Corporate Valuation – CA Final SFM Study Material is designed strictly as per the latest syllabus and exam pattern.
Corporate Valuation – CA Final SFM Study Material
Part-1 (Theory)
Question 1.
Tender Ltd. has earned a net profit of ₹ 15 lacs after tax at 30%. Interest cost charged by financial institutions was ₹ 10 lacs. The invested capital is ₹ 95 lacs of which 55% is debt. The company maintains a weighted average cost of capital of 13%. You are required to:
(a) Compute the operating income.
(b) Compute the Economic Value Added (EVA).
(c) Tender Ltd. has 6 lacs equity shares outstanding. How much dividend can the company pay before the value of the entity starts declining₹ [May 2011] [8 Marks]
Answer:
(a) Computation of Operating Income:
Profit before Tax(EBT) = ₹ 15 lac/(1 – 0.30)
= ₹ 21,42,857
Operating Income (EBT) = EBT + Interest
= ₹ 21,42,857 + ₹ 10,00,000
= ₹ 31,42,857
(b) Computation of Economic Value Added (EVA):
Net Operating Profit after tax = EBIT (1 – tax rate)
(NOPAT) = ₹ 31,42,857(1 – 30) = ₹ 22,00,000
EVA = NOPAT – (WACC × Invested Capital)
= ₹ 22,00,000 – (13% of ₹ 95,00,000)
= ₹ 9,65,000
(c) Maximum Dividend without effecting the value of business:
EVA Dividend = \(\frac{\text { Rs. } 9,65,000}{6,00,000}\) = ₹ 1.6083 Per share
Question 2.
RST Ltd.’s current financial year’s income statement reported its net income as Rs. 25,00,000. The applicable corporate income tax rate is 30%.
Following is the capital structure of RST Ltd. at the end of current financial year:
| Debt (11% Coupon rate ) | ₹ 40 lakhs |
| Equity (Share Capital + Reserves & Surplus) | ₹ 125 lakhs |
| Total Invested Capital | ₹ 165 lakhs |
Following data is given to estimate cost of equity capital:
| Beta of RST Ltd. | 1.36 |
| Risk free rate i.e. current yield on Govt, bonds | 8.5% |
| Average market risk premium | 9% |
(i.e. excess of return on market portfolio over risk-free rate)
Required:
(i) Estimate Weighted Average Cost of Capital (WACC) of RST Ltd.; and
(ii) Estimate Economic Value Added (EVA) of RST Ltd. [May 2014] [4 + 4 = 8 Marks]
Answer:
(i) Estimation Weighted Average Cost of Capital (WACC):
Cost of Equity as per CAPM (Ke) = Rf + β × Market Risk Premium
= 8.5% + 1.36 × 9%
= 8.5% + 12.24% = 20.74%
Cost of Debt (kd) = 11% (1 – 0.30) = 7.70%
WACC(k0) = \(\left[k_e \times \frac{E}{E+D}\right]+\left[k_d \times \frac{D}{E+D}\right]\)
= \(\left[20.74 \times \frac{125}{165}\right]+\left[7.70 \times \frac{40}{165}\right]\)
= 15.71 + 1.87 = 17.58%
(ii) Estimation of Economic Value Added (EVA)
Profit before Tax (EBT) = ₹ 25 lac/(1 – 0.30)
= ₹ 35,71,429
Operating Income (EBIT) = EBT + Interest
= ₹ 35,71,429 + ₹ 4,40,000
= ₹ 40,11,429
Net Operating Profit after tax (NOPAT) = EBIT (1 – tax rate)
(NOPAT) = ₹ 40,11,429 (1 – 30)
= ₹ 28,08,000
Economic Value Added (EVA) = NOPAT – (WACC × Invested Capital)
= ₹ 28,08,000 – (17.58% of ₹ 165 Lakhs)
= ₹ 28,08,000 – ₹ 29,00,700
= ₹ 92,700
There is depletion of value rather than value addition.
Question 3.
Delta Ltd.’s current financial year’s income statement reports its net income as ₹ 15,00,000. Delta’s marginal tax rate is 40% and its interest expense for the year was ₹ 15,00,000. The company has ₹ 1,00,00,000 of invested capital, of which 60% is debt. In additional, Delta Ltd. tries to maintain a Weighted Average Cost of Capital (WACC) of 12.6%.
(i) Compute the operating income or EBIT earned by Delta Ltd. in the cur-
(ii) What is Delta Ltd.’s Economic Value Added (EVA) for the current year₹
(iii) Delta Ltd. has 2,50,000 equity shares outstanding. According to the EVA
computed by you in (ii), how much can Delta Ltd. pay dividend per share before the value of the company would start to decrease ₹ If Delta does not pay any dividends, what would you expect to happen to the value of the company₹ [Nov. 2010] [8 Marks]
Answer:
(a) Computation of Operating Income:
Profit before Tax (EBT) i.e. Taxable Income = ₹ 15 lac/(1 – 0.40)
= ₹ 25,00,000
Operating Income (EBIT) = EBT + Interest
= ₹ 25,00,000 + ₹ 15,00,000
= ₹ 40,00,000
(b) Computation of Economic Value Added (EVA):
Net Operating Profit after tax (NOPAT) = EBIT (1 – tax rate)
= ₹ 40,00,000 (1 – 40)
= ₹ 24,00,000
EVA = NOPAT – (WACC × Invested Capital)
= ₹ 24,00,000 – (.126 × ₹ 100,00,000)
= ₹ 24,00,000-₹ 12,60,000
= ₹ 11,40,000
(c) Max. Dividend without effecting the value of business:
EVA Dividend = \(\frac{\text { Rs. } 11,40,000}{2,50,000 \text { Shares }}\) = ₹ 4.56 Per share.
