CWA ICWA Final Stage IV : Valuations Management and Case Study - June 2009

CWA ICWA Final - Stage IV • Valuations Management and Case Study • June 2009

This Paper has 37 answerable questions with 0 answered.

F—20(VMC) Revised Syllabus
Time Allowed : 3 Hours	Full Marks : 100

The figures in the margin on the right side indicate full marks.
Answer Question No. 1 which is compulsory carrying 20 marks and any five from the rest.
Marks

The figures in the margin on the right side indicate full marks.

Answer Question No. 1 which is compulsory carrying 20 marks and any five from the rest.

Marks

(a)

State whether the following statements are True or False:

1x9

(i)

Hedging protects against the price risk but not gains or losses.

(0)

(ii)

Synergy is a whole that is greater than the sum of its parts.

(0)

(iii)

Intangible assets are treated as fixed assets.

(0)

(iv)

Patents are normally written off.

(0)

(v)

In discounted cash flow valuation, the discount rates are not risk–adjusted.

(0)

(vi)

In DCF approach, lower rate of discount is used for safe projects.

(0)

(vii)

Standard deviation is better than co–efficient of variation as measure of risk.

(0)

(viii)

Exchange ratio of equity shares between merging firms is determined by their market prices alone.

(0)

(ix)

Call option premium is not always equal to put option premium.

(0)

(b)

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

1x5=5

(i)

Discounted cash flow valuation is based upon __________ cash flows and discount rates (Past/future)

(0)

(ii)

The three principal components of income approach are:

(a)	_____________ income;
(b)	Projection period; and
(c)	Appropriate capitalization rate. (taxable/economic)

(0)

(iii)

Assets held as stock–in–trade are not ___________ (investments/disinvestments)

(0)

(iv)

A positively skewed distribution means likely more _________ returns. (positive/negative)

(0)

(v)

If projected economic income flows are none–constant, ________ capitalization method will be useful for valuing the firm. (yield/direct)

(0)

(c)

Attempt all the questions by selecting the correct option:

2x3

(i)

Two– stage divided discount model is based upon two clearly delineated growth stages:

A.	High and low growth;
B.	High and stable growth;
C.	Low and stable growth;
D.	All of the above.

(0)

(ii)

When the right is not exercised, the value of option will be:

A.	Zero;
B.	Less than zero;
C.	Equal to market price of underlying asset;
D.	None of the above.

(0)

(iii)

Higher the Market value to Book value ratio of a company, ___________ is the value of intangibles of a company. (Higher/Lower)

(0)

Write short notes on any four of the following:

4x4

(a)

Valuation of stock index futures contract.

(0)

(b)

Economic Value Added.

(0)

(c)

Valuing Synergy.

(0)

(d)

Intellectual Capital Management.

(0)

(e)

Types of Futures.

(0)

(f)

Super profit method of valuing goodwill.

(0)

(a)

Xing Limited is in IT sector providing wireless networking solutions. It is a company with an annual turnover of Rs.2,500 crores. Now, it is looking for growth through acquiring BPO companies which would provide it strategic–synergic–fit. For this, the CFO of the company is negotiating a deal to acquire Shiva BPO Pvt. Ltd. Whose balance sheet as on March 31, 2009 is given below:

Balance Sheet of Shiva BPO Pvt.Ltd.as on 31.03.2009
Source of Funds	(Rs. In crores)
Equity Share Capital (Rs.10 par) Reserves and Surplus Shareholders Fund Loan Fund (average cost is 10.50%)	400 100 500 200
Total Source of Funds	700
Application of Fund
Net Fixed Assets Investments Net Current Assets	650 20 30
Total Applications of Funds	700

Additional Information:

•

The Shareholders of Shiva BPO Pvt. Ltd. will get 1.5 shares in Xing Limited for every share held. The shares of Xing Limited would be issued at its current price of Rs.18 per share.

•

The lenders of loan funds will be given 11% debentures of the same amount by the acquiring company.

•

The external liabilities are expected to be settled at Rs.150 crores.

•

The dissolution expenses of Rs.15 crores are to be borne by the acquiring company.

