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Case 1) Time Value of Money
As an investment advisor, you have been approached by a client called Nidhi, who wants some help in investment related matters.
Nidhi is currently 45 years old and has Rs.6, 00,000/= in the bank. She plans to work for 15 more years and retire at the age of 60.Nidhi’s present salary is Rs.4, 00,000/= per year. She expects her salary to increase at the rate of 12% per year until her retirement.
Nidhi has decided to invest her bank balance and future savings in a portfolio in which stocks and bonds would be equally weighted. For the sake of simplicity, assume that these proportions will be maintained by her throughout. She also believes that bonds would provide a return of 7% and stocks a return of 13%. You concur with her assessment.
Once Nidhi retires at the age of 60, she would like to withdraw Rs.5, 00,000/= per year from her investments for the following 15 years as she expects to live upto the age of 75 years. She also wants to bequeath Rs.10, 00,000/= to her children at the end of her life. How much money would she need 15 years from now?
How much should Nidhi save each year for the next 15 years to be able to meet her investment objectives spelt out above?
Suppose Nidhi wants to donate Rs.2, 00,000/= each year in the last three years of her life to a charitable trust. How much money would she need when she reaches the age of 60 to meet this specific need?
Nidhi 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. Nidhi is curious to find out the present value of her lifetime earnings. For the sake of simplicity assume that the present salary of Rs.4, 00,000/= will be paid in annual installments to grow at 12 % p.a..If Nidhi expects to work only for 5 more years what is the present value of her lifetime salary if the discount rate is 8%.
The below info is given:
PVIFA (15yrs/8%) =8.559 PVIF (15 yrs/8%) = .315 FVIF (15yrs/7%) = 2.759
FVIF (15yrs/13%) = 4.898 FVIFA (15yrs/7%) = 25.12 FVIFA (15yrs/13%) = 40
PVIFA (3yrs/8%) = 2.5771 PVIF (12yrs/8%) = .3971
Case 2) Cash Flow Statement for an Enterprise other than a Financial Enterprise
The following additional information is provided besides the I/S and B/S for the preparation of the statement of cash flows (figures are in Rs.’000).
(a) An amount of 250 was raised from the issue of share capital and a further 250 was raised from long term borrowings.
(b) Interest expense was 400 of which 170 was paid during the period.100 relating to interest expense of the prior period was also paid during the period.
(c) Dividends paid were 1,200.
(d) Tax deducted at source on dividends received (included in the tax expense of 300 for the year) amounted to 40.
(e) During the period, the enterprise acquired fixed assets for 350.The payment was made in cash.
(f) Plant with original cost of 80 and accumulated depreciation of 60 was sold for 20.
(g) Foreign exchange loss of 40 represents the reduction in the carrying amount of a short-term investment in foreign-currency designated bonds arising out of a change in exchange rate between the date of acquisition of the investment and the balance sheet date.
(h) Sundry debtors and sundry creditors include amounts relating to credit sales and credit purchases only.
Balance Sheet as at 31.12.1996 (Rs. ’000)
1996 1995
Assets
Cash on hand and balances with banks 200 25
Short-term investments 670 135
Sundry debtors 1,700 1,200
Interest receivable 100 –
Inventories 900 1,950
Long-term investments 2,500 2,500
Fixed assets at cost 2,180 1,910
Accumulated depreciation (1,450) (1,060)
Fixed assets (net) 730 850
Total assets 6,800 6,660
Liabilities
Sundry creditors 150 1,890
Interest payable 230 100
Income taxes payable 400 1,000
Long-term debt 1,110 1,040
Total liabilities 1,890 4,030
Shareholders’ Funds
Share capital 1,500 1,250
Reserves 3,410 1,380
Total shareholders’ funds 4,910 2,630
Total liabilities and shareholders’ funds 6,800 6,660
Statement of Profit and Loss for the period ended 31.12.1996
(Rs. ’000)
Sales 30,650
Cost of sales (26,000)
Gross profit 4,650
Depreciation (450)
Administrative and selling expenses (910)
Interest expense (400)
Interest income 300
Dividend income 200
Foreign exchange loss (40)
Net profit before taxation and extraordinary item 3,350
