7.10.11
I FINANCIAL MGT. OBJECTIVES
ROI = Net PAT X 100 ROI =Total Assets
ROI =
Assets Turnover =
Total Capital Employed
==================================================================================================================================================
CHAPTER 2
CAPITAL EXPENDITURE PROJECTS
II CAPITAL EXPENDITURE PROJECTS EVALUATION METHODS1 PAYBACK PERIOD METHOD
A --( when every year same amount of cash inflow )
PAYBACK PERIOD= Initial Investment (ie. Cost of mach)Average Annual Cash Inflow
B ---( when every year amount of cash inflow is not same ) cumulative cash inflows should be found
PAYBACK PERIOD = completed years X
C ---( when annual cost savings are given )
ROI means Return on Investment = EBIT X 100
PAYBACK PERIOD= Initial InvestmentAnnual Cost Savings
The project with the lowest payback period should be chosen.--------------------------------- -------------------------------------------------------------------------------------------------------------------------Payback Profitability = [Avg. Annual Cash Inflow X( Expected life of project - Payback Period) ] + sale of scrap
Payback Profitability = [Total Earnings from the Project - Cost of Project ] + sale of scrap
Payback Profitability = Surplus Life Profitability
Conclusion : The project with the highest payback profitability should be chosen.Better indicator than Payback Period because it considers total net cash inflows remaining after recovering original cost.
-------------------------------------------------------------------------------------------------------------------------Payback Profitability Index = ( Also called Benefit Cost Index )
Payback Profitability Index =
Conclusion : The project with the highest payback profitability index should be chosen.----------------------------------------------------------------------------------------------------------------------------------------
2 ARR -- Average Rate of Return Method OR Accounting Rate of Return Method
ARR = Avg. PATOriginal Investment
ARR = Avg. PATAvg. Investment
Avg. Investment =
Conclusion : Within ____ Payback period , the cost of project will be exactly recovered.
( When existing Profits and Profits after investment given )
ARR = Incremental Earnings or Profit
Incremental Investment
Incremental Earnings or Profit =
Incremental Investment +
( When Profits from existing machine and new machine given )
ARR = ( PAT from new machine - PAT from old machine )
( Investment in new machine - sale proceeds of old machine )
( When Profits from machine 'A ' and machine 'B" given )
ARR = ( PAT from machine 'A' - PAT from new machine 'B' )
( Investment in machine 'A' - Investment in machine 'B' )
III DISCOUNTED CASH FLOW METHODS
a) PRESENT VALUE METHOD
b) NET PRESENT VALUE METHOD
c) PROFITABILITY INDEX ( PI ) or BENEFIT - COST RATIO (B/C RATIO)
d) IRR---- Internal Rate of Return
e) DISCOUNTED PAYBACK PERIOD
a) PRESENT VALUE METHOD
Info : Cost 500000, W Cap. 60000, Scrap 40000, PV factor 12% , Life 4 years.
Year Profit before Dep
Dep. & Tax
1 100000 115000
2 200000 115000
3 250000 115000
4 300000 115000
850000 460000
Dep as per SLM = Cost of Asset -Scrap value =
Estimated life of Asset
Dep as per WDV method = Dep % X Opg. Bal. Of Asset
PV Factor / % also called as Post Tax Cutoff Rate
If Total PV > Cost of Project ----- Accept Project
If Total PV < Cost of Project ----- Reject Project
If Total PV = Cost of Project ----- Indifferent ie Neither profit nor loss from Project
Conclusion : Since Total Present Values of Cash Inflows Rs 533043/- is more than Cost Rs500000/- the project should be accepted.
b) NET PRESENT VALUE METHOD
Info : Cost 500000, W Cap. 60000, Scrap 40000, PV factor 12% , Life 4 years.
Year Profit before Dep
Dep. & Tax
0 Cost of machine
0 Working Capital
1 100000 115000
2 200000 115000
3 250000 115000
4 300000 115000
4 Release of WCap.
4 Sale of Scrap
850000 460000
If NPV > Zero ----- Accept Project
If NPV < Zero ----- Reject Project
If NPV = Zero ----- Indifferent
Conclusion : Since Net Present Values of Cash Inflows Rs. 36642.50 is more than zero ( positive) the project should be accepted.
c) PROFITABILITY INDEX ( PI ) or BENEFIT - COST RATIO (B/C RATIO)
PI = PV of cash inflows
PV of cash outflows
PI = Benefits
Cost
PI > 1 accept project ---- (NPV + ve )
PI < 1 reject project --- (NPV - ve)
PI = 1 indifferent --- (NPV zero )
Conclusion : Since Profitability Index 1.07 is more than one, the project should be accepted.
d) IRR---- Internal Rate of Return
Internal Rate of Return is that rate of profit expected from the investment in the project which covers the cost of capital invested in the project.
IRR is the rate at which Total Cash Inflow = Cost of Project
IRR is that rate at which Profitability Index is 1 . ( because Total PV of Cash Inflows = Total PV of Cash Outflows )
eg. If discounting factors are given for 10 % and 14%
IRR = 10% + (Total PV at 10% - Cost of Asset ) X ( 14 - 10 )
(Total PV at 10% -Total PV at 14% )
Conclusion : IRR of the given project is x % . It means at x% of cost of capital ( int rate or Div rate ) the income of the project will just exactly cover the cost of project.
At this rate of cost there will be neither profit nor loss .
---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
e) Discounted Payback Period
Use discounted cash inflows ie. Present values of cash inflows , then calculate cumulative PV of Cash inflows
---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
NOTES : Cost for conducting study / research for project is a sunk cost ( ie already incurred ) and hence not to be considered while evaluating the different projects.
=========================================================================================================================================================
CHAPTER 4
CASH BUDGET
RECEIPTS JULY AUG. SEPT.
Calculate Payback Period on Cumulative Present Values.
Opg. Balance 12000 12000 12000
Cash Sales 57000 60800 38000
Receipts from Debtors
1st month 53544 69840 74496
2nd month 112000 128800 168000
Dividend on Investment 14500 - -
TOTAL RECEIPTS 249044 271440 292496
Less : PAYMENTS
Cash Purchases 52000 60000 40000
Paid Creditors 66000 78000 90000
Wages 24000 32000 32000
Expenses in advance 6667 3333 0
Cash Expenses 13333 13333 6667
Furniture purchased - 90000 -
Machine purchased 20000 10000 10000
TOTAL PAYMENTS 182000 286667 178667
Purchase of Investments 55044 101829
( If Receipts are more than payments + Bal required)
Sale of Investments 27227
(If Payments + Bal required are more than Receipts )
Clg. Bal 12000 12000 12000
Calculations July --
Cash Sales 60000 less Discount 60000 X 5% =
Receipt from Debtors 1mth 240000 -- 30% in Aug =
Receipt from Debtors 2mth --70% in Sept =
------------ --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Cash bal not to exceed 20000. Excess to be deposited in SB A/c.on which int @ 3% is received monthly.
JULY AUG. SEPT.
