MINI CASE

March 21, 2018 | Author: Sammir Malhotra | Category: Cost Of Capital, Internal Rate Of Return, Beta (Finance), Net Present Value, Bonds (Finance)


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MINI CASEThe balance sheet and profit and loss account of GNL Limited for the year 20X5 are given below: Balance Sheet, GNL Limited (Rs. In million) 20 X4 20 x5 Liabilities and Equity 6.5 Share capital 9.3 Reserves and surplus 8.8 Long-term dept Short-term blank borrowing 6.7 Current liabilities 38.0 Assets Net fixed assets Current assets Cash and bank Receivables 2.0 Inventories 9.3 Other assets 2.4 6.5 7.4 5.2 8.3 6.7 6.6 34.0 19.6 23.2 0.6 1.1 2.9 8.2 2.7 34.0 38.0 Profit and Loss Account, GNL Limited (Rs. In million) 20X4 20X5 Net sales 57.4 Cost of goods sold 45.8 Gross profit 11.6 39.0 30.5 8.5 Compute the key ratios for GNL Limited for the year 20X5.0 Interest 2.4 Profit before interest and tax 4.6 Non-operating surplus/deficit 0.5 0. b.6 1.5 2.0 Operating profit 4.9 1. Identify the financial strengths and weaknesses of GNL Limited. Prepare the Du Pont Chart for the year 20X5. d. What are the problems in analyzing financial statements? f.9 3.1 5.0 Profit before tax 3.7 Required a. Prepare the common size and common base financial statements for GNL.0 Tax − Profit after tax 3.9 4.0 Dividends 1.Operating expenses 7. .6 0. e.1 Retained earnings 1. Discuss the qualitative factors relevant for evaluating the performance and prospects of a company.6 − 2. c. You concur with his assessment. who wants some help in investment related matters. He plans to work for 15 more years and retire at the age of 60. How much money would he need when he reaches the age of 60 to meet this specific need? . He expects his salary to increase at the rate of 12 percent per year until his retirement.000 per year from his investments for the following 15 years as he expects to live upto the age of 75 years.000 in the bank. Once Ramesh retires at the age of 60 he would like to withdraw Rs. you have been approached by a client called Ramesh. He also believes that bonds would provide a return of 7 percent and stocks a return of 13 percent. assume that these proportions will be maintained by him throughout. For the sake of simplicity. Suppose Ramesh wants to donate Rs. 200. He also wants to bequeath Rs. 600. Each donation would he made at the beginning of the year.000.000 per year. Ramesh has decided to invest his bank balance and future savings in a portfolio in which stocks and bonds would be equally weighted. 1. 500. How much money would he need 15 years from now? How much should Ramesh save each year for the next 15 years to be able to meet his investments objectives spelt out above? Assume that the savings will occur at the end of each year. 400.000 each year in the last three years of his life to a charitable cause. Ramesh’s present salary is Rs. Ramesh is currently 45 years old and has Rs.000 to his children at the end of his life.MINI CASE As an investment advisor. you have to answer the following questions. a prospective client. e. What is the present value of his life time salary. if it sells for Rs.000 will be exactly one year from now. In answering the above questions. 6. Rs. d. if the required rate of return is 8 percent? c.050. 1. What is the value of a 5-year. seeks your help in understanding how bonds and stocks are valued and what rates of return they offer. 400. Rs.00) and the dividend is expected to grow at a rate of 12 percent per year forever. MINI CASE You have recently graduated from a business school and joined SMART INVEST as a financial analyst. 1. Dinshaw Mistry. What is the yield to call of the bond described in part (c). If investors require a rate of .060. What is the approximate yield to maturity of an 8-year. if the discount rate is 8n percent? Remember that Ramesh expects his salary to increase at the rate of 12 percent per year until his retirement.000par value bond with a 10 percent annual coupon. and his salary will be paid annual installments. How is the value of a bond calculated? b. if the bond can be called after 2-years at the premium of Rs. 1. How is a constant growth stock valued? g. Ramesh is curious to find out the present value of his life time salary. Magnum chemicals is a constant growth company which paid a dividend of Rs. For the sake of simplicity assume that his present salary of Rs. irrespective of its dividend pattern? f.000 par value bond with a 10 percent annual coupon.Ramesh recently attended a seminar on human capital where the speaker talked about a person’s human capital as the present value of his life time earnings.00 per share yesterday (D˳ = Rs. In particular. a. What is the general formula for valuing any stock. 6. ignore the tax factor. 1. Your job is to help clients in choosing a portfolio of bonds and stocks. You have been asked to consider only the following investment alternatives: T-bills. 800). Zenith Electronics paid a dividend of Rs. The earnings and dividends of Ravi Pharma are expected to grow at a rate of 20 percent for the next 3 years. stock A. what is the intrinsic value per share? MINI CASE You have recently graduated as a major in finance and have been hired as a financial planner by Radiant Securities.000. Stock C. 1. a financial services company. 