CA FINAL

ADVANCED FINANCIAL MANAGEMENT

CORPORATE VALUATION
2 AND MERGERS

PART A - CORPORATE VALUATION

Q.1 Using the chop shop approach (or breakup 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 centers. Data for the firm’s three segments
are as follows:
Business Segment Segment Sales Segment Assets Segment Operating
Income
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 pure play firms have been compiled and are summarized as
follows:-
Business Segment Capitalization/ Capitalization/ Assets Capitalization/
Sales Operating Income
Wholesale 0.85 0.7 9
Retail 1.2 0.7 8
General 0.8 0.7 4

Q.2 AB Ltd., is planning to acquire and absorb the running business of XY Ltd. The
valuation is to be based on the recommendation of merchant bankers and the
consideration is to be discharged in the form of equity shares to be issued by AB
Ltd. As on 31.3.2006, the paid up capital of AB Ltd. consists of 80 lakhs shares of
` 10 each. The highest and the lowest market quotation during the last 6 months
were ` 570 and ` 430. For the purpose of the exchange, the price per share is to
be reckoned as the average of the highest and lowest market price during the last
6 months ended on 31.3.2006.

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XY Ltd.'s Balance Sheet as at 31.3.2006 is summarised below:

` in lakhs
Share Capital
20 lakhs equity shares of ` 10 each fully paid 200
10 lakhs equity shares of ` 10 each ` 5 paid 50
Loans 100
Total 350
Uses
Fixed Assets (Net) 150
Net Current Assets 200
Total 350

An independent firm of merchant bankers engaged for the negotiation, have

produced the following estimates of cash flows from the business of XY Ltd.:
Year ended By way of ` lakhs
31.3.07 after tax earnings for equity 105
31.3.08 do 120
31.3.09 do 125
31.3.10 do 120
31.3.11 do 100
terminal value estimate 200

It is the recommendation of the merchant banker that the business of XY Ltd., may
be valued on the basis of the average of (i) Aggregate of discounted cash flows at
8% and (ii) Net assets value. Present value factors at 8% for years.

1-5: 0.93 0.86 0.79 0.74 0.68

You are required to:

(i) Calculate the total value of the business of XY Ltd.
(ii) The number of shares to be issued by AB Ltd.; and
(iii) The basis of allocation of the shares among the shareholders of XY Ltd.

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Q.3 Eagle Ltd. reported a profit of ` 77 lakhs after 30% tax for the financial year 2011-12.
An analysis of the accounts revealed that the income included extraordinary items
of ` 8 lakhs and an extraordinary loss of ` 10 lakhs. The existing operations, except
for the extraordinary items, are expected to continue in the future. In addition, the
results of the launch of a new product are expected to be as follows:
` In lakhs
Sales 70
Material costs 20
Labour costs 12
Fixed costs 10
You are required to:
(i) Calculate the value of the business, given that the capitalization rate is 14%.
(ii) Determine the market price per equity share, with Eagle Ltd.‘s share capital
being comprised of 1,00,000 13% preference shares of ` 100 each and
50,00,000 equity shares of ` 10 each and the P/E ratio being 10 times.

Q.4 H Ltd. agrees to buy over the business of B Ltd. effective 1st April, 2012.The summarized
Balance Sheets of H Ltd. and B Ltd. as on 31st March 2012 are as follows:
Balance sheet as at 31st March, 2012 (In Crores of Rupees)
Liabilities: H. Ltd B. Ltd.
Paid up Share Capital
- Equity Shares of ` 100 each 350.00
- Equity Shares of ` 10 each Reserve & 6.50
Surplus 950.00 25.00
Total 1,300.00 31.50
Assets:
Net Fixed Assets 220.00 0.50
Net Current Assets 1,020.00 29.00
Deferred Tax Assets 60.00 2.00
Total 1,300.00 31.50

H Ltd. proposes to buy out B Ltd. and the following information is provided to you
as part of the scheme of buying:
(1) The weighted average post tax maintainable profits of H Ltd. and B Ltd. for
the last 4 years are ` 300 crores and `10 crores respectively.
(2) Both the companies envisage a capitalization rate of 8%.
(3) H Ltd. has a contingent liability of ` 300 crores as on 31st March, 2012.

