy employees and its creation of
value to shareholders.
Unfavourable arguments for wealth maximization are as follows:
1. Wealth maximization is a prescriptive idea: unfortunately, the concept of wealth maximization
has it fair share of drawbacks which arises because of conceptual or logical connection. Further it is
not logically possible to maximise both market share and profit together.
2. Lead to controversy: the concept of wealth maximization is controversial because it emphasises on
increasing the wealth of stock holders but neglects wealth of firm which includes other stake holders
such as debenture holders, preferred stock holders, employees etc.
3. Not socially desirable: Shareholder’s wealth maximization does not imply the company should
maximise shareholder value in any way including illegal means. Companies violate the law in order to
pursue temporary benefits.
4. Ownership and management conflict: Shareholding pattern of a company shows how it's shares
are split among the entities that make up its owners. There are two main sections the promoters and
the public shareholding. Promoter holdings show the extent of control promoters have over running of
the business. Percentage of business that is owned by the promoters can affect the business, the share
price and ultimately the profitability.
Other Objectives or Goals:
1. Financial Management must have a goal of maintaining balanced Asset Structure of a company
Balance between Fixed assets & current assets have to be maintained.
2. The liquidity objective of a company will exploit the long-term vision of a company. It a firm is
liquid it indicates a positive growth of a company.
3. It is the obligation of finance manager to be vigilant in increasing the efficiency level of a company
to meet the increasing competition there must be judicious planning of funds.

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

It is the responsibility of a company to have financial discipline to various techniques of financial

maximization.
Analysis of Financial Statements
The process of critical evaluation of the financial information contained in the financial statements in
order to understand and make decisions regarding the operations of the firm is called ‘Financial
Statement Analysis’.
It is basically a study of relationship among various financial facts and figures as given in a set of
financial statements, and the interpretation thereof to gain an insight into the profitability and
operational efficiency of the firm to assess its financial health and future prospects.
Financial statement analysis is a judgemental process which aims to estimate current and past financial
positions and the results of the operation of an enterprise, with primary objective of determining the
best possible estimates and predictions about the future conditions.
Objectives of Analysis of Financial Statements
Analysis of financial statements reveals important facts concerning managerial performance and the
efficiency of the firm. Broadly speaking, the objectives of the analysis are to apprehend the information
contained in financial statements with a view to know the weaknesses and strengths of the firm and to
make a forecast about the future prospects of the firm.
• to assess the current profitability and operational efficiency of the firm as a whole as well as its
different departments so as to judge the financial health of the firm.
• to ascertain the relative importance of different components of the financial position of the firm.
• to identify the reasons for change in the profitability/financial position of the firm.
• to judge the ability of the firm to repay its debt and assessing the short-term as well as the long-term
liquidity position of the firm.
Tools or Techniques of Analysis of Financial Statements
The most commonly used techniques of financial analysis are as follows:
1. Comparative Statements: These are the statements showing the profitability and financial position
of a firm for different periods of time in a comparative form to give an idea about the position of two
or more periods. It usually applies to the two important financial statements, namely, balance sheet and
statement of profit and loss prepared in a comparative form. The financial data will be comparative
only when same accounting principles are used in preparing these statements. If this is not the case,
the deviation in the use of accounting principles should be mentioned as a footnote. Comparative
figures indicate the trend and direction of financial position and operating results. This analysis is also
known as ‘horizontal analyses.
2. Common Size Statements: These are the statements which indicate the relationship of different
items of a financial statement with a common item by expressing each item as a percentage of that
common item. The percentage thus calculated can be easily compared with the results of corresponding
percentages of the previous year or of some other firms, as the numbers are brought to common base.
Such statements also allow an analyst to compare the operating and financing characteristics of two

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

companies of different sizes in the same industry. Thus, common size statements are useful, both, in
intra-firm comparisons over different years and also in making inter-firm comparisons for the same
year or for several years. This analysis is also known as ‘Vertical analyses.
3. Trend Analysis: It is a technique of studying the operational results and financial position over a
series of years. Using the previous years’ data of a business enterprise, trend analysis can be done to
observe the percentage changes over time in the selected data. The trend percentage is the percentage
relationship, in which each item of different years bear to the same item in the base year. Trend analysis
is important because, with its long run view, it may point to basic changes in the nature of the business.
By looking at a trend in a particular ratio, one may find whether the ratio is falling, rising or remaining
relatively constant. From this observation, a problem is detected or the sign of good or poor
management is detected.
4. Ratio Analysis: It describes the significant relationship which exists between various items of a
balance sheet and a statement of profit and loss of a firm. As a technique of financial analysis,
accounting ratios measure the comparative significance of the individual items of the income and
position statements. It is possible to assess the profitability, solvency and efficiency of an enterprise
through the technique of ratio analysis.
5. Cash Flow Analysis: It refers to the analysis of actual movement of cash into and out of an
organisation. The flow of cash into the business is called as cash inflow or positive cash flow and the
flow of cash out of the firm is called as cash outflow or a negative cash flow. The difference between
the inflow and outflow of cash is the net cash flow. Cash flow statement is prepared to project the
manner in which the cash has been received and has been utilised during an accounting year as it shows
the sources of cash receipts and also the purposes for which payments are made. Thus, it summarises
the causes for the changes in cash position of a business enterprise between dates of two balance sheets.
DU-PONT ANALYSIS
The Dupont analysis also called the Dupont model is a financial ratio based on the return on equity
ratio that is used to analyse a company’s ability to increase its return on equity.
In other words, this model breaks down the return on equity ratio to explain how companies can
increase their return for investors.
The name comes from the DuPont company that began using this formula in the 1920s. DuPont
explosives salesman Donaldson Brown invented the formula in an internal efficiency report in 1912.
Return on Equity = Net Profit Margin * Asset Turnover Ratio * Financial Leverage = (Net Income /
Sales) * (Sales / Total Assets) * (Total Assets / Total Equity)

3-Step DuPont Analysis

In a 3-step DuPont analysis, the equation states that if a company’s net profit margin, asset turnover,
and financial leverage are multiplied, you will arrive at the company’s return on equity (ROE).
As the simpler version between the two approaches, the ROE is broken into three components:

• Net Profit Margin = Net Income ÷ Revenue

• Asset Turnover = Revenue ÷ Average Total Assets

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

• Financial Leverage Ratio = Average Total Assets ÷ Average Shareholders’ Equity

Brief Explanation about Components of DuPont Analysis

This analysis has 3 components to consider;

1. Profit Margin
This is a very basic profitability ratio. This is calculated by dividing the net profit by total revenues.
This resembles the profit generated after deducting all the expenses. The primary factor remains to
maintain healthy profit margins and derive ways to keep growing it by reducing expenses, increasing
prices, etc, which impacts ROE.

2. Total Asset Turnover–

This ratio depicts the efficiency of the company is using its assets. This is calculated by dividing
revenues by average assets. This ratio differs across industries but is useful in comparing firms in the
same industry. If the company’s asset turnover increases, this positively impacts the ROE of the
company.

3. Financial Leverage-
This refers to the debt used to finance the assets. The companies should strike a balance in the usage
of debt. The debt should be used to finance the operations and growth of the company. However, usage
of excess leverage to push up the ROE can turn out to be detrimental to the health of the company.

The company can increase its Return on Equity if it-

1. Generates a high Net Profit Margin.

2. Effectively uses its assets so as to generate more sales

3. Has a high Financial Leverage

Time Value of Money

Meaning of Time value of Money
Time value of Money refers to “time has got a value”. The rupee value keeps on changing over a period
of time.
The concept of time value of money refers to the money received today is difference in its worth from
the money receivables at some other time in future.
Example of Time Value of Money
Imagine you lent a friend $1,000 and he paid you back today. You immediately deposit that money
into an account that earns 7% annually. It will be worth $1,070 in exactly one year’s time.
If, on the other hand, you received the $1,000 in one year’s time, it would only be worth $934.58
($1,000 ÷ 1.07), assuming a 7% annual interest rate.
Compounding Technique or Future Value
Compound value concept is used to find out the future value of present money.