When Delta Ltd. does not pay a dividend, we would expect the value of the firm to increase because it will achieve higher growth, therefore, a higher level of EBIT. If EBIT is higher, the value of the firm will increase provided all other variables are constant.
Question 4.
The following information is given for 3 companies that are identical except for their capital structure:
The tax rate is uniform 35% in all cases.
(a) Compute the Weighted average cost of capital for each company.
(b) Compute the Economic Value Added (EVA) for each company.
(c) Based on the EVA, which company would be considered for best invest-ment? Given reasons.
(d) If the industry PE ratio is 11 times, estimate the price for the share of each company.
(e) Calculate the estimated market capitalization for each of the Companies. [May 2010] [12 Marks]
Answer:
(a) Computation of cost of debt
Post tax Cost of Debt = Pre-tax Cost × (1 – tax rate)
Orange = 16% (1 – .35) = 10.4%
Grape = 13% (1 – .35) = 8.45%
Apple = 15% (1 – .35) = 9.75%
Computation of WACC
Orange = (10.4% × 0.8) + (2696 × 0.2) = 13.52%
Grape := (8.45% × 0.5) + (22% × 0.5) = 15.225%
Apple = (9.75% × 0.2) + (20% × 0.8) = 17.95%
(b) Computation of EVA
| Orange | Grape | Apple | |
| EBIT | 25,000 | 25,000 | 25,000 |
| Tax @ 35% | 8,750 | 8,750 | 8,750 |
| NOPAT (A) | 16,250 | 16,250 | 16,250 |
| Invested Capital | 1,00,000 | 1,00,000 | 1,00,000 |
| WACC | 13.52% | 15.225% | 17.95% |
| Cost of Capital (B) | 13,520 | 15,225 | 17,950 |
| EVA (A) – (B) | 2,730 | 1,025 | -1,700 |
(c) Orange would be considered as the best investment: since the EVA of the company is highest and its weighted average cost of capital is the lowest.
(d) Estimated Price of each company shares on the basis of P/E Ratio
Since the three entities have different capital structures they would be exposed to different degrees of financial risk. The PE ratio should therefore be adjusted for the risk factor. In the absence of adequate information, this aspect is ignored.
(e) Market Capitalisation (= No. of Shares × Estimated Share Price)
| Orange (₹) | Grape (₹) | Apple (₹) | |
| Estimated Share Price (₹) | 16.17 | 16.368 | 16.445 |
| No. of shares | 6,100 | 8,300 | 10,000 |
| Estimated Market Capitalisation (₹) | 98,637 | 1,35,854 | 1,64,450 |
Question 5.
With the help of the following information of Jatayu Limited compute the Economic Value Added:
| Capital Structure | Equity capital Rs. 160 Lakhs Reserves and Surplus Rs. 140 lakhs 10% Debentures Rs. 400 lakhs |
| Cost of equity | 14% |
| Financial Leverage | 1.5 times |
| Income Tax Rate | 30% |
[Nov. 2012} [4 Marks]
Answer:
Step 1: Calculation of PBIT using Financial Leverage
Financial Leverage = PBIT/PBT
1.5 = PBIT/(PBIT – Interest)
1.5 = PBIT/(PBIT – 40)
1.5 (PBIT – 40) = PBIT
1.5 PBIT – 60 = PBIT
1.5 PBIT – PBIT = 60
0.5 PBIT = 60
Or PBIT = \(\frac{60}{0.5}\) = Rs. 120 lakhs
Step 2: Calculation of NOPAT and WACC
NOPAT = PBIT – Tax = ₹ 120 lakhs (1 – 0.30) = Rs. 84 lakhs.
Weighted Average Cost of Capital (WACC)
= 14% (300/700) + ( 1 – 0.30) × (10%) × (400/700) = 10%
Step 3: Determination of EVA
EVA = NOPAT – (WACC Total Capital)
EVA = Rs. 84 lakhs – 0.10 Rs. 700 lakhs
EVA = Rs. 14 lakhs
Question 6.
Calculate economic value added (EVA) with the help of the following information of Hypothetical Limited:
| Financial leverage | 1.4 times |
| Capital structure | Equity Capital Rs.170 lakhs Reserves and surplus Rs. 130 lakhs 10% Debentures Rs. 400 lakhs |
| Cost of Equity | 17.5% |
| Income Tax Rate | 30% |
[Nov. 2004] [6 Marks]
Answer:
Step 1: Calculation of PBIT using Financial Leverage Financial Leverage = PBIT/PBT
1.4 = PBIT/(PBIT – Interest)
1.4 = PBIT/(PBIT – 40)
1.4 (PBIT – 40) = PBIT
1.4 PBIT – 56 = PBIT
1.4 PBIT – PBIT = 56
0.4 PBIT = 56
PBIT = \(\frac{56}{0.4}\) = Rs. 140 lakhs 0.4
Step 2: Calculation of NOPAT and WACC
NOPAT = PBIT – Tax = Rs. 140 lakhs (1 – 0.30) = Rs. 98 lakhs.