Opg Cash Bal
Receipts
Int on SB deposit 75
Total Receipts 150000
Payments
Total Payments 100000
Clg Bal ( to be adjusted) 50000
Deposited in SB A/c. 30000
Clg Bal 20000
--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Receipt cycle ( Systems of Collection from Debtors )
QuestionAverage daily receipts =Rs.
Collection period reduced due to concentration banking =
Annual Cost of concentration banking =Rs.
Income from investment =
Collection period reduced due to lock box system =
Cash released by concentration banking =Rs.
Should the Co. Adopt Concentration banking or Lock Box System ?
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Co. Has annual turnover (Sales) of 100 lakh. 50 working weeks. Receipts on Mondays , Tuesdays and Wednesdays are twice on other 2 days o the week.
Cost of banking is 1400 per day. Int rate of bank overdraft is 15% pa.
Advise whether daily , twice a week on Wednesdays and Fridays or only on Fridays.
=================================================================================================================================================
Defn. : Cost of Capital is the minimum required rate of earnings or the cut-off rate of Capital Expenditure.
Cost of Capital is the cost that is incurred in retaining the funds obtained from various sources and employed in business.
Utility : Designing a firm's capital structure.
Evaluation of investment alternatives.
Assessment of Financial Performance.
Components of Cost Of Capital
1) Cost of Debt ( Kd)--- Rate of Interest Less Tax benefit
2) Cost of Equity Share Capital ( Ke )-- Expected rate of dividend --Highest cost of capital
3) Cost of Retained Earnings -- Opportunity cost of dividends foregone
4) Cost of Preference Share Capital -- Fixed rate of dividend
Two Approaches of Calculating Cost of Capital
A) Overall Cost of Capital = Weighted Average Cost of Capital ( WACC ). Considers Cost of all types of Long Term Sources of Capital.
In case of New Company Overall Cost of Capital is equal to Marginal Cost of Capital.
B) Marginal Cost of Capital = Increase in Cost of Capital due to increase in Capital Structure.
In case of New Company Overall Cost of Capital is equal to Marginal Cost of Capital.
It helps to know what rate of return/profit the new project should earn to cover Cost of Capital.
Calculation of Weighted Average Cost of Capital ( WACC )
Source of Capital Amount Proportion Cost of
Capital
Equity Sh. Capital(10/-) 100000 0.10 14%
10% Pref. Sh. Capital 200000 0.20 10%
11% Debentures 300000 0.30 11%
12% Loan 400000 0.40 12%
TOTAL 1000000 1.00
1 ) WACC = 9.07%
2 ) Cost of Equity
If DPS =Rs.14/-. MPS = Rs. 120/- . Expected growth in Dividend = 4%.
Cost of Equity ( Ke ) = DPS X 100 + G
MPS
Cost of Equity ( Ke ) = ( 14 X 100 )+ 4% = 11.67 % + 4% =
120
Cost of Equity ( Ke ) = EPS X 100 + G
MPS
Cost of Preference Share Capital
Kp = Preference dividend >> if addnl info not given
If redeemable preference shares
>> FV = face value(par value) of one pref share
[FV + NP]/2 NP = Net Proceeds= Face value + premium - dicount - issue expenses per share
Cost of Debt
Cost of Debt ( Kd ) = Int. Rate ( 1 - tax rate)
Cost of redeemable Debt
>> FV = face value(par value) of one pref share
[FV + NP]/2 NP = Net Proceeds= Face value + premium - dicount - issue expenses per share
[FV - PP]/2
Cost of retained Earnings
Kre = Ke
3 ) Rate of Return on Equity Share Capital
If ROI = 25%
EBIT 250000
Less : Int. on Deb. 33000
Int. on Loan 48000
EBT 169000
Less : Tax 50700
PAT 118300
Less: Pref. Div. 20000
Profit Available to 98300
Equity Shareholders
Therefore , Rate of Return on Equity = 98300
100000
EPS = 9.83
Kp = [ Pref Div.amt + (FV - NP)/ N ] x 100
Kp = [ Interest + (FV - NP)/ N ] x (1 - tax rate )
Yield to maturity = [ Interest amt p.a. + (FV - PP)/ N ] x 100
4 ) Market Value of the Firm
Market Value of Equity = PAES =
= Cost of Eq. Capital
Market Value of Debt = Debenture + loan =
Market Value of Pref. Sh. = Pref. S. Cap. =
Market Value of the Firm >>>>>>
=========================================================================================================================================
CHAPTER 6
CAPITAL STRUCTURE PLANNING
a) Minimum Cost of Capital
b) Minimum Risk \
c) Maximum Market Value of Equity ;
d) Maximises EPS
Essentials of Optimum Capital Structure :
1 Flexibility-- increase/decrease and change in composition of Capital should be possible.
2 Economy--Minimum Cost of Capital
3 Solvency--No excessive debt requiring mortgaging of assets.
4 Efficiency-- Just adequate capital ensuring intensive utilization of funds.
5 Control-- Controlling position of Equity Shareholders should be maintained.
6 Liquidity -- Adequate cash and liquid resources should be maintained for smooth functioning of business.
INDIFFERENCE POINT
EPS as per Plan 1 = EPS as per Plan 2
[(EBIT - I1)(1 - t )] - PD1 = [(EBIT - I2)(1 - t )] - PD2
Capital Structure Planning means having such a combination of capital resources which gives Highest EPS.
Capital Structure Planning means determining the Composition of Owned Capital & Borrowed Capital, having following features :.
It is the EBIT which would keep the Equity Shareholders indifferent to the alternative capital plans.
Two alternative Capital Plans which give the same EPS
E1 E2
I1= Interest as per plan 1 I2= Interest as per plan 2
t = Tax Rate
PD1 = Pref. Dividend as per plan 1 PD2 = Pref. Dividend as per plan 2
E1 = No. of Eq. Sh. As per plan 1 E2 = No. of Eq. Sh. As per plan 2
------------------------------------------------------------------------------------------------------------------------------------------------------------
Financial Breakeven
Financial charges ie. Interest on loans /debt capital is just exactly covered by EBIT and PAT = Pref. Dividend. Leaving neithe
It is the minimum level of EBIT which is just adequate to pay interest on debt capital and preference dividend .
At financial Breakeven level of EBIT -- the firm's EPS is Zero.
-- PAT = Pref. Dividend
-- EBIT = Interest
-- EPS = 0
------------------------------------------------------------------------------------------------------------------------------------------------------------
Theories of Capital Structure
Theories to explain relationship between capital structure , cost of capital and value of firm.
1 Net Income Approach -->> Firm can minimize WACC and increase value of firm and MPS, by increasing debt capital to maximum.
because Int rate < Div. rate PLUS due to Tax benefit net interest cost is reduced still further.
2 Net Operating Income Approach-- No corelation between cost of capital and market value of firm.
3 Traditional Approach --
WACC is minimized if Debt Equity Ratio is increased .
Weakness-- As debt increases financial risk increases leading to higher expectation of dividend.
leading to increase in cost of capital.
4 Modigliani Miller Approach -- Average cost of capital is equal to capitalization rate of pure equity stream .
No corelation between cost of capital and market value of firm.