•

The following are projected incremental free cash flows expected from the acquisition for next 6 years:

Year–ended
1
2
3
4
5
6

Rs. in crores
150
200
260
300
220
120

•

The free cash flows of Shiva BPO Pvt. Ltd. are expected to grow at 3% per annum after 6 years forever.

•

Seeing the risk profile of the target company, it is estimated that the cost of capital relevant to it will be 13%.

•

It is found that the target company has unaccounted liabilities totaling Rs.20 crores.

You are required to advise Xing Limited whether the deal to acquire Shiva BPO Pvt. Ltd. would be financially feasible and profitable.
(See Present Value Table at Page 7)

(0)

(b)

Explain the salient features of Mckinsey Model of value– based management.

(0)

(a)

An analyst is working on a target company, Rainbow Paint Industry Ltd. in the area of paint industry. He is to necessary valuation of the business of the target company. The target company identified is from Gujarat and it has its plant located in Jamnager. On the basis of the past financial trends, he has projected necessary financials for the company for the next five years, which are given below:

	Year
	2010	2011	2012	2013	2014
Sales Less: Cost of goods Sold Gross Profit Depreciation Profit before Interest and Tax Interest Profit before Tax Tax @ 40% Profit after Tax Additional Information: Capital Expenditure Increase in Working Capital	180.50 144.15 36.35 9.5 26.85 5.45 21.40 8.56 12.84 0.65 2.10	193.73 154.72 39.01 10.20 28.82 5.85 22.97 9.19 13.78 2.25 2.33	207.93 166.06 41.87 10.94 30.93 6.28 24.65 9.86 14.79 1.50 2.40	223.17 178.23 44.94 11.75 33.20 6.74 26.46 10.58 15.88 2.00 1.50	237.30 189.51 47.79 12.49 35.30 7.16 28.13 11.25 16.88 1.75 2.00

The Cost of capital for the company is estimated to be 15%. Assuming that the free cash flows of the target company will grow at the rate of 10% forever after 2014, you are required to determine the value of the business based on the free cash flows.
(See Present Value Table at Page 7)

(0)

(b)

State the Impact of the following change on the value of a European Call Option by writing the appropriate word form (Increase/Decrease/No Impact).

(i)

Increase in the current share price of the underlying from RS.100 to Rs.120 (Increase/Decrease/ No.Impact)

(0)

(ii)

Strike Price has increased from Rs.75 to Rs.80. (Increase/Decrease/No.Impact)

(0)

(iii)

The volatility of the underlying represented by 0 has increased from 15 to 20. (Increase/Decrease/No Impact)

(0)

(iv)

Time to expiration has decreased from 3 months to 1 month. (Increase/Decrease/No Impact)

(0)

(v)

Risk Free Interest Rate has decreased from 9% to 8.5% (Increase/Decrease/No Impact).

(0)

Mr. S.K.Singh, the Managing Director of Dolphin Electronics Limited, attended recently a workshop on Economic Value Added (EVA) and he is convinced that EVA is a highly effective tool for performance evaluation and for valuation. Therefore, he wants that one should calculate EVA for this company. Fort hat he has provided the following summarized financial data for the year ending on March 31, 2008.
PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31.3.2008

	(Rs. in thousands)
INCOME
Sales Less Returns Income from Services Turnover(Gross) Less: Excise Duty Turnover(Net) Other Operating Revenues Accretion/Decretion to Work–in–progress, Finished Goods and Scrap Profit on Sale of Assets(Net) Transfer from Grants	14,758,944 182,514 14,941,458 365,545 14,575,913 283,839 491,462 30,503 1 15,381,718
EXPENDITURE
Consumption of Raw Materials and Components Consumption of Stores & Spares Purchase of Finished Goods Employees Remuneration and Benefits Other Expenses of manufacturing, administration, selling and distribution	5,896,697 318,966 1,688,371 3,397,721 1,624,195 12,925,950
Profit before Depreciation, Interest and Tax Depreciation on Fixed Assets Profit before Interest and Tax Interest Profit before Extraordinary Items and Tax Add: Expenditure allocated to Capital jobs and Work–in–Progress Profit before Tax Less: Provision for Taxation Profit after Tax	2,455,768 479,700 1,976,068 327,898 1,648,170 16,148 1,664,318 585,000 1,079,318
SOURCES OF FUNDS:
Shareholder Funds Share Capital Reserves & Surplus	800,000 4,448,287 5,248,287
Loan Funds
Secured Loans Unsecured Loans	Nil 1,097,357 1,097,357 6,345,644
APPLICATION OF FUNDS Fixed Assets
Gross Block Less: Depreciation Net Block Capital work–in–progress	7,722,230 5,718,745 2,003,485 111,120 2,114,605
Investments Current Assets, Loans & Advances Inventories Sundry Debtors Cash & Bank Balances Loans & Advances	651,034 6,715,544 6,034,787 1,292,704 2,002,231 16,045,266
Less: Current Liabilities and Provisions Current Liabilities Provisions	11,404,381 1,396,645 12,801,026
Net Current Assets Miscellaneous Expenditure (to the extent not written off or adjusted) Technical know–how fee	3,244,240 335,765 6,345,644