Weighted average cost of capital (WACC) = 17.5% × (300/700) + (1 – 0.30) × (1096) × (400/700)
= 11.5%
Step 3: Determination of EVA
EVA = NOPAT – (WACC Total Capital)
= Rs. 98 lakhs – 0.115 × Rs. 700 lakhs
= Rs. 17.5 lakhs
Question 7.
Constant Engineering Ltd. has developed a high tech product which has reduced the Carbon emission from the burning of the fossil fuel. The product is in high demand. The product has been patented and has a market value of Rs. 100 Crore, which is not recorded in the books. The Net worth (NW) of Constant Engineering Ltd. is Rs. 200 Crore. Long term debt is Rs. 400 Crore. The product generates a revenue of Rs. 84 Crore. The rate on 365 days Government bond is 10 per cent per annum. Bond portfolio generates a return of 12 per cent per annum. The stock of the company moves in tandem with the market. Calculate Economic Value added of the company. [Practice Question]
Answer:
(i) Estimated Weighted Average Cost of Capital (WACC):
Cost of Equity as per CAPM (Ke) = 12%
Cost of Debt (Kd) = 10%
WACC (k0) = \(\left[k_e \times \frac{E}{E+D}\right]+\left[k_d \times \frac{D}{E+D}\right]\)
= \(\left[12 \times \frac{300}{700}\right]+\left[10 \times \frac{400}{700}\right]\)
= 5.14% + 5.71% = 10.85%
(ii) Calculation of Total Investments:
| Amount (Rs. Crore) | |
| Net Worth | 200.00 |
| Long Term Debts | 400.00 |
| Patent Rights | 100.00 |
| Total | 700.00 |
(iii) Calculation of Economic Value Added (EVA):
Net Operating Profit after tax = Rs. 84 Crores
(NOPAT)
WACC = 10.85%
Invested Capital = Rs. 700 Crores
Economic Val- (10.85% of Rs. 700 Cr.)
= Rs. 8.05 Crore
Question 8.
Compute Economic Value Added (EVA) of good luck Ltd, From the following information:
Profit & Loss Statement
| Particulars | (Rs. in Lakh) | |
| (a) | Income : | |
| Revenue from operations | 2000 | |
| (b) | Expenses: | |
| Direct expenses | 800 | |
| Indirect expenses | 400 | |
| (c) | Profit before interest & tax (a-b) | 800 |
| (d) | Interest | 30 |
| (e) | Profit before tax (c-d) | 770 |
| (f) | Tax | 231 |
| C8) | Profit after tax (e-f) | 539 |
Balance sheet
| Particulars | (Rs. in Lakh) |
| Equity and liabilities: | |
| (a) Shareholders Fund | |
| Equity share capital | 1000 |
| Reserves & surplus | 600 |
| (b) Non-current liabilities | |
| Long terms Borrowing | 200 |
| (c) Current liabilities | 800 |
| Total | 2600 |
| Assets: | |
| (a) Non-current Assets | 2000 |
| (b) Current assets | 600 |
| Total | 2600 |
Other information:
1. Cost of debts is 15%.
2. Cost of equity (i.e. shareholders expected returns) is 12%.
3. Tax rate is 30%.
4. Bad Debts provision of Rs. 40 lakhs is included in indirect Expenses and Rs. 40 lakhs reduced from receivables in current assets. [May 2019][5 Marks]
Answer:
EVA = NOPAT – (Invested Capital × WACC)
NOPAT = EBIT – Tax + Non-Cash Expenses
= 800 lakhs – 231 lakhs + 40 lakhs
= Rs. 609 lakh
(OR)
Taxable Income + Interest + Non-cash Expenses
= 539 + 30 + 40 = Rs. 609 lakh
Invested Capital = 1000 + 600 + 200
= 1800 1800 + 40 (Non-cash expenses)
= Rs. 1840 lakhs
WACC = \(\frac{1600}{1800}\) × 12% + \(\frac{200}{1800}\) × 15% (1-0.3)
= 10.67% + 1.17% = 11.84%
Now, EVA = 609 – (1840 × 11.84%)
= 609 – 217.86
= Rs. 391.14 lakhs
(OR)
WACC = \(\frac{1000}{1200}\) × 12% + \(\frac{200}{1200}\) × 15% (1 – 0.3)
= 10.00% + 1.75% = 11.75%
Now, EVA = 609 – (1840 × 11.75%)
= 609 – 216.20
= Rs. 392.80 lakhs
Question 9.
Given below is the Balance Sheet of S Ltd. as on 31-3-2008: (f In lakh)
You are required to work out the value of the Company’s shares on the basis of Net Assets method and Profit-earning capacity (capitalization) method and arrive at the fair price of the shares, by considering the following information:
(i) Profit before tax for the current year ₹ 64 lakhs includes ₹ 4 lakhs extraordinary income and ₹ 1 lakh income from investments of surplus funds; such surplus funds are unlikely to recur.
