CWA/ICWA Final :: Valuation Management and Case Study : June 2003

*F-20(VMC)* *Revised Syllabus*
Time Allowed : 3 Hours		Full Marks : 100
Answer Question No. 1 which is compulsory carrying 20 marks and any five from the rest.
Marks

(a)

State whether the following statements are True or False:

(i)	The value of a firm’s equity to the value of the firm less than the value of non-equity claims.(True/False)
(ii)	Under discounted cash flow method in general, higher the risk level, higher will be the discount rate.(True/False)
(iii)	Book value concept of valuation is based on accounting information.(True/False)
(iv)	The estimates of the amount and timing of the cash flows expected by equity shareholders are more certain as compared to debentures and preference shares..(True/False)
(v)	The opportunity cost of capital cannot be measured by price earnings ratio.(True/False)
(vi)	Corporate brand and service brands are often perceived to be interchangeable.(True/False)

1x6

(b)

Fill in the blanks:

(i)	Land and Building is an example of _______ asset. (Real/Financial)
(ii)	Market value per share is expected to be _______ than the book value per share in case of profitable _______ and growing firms. (Higher/Lower)
(iii)	A bond or debenture is a _______ instrument. (Long- term/Short -term)
(iv)	The risk in holding a government bond is _______ the risk associated with a debenture issued by a company. (More than/Less than)
(v)	Usually, a _______ discount rate would be applied to the cash flows of the government bond and a _______ rate to the cash flows of the company debenture. (Higher/Lower)
(vi)	_______ makes the calculation of share value difficult. (Stable dividend/variable dividend)
(vii)	Investor’s expectations and the market appraisal of the performance of a firm is measured by _______ (Earning per share/ Return on Equity /Prie earning ratio)
(viii)	In valuing a _______ firm the tax rate should be used to compute the terminal value. (Marginal/Effective)

1x8=8

(c)

Mergers and acquisitions involve complex set of managerial problems than the purchase of an asset. Nevertheless, discounted cash flow (DCF) approach is an important tool in analyzing mergers and acquisitions. In order to apply DCF technique, write ‘Yes’ if following information is required for analyzing merger and acquisition and ‘No’ if not required:

6x1=6

(i)	Estimation of cost of capital	(Yes/No)
(ii)	Price Earning Ratio	(Yes/No)
(iii)	Discount Ratio	(Yes/No)
(iv)	Estimation of Cash flows	(Yes/No)
(v)	Timings if Cash flows	(Yes/No)
(vi)	Risk associated with the business	(Yes/No)

(a)

why might discounted cash flow valuation be difficult to do for the following types of firms? Also explain in brief how the difficulty can be overcome.

(i)	A private firm whose owner is planning to sell it.
(ii)	A biotechnology firm with no current products or sales, but with several promising product patents in the pipeline.
(iii)	A cyclist firm during a recession.
(iv)	A troubled firm that has had significant losses and is not expected to get out of trouble for a few years.
(v)	A firm in the process of restructuring that is selling some of its assets and changing its financial mix.
(vi)	A firm that owns a lot of valuable land that is currently unutilized.

6x2=12

Please turn over

( 2 )

F-20(VMC)
Revised syllabus

Marks

(b)

Fill in the blanks:

(i)	There is some evidence that investors like _______ skewed distribution. (Positively/ negatively)
(ii)	C.A.P.M. assumes that _______ is the only measure of risk that matters, (standard deviation/variance/beta)
(iii)	The ultimate test of a good model is to examine whether the _______ returns, in the long run are to the expected returns. (positive/ negative/ actual)
(iv)	The logical limit to diversification of assets of a portfolio is to hold a _______ proportion of every traded asset in the economy. (large/medium/small)

4x1=4

What drives M & A activity? What are its key facilitators in India? What are its benefits?