In addition to above, the following information is also available:a

•	The company–s average borrowing cost after tax is 8.5% per annum.
•	Yield on Government Securities is estimated at 6.75%.
•	Return on a benchmark index is 14.5% with a variance of 0.005.
•	The covariance between the company′s share return and that of the benchmark index is 0.006.

From the above information, you are required to estimate EVA for the company for the year ending on March 31, 2008.

(0)

(a)

Discuss the major aspects, assumptions and decision rules of the Discounted Cash Flow (DCF) Model.

(0)

(b)

What is an efficient market? What are the different level of market efficiency?

(0)

(a)

Happy Ltd. and Muskan Ltd. are in the same industry with identical earning per share for the last five years. Happy Ltd. has a policy of paying 40% of earnings as dividends while Muskan Ltd. pays a constant amount of dividend per share. There is disparity between the market price of the shares of these two companies. The price of the Happy’s share is generally lower than that of the Muskan Ltd., even though in some years Happy Ltd. paid more dividends than Muskan Ltd. The data on earnings, dividends and market price for the two companies are as under.

	Happy Ltd.			Muskan. Ltd.
Year	EPS (Rs.)	DPS(Rs.)	Market Price(Rs.)	EPS(Rs.)	DPS(Rs.)	Market Price(Rs.)
2004 2005 2006 2007 2008	4.00 1.50 5.00 4.00 8.00	1.60 0.60 2.00 1.60 3.20	12.00 8.50 13.50 11.50 14.50	4.00 1.50 5.00 4.00 8.00	1.80 1.80 1.80 1.80 1.80	13.50 12.50 12.50 12.50 15.00

You are required to calculate:

(i)	(1) Pay–Out ratio; (2) Dividend yield; and (3) Earning yield for both the companies.
(ii)	What are the reasons for the differences in the market prices of the two companies shares?
(iii)	What can be done by Happy Ltd. to increase the market price of its shares?

(0)

(b)

Is Hostile takeover legally allowed in India? If yes, what are the bases of arriving at the public offer price?

(0)

A company manufacturing electronic equipments is currently buying component A, from a local supplier at a cost of Rs.30 each. The company has under its consideration a proposal to install a machine for the manufacture of the component. Two alternative proposals are available as under:

(a)

Installation of semi–automatic machine, involving annual fixed expenses of Rs.18 lakhs and variable cost of Rs.12 per component manufactured.

(b)

Installation of automatic machine, involving an annual fixed cost of Rs.30 lakhs and a variable cost of Rs.10 per component manufactured:

(i)	Find the annual requirement of components to justify a switchover from purchase of components to (a) Manufacture of the same by installing semi–automatic machine and (b) Manufacture of the same by installing automatic machine.
(ii)	If the annual requirements of the component is 5,00,000 units, which machine would you advise the company to install?
(iii)	At what annual volume would you advise the company to select the automatic machine instead of semi–automatic machine?

(0)

Present Value Table:

Discount factor	10%	11%	12%	13%	15%	20%
Year end
1 2 3 4 5 6	.909 .826 .751 .683 .621 .564	.901 .812 .731 .659 .593 .535	.893 .797 .712 .636 .567 .507	.885 .783 .693 .613 .543 .480	.870 .756 .658 .572 .497 .432	.833 .694 .579 .482 .402 .335

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