(ii) In subsequent years, additional advertisement expenses of ₹ 5 lakhs are expected to be incurred each year.
(iii) Market value of Land and Building and Plant and Machinery have been ascertained at ₹ 96 lakhs and ₹ 100 lakhs respectively. This will entail additional depreciation of ₹ 6 lakhs each year.
(iv) Effective Income-tax rate is 30%.
(v) The capitalization rate applicable to similar business is 15%. [May 2008] [16 Marks]
Answer:
(a) Computation of value per share on the basis of Net Assets
Number of shares = \(\frac{\text { Rs. } 1,00,00,000}{10}\) = 10 00,000 shares or 10 lakhs shares
Value per share = \(\frac{\text { Rs. } 216 \text { Lakhs }}{10 \text { Lakhs }}\) = ₹ 21.6
(b)Computation of value per share on the basis of Profit-earning Capacity Method
Capitalised value of profits = \(\frac{\text { FMP }(\text { after taxes) }}{\text { Rate of capitalisation }}\) = \(\frac{\text { Rs. } 33.60 \text { Lakhs }}{0.15}\)
= Rs. 224 Lakhs
Value of business = ₹ 224 Lakhs
Value per share = \(\frac{\text { Value of Business }}{\text { No. of Shares }}\) = \(\frac{R s .224 \text { Lakhs }}{10 \text { Lakhs Shares }}\) = ₹ 22.4
(c) Computation of value per share on the basis of Fair Price Method
Fair Price = \(\frac{\text { Value as per Net Assets Method }+ \text { Value as per Profit earning capacity method }}{2}\)
= \(\frac{\text { Rs. } 21.6+\text { Rs. } 22 \cdot 4}{2}\) = \(\frac{\text { Rs. } 44}{2}\) = ₹ 22
Question 10.
H Ltd. agrees to buy over the business of B Ltd. effective 1st April, 2012. The summarized Balance Sheets of H Ltd. and B Ltd, as on 31st March 2012 are as follows:
H Ltd. proposes to buy out B Ltd. and the following information is provided to you as part of the scheme of buying.
1. The weighted average post tax maintainable profits of H Ltd. and B Ltd. for the last 4 years are ₹ 300 crores and 10 crores respectively.
2. Both the companies envisage a capitalization rate of 8%.
3. H Ltd. has a contingent liability of ₹ 300 crores as on 31st March, 2012.
4. H Ltd. to issue shares of ₹ 100 each to the shareholders of B Ltd. in terms of the exchange ratio as arrived on a Fair Value basis. (Please consider weights of 1 and 3 for the value of shares arrived on Net Asset basis and Earnings capitalization method respectively for both H Ltd. and B Ltd.)
You are required to arrive at the value of the shares of both H Ltd. and B
Ltd. under:
(i) Net Asset Value Method
(ii) Earnings Capitalization Method
(iii) Exchange ratio of shares of H Ltd. to be issued to the shareholders of B Ltd. on a Fair value basis (taking into consideration the assumption mentioned in point 4 above.) [Nov. 2012] [12 Marks]
Answer:
(i) Net asset value Method:
Assumption: It has been assumed that the contingent liability will materialize at its full value.
(ii) Earning capitalization value:
Capitalised value of profits = \(\frac{\text { FMP }(\text { after taxes) }}{\text { Rate of capitalisation }}\)
Value of business = Capitalised value of profits
Value per share = \(\frac{\text { Value of Business }}{\text { No. of Shares }}\)
| H Ltd. | B Ltd. | |
| Capitalised value of profits | = \(\frac{\text { Rs. } 300 \text { Crores }}{0.08}\) = Rs. 3,750 Crores |
= \(\frac{\text { Rs. } 10 \text { Crores }}{0.08}\) = Rs. 125 Crores |
| Value per share | = \(\frac{\text { Rs. } 3,750 \text { Crores }}{3.50 \text { Crores }}\) = ₹ 1,071.43 |
= \(\frac{\text { Rs. } 125 \text { Crores }}{0.65 \text { Crores }}\) = ₹ 192.31 |
(iii) Computation of value per share on the basis of Fair Value Method
H Ld.
= \(\frac{(\text { Rs.285.71 } \times 1)+(\text { Rs.1,071.43 } \times 3)}{4}\) = ₹ 875
B Ltd.
= \(\frac{(\text { Rs. } .48 .46 \times 1)+(\text { Rs.192.31 } \times 3)}{4}\) = ₹ 156.3475
(iv) Determination of Exchange Ratio
Exchange Ratio (with Fair Value as base) =
= \(\frac{R s .156 .347}{R \cdot 875}\) = 0.1787
H Ltd. will issue its 0.178/ share tor each share of B Ltd.
Question 11.