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Future value is the value of an asset at a specific date which measures the nominal future sum of money
wherein the sum of money is worth at a specified time in the future assuming a certain interest rate or
more rate of return.
The compounding technique is to find out the future value (FV) of the present worth of money, can be
explained with reference to:
a) The future value of a single present cashflows.
b) The future value of annuity/series of cashflows.
c) The future value of multiple cashflows.

a) Future value of a single present cashflows

In case of annual compounding:
FV = PV(1+r)"

• FV = Future value
• PV= Present value
• r = Rate of interest
• n = Number of years

Practical Problems

1. Find out the FV of a sum of Rs 2000 after a year with a time preference money of 12%?
Solution:

2. Find out the FV of a sum of Rs 1600 received after two years at 10%-time preference rate?
Solution:

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

3. X invests Rs 1000 for 3 years in a savings account that pays 10% interest pa. calculate FV?
Solution:

a) Future value of a single present cashflows

In case of Multiple compounding:
In the multiple compounding periods, if the compounding period varies, inter earned will also vary,
viz, if the interest is compounded semi-annually, quarterly monthly, such future value is calculated by
using the following formula:

1. Calculate the future value of Rs 4,000 is invested for 4 years and the interest on it is
compounded at 12% p.a. half yearly. Find out the compounded value or future value. Given
(1.06)8 1.594.
Solution:

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

2. Calculate the future value of Rs7000 invested for years at a rate of interest of 15%
compounded half yearly.
According to compound table compound value factor for Re. in 5 years at rate 15%.
Solution:

3. Calculate the Future Value of Rs 9000 is invested for a period of 5 years at 12% p.a.
interest compound Quarterly. Find Out FV given (1.03)20 = 1.806
Solution:

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

b) The future value of annuity/series of cashflows.

Even cashflows of a certain period of time is known as “Annuity". In other words, Annuity is a fixed
payment or receipt each year for a specified number of years. The future value of annuity can be
calculated by using annuity table as well as by adopting a formula.

1. Calculate the future value of annuity of Rs 75,000 deposited at the end of each year at 6%
for a period of 5 years.
Solution:

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

2. Calculate the future value of annuity of Rs 4000 deposited at the end of each year at 6%
for a period of 5 years.
Solution:

c) The future value of multiple cashflows.

1. Calculate the future value of the following cashflow if it is invested @ 8% P.a

At the end of each year Amount Deposited

1 2000

2 4000

3 6000

4 8000

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

2. Calculate FV @ the end of 4 years of the following series of payments at 9% Interest

Rs 1000 at the end of First Year
Rs 2000 at the end of Second Year
Rs 3000 at the end of Third Year
Rs 4000 at the end of Fourth Year

PRESENT VALUE TECHNIQUE OR DISCOUNTING TECHNIQUE

Present Value Technique is a reverse of compounding technique and is also known as discounting
technique. As these are future value of sums invested now, calculated as per the compounding
techniques, there are also the present values of a cash flow scheduled to occur in future.
Hence this method helps to find out the present value of the future money. The discounting technique
to find out the present value can be explained in terms of:
a) Present value of Single cashflows
b) Present value of Annuity/series of even cashflows
c) Present value of uneven future cashflows

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Find out the present value of ₹ 3000 received at the end of the year if the discount rate is 9%.

Calculate the present value of a sum of ₹ 50,000 received after 2 years if the discount rate is 8%$
p.a.

b) Present value of Annuity/series of even cashflows

Find out the present value of annuity receipt of ₹ 4000 received for 4 years at the rate of discount
rate.

Find the present value of a 5 years annuity of ₹ 10,000 discounted at 9%

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Perpetuity
The stream of regular cash flows for an infinite period is called perpetuity. It may be compared to an
annuity but it does not have any time limit. In perpetuity time is not finite. However, present value of
perpetuity can be calculated. Example of perpetuity is preference shares which carry certain fixed rate
of dividend payable for forever,

Perpetuity is a type of annuity that receives an infinite amount of periodic payments. An annuity is a
financial instrument that pays consistent periodic payments. As with any annuity, the perpetuity value
formula sums the present value of future cash flows

The value of perpetuity can change over time even though the payment remains the same occurs as the
discount rate used may change. If the discount rate used lowers, the denominator formula lowers, and
the value will increase.
This of the Formula for calculation of Present Value of Perpetuity
Present Value of a Perpetuity = A/r
Where,
A= Amount
r= Effective rate of interest/ discount rate
Determine the present value of perpetuity * 1,20,000 per year for infinite period at an effective
rate of interest of 12% p.a.?

What is the Present Value of Rs 50 per year forever at 6%

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

What is the Present value of Rs 10,000 received per year forever at 10% Discount Rate

Weighted Average of Cost of Capital

1. The Following is the capital structure of firm expected after tax component cost of the various
source of finance.
Source of Finance Amount in Rs Expected after
tax cost (%)

Equity share Capital 325000 20

Retained Earnings 125000 20

Preference share capital 75000 50

Debt Capital 225000 12

Solution:

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Determine the weighted average cost of capital using

a. Book value Weights b. Market value weights

Source of Capital Book Value Market Value Specific Cost

Debt 40,000 38000 5%

Preference 10,000 11000 8%

Equity 60,000 120,000 13%

Retained Earnings 20,000 _ 9%

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

2. Calculate the weighted average cost of Capital of XYZ co ltd from the following.

Source of Capital Book Value Market Value After tax Cost

Equity share capital 45000 90000 14%

Retained earnings 15000 Nil 13%

Pref Share Capital 10,000 10,000 10%

Debentures 30,000 30,000 5%

From the Following capital Structure of a company Calculate overall cost of capital using
a. Book Value weights b. Market Value Weights

Source of Finance Amount in Rs Expected after

tax cost (%)

Equity shares 15,00,000 20

Retained Earnings 6,00,000 15

Preference share capital 3,00,000 10

Debt Capital 6,00,000 10

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Capital Asset Pricing Model

The CAPM was introduced by Jack Treynor, William Sharpe, John Lintner and Jan Mossin
independently, building on the earlier work of Harry Markowitz on diversification and modern
portfolio theory,

A model that describes the relationship between risk and expected return and that is used in the
pricing of risky securities. The general idea behind CAPM is that investors need to be compensated
in two ways: time value of money and risk

CAPM is a framework for determining the equilibrium expected return for risky assets. It indicates the
relationship between expected return and systematic risk of individual assets or securities or portfolios.
William F Sharpe developed the CAPM. He emphasized that risk factor in portfolio theory is a
combination of two risk, systematic and unsystematic risk.

• Investors are rational and risk-averse.

• Investors seek maximizing the expected return.
• Investors base their decision on the basis of risk and return.
• Investors are assumed to have homogeneous expectations during the decision-making period. It
means the investors are assumed to have identical expectations with respect to holding period, risk
and return.
• The investors can lend or borrow any amount of funds freely at risk less rate of interest. The riskless
rate of interest is the rate of interest offered for the treasury bills or government securities.
• It is assumed that the Market is perfect. Purchases and sales by a single investor cannot affect
prices. This means that there is a perfect competition where investors in total determine prices by
their actions.
• Quantity of risky securities in market is given.
• There is no transaction cost and does not have an impact on decision making by the investors.
• It is assumed that all information is available at the same time to all investors.
There is no personal income tax.

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

CAPM FORMULA

What Is Beta?
Beta is a measure of the volatility—or systematic risk—of a security or portfolio compared to the
market as a whole. Beta is used in the capital asset pricing model (CAPM), which describes the
relationship between systematic risk and expected return for assets (usually stocks).

CAPM is widely used as a method for pricing risky securities and for generating estimates of the
expected returns of assets, considering both the risk of those assets and the cost of capital.

How do You calculate Beta?

The calculation for beta is as follows:

Beta coefficient β) Variance (Rm)

Covariance (Re,Rm)

where:
Re=the return on an individual stock
Rm=the return on the overall market
Covariance=how changes in a stock’s returns arerelated to changes in the market’s returns
Variance=how far the market’s data points spreadout from their average value

Companies and investors review the weighted average cost of capital (WACC) to evaluate the returns
that a firm needs to realize to meet all of its capital obligations, including those of creditors and
stockholders. Beta is critical to WACC calculations, where it helps 'weight' the cost of equity by
accounting for risk.
Un levering the Beta

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

WACC calculations incorporate levered and unlevered beta, but it does so at different stages when
being calculated. Unlevered beta shows the volatility of returns without financial leverage. Unlevered
beta is known as asset beta, while the levered beta is known as equity beta. Unlevered beta is
calculated as:

Unlevered beta = Levered beta / [1 + (1 - Tax rate) * (Debt / Equity)]

Unlevered beta is essentially the unlevered weighted average cost. This is what the average cost would
be without using debt or leverage. To account for companies with different debts and capital structure,
it’s necessary to un lever the beta. That number is then used to find the cost of equity.

Re-Levering the Beta

After finding an unlevered beta, WACC then re-levers beta to the real or ideal capital structure. The
ideal capital structure comes into play when looking to purchase the company, meaning the capital
structure will change. Re-levering the beta is done as follows:

Levered beta = Unlevered beta * [1 + (1 - Tax rate) * (Debt / Equity)]

In a sense, the calculations have taken apart all of the capital obligations for a firm and then
reassembled them to understand each part's relative impact. This allows the company to understand
the cost of equity, showing how much interest the company is required to pay per dollar of finance.
WACC is very useful in determining the feasibility of future capital expansion.