Extraordinary item – Insurance proceeds from
earthquake disaster settlement 180
Net profit after extraordinary item 3,530
Income-tax (300)
Net profit 3,230
Case 3) Neha Ltd: Funds Flow Statement and Cash Flow Statement
The MD of ABC was not happy to find a decline in the WC for the year 2009..he was perplexed to find that despite profits , the WC of the firm had declined. The financial statements of the Co. are as below:
Assets 2008 2009 Year ending 31st Mar,2009 CA Sales 3400
Cash 750 525 Less COGS 1920 Debtors 375 310 Gross Profit 1480
Stock 692 785 Less Op Exp 780 Prepaid Exp 18 15 Add Profit on
sale of Asset3
Total CA 1835 1635 EBIT 703Investments 280 400 Less Interest 60Net Block of Assets
800 1800 EBT 643
Total Assets 2915 3835 Less Tax 296NP 347
LiabilitiesCL
Creditors 229 210 Bank Borrowings
112 120
Accrued Exp 36 50 Provision for
Tax180 300
Total CL 557 680Debentures 900 750SH Equity 420 1000Share Premium
280 400
Reserves 758 1005Total Liabilities
2915 3835
Operating Exp include depreciation on machinery of Rs.140 lacs. The book value of the Asset sold was Rs.4 lacs and its original cost was Rs.10 lacs six years ago.
Discuss the Funds Flow Statement (Change in WC, Sources and application of funds) and make a Cash flow Statement
Case 4) Bharat Ltd : Funds Flow / Cash Flow Statement
The MD of Bharat Ltd is surprised to find that though his company incurred a loss during the year ended 2004, the cash balance had shown an increase. He was keen to know how the cash balance had increased although the Co had incurred a loss… Help him in ans
Sales 560COGS( including 60 lacs depreciation) 385GP 175Operating ExpOffice and Adm 170Selling and Distribution 55Amortization of Goodwill 25Net Loss -75
Assets 2008 2009
Cash 95 140Debtors 55 80Stock 80 100Insurance in advance 12 10Land 150 150Plant,net of Depn 600 440Goodwill 100 75Total Assets 1092 995
Liabilities
Creditors 90 60Bills payable 5 10Interest payable 9 10Accrued wages 18 20Debentures 245 245Share Capital 600 600Reserves & Surplus 125 50Total Funds 1092 995
Prepare Funds Flow St(sources/application of funds), Cash Flow Statement.
Case 5) Preparing Income Statement / Balance Sheet/ Working Capital Requirement
Write More & Co. a partnership firm engaged in manufacturing gel pen under the brand name ‘Flair’. The
firm is presently operating at 60% capacity & producing 36,00,000 Flair pens per annum. The gel pen
manufactured by the firm is used for writing mainly by school students of senior secondary group.
Students feel that ‘Flair’ pen has a life one & a half times more than the other similar pen in the market.
This was the competitive advantage for Write More & Co. Apart from longevity; the market condition is
also favourable for the gel pen industry. The partners after lot of deliberations decided that from 1st
January 2012, the Company would operate at 90% capacity. No major expansion plan or expenditure is
required to achieve the forecast. The following information are available:
It is expected that the cost of raw material, wages rate expenses and sales per unit will remain
unchanged in 2012. Existing cost-sheet & price structure per unit is given below:
(Rs.)
Raw materials 4.00
Wages 2.00
Overheads (Variable) 2.00
Overheads (Fixed) 1.00
Profits 1.00
The operating cycle has been computed based on the existing manufacturing process that is followed by
the firm for the last five years. ‘Write More’ has also decided not to change any credit-term to their
customers. The detailed operating cash cycle is given below:
Raw Material storage time is 2 months before these are issued to production. These units remain in
production process for 1 month (as per the practice of the firm, complete bill of material required for a
month’s productions are issued to production floor at the beginning of the month. Wages & overheads are
incurred evenly over the month) & finished goods remain in godown for 2 months.
All sales are on credit basis & customers are allowed payment period of 2 months after delivery &
invoicing. All suppliers of raw material required to manufacture gel pen are quite liberal & they extend
credit of 3 months whereas wages and overhead are payable in one
month. ‘Write More’ practices to maintain cash balance is 5% of the gross working capital.