ABC Company is considering acquisition of XYZ Ltd. which has 1.5 crores shares outstanding and issued. The market price per share is Rs. 400. At present. ABC’s average cost of capital is 12%. Available information from XYZ indicates its expected cash accruals for the next 3 years as follows:
| Year | Rs. in crores |
| 1 | 250.00 |
| 2 | 300.00 |
| 3 | 400.00 |
You are required to calculate the range of valuation that ABC Ltd. has to consider. Take P.V.F. (12%, 3) = 0.893, 0.797, 0.712. [Nov. 2009] [4 Marks]
Answer:
(a) Valuation based on Market Price
Market Price per share = Rs. 400.00
Value of total business = 1.5 crore × 400 = Rs. 600 Crore
(b) Valuation based on Discounted Cash Flow
Value per share = \(\frac{747.15}{1.5}\) = RS. 498.10
(c) Range of valuation
| Per Share (Rs.) | Total (Rs. Crore) | |
| Minimum | 400.00 | 600.00 |
| Maximum | 498.10 | 747.15 |
Question 12.
ABC Limited is considering acquisition of DEF Ltd., which has 3.10 crore shares issued and outstanding. The market price per share is ? 440.00 at present. ABC Ltd.’s average cost of capital is 12%. The cash inflows of DEF Ltd. for the next three years are as under:
| Year | 3 in crores |
| 1 | 460.00 |
| 2 | 600.00 |
| 3 | 740.00 |
You are required to calculate the range of valuation that ABC Ltd. has to consider. Take P.V.F. (12%, 3) = 0.893, 0.797, 0.712. [May 2013] [5 Marks]
Answer:
(a) Valuation based on Market Price
Market Price per share = ₹ 440.00
Value of total business = 3.10 crore × 440 = ₹ 1,364.00 Crore
(b) Valuation based on Discounted Cash Flow
| Year | Cash Flow (₹) | PVF@ 12% | Present Value (₹) |
| 1 | 460 Crore | 0.893 | 410.78 |
| 2 | 600 Crore | 0.797 | 478.2 |
| 3 | 740 Crore | 0.712 | 526.88 |
| Present Value of cash flows | 1,415.86 |
(c) Range of valuation
| Per Share (₹) | Total (₹ Crore) | |
| Minimum | 440.00 | 1364.00 |
| Maximum | 456.73 | 1415.86 |
Question 13.
ABC, a large business house is planning to sell its wholly owned subsidiary KLM. Another large business entity XYZ has expressed its interest in making a bid for KLM. XYZ expects that after acquisition the annual earning of KLM will increase by 10%.
Following information, ignoring any potential synergistic benefits arising out of possible acquisitions, are available:
(i) Profit after tax for KLM for the financial year which has just ended is estimated to be Rs. 10 crore.
(ii) KLM’s after tax profit has an increasing trend of 7% each year end the same is expected to continue.
(iii) Estimated post tax market return is 10% and risk free rate is 4%. These rates are expected to continue.
(iv) Corporate tax rate is 30%.
Assume gearing level of KLM to be the same as for ABC and a debt beta of zero.
You are required to calculate:
(a) Appropriate cost of equity for KLM based on the data available for the proxy entity.
(b) A range of values for KLM both before and after any potential synergistic benefits to XYZ of the acquisition. [May 2010][8 Marks]
Answer:
(a) β ungeared for the proxy company = (1.1 × 4)/[4 + (1 – 0.3) ] = 0.9362
0.9362 = (β equity geared × 3/[3 + (1 – 0.3)]
P Equity geared = 1.1546
Cost of equity = 0.04 + 1.1546 × (0.1 – 0.04) = 10.9396
(b) P/E valuation (Based on earning of Rs. 10 Crore)
| Using proxy Entity’s P/E | Using XYZ’s P/E | |
| Pre synergistic value | 12 × Rs. 10 Crore | 10 × Rs. 10 Crore |
| = Rs. 120 Crore | = Rs. 100 Crore | |
| Post synergistic value | 12 × Rs. 10 Crore × 1.1 | 10 × Rs. 10 Crore × 1.1 |
| = Rs. 132 Crore | = Rs. 110 Crore |
Dividend valuation model
| Based on 50% payout | Based on 40% payout | |
| Pre synergistic value | \(\frac{0.5 \times 10 \times 1.07}{0.1093-0.07}\) | \(\frac{0.4 \times 10 \times 1.07}{0.1093-0.07}\) |
| = Rs. 136.13 Crore | = Rs. 108.91 Crore | |
| Post synergistic value | \(\frac{0.5 \times 10 \times 1.1 \times 1.07}{0.1093-0.07}\) | \(\frac{0.4 \times 10 \times 1.1 \times 1.07}{0.1093-0.07}\) |
| = Rs. 149.75 Crore | = Rs. 119.79 Crore |
Market Price
Although no information is available about the value of KLM, it may be possible to calculate a market value based on proportion of earnings of ABC that is generated by KLM.
Market value of ABC = 80 Lakh Shares × Rs. 375 = Rs. 300 Crore
Post Tax earnings of ABC= Rs. 300/13 = Rs. 23.08 Crore.
If market value of ABC is allocated to KLM in the proportion of relative earning of KLM to that of ABC, KLM would have a market value of Rs. 300 crore × [10/23.08] = Rs. 130 Crore.
KLM’s Post Tax earning = Rs. 10 Crore.
If ABC’s P/E ratio is applied to it, the market value of KLM becomes Rs. 10 Crore × 13 = Rs. 130 Crore.