1. XYZ ltd is planning to calculate it cost of equity. XYZ operates in the Construction industry.
Average beta of comparable list of companies in the industry is 0.8. The comparable companies
have an average debt to equity ratio of 0.45. XYZ has a debt-to-equity ratio of 0.30 and a 35%
tax rate. Calculate Unlevered beta.

Calculate the levered beta using unlevered beta.

Un-levered beta (βu) = Levered Beta (βL)

___________________

[1+(1-Tax rate) x Debt ÷ Equity

Levered Beta (βL)= Un-levered beta (βu)

___________________

[1+(1-Tax rate) x Debt ÷ Equity

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Unit 2 CORPORATE VALUATION

Valuation of Firm and Valuation of Equity – Net Assets Method, Earnings Capitalization Method,
Relative Valuation, Chop Shop Method. Discounted Cash Flow (DCF) Method, Adjusted Present Value
(APV) Method.
Unit Wise Blue Print
Sl No Topics Concept Marks
1 Net Asset Method Practical 5 or 15 Marks
2 Earnings Capitalisation Model Theory 2 or 5 marks
3 Chop Shop Method Practical/Theory 5 or 15 Marks
4 Discounted Cash Flow Practical 5 or 15 Marks
5 Relative Valuation Theory 5 marks
6 Adjusted present Value Method Theory 2 0r 5 Marks

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Unit 2 CORPORATE VALUATION

Valuation of Firm and Valuation of Equity – Net Assets Method, Earnings Capitalization Method,
Relative Valuation, Chop Shop Method. Discounted Cash Flow (DCF) Method, Adjusted Present Value
(APV) Method.
Introduction:
Corporate valuation can be traced back to centuries ago when the United East India Company (referred
to as ‘Dutch East India Company’ by the Britishers) was the first corporation to be valued and an IPO
was launched.
The East India Company too stands as a fine example of a corporatized way of doing world trade, and
perhaps the earliest of institutions to focus on wealth maximization, albeit in unethical ways.
Today, almost every enterprise that generates a positive cash flow and generates suitable employment
opportunities feels the pressing need to ‘value’ itself – be it for going to the local bank for debt
financing, or for assessing an initial public offering.
WHAT IS CORPORATE VALUATION?
In the field of finance, corporate valuation is the process of determining the value of a business entity.
It is an important aspect of corporate finance, used for a wide variety of purposes. Valuation is essential
for mergers and acquisitions, where a sound decision has to be made whether and at what price to
acquire a company. The value of a company could be different for sellers and buyers, so valuation is
integral part of the negotiation process. It is also crucial for the effective management of a company,
for identifying its value-generating units, and formulating strategies for growth.
APPROACHES/ METHODS OF VALUATION
The purposes of the valuation is Mergers and Acquisitions as the carrying out valuation of target
company becomes important to gauge out the price to be offered to it. The target company can be listed
or unlisted. If the target company is unlisted then the price of acquisition shall be at the negotiated
price acceptable by both companies.
Broadly there are three approaches to value an enterprise:
• Assets Based Valuation Model
• Earning Based Models or Earnings Capitalisation Method
• Relative Valuation Method
• Chop Shop Method
• Discounted Cash Flow Models
• Adjusted Present Value Method

(a) Assets Based Valuation Model

What Is an Asset-Based Approach?
An asset-based approach is a type of business valuation that focuses on a company's net asset value.
The net asset value is identified by subtracting total liabilities from total assets.

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
 Advanced Financial Management B.com 5th Semester

This approach further can be classified into following three methods:

Net Asset Value
NAV method also called ‘Book Value’ Method computes the value of the shares of the company as
follows:
Net Fixed Asset = Fixed Assets + Net Current Assets – Long Term Debt (Total External liability)
1. Sri Ram ltd is in a stage of finalizing its books of Accounts, total assets are 2,50,00,000 total
liabilities (Excluding liability) are Rs 1,30,00,000 and Outstanding Equity share are 1,10,000
Solution: Net Asset Value = Total Asset – Total External Liability
Net asset per share = Net assets ÷ Number of Equity shares outstanding

2. A leading Bank in India reported the following items of assets and liabilities forv the year
2020-2021.
Borrowings Rs 8,54,817.50 crore
Other liabilities Rs 58,816.55 Crore
Net block Rs 5,008.15 crore
Investments Rs 2,58,461.50 crore
Other Assets Rs 8,70,764.50 crore
You are Required to determine net asset value of bank.

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

3. The following is the balance sheet of XYZ ltd

Liabilities Amount Assets Amount

Rs in Rs in
Crore Crore
Equity share capital 20 crore 200 Fixed assets 240 200
equity shares of Rs 10 each - Depreciation 40
Preference share capital Rs 100 50 Stock 120
each at 12%
Profit and Loss account 30 Debtors 60
Debentures at 10% 25 Bank 10
Creditors 80 Survey Expenses 5
Income tax Provisions 10
395 395

Calculate Net value of Assets

4. The following is the balance sheet of XYZ ltd

Liabilities Amount Assets Amount Rs

Rs in in Crore
Crore
Equity share capital 20 crore 200 Fixed assets 240 200
equity shares of Rs 10 each - Depreciation 40
Preference share capital Rs 100 50 Stock 120
each at 12%
Profit and Loss account 30 Debtors 60
Debentures at 10% 25 Bank 10
Creditors 80 Survey Expenses 5
Income tax Provisions 10
395 395

Calculate Net Assets Value if the fixed assets are over valued by Rs 20 crore and Rs 10 Crore of total
debts are expected to be written off.

Net Realizable Value

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Also called Liquidation Value or Adjusted Book Value it can be defined as realizable value of all assets
after deduction of liquidation expenses and paying off liabilities. Though in some case liquidation
expenses can be ignored if business of target company is acquired as a going concern.
Despite appearing to be simple method the calculation of net realizable value may not be so simple as
being an off-market purchase it is likely that buyer may offer lowest prices.
This method is not so popular as it involves total breakup of the target company. This method is
generally useful where the acquirer is interested in selling one part of business and integrate remaining
part of the business with the existing operations.
Replaceable Value
This method involves valuation as per determination of the cost of group of assets and liabilities of
equivalent company in the open market. This method has advantage over Book Value as it takes into
consideration proper valuation and generally it is slightly higher than Net Realizable Value as quick
asset disposal is not encouraged.
And due to this reason, many author believes that it is the maximum price that an acquirer would pay
for the equivalent business. However, this approach also suffers from limitation that hard assets are
taken into consideration still loyalty of the staff cannot be taken into consideration.
Conclusions:
The asset-based approach can depict the enterprise’s net worth fairly correctly using the fundamental
principle of ‘going concern’. However, it suffers from a major drawback – It fails to consider the ability
of the enterprise to generate future revenues and how the market dynamics will affect the future
operations and cash flow.
1. Earnings Capitalization Method

This method is used when determination of a profitably running business firm. In other words, the
value of a business firm is based on the concept of 'going concern'. It refers a continuing business with
profitable record.

This method needs to estimate future earnings with a level of activity. The earnings need to be arrived
after adjusting non-recurring/extraordinary items of income and expense.