For the purpose of estimation, It has been assumed that wages and overhead accrue evenly throughout
the production cycle.
You, as a finance chief, are required to:
(a) Prepare profit statement at 90% capacity level;
(b) Calculate the working capital requirements on an estimated basis to sustain the increased production
level. Assumption made, if any, should be clearly indicated.
Case 6 Preparing Income Statement / Balance Sheet/ Working Capital Requirement
In the following case situation, interest on loan is not part of cost structure. In a highly
competitive market, this may be normal phenomenon as market price of the product may not
take in to account the capital structure of the firm. On 1st January, 2011, the owner of Dowell
Co. wishes to know the amount of working capital that will be required to meet the program of
activity they have planned for the year. The following information is available:
i) Owner’s capital Rs. 2,00,000.
ii) @ 5% Interest-loan (secured on assets) Rs. 50,000.
iii) Fixed assets valued at Rs. 1,25,000 on 31.12.2010.
iv) Production during the previous year was 60,000 units. It is planned that the level of
activity should be maintained during the present year.
v) The ratios of cost to selling price are—raw materials 60%., direct wages 10%, and
overheads 20%.
vi) Raw materials are expected to remain in stores for an average of two months before
these are issued for production.
vii) Each unit of production is expected to be in process for one month (as per the
practice of the firm, complete bill of material required for a month’s productions are
issued to production floor at the beginning of the month. Wages & overheads except
interest cost are incurred evenly over the month).
viii) Finished goods will stay in warehouse for approximately three months.
ix) Creditors allow credit for 2 months from the date of delivery of raw materials.
x) Credit allowed to debtors is 3 months from the date of dispatch.
xi) Selling price per unit is Rs. 5.
xii) There is a regular production and sales cycle.
Prepare— a) working capital requirement forecast; and
b) an estimated Profit and Loss Account and Balance Sheet at the end of the year.
Case 7 GSPC (Capital Budgeting)
GSPC is a fast growing profitable company. The company is situated in western India. Its sales are expected to grow about three times from Rs.360 million in 2009 to Rs.1100 million in 2010. The company is considering of commissioning a 35 kms pipeline between two areas to carry gas to a state electricity board. The project will cost Rs.250 million. The pipeline will have a capacity of 2.5 MMSCM. The company will enter into a contract with the state electricity board (SEB) to supply gas. The revenue from the sale to SEB is expected to be 120 million per annum. The pipeline will also be used for transportation of LNG to other users in the area. This is expected to bring additional revenue of Rs.80 million per annum. The company management considers the useful life of the pipeline to be 20 years. The financial manager estimates cash profit to sales ratio of 20% per annum for the first 12 years of the projects operations and 17% p.a. for the remaining life of the project. The project has no salvage value. The project being in a backward area is exempt from paying any taxes. The company requires a rate of return of 15% from the project.
Discussion Questions:
What is the projects payback and ROI. Compute the projects NPV and IRR Should the project be accepted? Why?
Case 8) Calmex Ltd (Capital Budgeting)
Calmex is situated in north India. It specializes in manufacturing overhead water tanks. The management of Calmex has identified a niche market in certain southern cities that need a particular size of water tank, not currently manufactured by the company. The company is therefore thinking of manufacturing a new type of water tank. The survey of the company’s marketing department reveals that the company could sell 1, 20,000 tanks each year for the six years at a price of Rs.700 each. The company’s existing facilities cannot be used for manufacturing the new size tanks. Therefore it will have to buy new machinery. A manufacturer has offered two options to the company. The first option is that the company could buy four small machines with the capacity of manufacturing 30,000 each at Rs.15 million each machine. The machine operation and manufacturing cost of each tank will be Rs.535. alternatively Calmex can buy a larger machine with a capacity of 1, 20,000 units per annum for Rs.120 million. The machine operation and manufacturing costs of each tank will be Rs.400. The company has a required rate of return of 12 per cent. Assume that the company does not pay any taxes.
Discussion Questions:
Which option should the company accept? Use all methods of evaluation and justify your choice.
Case 9) CF estimation
After seeing snapple’s success with fruit drinks, the board of directors of Modern Foods is seriously considering a proposal for a lemon juice fruit.
You have been recently hired as a financial analyst by /modern Foods and you report to Mahajan, the CEO of the company. You have been entrusted with the task of evaluating the project.