Therefore, it assumes that KLM has the same P/E ratio as that of ABC.
Range of valuation:
| Pre synergistic | Rs. 100 Crore | Rs. 136.13 Crore |
| Post synergistic | Rs. 110 Crore | Rs. 149.75 Crore |
Question 14.
Eagle Ltd. reported a profit of ₹ 77 lakhs after 30% tax for the financial year 2011-12. An analysis of the accounts revealed that the income included extraordinary items of ₹ 8 lakhs and an extraordinary loss of ₹ 10 lakhs. The existing operations, except for the extraordinary items, are expected to continue in the future. In addition, the results of the launch of a new product are expected to be as follows:
| (₹ In Lakhs) | |
| Sales | 70 |
| Material costs | 20 |
| Labour costs | 10 |
| Fixed costs | 10 |
You are required to :
(i) Calculate the value of the business, given that the capitalization rate is 14%.
(ii) Determine the market price per equity share, with Eagle Ltd.’s share capital being comprised of 1,00,000 13% preference shares of ₹ 100 each and 50,00,000 equity shares of ₹ 10 each and the P/E ratio being 10 times. [Nov. 2012] [8 Marks]
Answer:
(i) Calculation of value of business
Capitalised value of profits = \(\frac{\text { FMP (after taxes) }}{\text { Rate of capitalisation }}\)
= \(\frac{\text { Rs. } 98 \text { Lakhs }}{0.14}\) = Rs. 700
Value of business = Rs. 700
(ii) Computation of Market Price of Equity Share
| Particulars | (₹) |
| Future maintainable profits (After Tax) | 98,00,000 |
| Less: Preference dividend (13% of Rs. 100 Lakhs) | (13,00,000) |
| Earnings available for Equity Shareholders | 85,00,000 |
| No, of Equity Shares | 50,00,000 |
Earnings per share = \(\frac{R s \cdot 85,00,000}{50,00,000}\) = ₹ 1.70
P/E ratio = 10
Market price per share = EPS × P/E Ratio = ₹ 1.70 × 10 = ₹ 17
Question 15.
XN Ltd. reported a profit of ₹ 100.32 lakhs after 34% tax for the Financial Year 2015-2016. An analysis of the accounts reveals that the income included extraordinary items of ₹ 14 lakhs and an extraordinary loss of ₹ 5 lakhs. The existing operations, except for the extraordinary items, are expected to continue in future. Further, a new product is launched and the expectations are as under:
| Particulars | Amount (Rs. in lakhs) |
| Sales | 70 |
| Material Costs | 20 |
| Labour Costs | 16 |
| Fixed Costs | 10 |
The company has 50,00,000 Equity Shares of ₹ 10 each and 80,000, 9% Preference Shares of ₹ 100 each with P/E Ratio being 6 times.
You are required to:
(i) Compute the value of the business. Assume cost of capital to be 12% (after tax) and
(ii) Determine the market price per equity share. [Nov. 2016] [8 Marks]
Answer:
(i) Calculation of value of business
| Particulars-(D Lakhs) | (D Lakhs) |
| Profit before tax \(\left(\frac{P A T}{1-\text { Tax Rate }}\right)\) i.e. \(\left(\frac{100.32}{1-0.34}\right)\) | 152 |
| Less: Extraordinary income | (14) |
| Add: Extraordinary losses | 5 |
(ii) Computation of Market Price of Equity Share
| Particulars | (Rs. in Lakhs) |
| Future maintainable profits (After Tax) | 1,10,22,000 |
| Less: Preference dividend (9% of Rs. 80 Lakhs) | 7,20,000 |
| Earnings available for Equity Shareholders | 1,03,02,000 |
| No. of Equity Shares | 50,00,000 |
Earnings per share = \(\frac{R s \cdot 1,03,02,000}{50,00,000}\) = ₹ 2.06
P/E ratio = 6 Times
Market price per share = EPS × P/E Ratio = ₹ 2.06 × 6 = ₹ 12.36
Question 16.
The closing price of LX Ltd. is Rs. 24 per share as on 31st March, 2019 on NSE Ltd. The Price Earnings Ratio was 6. It was found that an amount of Rs. 24 Lakhs as income and an extraordinary loss of Rs. 9 lakhs were included in the books of account. The existing operations except for the extraordinary items are expected to continue in future. Further the company has launched a new product during the year with the following expectations:
| (Rs. in Lakhs) | |
| Sales | 150 |
| Material Cost | 40 |
| Labour cost | 34 |
| Fixed Cost | 24 |
The company has 500,000 equity shares of Rs.10 each and 100,000 9% Preference Shares of Rs. 100 each. The Price Earnings Ratio is 6 times. Post tax cost of capital is 10 per cent per annum. Tax rate is 34 per cent.
You are required to determine:
(i) Existing Profit from old operations
(ii) The value of business [May 2019] [8 Marks]
Answer:
Question 17.