This approach looks to overcome the drawbacks of using the asset-backed valuation approach by
referring to the earning potential.
This method is more suitable when acquiring company is intending to continue business of target
company for foreseen future without selling or liquidating assets of the same.
Accordingly, if there is any additional earning is there due to acquisition same should also be
considered in valuation. Basically, PE Ratio also called Earning Yield is used in this approach.
The price or value of equity share can be calculated using the following equation:
Price Per Share = EPS x PE Ratio

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Though mainly this method is followed for listed companies but PE Ratio of equivalent companies or
the industry can be used to value the shares of the unlisted companies.
This method serves as minimum acceptable price to the shareholders of the target company. It
involves following steps:
(i) Choosing PE Ratio of equivalent quoted company.
(ii) Making adjustment downward for additional risk due to non-listing of shares.
(iii) Determination of future maintainable EPS.
(iv) Multiply same EPS with adjusted PE Ratio.
Relative Valuation Method
Relative Valuation is the method to arrive at a ‘relative’ value using a ‘comparative’ analysis to its
peers or similar enterprises. However, increasingly the contemporary financial analysts are using
relative valuation in conjunction to the afore-stated approaches to validate the intrinsic value arrived
earlier.
The Relative valuation, also referred to as ‘Valuation by multiples,’ uses financial ratios to derive at
the desired metric (referred to as the ‘multiple’) and then compares the same to that of comparable
firms.
Steps in Relative Valuation
There are several ways to go about valuing a company using the relative valuation method. The
following are the steps in relative valuation:
1. Identify the asset or company or business you want to value
2. Identify comparable companies with similar businesses, similar size, similar technology, similar
geographies, etc.
3. Obtain market values for those assets or company or business of comparable companies
4. Convert these market values into standardized values, since the absolute prices cannot be compared.
This process of standardizing creates price multiples.
5. Create multiples (ratios) using market values and financial data for these comparable companies
6. Multiply these multiples of comparable firms to the financial data of the subject of valuation
7. Control for any differences that may exist between the comparable firms and the subject of valuation,
to judge whether the value of the target is under or overvalued.
Chop-Shop Method
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 three steps:

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Step 1: Identify the firm’s various business segments and calculate the average capitalization ratios for
firms in those industries.
Step 2: Calculate a “theoretical” market value based upon each of the average capitalization ratios.
Step 3: Average the “theoretical” market values to determine the “chop-shop” value of the firm.
Question 1:
Using the chop-shop approach (or Break-up value approach), assign a value for Cornett GMBH. whose
stock is currently trading at a total market price of €4 million. For Cornett, the accounting data set forth
in three business segments: consumer wholesaling, specialty services, and assorted centres. Data for
the firm’s three segments are as follows:
Business Segments Segment Sales Segment Assets Segment Income
Consumer €1,500,000 € 750,000 €100,000
wholesaling
Speciality services €800,000 €700,000 €150,000
Assorted Centres €2,000,000 €3,000,000 €600,000

Industry data for “pure-play” firms have been compiled and are summarized as follows:
Business Segments Capitalisation Sales Capitalisation Capitalisation
Assets operating Income
Consumer 0.75 0.60 10.00
wholesaling
Speciality services 1.10 0.90 7.00
Assorted Centres 1.00 0.60 6.00

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Question 2

Using the chop-shop approach (or Break-up Value approach), assign a value for Cranberry Ltd.,
whose stock is currently trading at a total market price of € 4 million. For Cranberry Ltd., the
accounting data set forth three business segments: consumer wholesale, retail and general
centres. Data for the firm’s three segments are as follows:

Segment
Business Segment Sales Segment Assets
Operating Income
Segment € € €
Wholesale 2,25,000 6,00,000 75,000
Retail 7,20,000 5,00,000 1,50,000
General 25,00,000 40,00,000 7,00,000

Industry data for the “pure-play” firms have been compiled and are summarized as follows:

Business Capitalization / Capitalization / Capitalization /

Segment Sales Assets Operating Income
Wholesale 0.85 0.70 9
Retail 1.2 0.70 8
General 0.8 0.70 4

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Discounted Cashflow Method

What is the Discounted Cash Flow Method?

The discounted cash flow method is designed to establish the present value of a series of
future cash flows. Present value information is useful for investors, under the concept that
the value of an asset right now is worth more than the value of that same asset that is only
available at a later date. An investor will use the discounted cash flow method to derive
the present value of several competing investments, and usually picks the one that has the
highest present value. The investor may not pick an investment with the hi ghest present
value if it is also considered a riskier opportunity than the other prospective investments.
There are essentially five steps in performing DCF based valuation:
(a) Arriving at the ‘Free Cash Flows’
(b) Forecasting of future cash flows (also called projected future cash flows)
(c) Determining the discount rate based on the cost of capital
(d) Finding out the Terminal Value (TV) of the enterprise
(e) Finding out the present values of both the free cash flows and the TV, and interpretation of
the results.

Advantages of the Discounted Cash Flow Method

Ultimately, one of the best ways to determine the value of an asset is to derive the
discounted cash flows associated with it. This is a highly quantitative approach to
determining value, as opposed to a variety of qualitative methods that tend to overvalue
assets. At a minimum, an asset analysis should always include a review of discounted cash
flows, even if other valuation methods are being used as well.

Disadvantages of the Discounted Cash Flow Method

There are several concerns with using the discounted cash flow method, not least of which
is the difficulty of deriving accurate estimates for it. The person conducting the analysis
might estimate cash inflows and outflows too high or too low, or may not use a valid
discount rate. The result can be inordinately positive or negative outcomes that make the
analysis useless for decision-making purposes.

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

1. NH Pharma Ltd is operating in pharmaceutical industry. Analyst at NH Pharma projected

the following Data on the basis of financial reports, macroeconomic data and the analysis
of pharmaceutical industry.

Particulars Year 1 Year 2 Year 3 Year 4 Year 5

Net Profit 1,72,94,000 2,06,47,000 2,44,25,000 2,84,10,000 3,02,20,000
Depreciation 1,27,75,000 1,27,75,000 1,27,75,000 1,27,75,000 1,27,75,000
Investment in
net working 24,32,000 12,95,000 14,57,000 14,91,000 6,13,000
Capital
Outstanding 269,400 156,500 176,400 199,000 224,000
loan

Additional information – Risk free rate is 6% interest rate risk is 8%and required rate of
returning Investment is 11% and net profit is expected grow at 2% p.a.

You are Required to determine value of the firm using free cash flow to the Equity and
Value per equity share assuming 1,50,000 Equity shares outstanding.

2. Fun limited is operating in chemical industry. Analyst at the fun ltd. Estimated the
following data on the basis of financial reports, macroeconomic data and the analysis of
the chemical industry.

Particulars Year 1 Year 2 Year 3 Year 4 Year 5

Net Profit 86,00,000 1,03,24,000 1,22,08,000 1,42,05,000 1,50,10,000
Depreciation 63,88,000 63,88,000 63,88,000 63,88,000 63,88,000
Investment in net 12,20,000 6,50,000 7,30,000 7,45,000 3,07,000
working Capital
Outstanding loan 1,35,000 80,000 90,000 100,000 1,15,000

Additional information – Risk free rate is 6% interest rate risk is 8%and required rate of
returning Investment is 12% and net profit is expected grow at 1% p.a.

You are Required to determine value of the firm using free cash flow to the Equity and
Value per equity share assuming 1,50,000 Equity shares outstanding.

Adjusted Present Value Method

Adjusted present value is a valuation method introduced in 1974 by Stewart Myers. The idea
is to value the project as if it were all equity financed, and to then add the present value of the
tax shield of debt – and other side effects. Technically, an APV valuation model looks similar
to a standard DCF model.

Adjusted Present Value assumptions

1. The project’s risk is equal to the average risks of other projects within the firm, which is
also the risk of the firm. In other words, the project in question is a “typical” project that
the firm usually takes on. In this case, the relevant discount rate for the project is based on
the risk of the firm.
2. Corporate taxes are the only important market imperfection at the level of debt chosen.
This means that we focus only on the interest tax shields and ignore the effects generated
by the costs of debt issuance and financial distress.
3. All debt is perpetual.
Punith Kumar H S M.com (Ph.D.)
Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Advantages of APV

• It allows us to see whether adding any more debt is resulting in any increase in value.
• It does not require a constant proportion of debt in a company’s capital structure like the
WACC approach. It enables us to model different levels of debt for different stages of
valuation. This makes the APV approach especially useful in analysis of projects where
debt is repaid in accordance with a fixed schedule.
• Unlike the WACC approach which incorporates only the debt tax shield, the APV method
can be used to account for other financing side effects such as equity issue costs, cost of
financial distress, etc.

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Unit 3: VALUE BASED MANAGEMENT

Introduction to Value Based Management-Marakon Approach, Alcar Approach, Mc Kinsey Approach,

Stern-Stewart Approach (EVA Method) and BCG Approach. Performance Measurement and Analysis.
Balanced Scorecard.

Unit Wise Blue Print

Sl No Particulars Concept Marks
1 Value based Management Theory 2 marks
2 Marakon Approach Theory 5 marks
3 Alkar Approach Theory 5 marks
4 Mc Kinsey Approach Theory 5 marks
5 BCG Approach Theory 2 or 5 marks
6 Stern Stewart Approach (EVA Method) Practical 15 Marks
7 Short note on Balance score card Theory 2 or 5 marks
8 Performance Measurement and Analysis 2 Marks

Introduction to Value based Management

Value Based Management (VBM) is the management philosophy and approach that enables
and supports maximum value creation in organizations, typically the maximization of
shareholder value. VBM encompasses the processes for creating, managing, and measuring
value.
Value Based Management aligns a company’s overall aspirations, analytical techniques, and
management processes with the key drivers of value.

