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IPIM
THE INDIAN INSTITUTE OF PLANNING AND MANAGEMENT
Strategic Corporate Finance - Re-Examination Assignment
Paper Code: IIPM/FIN04/SCF002

Max. Marks: 100

General Instructions:
The Student should submit this assignment in his/her own handwritten (not in the typed format).
The Student should submit this assignment within 2 days from the issue of the assignment.
The student should attach this assignment paper with the answered papers.
Write legibly and keep the length of the answer as per the weightage (in terms of marks) assigned to each
question. DO NOT be unduly short or long in providing the relevant details.

The student should only use the Rule sheet papers for answering the questions.

Failure to comply with the above instructions would lead to rejection of assignment.

Specific Instructions:
 There are Four Questions in this assignment. The student should answer all the questions along with their
subparts. Marks are being assigned to each section of the question as well.
 Each Question carries equal marks (25 marks) unless specified explicitly

Question-1(A)[12.5M arks]
UB Inc. is examining its capital structure with the intent of arriving at an optimal debt ratio. It
currently has no debt and has a beta of 1.5. The riskless interest rate is 9%.
Your research indicates that the debt rating will be as follows at different debt levels;

D/(D+E)
0%
10%
20%
30%
40%
50%
60%
70%

Rating
AAA
AA
A
BBB
BB
B
CCC
CC

Interest Rate
10%
10.5%
11%
12%
13%
14%
16%
18%

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80%
90%

C
D

20%
25%

The firm currently has 1 million shares outstanding at $20 per share (tax rate =40%).
You are required to determine the optimal capital structure ratio for the company.
Question-1(B)[12.5]
RIL is a firm into multiple segments whereas RPL Ltd is into a single business. You being an
analyst asked to evaluate both firms using EVA. You are given following information to judge
the firm. Find out which of the two firms is most likely to create wealth for the shareholder using
Economic Value Addition for the firm concept? Justify your answer?
Item

RIL Ltd RPL

Ltd

Net Worth

250

300

NOPLAT (tax adjusted Operating Profit) 65

78

Cost of Equity

17%

19%

Cost of Debt

12%

11%

Debt

100

120

Is EVA the better value to evaluate the firm RIL Ltd who is into multiple segments? Explain

Question-2(A)[12Marks]
Union Pacific Railroad reported net income of Rs.770 million in 2011, after interest expenses of
Rs. 320 million. (The corporate tax rate was 36 %.) It reported depreciation of Rs.960 million in
that year, and capital spending was Rs.1.2 billion. The firm also had Rs.4 billion in debt
outstanding on the books, rated AA (carrying a yield to maturity of 8%) and trading at par (up
from Rs.3.8) billion at the end of 2010. The beta of the stock is 1.05 and there were 200 million
shares outstanding (trading at Rs.60 per share), with a book value of Rs.5 billion. Union Pacific
paid 40% of its earnings as dividends, and working capital requirements are negligible. (The
Treasury bond rate is 7%).
(i)Estimate the free cash flow to the firm in 2011.

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(ii)Estimate the value of the firm at eh end of 2011.
(ii)Estimate the value of equity at the end of 2011, and the value per share.
Question-2(B)[13Marks]
You have been asked to assess whether Walgreeen Company, a drugstore chain, is correctly
priced relative to its competitors in the drugstore industry at the end of 2010. The following are
the price / sales ratios, profit margins and other relative details of the firms in the drugstore
industry.

COMPANY
Arbor drugs
Big b Inc.
Drug
Importer.
Fays Inc.
Genovese
Longs drugs
Perry drugs
Rite aid
Walgreen

P/S
RATIO
0.42
0.30
0.10

PROFIT MARGIN PAYOUT

%
3.40
18
1.90
14
0.60
0

EXPECTED
GROWTH
14.0
23.5
27.5

1.05
0.70
0.90

0.15
0.18
0.30
0.12
0.33
0.60

1.30
1.70
2.00
1.30
3.20
2.70

11.5
10.5
6.0
12.5
10.5
13.5

0.90
0.80
0.90
1.10
0.90
1.15

37
26
46
0
37
31

BETA

Based entirely on a subjective analysis, do you think that Walgreen is overpriced because its
price / sales ratio is the highest in the industry? If it is not, how would you rationalize its value?

Question-3(A)[10 Marks]
Time warner is considering sale of its publishing division. The division has earnings before
interest, taxes and depreciation of Rs.550 million in the most recent year (depreciation was
Rs.150), growing at an estimated 5% a year. (You can assume that depreciation grows at the
same rate). The return on capital in the division is 15% and the corporate tax rate is 40%. If the
cost of capital for the division is 9%, estimate the following:
(i)Value / FCFF multiple.
(ii)Value / EBIT multiple.
(iii)Value / EBITDA multiple.
Question-3(B)[15Marks]

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A large profit making company is considering installation of a machine to process the waste
produced by one of its existing manufacturing process and convert it into a marketable product.
At present, the waste is being removed, for disposal by a contractor against payment of INR 50
lacs per annum. This arrangement will continue for next four years. The contract can be
terminated upon installation of aforesaid machine, on payment of a compensation of INR 30 lacs
before the processing operation starts. This compensation is not allowed as deduction for tax
purposes.
The machine required for carrying out the processing, costing INR 200 lacs will be financed by a
loan repayable in four installments, commencing from end of year 1. Interest rate is 16 percent
per annum. At end of the 4th year, the machine can be sold for INR 20 lacs and the cost of
dismantling and removal will be INR 15 lacs.
Sales and direct costs of the product emerging from waste processing, for 4 years are estimated
as under:
1
Year
Sales
Material Consumption
Wages
Other expenses
Factory overheads
Depreciation
(as
per
Income Tax Rules)

2
322
30
75
40
55
50

3
322
40
75
45
60
38

4
418
85
85
54
110
28

418
85
100
70
145
21

Initial stock of materials required before commencement of the processing operations is INR 20
Lacs at the start of year 1. The stock levels of materials to be maintained at the end of year 1, 2,
and 3 will be INR 55 lacs and stocks at end of year 4 will be nil. The storage of materials will
utilize space which would otherwise have been rented out at INR 10 lacs per annum. Labour
costs include wages of 40 workers, whose transfer to this process will reduce ideal time
payments of INR 15 lacs in year 1 and INR 10 lacs in year 2. Factory overheads include
apportionment of general factory overheads, except to the extent of insurance charges of INR 30
lacs per annum, payable on this venture. The companys tax rate is 50 percent.
Present value factors for 4 years are as under:
Year
PV factor at 15%

2
.870

3
.756

4
.658

.572

Advise management on the desirability of installing the machine for processing the waste. All
calculation should form part of the answer.
Question-4(A)[10Marks]
From the following income statement of a corporate for the current year, determine the EVA
during the year:
Sales revenue (in crores)
100
Less Cost of goods sold
40

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Administrative expenses
Selling Expenses
Interest
Earnings before taxes
Less: Taxes (40%)
Earnings after taxes

4
16
10

70
30
12
18

The firms weighted average cost of capital employed (consisting of equity and debt of INR 150
crore) is 12 percent; its cost of equity capital is 15 percent.
Question-4[B][15 Marks]
Work out the weighted average cost of capital from the following informations:
Rs

Debentures ( Rs 100 per debenture)

500000.00

Preference shares ( Rs 100 per deb)

500000.00

Equity shares ( Rs 10 per share)

1000000.00

Total

2000000.00

The Market prices of these securities are:

Debenture

Rs 105 per debenture

Preference

Rs 110 per share

ALL THE BEST