(a)

Estimate the brand value of the following information technology firm:

			(Rs. in crores)
Year Ended March 31,	2001	2000	1999
PBIT Non- branded income Inflation Compound factor @8% Remuneration of Capital (5% of average capital employed) Tax @ 39.55% Multiple applied	696.03 53.43 1.000 55.57 158.58 22.186	325.65 35.23 1.087	155.86 3.46 1.181

(b)

The chief executive of a company thinks that shareholders always look for the earnings per share. Therefore, he considers maximization of the earnings per share (EPS) as his company’s objective. His company’s current net profits are Rs.80 lakh and EPS is Rs.4. The current market price is Rs.42. He wants to buy another firm which has current income of Rs.15.75 lakh, EPS of Rs.10.50 and the market price per share of Rs.85.

What is the maximum exchange ratio which the chief executive should offer so that he could keep EPS at the current level? If the chief executive borrows funds at 15 percent rate of interest and buys out the other company by paying cash. How much should be offer to maintain his EPS? Assume a tax rate of 52%.

(a)

A company has a total investment of Rs.5,00,000 in assets and 50,000 outstanding ordinary shares of Rs.10 per share (par value). It earns a rate of 15% on its investment and has a policy of retaining 50% of the earnings. If the appropriate discount rate of the firm is 10%, determine the price of its share using Gordon’s model. What shall happen to the price of the share if the company has a payout of 80% or 20%?

(b)

What are the essentials of Walter’s dividend model?

(a)

The managing director of a company decides that his company will not pay any dividends till he survives. His current life expectancy is 20 years. After that time it is expected that the company could pay dividends of Rs.30 per share indefinitely. At present the firm could afford to pay Rs.5 per share forever. The required rate of return of this company’s shareholders is 10 percent. What is the current value of the share? What is the cost of each shareholder of the managing director’s policy?

(b)

Discuss various aspects of computation of Economic Value Added and its application in business planning and Valuation.

Please turn over

( 3 )

F-20(VMC)
Revised syllabus

Marks

(a)

The following is the data regarding two companies ‘X’ and ‘Y’ belonging to the same risk class.

	Company X	Company Y
No.of ordinary shares Face value of shares Market price per share 6% debentures Profit before interest	90,000 Rs.10 Rs1.20 Rs.6,00,000 Rs.18,000	1,50,000 Rs.10 Rs.100 — Rs.18,000

All profits after debentures interest are distributed as dividends.
Examine how under Modigliani and Miller approach and investor holding 10 percent of shares in company
X will be better off in switching his holdings to company Y.

(b)

A company is considering raising Rs.100 lakh by one of the two alternative methods viz. 14 percent Institutional term loan and 13 percent non-convertible debentures. The term loan portion would attract no major incidental cost. The debentures would have to be issued at a discount of 2.5 percent and would involve Rs.1 lakh as cost of issue.
Advise the Company as to the better option based on the effective cost of capital in each case. Assume a tax rate of 35 percent.

The Cement industry has been through a very trying period in the last five years and the constraints on operations have been removed in the early part of the year. The company hopes to improve its position in the years to come and has plans to put up an additional plant in the neighborhood of the present factory. Increased profits due to expansion in capacity are expected to be 25% of the additional capital investment after meeting interest charges but before depreciation on the additional plant installed. Shares of this Cement company are widely distributed and there is a large majority of holdings in the hands of middle class investors whose average holding do not exceed 500 shares.
The following data is also made available to you:
Last five years:

Particulars	1997-98	1998-99	1999-2000	2000-01	2001-02	2002-03 (current yr.)
Earning per share (Rs.)	6.00	5.00	4.50	4.50	4.00	17.50
Cash availability per share (Rs.)	7.50	6.00	5.00	4.00	4.00	20.00
Dividend /Share (Rs.)	3.00	3.00	3.00	2.00	Nil	?
Payout ratio (%)	50.00	60.00	67.00	45.00	Nil	?
Average Market price (Face value Rs.100)	80.00	70.00	70.00	70.00	60.00	150
P/E ratio	13.33 : 1	14 : 1	15.6 : 1	15.6 :1	15 : 1

Cement Company requires you to advise them with respect to the dividend policy they have to follow for the current year. What recommendations would you make? Give reasons for your answers.

__________