Using the chop-shop approach (on Break-up value approach), assign a value for Cranberry Ltd. whose stock is currently trading at a total market price of €4 million. For Cranberry Ltd., the accounting data set forth three business segments: consumer wholesale, retail and general centers. Data for the firm’s three segments are as follows:
Industry data for “pure-play” firms have been complied and are summarized as follows:
Answer:
Average theoretical value = \(\frac{30,55,250+35,70,000+46,75,000}{3}\) = 37,66,750
Average theoretical value of Cranberry Ltd. = ∈ 37,66,750
Question 18.
Calculate the value of share from the following information:
| Profit of the company (After Tax) | ₹ 290 crores |
| Equity capital of company | ₹ 1,300 crores |
| Par value of share | ₹ 40 each |
| Debt ratio of company | 27% |
| Long run growth rate of the company | 8% |
| Beta | 0.1 |
| Risk free Interest rate | 8.7% |
| Market return | 10.3% |
| Capital expenditure per share | ₹ 47 |
| Depreciation per share | ₹ 39 |
| Change in Working capital | ₹ 3.45 per share |
Answer:
No. of Shares = Equity Capital (in Rs.) ÷ Par Value per share
= ₹ 1,300 crores ÷ ₹ 40 each = 32.5 Crores shares
EPS = \(\frac{\text { PAT }}{\text { No. of shares }}\) = \(\frac{\text { Rs. } 290}{32.5}\) = ₹ 8.923
FCFE (Per Share) = Net income – [(1 – b) (CAPEX – Dep.) + (1 – b) (∆ WC)]
= 8.923 – ((1 – 0.27) (47 – 39) – (1 – 027) (3.45)] = 0.5645
Cost of Equity = Rf + β (Rm – Rf) = 8.7 + 0.1 (10.3 – 8.7) = 8.8%
Po = \(\frac{{FCFE}(1+g)}{K_e-\mathrm{g}}=\frac{0.5645(1.08)}{0.0886-.08}=\frac{0.60966}{0.0086}\) = Rs. 70.89
Question 19.
Calculate the value of share of Avenger Ltd. from the following information:
| Profit of the company (After Tax) | ₹ 290 crores |
| Equity capital of company | ₹ 1,300 crores |
| Par value of share | ₹ 40 each |
| Debt ratio of company | 27% |
| Long run growth rate of the company | 8% |
| Beta | 0.1 |
| Risk free Interest rate | 8.7% |
| Market return | 10.3% |
| Capital expenditure per share | ₹ 47 |
| Depreciation per share | ₹ 39 |
| Change in Working capital | ₹ 3.45 per share |
[May 2016] [5 Marks]
Answer:
No. of Shares = Equity Capital (in Rs.) ÷ Par Value per share
= ₹ 1,200 crores ÷ ₹ 40 each = 30 Crores shares
EPS = \(\frac{\text { PAT }}{\text { No. of shares }}\) = \(\frac{\text { Rs. } 300}{30}\) = ₹ 10 per share
FCFE (Per share) = Net income – [(1 – b) (CAPEX – Dep.) + (1 – b) (∆WC)]
= 10 – [(1 – 0.25) (48 – 40) + (1 – 0.25) (4)] = 1.0
Cost of Equity = Rf + β(Rm – Rf) = 8.70 + 0.1 (10.30 – 8.70) = 8.86%
Po = \(\frac{\mathrm{FCFE}(1+\mathrm{g})}{\mathrm{K}_e-\mathrm{g}}=\frac{1.00(1.08)}{0.0886-.08}=\frac{1.08}{0.0086}\) = Rs. 125.58
Question 20.
Tirupti Co. Ltd. promoted by a Multinational group “INTERNATIONAL INC” is listed on stock exchange holding 84% i.e. 63 lakhs shares.
Profit after Tax is ₹ 4.80 crores.
Free Float Market Capitalization is ₹ 19.20 crores.
As per the SEBI guidelines promoters have to restrict their holding to 75% to avoid delisting from the stock exchange. Board of Directors has decided not to delist the share but to comply with the SEBI guidelines by issuing Bonus shares to minority shareholders while maintaining the same P/E ratio.
Calculate
(i) P/E Ratio
(ii) Bonus Ratio
(iii) Market price of share before and after the issue of bonus shares
(iv) Free Float Market capitalization of the company after the bonus shares. [Nov. 2013] [8 Marks]
Answer:
(i) P/E Ratio:
| % of holding | No. of Shares | |
| Promoter’s Holding | 84% | 63 Lacs |
| Minority Holding | 16% | 12 Lacs |
| Total Shares | 100% | 75 Lacs |
Free Float Market Capitalization = ₹ 19.20 crores
Minority Holding = 12 Lacs Shares or 0.12 crores shares
Hence, Market price = \(\frac{\text { Rs. } 19.20 \text { crores }}{0.12 \text { Crores }}\) = ₹ 160 per share
EPS = PAT E No. of shares = ₹ 4.80 crores ÷ 75 lacs = ₹ 6.40 per share
P/E Ratio = Market Price ÷ EPS = ₹ 160 ÷ ₹ 6.40 = 25 times
(ii) No. of Bonus Shares to be issued:
Promoters holding = 84% ie. 63 lacs shares
As per the SEBI guidelines promoters have to restrict their holding to 75%. It means the existing 63 lacs shares held by the promoters shall now constitute 75% of the total number of shares post bonus issue.