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ADVANCED FINANCIAL MANAGEMENT

(4) H Ltd. to issue shares of `100 each to the shareholders of B Ltd. in terms of
the exchange ratio as arrived on a Fair Value basis. (Please consider weights
of 1 and 3 for the value of shares arrived on Net Asset basis and Earnings
capitalization method respectively for both H Ltd. and B Ltd.)

You are required to arrive at the value of the shares of both H Ltd. and B Ltd.
under:
(i) Net Asset Value Method
(ii) Earnings Capitalisation Method
(iii) Exchange ratio of shares of H Ltd. to be issued to the shareholders of B Ltd.
on a Fair value basis (taking into consideration the assumption mentioned in
point 4 above.)

Q.5 Compute EVA of A Ltd. with the following information:

All Figure are in `Lac
Profit and Loss Statement Balance Sheet
Revenue 1000 PPE 1000
Direct Costs -390 Current Assets 300
Selling, General & Admin. Exp. -200 1300
(SGA)
EBIT 410 Equity 700
Interest -10 Reserves 100
EBT 400 Non – Current Borrowings 100
Tax Expense -120 Current Liabilities & 400
Provisions
400 280 1300
Assume Bad Debts provision of `20 Lac is included in the SGA, and 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. shareholder’s expected return) is 8.45%.

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ADVANCED FINANCIAL MANAGEMENT

Q.6 With the help of the following information of Jatayu Limited compute the Economic
Value Added:
Capital Structure
Equity capital ` 160 Lakhs
Reserves and Surplus ` 140 lakhs
10% Debentures ` 400 lakhs
Cost of equity 14%
Financial Leverage 1.5 times
Income Tax Rate 30%

Q.7 ABC Co. is considering a new sales strategy that will be valid for the next 4
years. They want to know the value of the new strategy. Following information
relating to the year which has just ended, is available:
Income Statement `
Sales 20,000
Gross margin (20%) 4,000
Administration, Selling & distribution expense (10%) 2,000
PBT 2,000
Tax (30%) 600
PAT 1,400
Balance Sheet Information
Fixed Assets 8,000
Current Assets 4,000
Equity 12,000

If it adopts the new strategy, sales will grow at the rate of 20% per year for three
years. From 4th year onward Cash Flow will be stabilized. The gross margin ratio,
Assets turnover ratio, the Capital structure and the income tax rate will remain
unchanged.
Depreciation would be at 10% of net fixed assets at the beginning of the year.
The Company’s target rate of return is 15%.
Determine the incremental value due to adoption of the strategy.

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ADVANCED FINANCIAL MANAGEMENT

Q.8 BRS Inc deals in computer and IT hardwares and peripherals. The expected revenue
for the next 8 years is as follows:

Years Sales Revenue ($ Million)

1 8
2 10
3 15
4 22
5 30
6 26
7 23
8 20

Summarized financial position as on 31 March 2012 was as follows:

$ Million
Liabilities Amount Assets Amount
Equity Stocks 12 Fixed Assets (Net) 17
12% Bonds 8 Current Assets 3
20 20

Additional Information:
(a) Its variable expenses is 40% of sales revenue and fixed operating expenses
(cash) are estimated to be as follows:
Period Amount ($ Million)
1- 4 years 1.6
5-8 years 2

(b) An additional advertisement and sales promotion campaign shall be launched

requiring expenditure as per following details:
Period Amount ($ Million)
1 year 0.50
2-3 years 1.50
4-6 years 3.00
7-8 years 1.00

(c) Fixed assets are subject to depreciation at 15% as per WDV method.

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ADVANCED FINANCIAL MANAGEMENT

(d) The company has planned additional capital expenditures (in the beginning
of each year) for the coming 8 years as follows:

Period Amount ($ Million)

1 0.50
2 0.80
3 2.00
4 2.50
5 3.50
6 2.50
7 1.50
8 1.00

(e) Investment in Working Capital is estimated to be 20% of Revenue.