10. Zenith Electronics is expected to grow at a supernormal growth rate of 25 percent for the next 4 years.00 per share yesterday (D˳ = Rs. Stock B. You have gathered the following information from them: Returns on Alternative Investments State of the Stock C Economy Portfolio Probability Market T-Bills Stock A Stock B . before returning to a constant growth rate of 10 percent thereafter. Your boss has assigned you the task of investing Rs. Thereafter. The economics cell of Radiant Securities has developed the probability distribution for the state of the economy and the equity researchers of radiant securities have estimated the rates of return under each state of the economy. If investors require a return of 14 percent from the equity of Ravi Pharma. What will be present value of the stock. and market index. if investors require a return of 16b percent? i.00). Ravi Pharma paid a dividend of Rs. the growth rate is expected to decline linearly for the following 5 years before settling down at 10 percent per year forever. 800 per share yesterday (D˳ = Rs.return of 15 percent (i) what is the expected value of the stock a year from now? (ii) What is the expected dividend yield and capital gains yield in the first year? h. 10.000 for a client who has a 1-year investment horizon. 0% 6.0%) 30.4. He requests you to answer the following question: a.0 Your client is a very curious investor who has heard a lot relating to portfolio theory and asset pricing theory.2 6.   Recession (10.00 A 1. 0.0 (15.0) 15.0% 5. and 0.0 6. Period 1 2 3 4 5 Market (5%) 4 8 15 9 D (12%) 6 12 20 6 What is the beta for stock D? How would you interpret it? g. What is the expected return and standard deviation on a portfolio in which stocks A and B are equally weighted? In which the weights assigned to stocks A.0 30.C. The beta coefficients for the various alternatives.70) C 0. are as follows: Security Beta T-bills 0. What is the coefficient of correlation between the returns on A and B? returns on A and C? d.3 0.5 Boom 0.90 i. What is Capital Market Line (CML)? Security Market Line (SML)? h. Suppose the following historical returns have been earned for the stock market and the stock of company D. What is the alpha for stocks A.B.0 25. What is the basic difference between the CAPM and the APT? .0 20. What is the expected return and the standard deviation of return for stocks A.2 respectively? e.4.0%) Normal 0.20 B (0.0%) 16.0 (15. What is the SML relationship? ii.0 40. B. based on historical analysis. and the market portfolio? b. What is the covariance between the returns on A and B? returns on A and C? c.B and C are 0. and C? f.0 (5. before joining DCM. Avinash Joshi has asked you to educate and guide clients interested in using options.MINI CASE Delphi Capital Management (DCM) is an investment management firm which. a company in which Pradeep Sharma has equity shares. inter alia. After majoring in finance you worked for a well known securities firm where you received good exposure to derivative instruments. but often do not understand the risks and rewards associated with these instruments. You have decided to use the following data of Newage Hospitals Limited. Appreciating your expertise. an eminent surgeon and longtime client of DCM. who wants to understand about options and the strategies based on options. Newage Hospitals Option Quotes . You have been approached by Pradeep Sharma. offers portfolio management service to high net worth individuals. Avinash Joshi. realized that many clients have interest inn using options. You have joined DCM about six months ago. managing director of DCM. to guide him. and break-even price associated with the strategy of simultaneously buying March/340 call while selling March/360 call? e) What are the implications for Pradeep Sharma if he simultaneously writes March/340 all and buys March/300 put? f) What impact do the following have on the value of a call option? (i)Current price. MINI CASE Aman Limited is a leading manufacturer of automotive components. Its projects typically have a short life as it introduces new models periodically. g) What should be value of the March/320 call as per the Black-Scholes model? Assume that t = 3 months. and expiration date? b) Which options are in-the-money and which options are out-of-the-money? c) Assume that Pradeep Sharma owns 1000 shares of Newage Hospitals. To educate your client you have to develop answers for the following questions: a) What do the following terms mean: call option. rf= 6 percent. d) What is the maximum profit. and (v) V variability of the stock price. (iv) Risk-free rate. You have recently joined Aman Limited as a financial analyst reporting to Ravi Sharma.Stock Price: 325 Strike Price Calls Feb Jan March 280 Puts March Jan Feb 48 53 _* _ _ 34 38 41 2 4 15 18 20 6 9 5 8 14 17 19 2 4 5 _ 40 _ 300 6 320 _ 340 21 360 _ *A blank means that no quotation is available. It supplies to the original equipment manufacturers as well as the replacement market. the CFO of the company. (iii) Option term to maturity. maximum loss. that are bring considered by the Executive Committee of Sona Limited: . He has provided you the following information about three projects. What are the relative pros and cons of selling a call against the position using (i) January/340 versus (ii) March/300. strike price (exercise price).30. and C. A. and ó = 0. B. (ii) Exercise price. put option. 