The three elements of Value Based Management:

• Creating Value. How the company can increase or generate maximum future value. More
or less equal to strategy.
• Managing for Value. Governance, change management, organizational culture,
communication, leadership.
• Measuring Value. Value Based Management is dependent on the corporate purpose and
the corporate values. The corporate purpose can either be economic (Shareholder Value)
or can also aim at other constituents directly (Stakeholder Value).

What are the benefits of Value Based Management?

• Can maximize value creation consistently.
• It increases corporate transparency.
Punith Kumar H S M.com (Ph.D.)
Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

• It helps organizations to deal with globalized and deregulated capital markets.

• Aligns the interests of (top) managers with the interests of shareholders and stakeholders.
• Facilitates communication with investors, analysts and communication with stakeholders.
• Improves internal communication about the strategy.
• Prevents undervaluation of the stock.
• It sets clear management priorities.

APPROACHES FOR MEASURING SHAREHOLDER VALUE:

Marakon Approach:

Marakon Associates, an international management-consulting firm founded in1978, has done

pioneering work in the area of value-based management.

This measure considers the difference between the ROE and required return on equity (cost of
equity) as the source of value creation.

This measure is a variation of the EV measures. Instead of using capital as the entire base and
the cost of capital for calculating the capital charge, this measure uses equity capital and the
cost of equity to calculate the capital (equity) charge. Correspondingly, it uses economic value
to equity holders (net of interest charges) rather than total firm value.

According to Marakan model shareholder wealth creation is measured as the difference

between the market value and the book value of a firm's equity.

The book value of a firm's equity, B, measures approximately the capital contributed by the
shareholders, whereas the market value of equity, M, reflects how productively the firm has
employed the capital contributed by the shareholders, as assessed by the stock market. Hence,
the management creates value for shareholders if M exceeds B, decimates value if m is less
than B, and maintains value is M is equal to B.

According to the Marakon model, the market-to-book values ratio is function of thee return on
equity, the growth rate of dividends, and cost of equity. For an all-equity firm, both EV and the
equity-spread method will provide identical values because there are no interest charges and
debt capital to consider.

Even for a firm that relies on some debt, the two measures will lead to identical insights
provided there are no extraordinary gains and losses, the capital structure is stable, and a proper
re-estimation of the cost of equity and debt is conducted.

A market is attractive only if the equity spread and economic profit earned by the average
competitor is positive. If the average competitor's equity spread and economic profit are
negative, the market is unattractive.

For an all-equity firm, both EV and the equity spread method will provide identical values
because there are no interest charges and debt capital to consider. Even for a firm that relies on
some debt, the two measures will lead to identical insights provided there are no extraordinary
gains and losses, the capital structure is stable, and a proper re-estimation of the cost of equity
and debt is conducted.
Punith Kumar H S M.com (Ph.D.)
Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

ALCAR APPROACH
The Alcar group Inc. a management and software company, has developed an approach to
value-based management which is based on discounted cash flow analysis. In this framework,
the emphasis is not on annual performance but on valuing expected performance.

This method of valuing the firm is identical to that followed in calculating NPV in a capital-
budgeting context. Since the computation arrives at the value of the firm, the implied value of
the firm's equity can be determined by subtracting the value of the current debt from the
estimated value of the firm. This value is the implied value of the equity of the firm.

To estimate whether the firm's management has created shareholder value, one subtracts the
implied value at the beginning of the year from the value estimated at the end of the year,
adjusting for any dividends paid during the year. If this difference is positive (i.e., the estimated
value of the equity has increased during the year) management can be said to have created
shareholder value.

The Alcar approach has been well received by financial analysts for two main reasons:

* It is conceptually sound as it employs the discounted cash flow framework

* Alcar have made available computer software to popularize their approach

However, the Alcar approach seems to suffer from two main shortcomings:

(1) In the Alcar approach, profitability is measured in terms of profit margin on sales. It is
generally recognized that this is not a good index for comparative purposes.

(2) Essentially a verbal model, it is needlessly cumbersome. Hence it requires a fairly involved
computer programme.

McKINSEY APPROACH:

McKinsey & Company, a leading international consultancy firm has developed an approach to
value-based management which has been very well articulated by Tom Copeland, Tim Koller,
and Jack Murrain of McKinsey & Company.
According to them: Properly executed, value based management is an approach to management
whereby the company's overall aspirations, analytical techniques, and management processes
are all aligned to help the company maximize its value by focusing decision making on the key
drivers of value.
The key steps in the McKinsey approach to value-based maximization are as follows:
* Ensure the supremacy of value maximization
* Find the value drivers School of distance education
* Establish appropriate managerial processes
* Implement value-based management philosophy

BCG APPROACH

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

For a company with a big portfolio, it’s important to assess its product lines regularly to see
which product is profitable, which is making losses, and which ones need some working upon.
This practice helps the company to allocate its resources accordingly in order to function more
efficiently.

While there are many practices and tools available to the company to accomplish this mission,
the BCG matrix, developed by the Boston Consulting Group, is considered to be a gold
standard to find the cash cows, the stars, the question marks, and the dogs.

What is a BCG matrix?

BCG matrix (also referred to as Growth-Share Matrix) is a portfolio planning model used to
analyse the products in the business’s portfolio according to their growth and relative market
share.

The model is based on the observation that a company’s business units can be classified into
four categories:

• Cash Cows
• Stars
• Question Marks
• Dogs

It is based on the combination of market growth and market share relative to the next best
competitor.

Stars

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

High Growth, High Market Share

Star units are leaders in the category. These products have –

• A significant market share, hence they bring most cash to the business.
• A high growth potential that can be used to increase further cash inflow.

With time, when the market matures, these stars become cash cows that hold huge market
shares in a low growth market. Such cows are milked to fund other innovative products to
develop new stars.

Cash Cows

Low Growth, High Market Share

Cash cows are products with significant ROI but operating in a matured market which lacks
innovation and growth. These products generates more cash than it consumes.

Usually, these products finance other activities in progress (including stars and question
marks).

Dogs

Low Growth, Low Market Share

Dogs hold low market share and operate in a market with a low growth rate. Neither do they
generate cash nor do they require huge cash. In general, they are not worth investing
in because they generate low or negative cash returns and may require large sums of money to
support. Due to low market share, these products face cost disadvantages.

Question Marks

High Growth, Low Market Share

Question marks have a high growth potential but a low market share which makes their future
potential to be doubtful.

Since the growth rate is high here, with the right strategies and investments, they can become
cash cows and ultimately stars. But they have low market share so wrong investments can
downgrade them to Dogs even after lots of investment.

Advantages of BCG Matrix

• It is simple and easy to understand.

• It helps you to quickly and simply screen the opportunities open to you, and helps you think
about how you can make the most of them.
Punith Kumar H S M.com (Ph.D.)
Assistant Professor Commerce and Management
Bapu Degree College
 Advanced Financial Management B.com 5th Semester

• It is used to identify how corporate cash resources can best be used to maximize a
company’s future growth and profitability.
• The BCG Matrix produces a framework for allocating resources among different products
and makes it possible to compare the product portfolio at a glance.

Limitations of BCG Matrix

• BCG Matrix uses only two dimensions, relative market share and market growth rate. These
are not the only indicators of profitability, attractiveness or success.
• It neglects the effects of synergy between brands.
• Business with low market share can be profitable too.
• High market share does not always lead to high profits since there is also a high cost that goes
into getting a high market share.
• At times, dogs may help the business or other products in gaining competitive advantage.

Balanced Score Card

What is a Balanced Scorecard?

The balanced scorecard (BSC) is a strategic planning and management system. Organizations
use BSCs to:

• Communicate what they are trying to accomplish

• Align the day-to-day work that everyone is doing with strategy
• Prioritize projects, products, and services
• Measure and monitor progress towards strategic targets

The name “balanced scorecard” comes from the idea of looking at strategic measures in
addition to traditional financial measures to get a more “balanced” view of performance.

The concept of balanced scorecard has evolved beyond the simple use of perspectives and it is
now a holistic system for managing strategy.

A key benefit of using a disciplined framework is that it gives organizations a way to “connect
the dots” between the various components of strategic planning and management, meaning that
there will be a visible connection between the projects and programs that people are working
on, the measurements being used to track success (KPIs), the strategic objectives the
organization is trying to accomplish, and the mission, vision, and strategy of the organization.

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Economic Value-Added Method

Consulting firm Stern Steward has developed the concept of Economic Value Added. EVA is
a useful tool to measure the wealth generated by a company for its equity shareholders. In other
words, it is a measure of residual income after meeting the necessary requirements for funds.
Economic Value Added (EVA) is a holistic method of evaluating a company’s financial
performance, which means that EVA is used not only as a mere valuation technique, but also
to find the economic contribution of a company to the society at large.
The core concept behind EVA is that a company generates ‘value’ only if there is a creation of
wealth in terms of returns in excess of its cost of capital invested.
EVA insists on separation of firm’s operation from its financing. So if a company's EVA is
negative, it means the company is not generating value from the funds invested into the
business. Conversely, a positive EVA shows a company is producing value from the funds
invested in it.