Using the above equation Indifference Level of EBIT should be found.
Financial Breakeven is that level of EBIT where EPS is exactly equal to zero .
Change in Capital Structure affects market value of firm
Debt -Equity Mix influences WACC
The optimal Capital Structure is one which uses maximum debt capital.
Change in Capital Structure does not affect market value of firm
Debt -Equity Mix does not influence WACC
There is no optimal Capital Structure
Change in Capital Structure does affect market value of firm
There is optimal Capital Structure
Problem 1400000
1) Value of Firm under Net Income Approach = Market Value of Equity + Market Value of Debt
Market Value of Equity = PAT less Pref. Dividend ( ie. PAES )
Capitalization rate of Equity
Market Value of Debt = Borrrowed Capital
2) Value of Firm under Net Operating Income Approach =
=======================================================================================================================================
CHAPTER 9
BUSINESS RESTRUCTURING
Definition : Process by which business orgn. Alters its present structure , either asset structure or liability structure or both.
BR. is done through Merger, Amalgamation, Demerger , Joint Venture , Takeover .
ImportanceBR gains importance due to--Changes in laws, competitive world , cost cutting
Financial implications
Financial Implications means the valuation of the business from the point of view of buyer and seller.
Value is dependent on bargaining powers of buyer and seller of business and their expectations of income from the business being takenover.
Valuation is dynamic and not static since it changes with the time .
Valuations
Types of Bus. Restructuring
Mergers-- combination of two/more companies into one large company.
Debt -Equity Mix does not influence WACC
a) Horizontal Merger-- combination of companies producing similar products> >anticompetitive , advantage over other competitors.
b) Vertical Merger-- combination of companies at different stages in production of same product. Noncompetiting firms
bachward integration moving towards sources of rawmaterial, forward integration --moving towards consumers by eliminating distributors.
c) Congeneric Merger - Firms in Same general industry but are not buyer- supplier of eachother, but are co-related--eg. Bank and insurance
d) Conglomerate merger--firms in different industry >> for diversifying business risk.
PROBLEM ON AMALGAMATION
a) Book Values ( Given)
A Co B Co
Fixed Assets 300000 200000
Current Assets 100000 29000
Total 400000 229000
Eq Capital ( of Rs 10 each) 250000 192000
Res. & Surplus 14000
12% Pref Cap 80000 10000
13% Deb 36000 15000
Current Liab 20000 12000
Total 400000 229000
b) Revalued figures
A Co B Co
Fixed Assets 350000 20000
Current Assets 90000 30000
Total 440000 50000
c) New Co. formed from the amalgamation of A Co and B Co is AB Co.
d) 15% Deb to be issued to existing Deb holders so that they get same amount of int as they are now getting.
e) Eq shares of new AB Co. shall be issued 30000 shares to existing shareholders of A Co. anf B Co. in proportion to their existing share values .
f) 11% Pref shares to be issued to current Pref. share holders.
Calculate Debentures , Pref shares and Equity shares to be issued .
Prepare Balancesheet of new Co. after amalgamation.
-------------------------------------------------------------------------------------------------------------------------------
ANSWER
A ) Calculation of Net Assets taken over
Revalued figures if given
A Co B Co Total
Fixed Assets 350000 20000 370000
Current Assets 90000 30000 120000
Total 440000 50000 490000
Current Liab 20000 12000 32000
Total 20000 12000 32000
Net Assets taken over 420000 38000 458000
Purchase consideration Paid by New Co.
a ) To Pref Shareholders A Co B Co Total
11% Pref Shares of AB Co 80000 10000 90000
b) To Deb. Holders
15% Deb of AB Co. 31200 13000 44200
c ) To Equity Shareholders
Equity Shares of AB Co. 275109 24891 300000
Total ( B ) 386309.2 47891 434200
Goodwill 9891
(If Purch Con more than Net Assets )
Capital Reserve 33691
(If Purch Con less than Net Assets )
BALANCE SHEET OF AB Co.
Liabilities Amount
Equity Share Capital 300000 Fixed Assets
11% Pref. Share Cap. 90000 Current Assets
15% Deb. 44200
Capital Reserve 33691 Goodwill
Current Liab. 32000
TOTAL 499891 TOTAL
------------------------------------------------------------------------------------------------------------------------------------------------------------
MERGER / TAKEOVER
From the following Balance Sheets + info Calculate Purchase Consideration and prepare revised Balance sheet of company AAA Ltd.
AAA Ltd. shall purchase BBB Ltd.
Liabilities AAALtd BBB Ltd
Equity Shares (Rs 100/-) 400000 100000
Pref. Shares (Rs.100/-) 50000
Reserve & Surplus 100000 20000
9% Debentures 130000
10% Debentures 100000
Bank Loans 50000 40000
Current Liabilities 55000 20000
785000 280000
BBB Ltd. Is seller / vendor company .
a) BBB Ltd's Assets & liabilities are valued as under :
Land & Bldg. 140000
Machinery 110000
Furniture 5000
Investments book value
Current Assets provide for bad debts 1000
Current Liabilities consider unrecorded liab. 2000
b ) Purchase consideration is paid
9% Debentures 100000 To Debentureholders of BBB Ltd.
1000 Shares of AAA Ltd. at premium of Rs.10/ -
Balance in cash
ANSWER
Calculation of Purchase Consideration of BBB Ltd.
Assets of BBB Ltd. Revalued figures
Land & Bldg. 140000
Machinery 110000
Furniture 5000
Investments 10000
Current Assets 9000
274000
Less : Liabilities of BBB Ltd.
Bank Loans 40000
Current Liabilities 22000
62000
Net Assets takenover 212000
Purchase Consideration Paid as
9% Debentures 100000
Shares of AAA Ltd. 100000
Share Premium 10000
Balance in cash 2000
212000
REVISED Balance Sheet of AAA Ltd. ( after merger )
Liabilities Amount
Equity Shares (Rs 100/-) 500000
Pref. Shares (Rs.100/-) 50000
Reserve & Surplus 110000
9% Debentures 230000
Bank Loans 90000
Current Liabilities 77000
TOTAL 1057000
P Co S Co
MPS 25 15
No. of Equity shares 200000 100000
Earnings after Tax 400000 120000
P Co is merging with S Co that is , P Co is purchasing S Co
Merger will be effected by Stock Swap ( exchange of shares)
a ) Find pre-merger EPS and P/E Ratios of both Cos.
b ) What is the exchange ratio based on current MPS?
b ) What will be post -merger EPS?
c ) What must be the exchange ratio so that pre-merger and post-merger EPS to be same ?
What is exchange ratio based on current MPS?
ANSWER Purchasing Co Sold Co.
a ) EPS and P/E P Co S Co
400000 120000
No of Eq Sh 200000 100000
= Rs. 2 1.2
25 15
EPS 2 1.2
= 12.5 12.5
b ) Exchange ratio based on current MPS
Current MPS 25 15
MPS of P Co
Exchange Ratio = 100000 X 15
25
= 60000 shares
Shareholders of S Co will exchange their 100000 shares for 60000 shares of P Co.
c ) Post merger EPS
EPS = PAT
P/E = MPS
Exchange ratio=Eq Sh of S Co X MPS of S Co
Total PAT = PAT of P. Co. + PAT of S Co.