000 4.000 (4. Project A is an extension of an existing line. 12 percent.000) 11. MINI CASE After seeing Snapple’s success with fruit drinks.000 7. You have been recently hired as a financial analyst by Modern Foods and you report to Mahajan.000) _ Ravi Sharma believes that all the three projects have risk characteristics similar to the average risk of the firm and hence the firm’s cost of capital. B and C.000 13.  Project B involves a new product. d) What is modified internal rate of return (MIRR)? What are the pros and cons of MIRR vis-à-vis IRR and NPV? Calculate the MIRRs for projects A.  Project C is concerned with sponsoring a pavilion at a Trade Fair. the board of directors of modern Foods is seriously considering a proposal for a lemon juice project.500 8.800 Project B (15. in the year following that a substantial cost will be incurred to raze the pavilior… The expected net cash flows of the three projects are as follows. B. You have been entrusted with the task of evaluating the project. b) What is the net present value (NPV)? What are the properties of NPV? Calculate the NPVs of projects A. c) What is internal rate of return (IR)? What are the problems with IRR? Calculate the IRRs for projects A. and C assuming that the intermediate cash flows can be reinvested at 12 percent rate of return. It will entail a cost initially which will be followed by a huge benefit for one year. However.000 Project C (15. B and C. will apply to them.000) 3. a) What is payback period and discounted payback period? Find the payback periods and the discounted payback periods of Projects A and B. Building its market will take some time and hence its cash flow will increase over time. Year 0 1 2 3 Project A (15. . Its cash flow will decrease over time. the CEO of the company.000) 42. You are asked to evaluate the projects. viz. at the end of year 5. Assume that there is no other tax benefit. For tax purposes. 5 million and Rs. You can assume that the outlay will occur right in the beginning. 15 million toward plant and machinery and Rs. which is the expected life of the project. 10 million toward gross working capital. Mahajan wants you to estimate the cash flows from two different points of view: a. owned by Modern Foods. The building. 1 million. 8 million of term loan.The lemon juice would be produced in an unused building adjacent to the main plant of Modern Foods. Recovery of working capital. the depreciation rate on fixed assets will be 25 percent as per the written down value method. is expected to be at book balue. 2 million respectively. 5 million of working capital advance. 20 million a year. The proposed scheme of financing is as follows: Rs. The income tax rate is expected to be 30 percent. 10 million of equity. The interest on the term loan will be 15 percent. 25 million – Rs. Working capital advance will carry an interest rate of 14 percent. it can be rented out for an annual rental of Rs. The lemon juice project is expected to generate a revenue of Rs. Rs. 1 million each. The term loan is repayable in 8 equal semi-annual installments of Rs. 2 million of trade credit. The outlay on the project is expected to be Rs. Rs. Cash flows from the point of equity investors. However. The net salvage value of plant and machinery is expected to be Rs. 5 million at the end of the year 5. MINI CASE . is fully depreciated. The operating costs (excluding depreciation and interest) are expected to be Rs. Cash flows from the point of all investors (which is also called the explicit cost funds point of view) b. till they are paid back or retired at the end of 5 years . The first installment will be due after 18 months. and Rs. The levels of working capital advance and trade credit will remain of Rs. 30 million a year. This means that there is no interest during the construction period. Managing Director of Omega Textiles. (ii) Their cost of debt is 11 percent. 112. He also wants you to estimate the hurdle rate for the new line of business. What is Omega’s estimated cost of equity using the dividend discount model? e. 100 par. 9 percent annual dividend. 10 percent preference. and 40 percent debt. 106. he has provided the following data. The latest balance sheet of Omega is given below. the risk-free rate is 7 percent. These debentures are selling currently at Rs. preference shares with a residual maturity of 5 years. on overage. The market price of these preference shares is Rs. 80 per share. What is Omega’s cost of preference? d. What is Omega’s estimated cost of equity using the capital asset pricing model? . the following characteristics: (i) Their capital structure has debt and equity in equal proportions. noncallable debentures with 8 years to maturity. (Rs. Loans and advances 400 Debenture 450 Current liabilities and 100 provisions 1200 1200        Omega’s target capital structure has 50 percent equity.5. Its last dividend was Rs. Omega’s equity stock is currently selling at Rs. Omega has Rs. In million) Liabilities Assets Equity capital 350 Fixed Assets 700 Preference capital 100 Investments 100 Reserves and surplus 200 Current Assets. The new business that Omega is considering has different financial characteristics that omega’s existing business. The first one is for expanding the capacity in the main line of business and the second one is for diversifying into a new line of business.1. a. Omega’s tax rate is 30 percent. annual payment. Omega’s equity beta is 1. (iii) Their equity beta is 1. 