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

1. Following is the condensed income statement of a firm for the current year:

Income Statement (in Rs. Lakhs)

Sales Revenue 500

Less: Operating costs 300
Interest costs 12
Earnings before tax 188
Less; Taxes @ 40% 75.2
Earnings after taxes 112.8

The firm’s existing capital consists of Rs. 150 lakh equity funds, having 15 per cent cost
and Rs. 100 lakh 12 per cent debt. Determine the economic value added during the year.
Assume the sales revenue is Rs. 330 Lakhs. What is the Earnings after Tax and EVA?

2. From the following details, compute EVA:

Net Sales Rs. 3,00,000.

Cost of goods sold 60% of Sales.
Fixed costs Rs 35,000 (including depreciation of Rs.
20,000)
Tax rate applicable to the firm 30%
Pre-tax cost of debt is 12%
and cost of equity is estimated at 15%.
The target capital structure of the firm has a debt of 30% to total capital and the
balance will be equity funds employed.
Total capital employed by the firm is Rs. 1,50,000.

3. From the following condensed income statement of a corporate for the current
year, determine the EVA during the year.

Income Statement (in Rs. Crores)

Sales revenue 100
Less: Cost of goods sold 40
Administrative expenses 4
Selling expenses 16
Interest 10 70
Earnings before taxes 30
Less: Taxes @ 40% 12
Earnings after taxes 18
The firm’s weighted average cost of total capital employed (consisting of equity
and debt of Rs. 150 crore) is 12 per cent, its cost of equity capital is 15 per cent.
(Ans: Rs. 6 Crores)

4. From the following information calculate EVA Under

1. Present case,
2. When NOPAT Increases to Rs 35000
3. When Cost of Capital reduces to 10%
4. when withdrawing unproductive capital withdrawal of Rs 10,000, NOPAT Comes down
Rs 3000.
Punith Kumar H S M.com (Ph.D.)
Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

NOPAT = 30,000
Cost of Capital=14%
Return on capital=20%
Capital=Rs 1,00,000

5. The following data pertains to XYZ Inc. engaged in software consultancy business as
on 31 December 2010.

$Million
Income from Consultancy 935.00
EBIT 118.00
Less Interest on Loan 18.00
EBT 162.00
Tax @ 35% 56.70
105.30

Balance Sheet
Liabilities Amount Assets Amount
Equity Stock (10 million 100 Land and Building 200
share @ $ 10 each)
Reserves & Surplus 325 Computers & Software’s 295
Current Assets:
Loans 180 Debtors 150
Bank 100
Cash 40 290
Current Liabilities 180
785 785

With the above information and following assumption you are required to compute
(a) Economic Value Added

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

6. Compute EVA of A ltd with the following information

All figures are in Rs lac

Profit & Loss Statement Balance Sheet
Revenue 1000 PPE 1000
Direct Cost -390 Current Assets 300
Selling. General & -290 1300
Admin Exp (SGA)
EBIT 410 Equity 700
INTEREST -10 Reserves 100
EBT 400 Non-Current 100
Borrowings
Tax Expenses -120 Current liabilities & 400
provisions
EAT 280 1300

Assume Bad debts provision of Rs 20 Lac is Included in the SGA & the same amount is reduced
from the trade receivables in current assets.
Also assume that the pre-tax cost of debt is 12%. Tax rate is 30% and cost of equity (i.e
shareholders expected return) is 8.45%.
7. From the following Calculate EVA

Particulars 2019 2020 2021

Capital Invested 37,96,000 38,72,750 39,20,000

WACC 8.50 8.75 8.95

NOPAT 5,08,900 3,75,000 3,04,500

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Unit 4:
CORPORATE RESTRUCTURING –
Corporate Restructuring – Forms of Corporate Restructuring. Asset Restructuring –
Securitization, Sale and Lease; Financial Restructuring – Designing and re-designing capital
structure; Restructuring of companies incurring continuous losses, restructuring in the event
of change in law, Buy-back of shares.
Introduction
Corporate restructuring is an action taken by the corporate entity to modify its capital structure
or its operations significantly. Generally, corporate restructuring happens when a corporate
entity is experiencing significant problems and is in financial jeopardy.

The process of corporate restructuring is considered very important to eliminate all the financial
crisis and enhance the company’s performance. The management of the concerned corporate
entity facing the financial crunches hires a financial and legal expert for advisory and assistance
in the negotiation and the transaction deals.

Usually, the concerned entity may look at debt financing, operations reduction, any portion of
the company to interested investors. In addition to this, the need for corporate restructuring
arises due to the change in the ownership structure of a company. Such change in the ownership
structure of the company might be due to the takeover, merger, adverse economic conditions,
adverse changes in business such as buyouts, bankruptcy, lack of integration between the
divisions, over-employed personnel, etc.

Types of Corporate Restructuring

Financial Restructuring: This type of restructuring may take place due to a severe fall in
the overall sales because of adverse economic conditions. Here, the corporate entity may
alter its equity pattern, debt-servicing schedule, equity holdings, and cross-holding pattern.
All this is done to sustain the market and the profitability of the company.
Organisational Restructuring: Organisational Restructuring implies a change in the
organisational structure of a company, such as reducing its level of the hierarchy,
redesigning the job positions, downsizing the employees, and changing the reporting
relationships. This type of restructuring is done to cut down the cost and to pay off the
outstanding debt to continue with the business operations in some manner.
Reasons for Corporate Restructuring
Corporate restructuring is implemented in the following situations:
• Change in the Strategy: The management of the distressed entity attempts to improve
its performance by eliminating certain divisions and subsidiaries which do not align with
the core strategy of the company. The division or subsidiaries may not appear to fit
strategically with the company’s long-term vision. Thus, the corporate entity decides to
focus on its core strategy and dispose of such assets to the potential buyers.

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

• Lack of Profits: The undertaking may not be enough profit-making to cover the cost of
capital of the company and may cause economic losses. The poor performance of the
undertaking may be the result of a wrong decision taken by the management to start the
division or the decline in the profitability of the undertaking due to the change in
customer needs or increasing costs.
• Reverse Synergy: This concept is in contrast to the principles of synergy, where the
value of a merged unit is more than the value of individual units collectively. According
to reverse synergy, the value of an individual unit may be more than the merged unit.
This is one of the common reasons for divesting the assets of the company. The
concerned entity may decide that by divesting a division to a third party can fetch more
value rather than owning it.
• Cash Flow Requirement: Disposing of an unproductive undertaking can provide a
considerable cash inflow to the company. If the concerned corporate entity is facing
some complexity in obtaining finance, disposing of an asset is an approach in order to
raise money and to reduce debt.
Characteristics of Corporate Restructuring
• To improve the Balance Sheet of the company (by disposing of the unprofitable
division from its core business)
• Staff reduction (by closing down or selling off the unprofitable portion)
• Changes in corporate management
• Disposing of the underutilized assets, such as brands/patent rights.
• Outsourcing its operations such as technical support and payroll management to a more
efficient 3rd party.

Types or Forms or Modes of Corporate Restructuring Strategies

Merger: This is the concept where two or more business entities are merged together either by
way of absorption or amalgamation or by forming a new company. The merger of two or more
business entities is generally done by the exchange of securities between the acquiring and the
target company.
Demerger: Under this corporate restructuring strategy, two or more companies are combined
into a single company to get the benefit of synergy arising out of such a merger.
Reverse Merger: In this strategy, the unlisted public companies have the opportunity to
convert into a listed public company, without opting for IPO (Initial Public offer). In this
strategy, the private company acquires a majority shareholding in the public company with its
own name.
Disinvestment: When a corporate entity sells out or liquidates an asset or subsidiary, it is
known as “divestiture”.
Takeover/Acquisition: Under this strategy, the acquiring company takes overall control of the
target company. It is also known as the Acquisition.
Joint Venture (JV): Under this strategy, an entity is formed by two or more companies to
undertake financial act together. The entity created is called the Joint Venture. Both the parties

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

agree to contribute in proportion as agreed to form a new entity and also share the expenses,
revenues and control of the company.
Strategic Alliance: Under this strategy, two or more entities enter into an agreement to
collaborate with each other, in order to achieve certain objectives while still acting as
independent organisations.
Slump Sale: Under this strategy, an entity transfers one or more undertakings for lump sum
consideration. Under Slump Sale, an undertaking is sold for consideration irrespective of the
individual values of the assets or liabilities of the undertaking.