= 400000+ 120000 =520000
Total shares = 200000 +60000 =260000 shares
Total shares
2
260000
d ) Exchange Ratio to earn same EPS
Pre merger EPS of P Co
= 520000 =
2
No of new shares required to be issued = Total no. of shares in post merger Co - No of shares in pre merger P Co
= 260000 - 200000 =
Exchange Ratio = 60000 X 1.2 = 0.6
120000
===================================================================================================================================================
LEVERAGES
Income Structure
Contribution 260
Less : Fixed Costs 100
EBIT 160
Less : Interest 60 60 = 12% of 500 loans
EBT 100
Debt Equity Ratio = Borrowed Capital =Owned Capital
Post merger EPS = Total PAT
= 520000 =
Total No of Shares in post merger Co = Post merger Earnings
Interest Coverage Ratio = EBIT =
Interest on loan & debenture
Operating Leverage = Contribution =EBIT
Financial Leverage = EBIT =EBT
Combined Leverage = Contribution =EBT
==============================================================================================================================================================
2011 PRELIM PAPER SOLUTION
PRELIM MORF Co. EVALUATION OF ALTERNATIVE CAPITAL PLANS
Q3
Source of Capital Existing Option 1 Option 2
Equity Sh. Capital(10/-) 4000000 8166667 4000000
13% Pref. Sh. Capital 1000000 1000000 3500000
15% Debentures 3000000 3000000 3000000
14% Debentures 2500000
Share Premium 833333
TOTAL 8000000 13000000 13000000
ROI = 3307143/8000000 = 41.34 %
EBIT 3307143 5374107 5374107
Less : Int. on 15% Deb. 450000 450000 450000
Less : Int. on 14% Deb. 350000
EBT 2857143 4924107 4574107
Less : Tax @30% 857142.9 1477232 1372232
PAT (given) 2000000 3446875 3201875
Less: Pref. Div. 130000 130000 455000
Profit Available to 1870000 3316875 2746875
Equity Shareholders
No.of Eq Shares 400000 816667 400000
EPS 4.675 4.06 6.87
Grading >>> II III I
----------------------------------------------------------------------------------------------------------------------------------
Not given in PRELIM Problem
If P/E given 6 7 4
MPS = P/E X EPS 28.05 28.43 27.47
Grading >>> II I III
It is the prime function of Finance Manager to maximise wealth of shareholders
Hence Option maximising MPS should be chosen.
-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
PRELIMQ2 Year PBDT Dep. PBT
1 1000000 500000 5000002 1075000 375000 7000003 1081250 281250 8000004 1743750 843750 9000004 Release of W. Cap4 Sale of Scrap Mach.
4900000 2000000 2900000Total Present Values of Cash Inflows
Less : Present Values of Cash Outflows Investment in Machine
Investment in Working CapitalTotal Present Values of Cash Outflows
NET PRESENT VALUE
NOTE : If Research Cost, Project preparation cost is incurred it is a sunk cost and does not affect the ranking of the projects hence and to be considered for above calculations.
NOTE : Dep Mach -WDV Method Opg. Bal Dep @25%Year 1 2000000 500000Year 2 1500000 375000Year 3 1125000 281250Year 4 843750 843750 bal fig.
2000000 2000000
Discounted PAYBACK PERIOD = 2 +
ARR ( Accounting Rate of Return ) = Average PAT XAverage Investment
Average Investment = (Cost - Scrap value) + W Cap + Scrap Value2
= (2000000 - 200000) +400000+2000002
= 900000 + 400000+200000 =
ARR = 507500 X 100 =1500000
Payback Profitability = Total Cash Inflows - Total Cash Outflows --->>> If Annual Cashinflow not same every year. = 4630000 -2400000 =
-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
PRELIM Maximum Permissible Bank Finance
QI B i
Category 1 -- Minimum Risk Borrowers
MPBF = 0.75 ( CA - CL )
MPBF = 0.75 ( 230000 - 120000)
MPBF = 0.75(110000) MPBF = 82500
Category 2 -- Medium Risk Borrowers MPBF = (0.75 X CA) - CL MPBF = ( 0.75 X 230000) - 120000 MPBF = 172500 - 120000 MPBF = 52500
Category 3 -- High Risk Borrowers MPBF = 0.75 ( CA - CCA ) - CL MPBF = 0.75( 230000 - 69000 ) - 120000 MPBF = 0.75 (161000 ) - 120000 MPBF = 120750 - 120000 MPBF = 750
As risk magnitude increases MPBF decreases.--------------------------------------------------------------------------------------------------------------
PRELIMQI B ii Calculation of Working Capital ( Normal )
Payback Profitability = Annual Cash Inflow X ( Life of project - Payback Period ) --->>> If Annual Cashinflow same every year.
Current AssetsFinished Goods 134000Debtors 150000Other Current Assets( bal. fig.) 166000 Total Current Assets 450000
Less : Current LiabilitiesCurrent Liabilities 200000 Total Current Liabs. 200000
W. Cap. 250000
--------------------------------------------------------------------------------------------PRELIMQI B iii Weighted Average cost of Capital ( WACC )
Tax rate is 30%. Dividend expected by Eq Shareholders is 15%
Capital Item Amount Proportion CostEq. Sh. Capital 350000 0.45 15%Retained Earnings 120000 0.16 15%10% Pref. Share Capital 100000 0.13 10%12% Borrowed Capital 200000 0.26 12%
TOTAL 770000 1.00 0.52
WACC is 12.64 %
-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
PRELIM SERA SERA Co.Q5 EVALUATION OF CREDIT POLICIES
Existing Option I Option IIPolicy
CreditSales 2200000 2500000 3000000Less :Variable Cost 65% 1430000 1625000 1950000Contribution 770000 875000 1050000Less : Fixed cost 200000 200000 200000PROFIT 570000 675000 850000
Less : COSTSTotal Costs =FC+VC 1630000 1825000 2150000Debtors' Turnover Ratio 7 6 5
Investment in debtors 232857.1 304167 430000
1 Opportunity Cost @25%pa 58214 76042 1075002 Bad Debts 20000 30000 400003 Recovery Cost 0 0 0
Total Costs 78214 106042 147500
NET BENEFIT 491786 568958 702500RANKING 3 2 1
Option II should be selected since it gives highest Net Benefit
Debtors = Sales /Debtors Turnover Ratio-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
PRELIMQ4 Calculation of Working Capital
10000 unitsCost Structure per unit TOTALRaw Material 54.00 540000+ Wages 12.00 120000+Overheads 9.90 99000Cost 75.90 759000+ Profit 44.10 441000SALES 120.00 1200000
CURRENT ASSETS1 Stock of Raw Material ( 1 mth. ) = =540000 X 1/12mth =
2 Stock of WIP ( Prodn. Period 0.5 mth.)-- Material = 540000 X 0.5/12mth=--Wages = 120000 X 0.5/12mthX1/2=--Overheads = 99000 X 0.5/12mthX1/2=
3 Stock of Finished goods ( 2 mth of Prodn. Cost)=759000 X 2/12mth =
4 Debtors ( 1mth of Cost of sales )=1200000 X 1/12mth ==759000 X 1/12 mth =
5 Overheads in advance (1/2 mth)=99000 X 0.5 /12mth =
6 Cash Balance
TOTAL CURRENT ASSETS
Less : CURRENT LIABILITIES1 Creditors ( 1 mth) = 540000 X 1 mth/12 mth=2 O/s. Wages ( 1/2 mth ) =120000 X 0.5/12 mth =3 Bank overdraft
TOTAL CURRENT LIABILITIES
WORKING CAPITAL
-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
BMS .