The lemon juice would be produced in an unused building adjacent to the main plant of Modern Foods. The building owned by Modern Foods is fully depreciated. However it can be rented out for an annual rental of Rs.1 million. The outlay on the project is expected to be Rs.25 million- Rs.15 million toward plant and machinery and Rs.10 million towards gross working capital. You can assume that the outlay will occur right in the beginning. This means that there is no interest during the construction period.
The proposed scheme of financing is as follows: Rs.10 million of equity, Rs.8 million of term loans, Rs.5 million of working capital advance and Rs.2 million of trade credit.
The term loan is repayable in eight equal semi annual installments of Rs.1 million each. The first installment will be due after 18 months. The interest on term loans will be 15 per cent.
The levels of the WC advance and trade credit will remain at Rs.5 million and Rs.2 million respectively, till they are paid back or retired at the end of five years., which is the expected life of the project. WC advance will carry an interest of 14%.
The lemon juice project is expected to generate revenue of Rs.30 million a year. The operating costs (excluding depreciation and interest) are expected to be Rs.20 million a year.
For tax purposes, the depreciation rate on fixed assets will be 20% per year. Assume that there is no other tax benefit.
The net salvage value of plant and machinery is expected to be Rs.5 million at the end of 5 years. Recovery of WC at the end of year 5 is expected to be at book value.
The income tax rate is expected to be 30%.
Mahajan wants you to estimate the cash flows from two different points of view
Cash flows from the point of all investors Cash flows from the point of equity investors
Case 10) Cost of Capital
Hindustan Unilever Ltd (HUL) was known as Hindustan Lever Ltd(HLL) until 18th May 2007. The company was set up in 1933. It completed 75 years of operations in India in 2007. It is an important subsidiary of Unilever. Unilever has a large number of subsidiary and associate companies in more than 100 countries..HUL’s business areas include home and personal care, foods and beverages, industrial, agricultural and other products. It is one of the largest producers of soaps and detergents in India. The company has grown organically as well as through acquisitions.
HUL places equal focus on serving both the employees and the shareholders and it is committed to add value to both. Over years the company has built diversified portfolio of powerful brands.
The company requires cost of capital estimates for evaluating its acquisitions, investment decisions and the performance of its businesses and for determining the value added to shareholders. It needs to develop a methodology of calculating costs of equity and debt and determine the weighted average cost of capital.
HUL’s Performance: Table below contains a summary of HUL’s EPS,DPS,Share price and market capitalization. (EPS/DPS/Share Price in Rs while M-Cap in Billion Rs)
Year 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007DPS 1.7 2.2 2.9 3.5 5 5.16 5.5 5 5 6 9EPS 2.81 3.67 4.86 5.95 7.46 8.04 8.05 5.44 6.4 8.41 8.73Share Price
138 166 225 206 223 181 204 143 197 216 213
M-Cap
275 365 495 454 492 400 450 315 434 477 465
The Company has been paying dividendsregularly. HUL’s shares have enjoyed high price in the stock market. The Company’s share price has increased from Rs.138 in 1997 to Rs.213 in 2007. The Company’s sales and assets have shown significant growth and company’s profitability has also increased over years. The company is conservatively financed. HUL’s financial performance is as below( figures in Rs Million)
2005 2006 2007Net Sales 110606 121034 137178Total Income 112130 122949 139426EBDIT 15958 18395 21105Interest Expense 192 107 255EBT 16045 18617 21845PAT (before exceptional items
13545 15397 17691
PAT 14081 18554 19255Share Capital 2201 2207 2177Reserves & Surplus 20855 25028 12215Loan Funds 569 736 885
The company considers cost of its debt as the effective rate of interest applicable to an AAA rated company. It thinks that considering the trends over the years this rate is 9.5% in 2007. The risk free rate is assumed as the yield on long term government bonds which the company regards as about 8 %. HUL regards the market-risk premium to be equal to 11%. The company uses CAPM to calculate its cost of equity. The alternative method is the constant growth model.