Asset Restructuring

It is the process of buying or selling of a company’s assets that comprise of far more significant
than half of the target company’s consolidated assets.

It’s usually a one-time expense that needs to be funded by any company when the restructuring
takes place. Asset restructuring is a cost that may occur during the entire process of
strategically writing off its assets or sometimes shifting the entire production facility to any
new location, shutting down the manufacturing facilities, and uniquely laying off all the non-
strategic employees.

Asset restructuring could be implemented due to a variety of reasons including, targeting the
organization to become more competitive, successfully survive and emerge stronger from the
existing hostile economic environment, or position the company to move towards an entirely
new direction.
Under Asset Restructuring a business firm may buy an asset or sell an Assets with Intention of
maximising value or minimising cost.
Example, A company Goes for upgradation of existing computers to increase speed or storage.
Securitization
The conversion of an asset, especially a loan, into marketable securities, typically for the
purpose of raising cash by selling them to other investors.
Securitization is the financial practice of pooling various types of contractual debt such as
residential mortgages, commercial mortgages, auto loans or credit card debt obligations (or
other non-debt assets which generate receivables) and selling their related cash flows to third
party investors as securities, which may be described as bonds, pass-through securities,
or collateralized debt obligations (CDOs).
Buy Back of Shares
Buy-back is the process by which Company buy-back it’s Shares from the existing
Shareholders usually at a price higher than the market price. When the Company buy-back the
Shares, the number of Shares outstanding in the market reduces/fall. It is the option available
to Shareholder to exit from the Company business. It is governed by section 68 of the
Companies Act, 2013.

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Reasons of Buy-back: -
• To improve Earning per Share;
• To use ideal cash;
• To give confidence to the Shareholders at the time of falling price;
• To increase promoter’s shareholding to reduce the chances of takeover;
• To improve return on capital, return on net-worth;
• To return surplus cash to the Shareholder.
Modes of Buy-back: -
A Company may buy-back its Shares or other specified Securities by any of the following
method-
• From the existing shareholders or other specified holders on a proportionate basis through
the tender offer;
• From the open market through
1. Book-Building process
2. Stock Exchange Provided that no buy-back for fifteen percent or more of the paid-up capital
and reserves of the Company can be made through open market.
• From odd-lot holders.
SEBI GUIDELINES FOR BUY BACK OF SHARES
SEBI guidelines for buyback for shares are as follows: (a) Notice of special resolution (b)
Buying from Members through Tender offer (c) Buyback through Stock Exchange.

(a) Notice of special resolution:

The notice of special resolution to be passed by the members should contain explanatory
statement giving details of the buyback deal as prescribed in Schedule I of SEBI Regulations.

(b) Buying from Members through Tender offer:

Under this method, the maximum price at which the company intends to buy back the shares
should be indicated in the notice of the general meeting. If the promoters intend to offer their
shares for buy back, details should be given in the notice of the general meeting. The company
should make a public announcement in at least one English National Daily, One Hindi National
Daily and One regional newspaper daily, all with wide circulation giving details prescribed in
Scheduled II of SEBI Regulations.

The public announcement will mention the ‘specified date’ for the purpose of determining the
names of shareholders to whom letters of offer shall be sent. Draft offer letter giving prescribed
details should be submitted to SEBI along-with prescribed fees, at least 21 days before dispatch
of letters of offer to shareholders. Offer for buy back will remain open for minimum 15 days
and maximum 30 days.

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Letters of offer should be sent to the members well in advance so as to reach them before the
opening date of the offer. If the acceptances by the shareholders are more than the number of
shares offered to them for repurchase, the actual buy back will be on proportionate basis. The
company shall have to open and maintain an escrow account with prescribed amount as deposit.
Within 15 days of closure of offer for buy back, payment should be made or regret letters
should be sent to the shareholders.

(c) Buyback through Stock Exchange:

In case of buy back of shares through stock exchange route, special resolution of members
should prescribe maximum price at which shares can be bought and the buy backs shall not be
made from promoters or persons having control in the company. Such persons will not deal in
shares in stock exchanges when offer for buy back is open.

The company should appoint a merchant banker. Public announcement should be made at least
7 days prior to commencement of buy back. A copy of public announcement is to be filed with
SEBI along-with prescribed fee within 2 days of such announcement.

Companies buying back via stock exchange route must disclose purchases daily. Details of
shares purchased every day should be informed to the stock exchanges. Payment will be made
as per rules of trading in the stock exchanges.

Other Guidelines:

(a) The company will make true and full disclosure in the letter of offer and the public
announcement.

(b) Bonus shares will not be announced when the buy- back offer is open.

(c) All payments will be made only by cash/cheque.

(d) Buy- back offer will not be withdrawn after public announcement.

(e) Locked-in-shares will not be bought back.

(f) The details regarding number of shares bought, price, total amount invested in buy back,
details of shareholders from whom more than 1% of the total shares were bought and the
consequent change in the capital structure.

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Unit 5: CORPORATE RESTRUCTURING - II

Mergers and Acquisitions – Meaning and differences; Financing of merger (deciding between
merger and acquisition), Determining Exchange Ratio – Range and Terms. Feasibility of
Mergers and Acquisitions

What is a Merger?

A merger refers to an agreement in which two companies join together to form one company.
In other words, a merger is the combination of two companies into a single legal entity.

Types of Mergers

There are five basic categories or types of mergers:

1. Horizontal merger: A merger between companies that are in direct competition with
each other in terms of product lines and markets
2. Vertical merger: A merger between companies that are along the same supply chain
(e.g., a retail company in the auto parts industry merges with a company that supplies
raw materials for auto parts.)
3. Market-extension merger: A merger between companies in different markets that sell
similar products or services
4. Product-extension merger: A merger between companies in the same markets that
sell different but related products or services
5. Conglomerate merger: A merger between companies in unrelated business activities
(e.g., a clothing company buys a software company)

Acquisitions
An acquisition is where one company takes control of another by purchasing its assets or the
majority of its shares. There are five main types of acquisitions:

▪ Value creating – Value creating is where a company acquires another company, improves
its performance and then sells it again for a profit.
▪ Consolidating – This is where a company acquires another company to remove
competition from an over-supplied market.
▪ Accelerating – Accelerating is when a larger company acquires a smaller company and
uses its greater resources to accelerate market access for the smaller company’s products.

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

▪ Resource acquiring – This is where a company acquires other companies to gain

resources, skills, intellectual property, technologies or market positioning they need,
because it is more cost effective than developing their own.
▪ Speculating – Speculating is when a larger company acquires a smaller company with a
new product, with the aim of cashing in on its future growth potential.

Difference Between Mergers and Acquisition

DIFFERENCE MERGER ACQUISITION

Procedure Two or more individual One company completely takes

companies join to form a over the operations of another.
new business entity.

Mutual Decision A merger is agreed upon The decision of acquisition might

by mutual consent of the not be mutual; in case the
involved parties. acquiring company takes over
another enterprise without the
latter’s consent, it is termed as a
hostile takeover.

Name of Company The merged entity The acquired company mostly

operates under a new operates under the name of the
name. parent company. In some cases,
however, the former can retain its
original name if the parent
company allows it.

Comparative Stature The parties involved in a The acquiring company is larger

merger are of similar and financially stronger than the
stature, size, and scale of target company.
operations.

Power There is dilution of power The acquiring company exerts

between the involved absolute power over the acquired
companies. one.

Shares The merged company New shares are not issued.

issues new shares.

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Determine the Exchange Ratio

Larson and Gonedes developed a model for computing for Exchange ratio. Their model holds
that both firms would ensure that post-merger; their equivalent price per share will at least
equal their pre-merger price per share.

ER= Exchange Ratio P= Price per share

EPS = Earnings Per share PE= Price Earning Multiple

E= Earning S= Number of Outstanding Equity Shares

AER = Actual Exchange Ratio

Formula for calculation of Exchange Ratio

ERA = (-SA/SB) +(EA+EB) PEAB]/PASB

1.The following relevant information for firm A & Firm B Determine the Maxi. Change
ratio if PE ratio for combined firm is 3,9,10,11,12,15 & 20.