FINANCIAL MANAGEMENT.
Net Profit Margin X Total Assets Turnover
PAT X Net Sales X 100Net Sales Total assets
Assets Turnover = SalesTotal Assets
==================================================================================================================================================
CAPITAL EXPENDITURE PROJECTS
CAPITAL EXPENDITURE PROJECTS EVALUATION METHODS
A --( when every year same amount of cash inflow )
Initial Investment (ie. Cost of mach)Average Annual Cash Inflow
B ---( when every year amount of cash inflow is not same ) cumulative cash inflows should be found
completed years X ( Balance Amt. X 12 mths. )( next year's annual cash inflow )
Initial InvestmentAnnual Cost Savings
The project with the lowest payback period should be chosen.-------------------------------------------------------------------------------------------------------------------------[Avg. Annual Cash Inflow X( Expected life of project - Payback Period) ] + sale of scrap
[Total Earnings from the Project - Cost of Project ] + sale of scrap
The project with the highest payback profitability should be chosen.Better indicator than Payback Period because it considers total net cash inflows remaining after recovering original cost.
-------------------------------------------------------------------------------------------------------------------------Total Cash Inflows + Scrap Value
Cost of asset
Surplus Life Profitability + Cost of AssetCost of asset
The project with the highest payback profitability index should be chosen.----------------------------------------------------------------------------------------------------------------------------------------ARR -- Average Rate of Return Method OR Accounting Rate of Return Method
X 100
X 100
( Initial cost of machine - Salvage value )2
Within ____ Payback period , the cost of project will be exactly recovered.
( When existing Profits and Profits after investment given )
X 100
Increase in Profit after Investment
= Investment in Project
( When Profits from existing machine and new machine given )
( PAT from new machine - PAT from old machine ) X 100 ( Investment in new machine - sale proceeds of old machine )
( When Profits from machine 'A ' and machine 'B" given )
( PAT from machine 'A' - PAT from new machine 'B' ) X 100 ( Investment in machine 'A' - Investment in machine 'B' )
c) PROFITABILITY INDEX ( PI ) or BENEFIT - COST RATIO (B/C RATIO)
Info : Cost 500000, W Cap. 60000, Scrap 40000, PV factor 12% , Life 4 years.
PBT Tax PAT Cash Inflow
30% (PAT+Dep)
-15000 0 -15000 100000
85000 25500 59500 174500
135000 40500 94500 209500
185000 55500 129500 244500
390000 121500 268500 728500
500000-40000
4 years
= 115000
Dep % X Opg. Bal. Of Asset
If Total PV = Cost of Project ----- Indifferent ie Neither profit nor loss from Project
Since Total Present Values of Cash Inflows Rs 533043/- is more than Cost Rs500000/- the project should be accepted.
Info : Cost 500000, W Cap. 60000, Scrap 40000, PV factor 12% , Life 4 years.
PBT Tax PAT Cash Inflow
(PAT+Dep)
-500000
-60000
-15000 0 -15000 100000
85000 25500 59500 174500
135000 40500 94500 209500
185000 55500 129500 244500
60000
40000
390000 121500 268500 268500
Since Net Present Values of Cash Inflows Rs. 36642.50 is more than zero ( positive) the project should be accepted.
c) PROFITABILITY INDEX ( PI ) or BENEFIT - COST RATIO (B/C RATIO)
= Discounted cash inflows
Discounted cash outflows
= 596642.5 = 1.07
560000
Since Profitability Index 1.07 is more than one, the project should be accepted.
Internal Rate of Return is that rate of profit expected from the investment in the project which covers the cost of capital invested in the project.
IRR is the rate at which Total Cash Inflow = Cost of Project
IRR is that rate at which Profitability Index is 1 . ( because Total PV of Cash Inflows = Total PV of Cash Outflows )
(Total PV at 10% - Cost of Asset ) X ( 14 - 10 )
(Total PV at 10% -Total PV at 14% )
Conclusion : IRR of the given project is x % . It means at x% of cost of capital ( int rate or Div rate ) the income of the project will just exactly cover the cost of project.
At this rate of cost there will be neither profit nor loss .
---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Use discounted cash inflows ie. Present values of cash inflows , then calculate cumulative PV of Cash inflows
---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Cost for conducting study / research for project is a sunk cost ( ie already incurred ) and hence not to be considered while evaluating the different projects.
=========================================================================================================================================================
May June
Sales 200000 230000
Purchases 100000 110000
Wages 20000 24000
Expenses 15000 16000
1 SALES 20% are cash sales. 5% discount is given on cash sales.
Out of the credit sales 30% pay in the next month with3% discount and balance in the second month with no discount.
2 PURCHASECash purchases are 40%
3 WAGES Wages are paid in the next month = lag in payment is 1 mth = wages payable one mth in arrear.
4 CASH Cash balance on 1.07.11 is Rs 12000
Cash bal. to be maintained at 12000 every month.
5 EXPENSES1/3 Expenses are paid 1 month in advance.
6 ASSET Machine of 50000 to be purchased in July . Down payment is 20000 and balance in 3 equal instalments.
Furniture purchased in Aug. Rs 90000
INCOME Dividend on Investment is received in July Rs 14500
less Discount 60000 X 5% = 57000
72000 less 3% discount = 69840
168000
--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Cash bal not to exceed 20000. Excess to be deposited in SB A/c.on which int @ 3% is received monthly.
--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
4000000 ANSWER >>> a) Cash released by concentration banking =
2 days Savings in concentration banking =
75000 Net benefit from concentration banking =
8%
4 days b) Cash released by Lock box system =
120000 Savings in Lock box system =
Should the Co. Adopt Concentration banking or Lock Box System ? Net benefit from Lock box system =
Since the net benefit from Lock Box System is more than from Concentration banking, Lock box system should be adopted.
---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Co. Has annual turnover (Sales) of 100 lakh. 50 working weeks. Receipts on Mondays , Tuesdays and Wednesdays are twice on other 2 days o the week.
Cost of banking is 1400 per day. Int rate of bank overdraft is 15% pa.
Advise whether daily , twice a week on Wednesdays and Fridays or only on Fridays.
=================================================================================================================================================
CHAPTER 5
COST OF CAPITAL
Cost of Capital is the minimum required rate of earnings or the cut-off rate of Capital Expenditure.
