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# Tutorial 3 for FM-I (Sec: C&D) 1. Shinde Pharma Ltd. is trading on NSE for Rs. 167.40 per share.

I am seeking your advice for investing in this companys equity share. You have only the following information for decision: For FY13, the company reported a revenue of Rs.378 million. With a new product in cardio-vascular segment, it is expected that the revenue will grow by 12% in FY14. As there has not been much changes in the operating environment and the cost structure, the company will maintain its net profit margin (NPM) of 17.12% for FY14. It has a total of 5.00 million equity shares. The historical PE ratios are as follows: High PE: 15.7 times Low PE: 4.5 times. Compute EPS for FY14. Using historical average PE ratios, give your recommendations. What price range for Shinde Pharmas equity shares are expected? 2. A companys equity share is trading for Rs. 45.60. The company expects to pay a dividend of Rs. 6.85 per share in the next year. It is assumed that the dividends will grow by 5% for infinite period. If the cost of equity (Ke) is 14.55%, is it wise to invest in this stock? ABC Ltd. is deciding to issue Rs. 1000, 14%, 7 year debentures. The debentures will have to be sold at a discount of 3% to attract investors. Further, the firm will pay an underwriting fee of 2% of face value. Assume a tax rate of 35%. Calculate the after-tax cost of debt. What would be the after-tax cost of debt if the debentures were sold at a premium of Rs. 30? 4. A company issues new debentures of Rs 2 million, at par; the net proceeds being Rs 1.8 million. It has a 13.5 percent rate of interest and 7 year maturity. The companys tax rate is 52 per cent. What is the cost of the debentures issue? What will be the cost in 4 years if the market of debentures at that time is Rs 2.2 million? A firm has 8,000,000 ordinary shares outstanding. The current market price is Rs 25 and the book value is Rs 18 per share. The firms earnings per share is Rs 3.60 and dividend per share is Rs 1.44. How much is the growth rate assuming that the past performance will continue? Calculate the cost of equity capital. A firm is thinking of raising funds by the insurance of equity capital. The current market price of the firms share is Rs 150. The firm is expected to pay a dividend of Rs 3.55 next year. The firm has paid dividend in the past years as follows: Year Dividend per share (Rs) 2003 2.00 2004 2.20 2005 2.42 2006 2.66 2007 2.93 2008 3.22

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The firm can sell shares for Rs 140 each only. In addition, the floatation cost per share is Rs 10. Calculate the cost of new issue. 7. A company is considering the possibility of raising Rs 100 million by issuing debt, preference capital and equity and retaining earnings. The book values and the market values of the issues are as follows: Book Value (mn) 30 10 20 40 100 Market Value (mn) 60 -24 36 120

## Ordinary Shares Reserves Preference shares Debt

The following costs are expected to be associated with the above mentioned issues of capital. (Assume a 35 per cent tax rate) (i) The firm can sell a 20 year, Rs 1,000 face value debenture with a 16 per cent rate of interest. An underwriting fee of 2 per cent of the market price would be incurred to issue the debentures. (ii) The 11 per cent, Rs 100 face value preference issue can fetch Rs 120 per share. However, the firm will have to pay Rs 7.25 per preference share as underwriting commission. (iii) The firms ordinary share is currently selling for Rs. 150. It is expected that the firm will pay a dividend of Rs.12 per share at the end of the next year, which is expected to grow at a rate of 7 per cent. The new ordinary shares can be sold at a price of Rs 145.The firm should also incur Rs 5 per share flotation cost. Compute the weighted average cost of capital using (i) book value weights (ii) market value weights. 8. The following capital structure is extracted from Delta Ltd.s balance sheet as on 31 March 2009: (Rs000) Equity (Rs 25 par) Reserves Preference(Rs 100 par) Debentures Long term loans 66,412 65,258 3,000 30,000 5,360 170,030

The earnings per share of the company over the period 2000 2009 are: Year Rs Year Rs 2000 2.24 2005 4.40 2001 3.00 2006 5.15 2002 4.21 2007 5.05 2003 3.96 2008 6.00 2004 4.80 2009 6.80 The equity share of the company is selling for Rs 50 and preference for Rs 77.50.The preference dividend rate and the interest rate on debenture respectively are 10 per cent and 13 per cent. The long term loans are raised at an interest rate of 14 per cent from the financial institution. The equity dividend is Rs 4 per share. Calculate the weighted average cost of capital for Delta Ltd, making me for necessary assumptions.
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An investment project requires an investment of Rs. 66.85 crores. The company plans to finance the project with Rs. 40 crores from equity, and the rest from debt. The cost of equity is estimated to be 16.7% and the after-tax cost of debt is 9.5%. From the forecasted financial statements, the net cash flows of the project are computed as follows: Year 1 2 3 4 5 6

Cash Flows 8.5 12.3 16.4 21.4 33.2 21.6 (Rs. crore) a. Compute WACC of the project. b. Compute IRR of the project and advice if the project to be accepted or rejected. Give reasons. 10. Assume that you are the manager of a large departmental store and you are comparing two mutually exclusive projects. The first project, which is the installation of a simple computerized inventory management system, requires an initial investment of Rs. 30 mn and will produce a cash flows as given in the table below. The second project is an investment of Rs. 100 mn in a more sophisticated inventory system and is likely to produce much higher cash flows. The hurdle rate is 14% for both. What wold you implement? Investment Proposal-1 Proposal-2 30 mn 100 mn CF1 11mn 22mn CF2 14mn 40mn CF3 18mn 48mn CF4 22mn 60mn

11. The NPVs and IRRs of two projects are given below: Project A B C NPV (Rs. Crore) 23.5 46.7 11.3 IRR (%) 20.4 15.6 22.3

If the projects are mutually exclusive, which project would you recommend using the following options? Give reasons for each of your choice. a. Only NPV criterion b. Only IRR criterion c. Both NPV and IRR criteria together 12. You have to pick between three mutually exclusive projects with the following cash flows: Year ProjectA ProjectB ProjectC 0 1 2 -10000 8000 7000 5000 5000 -8000 -15000 10000 10000

The cost of capital is 12%. a. Which project would you pick using NPV rule? b. Which project would you pick using IRR rule? c. How would you explain the difference between the two rules? Which one would you rely on to make your choice?

