CWA/ICWA Final :: Valuation Management and Case Study : June 2005

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
1. (a) Attempt all the questions, by selecting the correct option. 2x5=10
(i)Systematic or market risks does not include
(a) increase in inflation rate
(b) changes in the interest policy of the government
(c) increase in import duty on materials used by the firm
(d) changes from sales tax to VAT system
(ii)A put option is said to be in the money if
(a) St < E (b) St > E (c) St = E (d) None of these
(iii)A firm with a 5% growth rate and a return on equity of 15% will have a stable period payout ratio of ) __________ percent.
(a) 33% (b) 50% (c) 66.67% (d) 80%
(iv)The management can increase the value of their business by
(a) maintaining growth by retained profit
(b) increasing the par value of shares by consolidation of shares
(c) purchasing of non-current assets
(d) earning more profits form existing assets
(v)S Ltd is considering acquiring H.Ltd. after reorganization H.Ld’s earnings would increase from Rs.4,80,000 to Rs.6,00,000. iif post tax accounting rate of return on capital employed of S.Ltd is 15%, the value of H.Ltd would be
(a) Rs. 8,00,000 (b) Rs.10,00,000 (c) Rs.32,00,000 (d) 40,00,000
(b) State whether the following statements are True or False: 1x6=6
(i)Comparable Income Differential Method is an example of market approach of valuation . (True/false)
(ii)The P/E ratio can be used to value the shares of unlisted companies. (True/false)
(iii)In a company where return on investment is higher than market capitalization shareholders would prefer higher dividend. (True/false)
(iv)When the return on equity is higher than the cost of equity, the higher a firm's growth rate the higher its market value to book value ratio. (True/false)
(v)Stock that pay low dividends and have high price earnings ratios are more likely to come out as undervalued using the dividend discount model. (True/false)
(vi)Organizational capital is a primary component of Intellectual capital. (True/false)
(c) Fill in the blanks by filling the appropriate word given in the brackets: 1x4=4
(i)An investment is risk free when expected returns are always ______ the actual returns. (less than, equal to, more than)
(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)Decrease in strike price ______ call value but ______ put value. (increases/decreases; decreases/increases; decreases/ increases)
(iv)In valuing a firm, the ______ tax rate should be applied to earnings of every period. (marginal /effective/ average)
2. (a) What are the limitations of Economic Value Added? 6
(b) A company in operation for five years has tangible assets worth Rs.20,00,000. Maintainable future profits are estimated at Rs.4,00,000. The nominal rate of return expected for the company is 15%. It desires to capitalize super profits at 20%. Determine the value of the company. 6
(c) Differentiate between operating and financial synergy. 4
3. X and Y are two fast growing companies in the engineering industry. They are close competitors and their composition, capital structure and profitability records have been very similar for several years. The primary difference between the companies from a financial management perspective is their dividend policy. Company X tries to maintain a non-decreasing dividend per share while company Y maintains a constant dividend payment ratio. Their recent earnings per share (EPS), dividend per share (DPS) and share price (P) history are as follows: 16
 Company X (in Rs.)Company X (in Rs.)
YearEPSDPSP (Ranges)EPSDPSP (Ranges)
1
2
3
4
5
6
7 		 9.30
7.40
10.50
12.75
20.00
16.00
19.00 		 2.00
2.00
2.00
2.25
2.50
2.50
2.50 		 75-90
55-80
70-110
85-135
135-200
150-190
155-210 		 9.50
7.00
10.50
12.25
20.25
17.00
20.00 		 1.90
1.40
2.10
2.45
4.05
3.40
4.00 		 60-80
25-65
35-80
80-120
110-225
140-180
130-190 
The Management of Company “Y” is puzzled as to why their share prices are lower than those of Company x in spite of the fact that profitability record of the company “Y” is slightly better (particularly of past three years).
As a financial consultant, how would you explain the situation?
Please turn over

( 2 )

F-20(VMC)
Revised syllabus		 Marks
4. (a) The price of a company’s share is Rs.80 and the value of growth opportunities is Rs.20. if the company’s capitalization rate is 15 percent, what is the earnings price ratio? How much is earning per share? 4
(b) A company’s current price of share is Rs.60 and dividend per share is Rs.4. if its capitalization rate is 12 percent, what is the dividend growth rate? 4
(c) How is Intellectual Capital Valued? 4
(d) What is the methodology of Brand Valuation? 4
5. (a) What are the motives and strategies influencing merges and acquisitions? 6
(b) What are the salient features of the Accounting Standard (AS) 13 applicable to corporate regarding valuation of investments? 6
6. The chairman of Rose Ltd. at a board meeting proposed the acquisition of Beauty Ltd.
He stated:
As a result of this take over we will diversify our operations and our earnings per share will rise by 13 percent, bringing great benefits to out shareholders.
No bid has yet been on a share-for-share exchange, which would be one Rose share for every six Beauty shares. Financial data for the two companies include:
Rose
Rs. Crore		Beauty
Rs. Crore
Turnover
Profit before Tax
Profit available to equity holders
Dividend
Retained earnings
Issued ordinary shares (crore)
Market price per share (Rs)		 5.60
1.20
0.78
0.32
0.46
4
3.0\20 		 4.20
1.00
0.65
0.34
0.31
15
0.45 
Required:—
(a) Explain whether you agree with the chairman of Rose when he says that the take over would bring great benefits to out shareholders.
Support your explanation with relevant calculations. State clearly any assumptions that you make.		 12
(b) On the basis of information provided, calculate the likely post-acquisition share price of Rose if the bid is successful. 4
7. On March 9,2004, Ferguson Systems was trading at Rs.13.62. 12+4
(a) To value a July 2004 call option with a strike price of Rs.15, trading on he Board Options Exchange on the same day for Rs.2. The following are the other parameters of the options:
–The annualized standard deviation in Ferguson Systems stoc price over he previous year was 81%.
–The option expiration date is Friday, July 23,2004. there are 103 days to expiration (year = 365 days), and the annualized Treasury Bill rate corresponding to this option life is 4.63%
–The value using the normal distribution of N(d1) = 0.5085 and n(d2) = 0.3412.
(b) Comment on the trading value as at 23rd July, 2004.
8. A strategic approach to takeover would imply that acquisitions are only made after a full analysis of the underlying strengths of the acquirer company and identifications of candidates strategic fit with existing activities. Below are given (A) Possible strategic reasons for a take over and (B) Suggested ways of achieving the aim: 2x8=16
List A (where you are)List B (How to get to where you want to be )
1.Growing steadily but in a mature market with limited growth prospects(a)Acquire a company making similar products operating substantially below capacity.
2.Marketing an incomplete product range, or having the potentials to sell other products or services to your existing customers(b)Acquire company into which your talents can extend
3.Operating at maximum productive capacity(c)Acquire a suitable company which will enhance earnings per share.
4.Under utilizing management resources(d)Acquire a company with the right customer profile.
5.Lacking key clients in a targeted sector(e)Acquire a company with a complementary product range.
6.Preparing for floatation but needing to improve your balance sheet(f)Acquires a company with the key talents and / or technology.
7.Needing to increase market share(g)Acquire a company in a younger market with a higher growth rate
8.Needing to widen your capability.(h)Acquire an important competitor.
Required:
Match the numbered items A (1, 2, 3 ……) with the lettered items in B (a, b, c, ...)
__________

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