Cost of Capital is the cost that is incurred in retaining the funds obtained from various sources and employed in business.
Assessment of Financial Performance.
1) Cost of Debt ( Kd)--- Rate of Interest Less Tax benefit
2) Cost of Equity Share Capital ( Ke )-- Expected rate of dividend --Highest cost of capital
3) Cost of Retained Earnings -- Opportunity cost of dividends foregone
4) Cost of Preference Share Capital -- Fixed rate of dividend
A) Overall Cost of Capital = Weighted Average Cost of Capital ( WACC ). Considers Cost of all types of Long Term Sources of Capital.
In case of New Company Overall Cost of Capital is equal to Marginal Cost of Capital.
B) Marginal Cost of Capital = Increase in Cost of Capital due to increase in Capital Structure.
In case of New Company Overall Cost of Capital is equal to Marginal Cost of Capital.
It helps to know what rate of return/profit the new project should earn to cover Cost of Capital.
Calculation of Weighted Average Cost of Capital ( WACC )
Tax Shield After Tax Weighted Cost
Tax Rate30% Cost of Capital
NIL 14% 1.40%
NIL 10% 2.00%
3.30% 7.70% 2.31%
3.60% 8.40% 3.36%
9.07%
If DPS =Rs.14/-. MPS = Rs. 120/- . Expected growth in Dividend = 4%.
G= growth rate in dividend
= 11.67 % + 4% = 15.67%
>> FV = face value(par value) of one pref share
NP = Net Proceeds= Face value + premium - dicount - issue expenses per share
Cost of loan = 12 ( 1 - 0.30) = 8.40
Cost of Debentures = 11 ( 1 - 0.30) = 7.70
>> FV = face value(par value) of one pref share
NP = Net Proceeds= Face value + premium - dicount - issue expenses per share
>> FV = face value(par value) of one pref share
PP = Purchase Price
N= No of years to maturity
X 100 = 98.3 %
98300 = 627,313
15.67%
700,000
200,000
1,527,313
=========================================================================================================================================
Flexibility-- increase/decrease and change in composition of Capital should be possible.
Efficiency-- Just adequate capital ensuring intensive utilization of funds.
Control-- Controlling position of Equity Shareholders should be maintained.
Liquidity -- Adequate cash and liquid resources should be maintained for smooth functioning of business.
EPS as per Plan 2
[(EBIT - I2)(1 - t )] - PD2
Capital Structure Planning means having such a combination of capital resources which gives Highest EPS.
determining the Composition of Owned Capital & Borrowed Capital, having following features :.
which would keep the Equity Shareholders indifferent to the alternative capital plans.
E2
I2= Interest as per plan 2
PD2 = Pref. Dividend as per plan 2
E2 = No. of Eq. Sh. As per plan 2
------------------------------------------------------------------------------------------------------------------------------------------------------------
Financial charges ie. Interest on loans /debt capital is just exactly covered by EBIT and PAT = Pref. Dividend. Leaving neithe
It is the minimum level of EBIT which is just adequate to pay interest on debt capital and preference dividend .
the firm's EPS is Zero.
PAT = Pref. Dividend
EBIT = Interest
------------------------------------------------------------------------------------------------------------------------------------------------------------
Theories to explain relationship between capital structure , cost of capital and value of firm.
Firm can minimize WACC and increase value of firm and MPS, by increasing debt capital to maximum.
because Int rate < Div. rate PLUS due to Tax benefit net interest cost is reduced still further.
No corelation between cost of capital and market value of firm.
WACC is minimized if Debt Equity Ratio is increased .
Weakness-- As debt increases financial risk increases leading to higher expectation of dividend.
leading to increase in cost of capital.
Average cost of capital is equal to capitalization rate of pure equity stream .
No corelation between cost of capital and market value of firm.
should be found.
EPS is exactly equal to zero .
Change in Capital Structure affects market value of firm
Debt -Equity Mix influences WACC
optimal Capital Structure is one which uses maximum debt capital.
Change in Capital Structure does not affect market value of firm
Debt -Equity Mix does not influence WACC
no optimal Capital Structure
Change in Capital Structure does affect market value of firm
optimal Capital Structure
Market Value of Equity + Market Value of Debt
PAT less Pref. Dividend ( ie. PAES )
Capitalization rate of Equity
EBIT (1 - T ) T = Tax rate
Capitalization rate of Equity
=======================================================================================================================================
CHAPTER 9
BUSINESS RESTRUCTURING
Definition : Process by which business orgn. Alters its present structure , either asset structure or liability structure or both.
BR. is done through Merger, Amalgamation, Demerger , Joint Venture , Takeover .
BR gains importance due to--Changes in laws, competitive world , cost cutting
Financial Implications means the valuation of the business from the point of view of buyer and seller.
Value is dependent on bargaining powers of buyer and seller of business and their expectations of income from the business being takenover.
Valuation is dynamic and not static since it changes with the time .
Mergers-- combination of two/more companies into one large company.
Debt -Equity Mix does not influence WACC
a) Horizontal Merger-- combination of companies producing similar products> >anticompetitive , advantage over other competitors.
b) Vertical Merger-- combination of companies at different stages in production of same product. Noncompetiting firms
bachward integration moving towards sources of rawmaterial, forward integration --moving towards consumers by eliminating distributors.
c) Congeneric Merger - Firms in Same general industry but are not buyer- supplier of eachother, but are co-related--eg. Bank and insurance
d) Conglomerate merger--firms in different industry >> for diversifying business risk.
New Co. formed from the amalgamation of A Co and B Co is AB Co.
15% Deb to be issued to existing Deb holders so that they get same amount of int as they are now getting.
Eq shares of new AB Co. shall be issued 30000 shares to existing shareholders of A Co. anf B Co. in proportion to their existing share values .
Calculate Debentures , Pref shares and Equity shares to be issued .
-------------------------------------------------------------------------------------------------------------------------------
Calculation A Co
13% Debentures 36000
Currently the Deb holders are getting int @13% 4680
15% Deb of AB Co to be issued 31200
( 4680/15 X 100)
A Co
No. of Equity Shares of AB Co. to be issued 27511
Equity Share Capital @ Rs10/-. 275109
Assets Amount
Fixed Assets 370000
Current Assets 120000
9891
TOTAL 499891
------------------------------------------------------------------------------------------------------------------------------------------------------------
From the following Balance Sheets + info Calculate Purchase Consideration and prepare revised Balance sheet of company AAA Ltd.
Assets AAALtd BBB Ltd
Land & Bldg. 340000 100000
Machinery 319000 150000
Furniture 45000 10000
Investments 56000 10000
Current Assets 25000 10000
785000 280000
To Debentureholders of BBB Ltd.
REVISED Balance Sheet of AAA Ltd. ( after merger )
Assets Amount
Land & Bldg. 480000
Machinery 429000
Furniture 50000
Investments 66000
Current Assets 32000
TOTAL 1057000
What must be the exchange ratio so that pre-merger and post-merger EPS to be same ?
