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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) Rating Interest Rate 0% AAA 10% 10% AA 10.5% 20% A 11% 30% BBB 12% 40% BB 13% 50% B 14% 60% CCC 16% 70% CC 18%

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80% C 20% 90% D 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 P/S RATIO

PROFIT MARGIN %

PAYOUT EXPECTED GROWTH

BETA

Arbor drugs 0.42 3.40 18 14.0 1.05 Big b Inc. 0.30 1.90 14 23.5 0.70 Drug Importer.

0.10 0.60 0 27.5 0.90

Fays Inc. 0.15 1.30 37 11.5 0.90 Genovese 0.18 1.70 26 10.5 0.80 Longs drugs 0.30 2.00 46 6.0 0.90 Perry drugs 0.12 1.30 0 12.5 1.10 Rite aid 0.33 3.20 37 10.5 0.90 Walgreen 0.60 2.70 31 13.5 1.15

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:

Year 1 2 3 4 Sales 322 322 418 418 Material Consumption 30 40 85 85 Wages 75 75 85 100 Other expenses 40 45 54 70 Factory overheads 55 60 110 145 Depreciation (as per Income Tax Rules)

50 38 28 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 1 2 3 4 PV factor at 15% .870 .756 .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 4 Selling Expenses 16 Interest 10 70 Earnings before taxes 30 Less: Taxes (40%) 12 Earnings after taxes 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