The regression of monthly returns of the stock and the returns on the stock market from Apr 2003 to Dec 2007 gives the equation:
RHUL = - 1.7603 + .0.7813 R Market
R2 = 0.3093
Calculate HUL cost of equity using
Dividend growth model CAPM
Case 11) Cost of Capital
Suman Joshi,Managing Deirector of Omega Tesxtiles, was reviewing two very different investment
proposals. 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.
Suman Joshi asks for your help is estimating Omega’s WACC which she believes is relevant for
evaluating the investment proposal. He also wants you to estimate the hurdle rate for the new line of
business. To enable you to carry out your task he has provided the following data.
The latest balance sheet of Omega is given below:
Liabilities Assets Rs. In Million
Equity Capital 350 Fixed Assets 700
Preference Capital 100 Investments 100
Reserves and Surplus 200 CA,Loans,Advances 400
Debentures 450
CL and provisions 100
1200 1200
Omega’s target capital structure has 50% equity,10% preference and 40% debt
Omega has Rs.100 par,10 % coupon, annual payment, non callable debentures with 8 years to
maturity. These debentures are selling currently at Rs.112
Omega has Rs.100 par, 9 % annual dividend ,preference shares with a residual maturity of 5
years. The market price of these preference shares is Rs.106.
Omega’s equity stock is currently selling at Rs.80 per share. Its last dividend was Rs.2.80 and the
dividend per share is expected to grow at a rate of 10% in future.
Omega’s equity beta is 1.1, the risk free rate is 7% and the market risk premium is estimated to
be 7%.
Omega’s tax rate is 30%.
The new business that Omega is considering has different financial characteristics than Omega’s
existing business. Firms engaged purely in such businesses have, on average the following
characteristics i) their capital structure has debt and equity in equal proportions ii) their cost of
debt is 11% iii) their equity beta is 1.5
o What sources of capital would you consider relevant for calculating WACC
o What is Omega’s post tax cost of debt
o What is Omega’s cost of preference
o What is Omega’s Cost of equity using the dividend discount model
o What is Omega’s Cost of equity using the CAPM
o What is Omega’s WACC.
Case 12) Capital Structure
Two firms a and B are identical in all respects except that B has Rs.5,00,000 debt outstanding at a 6%
rate of interest. The values of the two are given below
Firm A Frim B
EBIT 1,50,000 1,50,000
Cost of debt - 30,000
NI 1,50,000 1,20,000
Cost of equity .10 .15
MV of equity 15,00,000 8,00,000
MV of debt - 5,00,000
Value of frim(E+D) 15,00,000 13,00,000
Overall capitalization rate .10 0.1154
Assume that an investor owns 10% of A’s shares.
How can the investor obtain same return at a lower cost ?
Case 13) Credit Management
The Sahil Proprietor desires to increase the annual sale at least by 25% from the existing sale
of Rs. 12,00,000/- The following are the details regarding the operations of a firm during the
previous year of 12 months. However, the cost structure & sale price is not likely to change over
the next year. The firm is considering a proposal for a more liberal extension of credit which will
result in increasing the average collection period from one month to two months.
Sales Rs.12,00,000
Selling price per unit Rs.10
Variable cost price per unit Rs. 7
Total cost per unit Rs. 9
You are required to advise the firm regarding adoption of the new credit policy, presuming that
the firm’s required return on investment is 25%.
Case 14) Risk and Return
You have recently graduated as a major in finance and have been hired as a financial planner by
Citibank. Your boss has assigned you the task of investing Rs.10 lacs for a client who has a one year
investment horizon. You have been asked to consider only the following investment alternatives: T Bills,
Stock A, Stock B, Stock C and market index.
The economics cell of Citibank has developed the probability distribution for the state of the economy and
the equity researchers at Citibank have estimated the rate of return under each state of economy. You
have gathered the foll information from them:
Returns of alternative investments: returns in % and in ( ) implies negative returns on the instrument
State of the
economy
probability T Bills Stock A Stock B Stock C Market
Portfolio
Recession .2 6 (15) 30 (5) (10)
Normal .5 6 20 5 15 16
Boom .3 6 40 (15) 25 30
Your client is a very cautious investor who has heard a lot relating to portfolio theory and asset pricing
theory. He requests you to answer the following questions.
What is the expected return and standard deviation of return for stocks A,B,C and market
portfolio.