What is exchange ratio based on current MPS?
times
Shareholders of S Co will exchange their 100000 shares for 60000 shares of P Co.
260000 shares
No of new shares required to be issued = Total no. of shares in post merger Co - No of shares in pre merger P Co
60000 shares
: 1
===================================================================================================================================================
60 = 12% of 500 loans
500 = 2.04245
160 = 2.6760
260 = 1.63160
160 = 1.6100
260 = 2.6100 s
==============================================================================================================================================================
EVALUATION OF ALTERNATIVE CAPITAL PLANS
NOTE: Option 1 Equity shares at 20% premium
Eq. Share Capital= 5000000 X 100 =
120
Share Premium= 5000000-4166667 =
=PAT + Tax
=PAT / 70 X 30
----------------------------------------------------------------------------------------------------------------------------------
It is the prime function of Finance Manager to maximise wealth of shareholders
-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Tax @ 30% PAT Cash Inflow PV Factor150000 350000 850000 0.909210000 490000 865000 0.826240000 560000 841250 0.751270000 630000 1473750 0.683
400000 0.683200000 0.683
870000 2030000 4630000
2000000 1
400000 12400000
If Research Cost, Project preparation cost is incurred it is a sunk cost and does not affect the ranking of the projects hence and to be considered for above calculations.
(2000000-1487140) years = 2 + 0.81631779 =2.81 years
Average PAT X 100Average Investment+ W Cap + Scrap Value
+400000+200000
1500000
34 %
Payback Profitability = Total Cash Inflows - Total Cash Outflows --->>> If Annual Cashinflow not same every year.2230000
-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
CA = Current Assets =230000
CL = Current Liabilities= 120000
CCA = Core Current Assets = CA X 30%=230000 X 30%=69000If core CA not given , assume all current assets other than Marketable Securities are Core Current Assets
--------------------------------------------------------------------------------------------------------------
Calculation of Working Capital ( at Cost )
= Annual Cash Inflow X ( Life of project - Payback Period ) --->>> If Annual Cashinflow same every year.
Current AssetsFinished Goods 134000Debtors(Sales - Profit) 117000Other Current Assets( bal. fig 166000 Total Current Assets 417000
Less : Current LiabilitiesCurrent Liabilities 200000 Total Current Liabs. 200000
W. Cap. 217000( Only Debtors change)------------------------------------------------------------------------------------
Tax rate is 30%. Dividend expected by Eq Shareholders is 15%
After Tax Cost WACC %15% 6.8215% 2.3410% 1.30
8.40% 2.18 (12 less 35% of 12)(13 less 35% of 13)
0.48 12.64
-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
W Cap W Cap Normal at Cost
45000 45000
2250025002063 27063 27063
126500 126500
10000063250
4125 4125
10000 10000
312688 275938
45000 450005000 5000 fortnight = 15 days = 1/2 mth.
14000 1400064000 64000
248688 211938
-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
==================================================================================================================================================
Example 1. Sales in 1st. Year 50 Lakh shall double every year . Salvage 1 crore.Net Profit margin( PAT ) is 50%. Initial Outlay 5 crore . W. Cap. 1 crore, Dep SLM. Year 1
17% 0.855518% 0.847
Calculate A) Payback Period . B) Payback Profitability.NPV @ 17 % & @18% . M51
A) Payback Period .12 mths. ) Dep. =
-------------------------------------------------------------------------------------------------------------------------[Avg. Annual Cash Inflow X( Expected life of project - Payback Period) ] + sale of scrap
B) Payback Profitability.
C) Payback Profitability Index = ( Also called Benefit Cost Index )
Payback Profitability Index = ( when PV available )
Better indicator than Payback Period because it considers total net cash inflows D) NPV @17%.
-------------------------------------------------------------------------------------------------------------------------
The project with the highest payback profitability index should be chosen.
Conclusion :----------------------------------------------------------------------------------------------------------------------------
E ) IRR ( Internal Rate of Return )+ Addnl. W. Cap. + Salvage Value
=
=
==
F ) ARR =
Present value PV Factor @ 12 % (Present Value)
0.893 89300
0.797 139076.5
0.712 149164
0.636 155502
533042.5
Since Total Present Values of Cash Inflows Rs 533043/- is more than Cost Rs500000/- the project should be accepted.
Present value N PV Factor @ 12 % (Net Present Value)
1 -500000
1 -60000
0.893 89300
0.797 139076.5
0.712 149164
0.636 155502
0.636 38160
0.636 25440
36642.5
Since Net Present Values of Cash Inflows Rs. 36642.50 is more than zero ( positive) the project should be accepted.
Internal Rate of Return is that rate of profit expected from the investment in the project which covers the cost of capital invested in the project.
Conclusion : IRR of the given project is x % . It means at x% of cost of capital ( int rate or Div rate ) the income of the project will just exactly cover the cost of project.
---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Cost for conducting study / research for project is a sunk cost ( ie already incurred ) and hence not to be considered while evaluating the different projects.
=========================================================================================================================================================
July August Sept
300000 320000 200000
130000 150000 100000
32000 32000 22000
20000 20000 10000
20% are cash sales. 5% discount is given on cash sales.
Out of the credit sales 30% pay in the next month with3% discount and balance in the second month with no discount.
Wages are paid in the next month = lag in payment is 1 mth = wages payable one mth in arrear.
Cash balance on 1.07.11 is Rs 12000
Cash bal. to be maintained at 12000 every month.
1/3 Expenses are paid 1 month in advance.
Machine of 50000 to be purchased in July . Down payment is 20000 and balance in 3 equal instalments.
Furniture purchased in Aug. Rs 90000
Dividend on Investment is received in July Rs 14500
Cash released by concentration banking = 4000000 X 2Savings in concentration banking = 8000000 X 8%Net benefit from concentration banking = 640000 - 75000
Cash released by Lock box system = 4000000 X 4Savings in Lock box system = 16000000 X 8%Net benefit from Lock box system = 1280000 - 120000Since the net benefit from Lock Box System is more than from Concentration banking, Lock box system should be adopted.
--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Co. Has annual turnover (Sales) of 100 lakh. 50 working weeks. Receipts on Mondays , Tuesdays and Wednesdays are twice on other 2 days o the week.
=================================================================================================================================================
Cost of Capital is the cost that is incurred in retaining the funds obtained from various sources and employed in business.
A) Overall Cost of Capital = Weighted Average Cost of Capital ( WACC ). Considers Cost of all types of Long Term Sources of Capital.
NP = Net Proceeds= Face value + premium - dicount - issue expenses per share
%
%
NP = Net Proceeds= Face value + premium - dicount - issue expenses per share
=========================================================================================================================================
, having following features :.
EBIT = Interest
EPS = 0 PAT = Pref. Dividend
Firm can minimize WACC and increase value of firm and MPS, by increasing debt capital to maximum.
because Int rate < Div. rate PLUS due to Tax benefit net interest cost is reduced still further.
Weakness-- As debt increases financial risk increases leading to higher expectation of dividend.
