Mini-Case on Capital Budgeting

As such it was a bad morning for you. Last nights party hangover was still there.
The nagging headache was troubling you and it was somehow not getting cured inspite of double shots of aspirins and numerous cups of black coffee. The party was
thrown by your CFO Ms. Cheeky Kamchor to celebrate of your promotion to Sr.
Financial Analyst position in your company Least Reliance Energy Limited, an
energy distribution company.
The company in recent years was really on go, as it had bagged three new
distribution blocks in last two years government auctions. The rumors in the
markets were pointing to a close connection of your CEO
Mr. Jealousbhai Nautanki with the Energy Minister. But then rumors are just
rumors, and why should you be bothered about it, as your career path is on the
move. Added to the excellent work conditions, your boss Ms. Cheeky was
extremely co-operative and understanding.
But then todays problem is your own doing, and Ms. Cheeky was least bothered
about it, as she was feeling the heat since morning from her CEO to analyze and
submit all necessary results within a couple of days to him, before the real duediligence process was to begin.
All this was going through your mind when she called you up in her office, and
started explaining the issue at hand. She wanted you to take-up this matter leaving
aside all other tasks and submit to her your Course Financial Management
findings by tomorrow 10:00 am sharp. Looks like you had to somehow forget your
headache and start working immediately.
This is what she explained to you; your company is thinking of acquiring another
corporation in the similar line of business. Since the three contracts which were
bagged in quite a short period, the Board of
Directors of you company were of the opinion that it would be better to acquire a
company to quickly expand operations and capacities, rather than build capacities
on your own, which will be far more expensive and time-consuming. The
Investment Bankers engaged by your company had short-listed two possible targets
and were waiting for your internal opinion before they could go ahead with
detailed valuation, due-diligence, negotiations, and arranging for requisite funds to
initiate the take-over.
Ms Cheeky asks you to evaluate the data as given below and further to submit your
detailed findings through two approaches.
(1) First, assuming there is no capital rationing, as the status your company
enjoyed in the capital markets, the Investment Bankers could easily arrange for all
the necessary funds required for acquisitions either of the company or both;
(2) Second, assuming the cost of each choice is Rs. 25,000,000. You cannot spend
more than that, so acquiring both corporations is not an option.

The following are your critical case data:

(A) Load-Shedding Corporation Limited:
a. Revenues = 10,000,000/- in year one, increasing by 10% each year.
b. Expenses = 2,000,000/- in year one, increasing by 15% each year.
c. Depreciation Expense = 500,000/- each year (uniform).
d. Tax Rate = 25%
e. Discount Rate = 10%
(B) Power-Cut Corporation Limited:
a. Revenues = 15,000,000/- in year one, increasing by 8% each year.
b. Expenses = 6,000,000/- in year one, increasing by 10% each year.
c. Depreciation Expense = 1,000,000/- each year (uniform).
d. Tax Rate = 25%
e. Discount Rate = 11%
Your ordinary task:
(Ordinary meaning you have to do this by tomorrow 10:00 am else you lose your
job right there!)
Your need to present your report on the basis of following calculations carried out
for both the companies and remarks thereon:
(1) A 5-year projected income statements;
(2) A 5-year projected cash flows;
(3) Net Present Value calculations;
(4) Internal Rate of Return;
(5) Profitability Index;
(6) Payback Period;
(7) Discounted Payback Period;
(8) Modified Internal Rate of Return;
(9) Based on items (1) through (8), which company/ies would you recommend
acquiring?
Your extraordinary task:
(Extraordinary meaning even if you dont do this Ms Cheeky is going to retain
your job but might just open-up your personal appraisal review report to
reconsider your latest promotion!)
You further need to dig into some economic & business data during the past years
or so (Tip: the CMIE database might just come in handy for you but then offcourse you are the king/or/Queen so you may very well trust your own authentic
sources!), and try to find-out whether there was any such merger/takeover/
amalgamation in India or abroad, in the same business sector? If you could find
one, then write a report on the same. It will be better if you could use certain
guidelines to write this report as: Which were the parties involved, was it a
complete takeover (friendly or hostile) or was it a sort of stake-purchase or was it
an amalgamation or something like that, what is it mean by open offer in India,
how the takeover/merger was funded, & why was the takeover/merger at all?