100 par.80 and the dividend per share is expected to grow at a rate of 10 percent in future. Suman Joshi asks for ypur help in estimating Omega’s weighted average cost of capital which he believes is relevant for evaluating the expansion proposal.Suman Joshi. Firms engaged purely in such business have. 10 percent coupon. and the market risk premium is estimated to be 7 percent. 2. was reviewing two very different investment proposals. What sources of capital would you consider relevant for calculating the weighted average cost of capital? b. What is Omega’s post-tax cost of debt? c. Omega has Rs. To enable you to carry out your task. What would be your estimate for the cost of capital for the new business? h. What is Omega’s weighted average cost of capital? Use the capital asset pricing model to estimate the cost of equity.f. g. What is the difference between company cost of capital and project cost of capital? MINI CASE . however. This initiative. alluring business opportunities and competitive compulsions persuaded Prakash Naik to set up a few branches of PTR at select locations in Bangalore and Chennai. the Naik family. Prakash Naik was unwilling to set up branches because he was concerned about the dilution of quality. has chalked up an ambitious plan to set up a nation-wide chain of PTR restaurants and to support this initiative it wants to raise Rs. Prakash Naik has asked you to brief the family members on various issues associated with the move. financed mainly through internal accruals.PTR is a venerable restaurant of Bangalore set up decades ago by Prakash Naik. 100 crore through an initial public offering. In the last decade. by answering the following questions (a) What the pros of going public? (b) What are the cons of going public? (c) What conditions should a company satisfy to make an IPO? (d) What is book building? (e) What are the principal steps in an IPO? (f) What role is played by the lead manager? (g) What are the costs of a public issue? (h) Can a company making a public issue freely price its shares? (i) Why is under-pricing of IPOs a universal phenomenon? (j) What is a rights issue? (k) What are the different kinds of dilution? MINI CASE . Buoyed by this success. Despite its phenomenal success. which owns 100 percent equity of PTR Limited. turned out to be quite profitable. the highest in its history. The profit and loss account has been cast in the contribution format to facilitate the calculation of leverages. who continues to be the Executive Chairman of the firm. 500 million. 2000 million which will be supported by external financing. the proportion of dept in the capital structure diminished. Shareholder’s Funds 800  Paid up equity capital (140 million shares of 4800 Rs. The firm has an expansion project on hand that will require an outlay of Rs. it has performed fairly well and has been reasonably profitable.Divya Electronics was promoted about twenty years by Dipankar Mitrs. Net Fixed Assets 360 2. . Its variable costs will be 60 percent of revenues and its fixed operating costs would be Rs. Initially. In million Revenues 1400 Contribution margin 2500 2000 6000 200 Application of funds 1200 1.5:1 as the promoter had limited resources. The firm also issued bonus shares on two occasions once before making its IPO eight years ago and once subsequently. 2400 million. giving a retrospective PE ratio of 19. The expansion can be completed quickly. The expansion project is expected to generate annual revenue of Rs. Over time. The rest is held more or less equally by institutional investors and retail investors. Balance Sheet Profit And Loss Account Sources of Funds Rs. 115. The financial statements of the firm for the just concluded financial year are given below.17. In million 1. 10 each) 3200  Reserve and surplus 1800 2. Net Current Assets 840 Variable costs Fixed operating costs Profit before interest and Interest Profit before tax 4000 Tax 2000 Profit after tax 6000 The current market price per share is Rs. the firm employed a dept-equity ratio of 1. Dipankar Mitra and his family holds 45 million shares of Divya Electronics. Loan Funds taxes 1400 Rs. While the firm had a few bad patches. 106. Show how the degree of total leverage will change under the two financing options. the merchant bankers of Divya Electronics. The other option is to privately place debentures carrying an interest rate of 8 percent. Highlight any other issues that you believe are important for taking the decision. c. you have been asked to. 6 per share. Compute the EPS-PBIT indifference point for the two financing options. The issue expenses. will be Rs. however. . The board of directors of Divya Electronics would be meeting shortly to decide on the means of financing to be adopted for the proposed expansion plan. In particular. a.EMAN Consultants. d. believe that Divya Electronics can make public issues of equity shares at Rs. You have been requested to present an analysis of the two options. Calculate the EPS for the following year under the two financing options assuming that the expansion project would be fully operational. b.
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