T = Tax rate
=======================================================================================================================================
Value is dependent on bargaining powers of buyer and seller of business and their expectations of income from the business being takenover.
a) Horizontal Merger-- combination of companies producing similar products> >anticompetitive , advantage over other competitors.
bachward integration moving towards sources of rawmaterial, forward integration --moving towards consumers by eliminating distributors.
c) Congeneric Merger - Firms in Same general industry but are not buyer- supplier of eachother, but are co-related--eg. Bank and insurance
Eq shares of new AB Co. shall be issued 30000 shares to existing shareholders of A Co. anf B Co. in proportion to their existing share values .
B Co
15000
1950
13000
( 1950/15 X 100)
B Co
2489
24891
From the following Balance Sheets + info Calculate Purchase Consideration and prepare revised Balance sheet of company AAA Ltd.
===================================================================================================================================================
==============================================================================================================================================================
Option 1 Equity shares at 20% premium
5000000 X 100 = 4166667
5000000-4166667 = 833333.3
-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Present Value Cumulative Present Value772650 772650714490 1487140631779 2118919
1006571 3125490273200 3398690136600 3535290
35352903535290
2000000
4000002400000
1135290
If Research Cost, Project preparation cost is incurred it is a sunk cost and does not affect the ranking of the projects hence and to be considered for above calculations.
years
Payback Profitability = Total Cash Inflows - Total Cash Outflows --->>> If Annual Cashinflow not same every year.
-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
CCA = Core Current Assets = CA X 30%=230000 X 30%=69000If core CA not given , assume all current assets other than Marketable Securities are Core Current Assets
Calculation of Working Capital ( at Cash Cost ) Note:
= Annual Cash Inflow X ( Life of project - Payback Period ) --->>> If Annual Cashinflow same every year.
Current Assets Cash (other) Cost Finished Goods(Cost - Dep) 115240 DepDebtors(Sales -Profit-Dep) 100620 Total CostOther Current Assets( bal. fig.) 166000 Add : Profit Total Current Assets 381860 Sales
Less : Current LiabilitiesCurrent Liabilities 200000 Total Current Liabs. 200000
W. Cap. 181860( Finished Goods, WIP stock and Debtors change)------------------------------------------------------------------------------------------------ --------------------------------
(12 less 35% of 12)(13 less 35% of 13)
-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
fortnight = 15 days = 1/2 mth.
-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Sales in 1st. Year 50 Lakh shall double every year . Salvage 1 crore.Net Profit margin( PAT ) is 50%. Initial Outlay 5 crore . W. Cap. 1 crore, Dep SLM.
2 3 40.731 0.624 0.5340.718 0.609 0.516
Calculate A) Payback Period . B) Payback Profitability.NPV @ 17 % & @18% . M51
A) Payback Period .Cost of Asset - Salvage = 5,00,00,000 - 1,00,00,000 =
Estimated Life
Year Sales Net Profit Dep1 5,000,000 2,500,000 10,000,000 2 10,000,000 5,000,000 10,000,000
3 20,000,000 10,000,000 10,000,000 4 40,000,000 20,000,000 10,000,000
75,000,000.00 37,500,000.00 40,000,000.00 Payback Period = 3 years + (50000000- 47500000) X 12mths.
30,000,000.00
B) Payback Profitability. = (Total Cash Inflow + Salvage) - Cost = 7,75,00,000 + 1,00,00,000 - 5,00,00,000 = 37,50,00,000
C) Payback Profitability Index = Total Cash Inflows + Scrap Value = 7,75,00,000+ 100,00,000 =( Also called Benefit Cost Index ) Cost of asset
Payback Profitability Index = PV of cash inflows = ( when PV available ) PV of cash outflows
Year Cash Inflow PV Factor @17% PV of C.inflow
1 12,500,000 0.855 10,687,500 2 15,000,000 0.731 10,965,000 3 20,000,000 0.624 12,480,000 4 30,000,000 0.534 16,020,000 4 10,000,000 0.534 5,340,000
( Salvage ) 4 10,000,000 0.534 5,340,000
( W. Cap. )Total PV of Cash Inflows 60,832,500
Less : Initial Outlay 50,000,000 Less : Initial W Cap. 10,000,000 Net Present Value 832,500
Conclusion : Project with negative NPV should be avoided . Between projects with positive NPV , project with highest NPV should be chosen.----------------------------------------------------------------------------------------------------------------------------
E ) IRR ( Internal Rate of Return )
17 + 60832500-60000000 X (18-17) 60832500-59337500
17 + 832,500 X 1 1,495,000
17 + 0.56 X 117.56%
Avg. PAT X 100 = 9,375,000.00 X 100 =Avg. Investment 40000000
Avg. Investment = ( Initial cost of machine - Salvage value )2
= (50000000 - 10000000 ) + 10000000+ 10000000 2
= 40000000
Out of the credit sales 30% pay in the next month with3% discount and balance in the second month with no discount.
= 8000000= 640000= 565000
= 16000000= 1280000= 1160000
Since the net benefit from Lock Box System is more than from Concentration banking, Lock box system should be adopted.
--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
% for finished goods for debtors
Cash (other) Cost 86% 115240 100620
14% 18760 16380
Total Cost 100% 134000 117000
Add : Profit 33000
150000
-------------------------------- --------------------------------------------------------------------------------------------------------------
Net Profit margin( PAT ) is 50%. Initial Outlay 5 crore . W. Cap. 1 crore, Dep SLM.
Calculate A) Payback Period . B) Payback Profitability.NPV @ 17 % & @18% . M51
5,00,00,000 - 1,00,00,000 = 1,00,00,0004 years
Cash Inflow Cum. Cash Inflow 12,500,000 12,500,000 15,000,000 27,500,000
20,000,000 47,500,000 30,000,000 77,500,000 77,500,000.00 165,000,000.00
(50000000- 47500000) X 12mths. = 3 years and 10 mths.
= (Total Cash Inflow + Salvage) - Cost = 7,75,00,000 + 1,00,00,000 - 5,00,00,000 = 37,50,00,000
Total Cash Inflows + Scrap Value = 7,75,00,000+ 100,00,000 = 1.75 5,00,00,000
60,832,500 1.0139 60,000,000
Year Cash Inflow
1 12,500,000 0.8472 15,000,000 0.7183 20,000,000 0.6094 30,000,000 0.5164 10,000,000 0.516
( Salvage ) 4 10000000 0.516
( W. Cap. )Total PV of Cash Inflows
Less : Initial OutlayLess : Initial W Cap.Net Present Value
Project with negative NPV should be avoided . Between projects with positive NPV , project with highest NPV should be chosen.----------------------------------------------------------------------------------------------------------------------------
PVF@18%
23.44 %
( Initial cost of machine - Salvage value ) + Addnl. W. Cap. + Salvage Value
(50000000 - 10000000 ) + 10000000+ 10000000
--------------------------------------------------------------------------------------------------------------
PV of C.inflow
10,587,500 10,770,000 12,180,000 15,480,000 5,160,000
5,160,000
59,337,500
50,000,000 10,000,000 (662,500)
Project with negative NPV should be avoided . Between projects with positive NPV , project with highest NPV should be chosen.
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