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13. You have been asked to estimate the expected earnings on a new store for Reliance Trendz. The company currently has 80 stores open and had a total revenue of Rs. 6400 crore last year. The cost of goods sold, not including depreciation, is 60% of revenues. The firm will have to make an initial investment of Rs. 50 mn in the new store and the store will depreciate at 20% written-down method. In addition, the firm has selling and advertising expense of Rs. 320 crores that are allocated equally existing stores. If the tax rate is 30% and the expected inflation is 6%, estimate the after-tax operating income on the new store each year for the next five year. 14. You are an expert at working with PCs and are considering setting up a software development business. To setup the enterprise, you anticipate that you will need to acquire computer hardware costing Rs. 50 lakh. (The lifetime of the hardware is five years for depreciation purposes and straight-line method will be used.) In addition, you will have to rent an office for Rs. 20 lakh a year. You estimate that you will need to hire 10 software specialists at Rs. 3 lakh a year to work on the software. Your marketing and selling cost will be Rs. . a year. You expect to price the software you produce at Rs. 1000 per unit and to sell 6000 units in the first year. The actual cost of materials used to produce each unit is Rs. 150. The number of units sold is expected to increase 10% a year and the revenue and cost are expected to increase at 5% a year due to inflation. You will need to maintain working capital at 10% of revenues. Your tax rate will be 30% and cost of capital is 14%. a. Estimate the after-tax operating income on this project. b. Estimate the cash flows each year. c. Estimate the NPV. 15. You are analysing a project with a 30-year lifetime with the following characteristics: The project will require an initial investment of Rs. 20 mn and additional investments of Rs. 5 mn in year 10 and Rs. 5 mn in year 20 The project will generate earnings before interest and taxes of Rs. 3 mn each year (tax rate is 40%) The depreciation will amount to Rs. 500,000 each year and the salvage value of the equipment will be equal to the remaining book value at the end of year 30 The cost of capital is 12.5% Estimate the following: a. NPV of the project b. IRR of the project. What might be some of the problems in estimating the IRR for this project? 16. You are evaluating investment proposal of new outlet for Planet Health chain of health clinics. The estimated cost is Rs. 32mn. Revenue estimated in the first year is based on a customer base of 20,000 and expect 5% footfall every month. The average bill per customer is estimated to be Rs. 2500. estimate the revenue for Year1. The cost of services sold, not including depreciation, is 50% of revenues. The store will depreciate straight-line for 5 years. Firm has taken a loan of Rs. 10mn at 10% interest. If the tax rate is 30%, estimate the after-tax cashflow for Year1. Considering that revenue will increase by 10% each year, and cost remain 50% of revenue, estimate the cashflows for the new clinic for each year for the next four year.

If cost of equity is 18.73%, find NPV and decide is this project is feasible. 17. A company is planning to increase its competitiveness by investing in a new business which will give a synergistic advantage. The total investment to be made on plant & machinery will be Rs. 350 lakhs and as working capital margin will be Rs. 40 lakhs. The company plans to raise Rs. 270 from equity and the rest as a term loan from a bank to finance its investments. The term loan will have 12% rate of interest. It is estimated that the salvage value of assets at the end of five years will be Rs. 63 lakhs. Working capital margin money will be recovered at par.
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The estimated income statements are presented in Table 1. Table 1: Estimated Income statement of the company Summarized Items Revenue Expenses Depreciation Profit Before Tax Tax PAT You are required to: Estimate the Net Cash Flows for the project for five years. Compute cost of equity for the firm. (Use CAPM model to compute the cost of equity. The beta of companys equity share is 0.87. The yield on Govt. bond is 8.15%, and the average market return over the last 10 years is 19.40 %.) Compute after-tax cost of debt and WACC. Compute NPV of the project. Will the project be accepted? Year1 267 152.19 87.50 27.31 8.19 19.12 Year 2 288.36 164.37 65.63 58.37 17.51 40.86 Year 3 311.43 177.51 49.22 84.70 25.41 59.29 (Rs. Lakhs) Year 4 348.80 198.82 36.91 113.07 33.92 79.15 Year 5 401.12 228.64 27.69 144.80 43.44 101.36

18. Raikar Shippings equity shares are trading for Rs. 310.20. It reported a revenue of Rs. 420 crores and FY13 and expects are a growth of around 10% in the next year. Use the following information to help find the fair value of Raikar Shipping: FCFF for FY13 is Rs. 104 crore Estimated growth in FCFF for FY14 is similar to the expected growth in Revenue Assumed constant growth rate of FCFF from FY15 onwards: 5% in perpetuity Total Debt amount Rs. 40 crore; Total Equity: Rs. 120 crore. No. of equity share: 6 crores Cost of equity: 14%, post-tax cost of Debt: 8%.

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