What is the covariance between the returns of A and B ? returns of A and C
What is the correlation between the returns of A and B ? between A and C ?
What is the expected return and standard deviation on a portfolio in which stocks A and B are
equally weighted ?
Case 15) Credit Management
Yashwanth Nath has received an order from Green Ltd. which insists that the Rs.50,000 of
machinery ordered be supplied on 60 days credit. Normally, it is well known in the market that
Green Limited is a tuff negotiator and they need more many such machineries in the near
future. Even though Yashwanth Nath is small manufacturer yet, they do their home work in
evaluating customer credit worthiness before agreeing to customer’s term. The variable costs of
production which would be incurred by Yashwanth Nath in meeting the order amount to
Rs.40,000. Based on the market references, Green’s credit worthiness is in doubt and the
following estimates have been made after taking feedback from other suppliers of Green
Limited:
Probability of Green Ltd. paying in full in 60 days is 0.6
However, if the order is accepted by Yashwanth Nath and if Green Ltd. does not default, then
there is felt to be a probability of about 0.7 that a further eight identical orders will be placed by
Green Ltd. in exactly 1 year’s time, and further orders in later years may also be forth coming.
Experience has shown that once a firm meets the credit terms on an initial order, the probability
of default in the next year reduces to 0.1. Any work carried out on
Green’s Ltd. order would take place in otherwise idle time and would not encroach upon
Yashwanth’s other activities. Should Green Ltd. defaults, the legal and other costs of debt
collection would equal any money obtained.
Yashwanth Nath finances all trade credit with readily available overdrafts at a cost of 12% p.a.
An appropriate discount rate for long term decisions is 15% p.a.
Evaluate the proposal if (i) only one order is expected from Green Ltd., and (ii) if further orders
are also expected from it (year may be taken consisting of 360 days)
Case 16:
A father is planning a savings program to put his daughter through college. His daughter is now 13 years old. She plans to enroll at the University in 5 years and it should take her 4 years to complete her education. Currently the cost (for everything—food, clothing, tuition, books…) is Rs.12500 but a 5% annual inflation rate in these costs is forcasted. The daughter recently received Rs7500 from her grandfather; this money which is invested in a bank account paying 8% interest compounded annually will be used to help meet the costs of the daughter’s education. The remaining costs will be met by money the father will deposit in the savings account. He will make 6 equal deposits to the account one deposit in each year from now until his daughter starts college. These deposits will begin today and will also earn 8 % interest compounded annually.
a. What will be the PV of the cost of 4 years of education at the time the daughter becomes 18?
b. What will be the value of Rs.7500 that the daughter received from her grandfather when she starts college at age 18?
c. If the father is planning to make the first of 6 deposits today, how large must each deposit be for him to be able to put his daughter through college?
Case 17:
You are 35 years old today and are considering your retirement needs. You expect to retire at age 65 and your actuarial table suggests that you will live to be 100…you want to move to Bahamas when you retire… you estimate that it will cost you Rs.3, 00,000/= to make the move on you 65th birthday and that your living expenses will be Rs.30000/= per year starting the end of 66th year and continuing through the end of year 100 after that
How much will you need to have saved by your retirement date to be able to afford this course of action
You already have Rs.50,000 in savings if you can invest money, tax free, at 8% a year, how much would you need to save each year for the next 30 years to be able to afford this retirement plan
If you did not have any current savings and do not expect to be able to start saving money for the next 5 yrs, how much would you have to set aside each yr after that to be able to afford this retirement plan
Case 18:
You are an investment advisor who has been approached by a client for help on his financial strategy….he has Rs.2, 50,000/= in savings in the bank..he is 55 years old and expects to work for 10 more years making Rs.1,00,000 per year…he expects to make a return of 5% on his investment for the foreseeable future.
Once he retires 10 years from now,he would like to be able to withdraw Rs.80,000 a year for the following 25 years…his actuary tells him he will live to be 90 years old..how much would he need in the bank 10 years from now to be able to do this.
How much of his income would he need to save each year for the next 10 years to be able to afford these planned withdrawals( Rs.80,000 a year after the tenth year)
Assume that the interest rate declines to 4% ,10 years from now…how much,if any, would your client have to lower his annual withdrawal, assuming that he still plans to withdraw cash each year for the next 25 years.