Particulars Firm (A) Firm (B)

Market price per share (P) 12 4
Earnings per share (EPS) 1 0.5
Price Earnings ratio (PE) 6 4
times
Total Earnings (E) 90,00,000 30,00,000
Number of outstanding 45,00,000 30,00,000
Equity Shares (S)

Problems on Mergers and Acquisition Calculation of Exchange Ratio

2. A ltd wants to take over B ltd and the financial details of both the company are as below.

Particulars A ltd B Ltd

Equity share capital of Rs 10 200,000 100,000
Each
Preference share capital 40,000 -
Share Premium - 4000
Profit and Loss account 76000 8000
10% debentures 30,000 10,000
Total Liabilities 346000 122000
Fixed Assets 244000 70,000
Current assets 102,000 52000
Total Assets 346000 122000

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Profit after tax and 48000 30000

Preference dividend
Market Price per share 24 27

You are Required to determine the share exchange ratio to be offered to the shareholders of B
ltd, based on.
i. Net asset value
ii. EPS
iii. Market Price per share
Which Should be preferred from the point of view of A ltd?

3. A ltd Wants to take over B ltd and the financial details of Both the Companies are as
follows.

Particulars A ltd Rs B ltd Rs

Equity Share capital of Rs 1,00,000 50,000
10 Each
Preference share capital 20,000 -
Share Premium - 2000
P/l account 38,000 4000
10% Debentures 15,000 5,000
Total Liabilities 1,73,000 61,000
Fixed assets 1,22,000 35,000
Current assets 51000 26000
Total assets 1,73,000 61,000
PAT & Profit Dividend 24000 15,000
Market price per share 24 27

You are required to determine the share Exchange ratio to be offered to the shareholders of B
ltd based on.
i. Net asset Value and
ii. Market Price

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

4. Active Ltd taking over Bright ltd. As per understanding between management of two
companies, shareholders of bright ltd. Would receive 0.7 share of active ltd. For each share
held by them. The relevant data for two companies are as follows.
Particulars Active ltd Bright ltd
Net sales 40 15
Profit after tax (Rs. In lakhs) 8 2
Number of shares (Lakhs) 1.6 0.5
Earnings per share 2.5 2
Market Price per share 15 10
Price Earnings Ratio 6 5

Ignoring the economies of scale and the operating synergy. You are required to calculate.
i. Premium paid by Active to the shareholders of Bright ltd
ii. No of shares after the Merger
iii. Combined EPS
iv. Combined P/E Ratio
v. Market value per share and
vi. Total Market Capitalisation after the merger.

5. RD Company taking over MD company. As per understanding between management of

two companies, shareholders of bright ltd. Would receive 0.6 share of active ltd. For each
share held by them. The relevant data for two companies are as follows.
Particulars RD company MD company
Net sales 60 10
Profit after tax (Rs. In 6 1
lakhs)
Number of shares (Lakhs) 1.2 0.5
Earnings per share 1.50 1
Market Price per share 10 08
Price Earnings Ratio 7 6

Ignoring the economies of scale and the operating synergy. You are required to calculate.
i. Premium paid by Active to the shareholders of Bright ltd
ii. No of shares after the Merger
iii. Combined EPS
iv. Combined P/E Ratio
v. Market value per share and
vi. Total Market Capitalisation after the merger.

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Model Question Paper 1

Section A
1. Answer any 5 sub Question Each Question carries 2 Marks (5x2=10)
a. What do You mean by financial statement analysis and its purpose?
b. What is continuous compounding?
c. What is unlevered beta?
d. What is DCF Method?
e. What is EVA?
f. What is performance analysis?
g. What is equity restructuring?

Section B
Answer any 3 Questions Each Question carries 5 Marks (5x3=15)
2. What are the Merits and Limitations of financial statements?
3. Discuss the purposes of relative valuation method.
4. Calculate FV @ the end of 4 years of the following series of payments at 9% Interest
Rs 1000 at the end of First Year
Rs 2000 at the end of Second Year
Rs 3000 at the end of Third Year
Rs 4000 at the end of Fourth Year

5. Explain the concept of Marakon Approach

6. State the reasons for corporate restructuring

Section C
Answer any 3 Questions Each Question carries 5 Marks (15x3=45)
7. Discuss the techniques of financial statement analysis?
8. What is value-based management? Write a short note
i. Alcar Approach
ii. BCG Matrix
9. Company X is considering the purchase of company Y. The following are the financial data
of the 2 companies.

Particulars Company X Company Y

Number of shares 400,000 100,00
EPS 6 4.50
MVPS 30 20

i. The Relative EPS of the firms

ii. 4 shares of company X for every 5 shares held in company Y

You are Required to illustrate and comment on the impact of merger on the EPS.

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

Model Question Paper 2

Section A

1. Answer any 5 sub Question Each Question Carries 2 marks

a. What is financial Management?
b. What is Corporate Valuation?
c. What is the Present Value of Rs 50 per year forever at 6%?
d. Find out the FV of a sum of Rs 2000 after a year with a time preference money of
12%?
e. What is Balance score card?
f. What is levered beta?

Section B
2. Explain arguments in favor of Wealth Maximization?
3. A leading Bank in India reported the following items of assets and liabilities forv the
year 2020-2021.
Borrowings Rs 8,54,817.50 crore
Other liabilities Rs 58,816.55 Crore
Net block Rs 5,008.15 crore
Investments Rs 2,58,461.50 crore
Other Assets Rs 8,70,764.50 crore
You are Required to determine net asset value of bank.
4. Explain the Concept of BCG Matrix?
5. Write a short note on Buy back of Shares?
6. Explain different forms of Corporate Restructuring?

Section C
7. Write a short Note on
i. Do Pont Analysis
ii. CAPM Model
iii. APV Method
iv. Mc. Kinsey Approach

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

8. Determine the weighted average cost of capital using

a. Book value Weights b. Market value weights

Source of Capital Book Value Market Value Specific Cost

Debt 40,000 38000 5%

Preference 10,000 11000 8%

Equity 60,000 120,000 13%

Retained Earnings 20,000 _ 9%

9. A ltd Wants to take over B ltd and the financial details of Both the Companies are as follows.

Particulars A ltd Rs B ltd Rs

Equity Share capital of Rs 1,00,000 50,000
10 Each
Preference share capital 20,000 -
Share Premium - 2000
P/l account 38,000 4000
10% Debentures 15,000 5,000
Total Liabilities 1,73,000 61,000
Fixed assets 1,22,000 35,000
Current assets 51000 26000
Total assets 1,73,000 61,000
PAT & Profit Dividend 24000 15,000
Market price per share 24 27

You are required to determine the share Exchange ratio to be offered to the share holders of B
ltd based on.
i. Net asset Value and
ii. Market Price

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

10. Using the chop-shop approach (or Break-up Value approach), assign a value for
Cranberry Ltd., whose stock is currently trading at a total market price of € 4 million.
For Cranberry Ltd., the accounting data set forth three business segments: consumer
wholesale, retail and general centres. Data for the firm’s three segments are as follows:

Segment
Business Segment Sales Segment Assets
Operating Income
Segment € € €
Wholesale 2,25,000 6,00,000 75,000
Retail 7,20,000 5,00,000 1,50,000
General 25,00,000 40,00,000 7,00,000

Industry data for the “pure-play” firms have been compiled and are summarized as
follows:

Business Capitalization / Capitalization / Capitalization /

Segment Sales Assets Operating Income
Wholesale 0.85 0.70 9
Retail 1.2 0.70 8
General 0.8 0.70 4

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College
Advanced Financial Management B.com 5th Semester

QUESTION BANK

1. What is Business finance? Explain the objectives of financial management.

2. Explain the Concept of DU PONT ANALYSIS?
3. What is CAPM Model? What are the assumptions of CAPM?
4. Write a short note on
i. Earnings Capitalization method
ii. Relative valuation Model
iii. Adjusted Present Value Method
5. What is value-based management? Explain its Need and Benefits.
6. How do you create value for shareholders using
i. Marakon approach
ii. Mc kinsey approach
iii. BCG Matrix
iv. Alkar approach
7. What is performance measurement? Explain the Balance score card technique of
performance measurement.
8. What is corporate restructuring? Explain the reasons for corporate restructuring.
9. Explain the different forms of corporate restructuring?
10. Write a short note on
i. Asset restructuring
ii. Securitization
iii. Financial Restructuring
11. What is Buy back of shares? State the reasons why company go for buy back of
shares? State the guidelines issued by SEBI for buy back of shares?
12. What are mergers? Explain different types of Mergers.
13. What are the difference between Mergers and Acquisition?
Practical Oriented Questions
14. Calculation of Compounding and Discounting value
15. Calculation of Weighted average cost of capital
16. Calculation of perpetuity, levered or unlevered beta
17. Calculation of Net Asset value
18. Calculation of Discounted Cash Flow
19. Calculation of chop shop method
20. Calculation of Economic value added?
21. calculation of exchange ratio in mergers and acquisition

Punith Kumar H S M.com (Ph.D.)

Assistant Professor Commerce and Management
Bapu Degree College