(f) Applicable tax rate for the company is 30%.
(g) Cost of Equity is estimated to be 16%.
(h) The Free Cash Flow of the firm is expected to grow at 5% per annuam after 8
years.
With above information you are require to determine the:
(i) Value of Firm (ii) Value of Equity

Q.9 Following information is given in respect of WXY Ltd., which is expected to grow
at a rate of 20% p.a. for the next three years, after which the growth rate will
stabilize at 8% p.a. normal level, in perpetuity.
Year For the year ended March
31, 2014
Revenues ` 7,500 Crores
Cost of Goods Sold (COGS) ` 3,000 Crores
Operating Expenses ` 2,250 Crores
Capital Expenditure ` 750 Crores
Depreciation (included in Operating Expenses) ` 600 Crores
During high growth period, revenues & Earnings before Interest & Tax (EBIT) will
grow at 20% p.a. and capital expenditure net of depreciation will grow at 15%
p.a. From year 4 onwards, i.e. normal growth period revenues and EBIT will grow
at 8% p.a. and incremental capital expenditure will be offset by the depreciation.
During both high growth & normal growth period, net working capital requirement
will be 25% of revenues.

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ADVANCED FINANCIAL MANAGEMENT

The Weighted Average Cost of Capital (WACC) of WXY Ltd. is 15%. Corporate Income
Tax rate will be 30%.
Required:
Estimate the value of WXY Ltd. using Free Cash Flows to Firm (FCFF) & WACC
methodology.
The PVIF @ 15 % for the three years are as below:
Year t1 t2 t3
PVIF 0.8696 0.7561 0.6575

Q.10 RST Ltd.’s current financial year's income statement reported its net income after
tax as ` 25,00,000. The applicable corporate income tax rate is 30%.
Following is the capital structure of RST Ltd. at the end of current financial year:
`
Debt (Coupon rate = 11%) 40 lakhs
Equity (Share Capital + Reserves & Surplus) 125 lakhs
Invested Capital 165 lakhs

Following data is given to estimate cost of equity capital:

Equity Beta of RST Ltd. 1.36

Risk –free rate i.e. current yield on Govt. bonds 8.5%
Average market risk premium (i.e. Excess of return on 9%
market portfolio over risk-free rate)
Required:
(i) Estimate Weighted Average Cost of Capital (WACC) of RST Ltd.; and
(ii) Estimate Economic Value Added (EVA) of RST Ltd.

Q.11 The following information is given for 3 companies that are identical except for
their capital structure:
Orange Grape Apple
Total invested capital 1,00,000 1,00,000 1,00,000
Debt/assets ratio 0.8 0.5 0.2
Shares outstanding 6,100 8,300 10,000
Pre tax cost of debt 16% 13% 15%
Cost of equity 26% 22% 20%
Operating Income (EBIT) 25,000 25,000 25,000

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The tax rate is uniform 35% in all cases.

(i) Compute the Weighted average cost of capital for each company.
(ii) Compute the Economic Valued Added (EVA) for each company.
(iii) Based on the EVA, which company would be considered for best investment?
Give reasons.
(iv) If the industry PE ratio is 11x, estimate the price for the share of each company.
(v) Calculate the estimated market capitalisation for each of the Companies.

Q.12 Delta Ltd.’s current financial year’s income statement reports its net income as
` 15,00,000. Delta’s marginal tax rate is 40% and its interest expense for the year
was ` 15,00,000. The company has ` 1,00,00,000 of invested capital, of which 60%
is debt. In addition, Delta Ltd. tries to maintain a Weighted Average Cost of Capital
(WACC) of 12.6%.
(i) Compute the operating income or EBIT earned by Delta Ltd. in the current
year.
(ii) What is Delta Ltd.’s Economic Value Added (EVA) for the current year?
(iii) Delta Ltd. has 2,50,000 equity shares outstanding. According to the EVA you
computed in (ii), how much can Delta pay in dividend per share before the
value of the company would start to decrease? If Delta does not pay any
dividends, what would you expect to happen to the value of the company?

Q.13 Constant Engineering Ltd. has developed a high tech product which has reduced
the Carbon emission from the burning of the fossil fuel. The product is in high
demand. The product has been patented and has a market value of ` 100 Crore,
which is not recorded in the books. The Net Worth (NW) of Constant Engineering
Ltd. is ` 200 Crore. Long term debt is ` 400 Crore. The product generates a revenue
of ` 84 Crore. The rate on 365 days Government bond is 10 percent per annum.
Market portfolio generates a return of 12 percent per annum. The stock of the
company moves in tandem with the market. Calculate Economic Value added of
the company.

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