Therefore, the Post-Bonus number of shares shall be:
Total number of shares = \(\frac{63 \text { lacs }}{75 \%}\) = 84 lacs
Shares to be held by Minority = Total shares – shares held by promoters
= 84 lacs – 63 lacs = 21 lacs
Existing shares held by Minority = 12 lacs
Bonus shares issued to Minority = 21 lacs – 12 lacs = 9 lacs
Bonus Ratio = 3 shares for every 4 shares held (but these will be issued to minority shareholders only).
(iii) Market price before & after Bonus:
| Market Price Before Bonus | |
| ₹ 160 per share [as per workings given in (i) above] | |
| Market Price After Bonus | |
| PAT (Same as pre-bonus) (A) | ₹ 4.80 crores |
| No. of shares (B) | 84 lacs |
| EPS (After bonus) (A) ÷ (B) | ₹ 5.71 per share |
| P/E Ratio | 25 times |
| Market Price (After bonus) = EPS × P/E = 5.71 × 25 | 142.75 |
(iv) Free Float Capitalization
= Market Price (After bonus) Shares held by minority
= ₹ 142.75 × 21 lacs = ₹ 29.9775 crores
Question 21.
Following information’s are available in respect of XYZ Ltd. which is expected to grow at a higher rate for 4 years after which growth rate will stabilize at a lower level:
Base year information:
| Revenue | ₹ 2,000 crores |
| EBIT | ₹ 300 crores |
| Capital expenditure | ₹ 280 crores |
| Depreciation | ₹ 200 crores |
Information for high growth and stable growth period are as follows:
| High Growth | Stable Growth | |
| (growth in Revenue & EBIT | 20% | 10% |
| Growth in capital expenditure and depreciation | 20% | Capital expenditure are offset by depreciation |
| Risk free rate | 10% | 9% |
| Equity beta | 1.15 | 1 |
| Market risk premium | 6% | 5% |
| Pre tax cost of debt | 13% | 12.86% |
| Debt equity ratio | 1: 1 | 2:3 |
For all time, working capital is 25% of revenue and corporate tax rate is 30%.
What is the value of the firm? [May 2010(M)] [10 Marks]
Answer:
High growth phase:
Ke = 0.10 + 1.15 × 0.06 = 0.169 or 16.9%.
Kd = 0.13 × (1 – 03) = 0.091 or 9.1%.
Cost of capital = 0.5 × 0.169 + 0.5 × 0.091 = 0.13 or 13%.
Stable growth phase:
Ke = 0.09 + 1.0 × 0.05 = 0.14 or 14%.
Kd = 0.1286 × (1 – 0.3) = 0.09 or 9%.
Cost of capital = 0.6 × 0.14 + 0.4 × 0.09 = 0.12 or 12%.
Determination of forecasted Free Cash Flow of the firm (FCFF) (₹ in crores)
Present Value (PV) of FCFF during the explicit forecast period is:
| FCF (₹ in crores) | PVF @ 13% | PV (₹ in crores) |
| 56.00 | 0.885 | 49.56 |
| 67.20 | 0.783 | 52.62 |
| 80.64 | 0.693 | 55.88 |
| 96.77 | 0.613 | 59.32 |
| ₹ 217.38 |
Terminal Value of Cash Flow
\(\frac{375.32}{0.12-0.10}\) = ₹ 18,766 Crores
PV of the terminal, value is:
₹ 18,766 Crores × \(\frac{1}{(1.13)^4}\) = ₹ 18,766 Crores × 0.613 = ₹ 11,503.56 Crores
The value of the firm is:
₹ 217.38 Crores + ₹ 11,503.56 Crores = ₹ 11,720.94 Crores
Question 22.
Following information is given in respect of WXY Ltd., which is expected to grow at a rate of 20% p.a. for the next three years, after which the growth rate will stabilize at 8% p.a. normal level, in perpetuity.
| For the year ended March 31, 2014 | |
| Revenues | ₹ 7,500 Crores |
| Cost of Goods Sold (COGS) | ₹ 3,000 Crores |
| Operating Expenses | ₹ 2,250 Crores |
| Capital Expenditure | ₹ 750 Crores |
| Depreciation (included in COGS & Operating Expenses) | ₹ 600 Crores |
During high growth period, revenues & Earnings before Interest & Tax (EBIT) will grow at 20% p.a. and capital expenditure net of depreciation will grow at 15% p.a. From year 4 onwards, i.e. normal growth period revenues and EBIT will grow at 8% p.a. and incremental capital expenditure will be offset by the depreciation. During both high growth & normal growth period, net working capital requirement will be 25% of revenues.
The Weighted Average Cost of Capital (WACC) of WXY Ltd. is 15%. Corporate Income Tax rate will be 30%.
Required:
Estimated the value of WXY Ltd. using Free Cash Flows to Firm (FCFF) & WACC methodology.
The PVIF @ 15% for the three years are as below:
[May 2014] [8 Marks]
Answer:
Determination of forecasted Free Cash Flow to the Firm (FCFF)(₹ in crores)
Present Value (PV) of FCFF during the explicit forecast period is:
| FCFF (C in crores) | PVF (5) 15% | PV (₹ in crores) |
| 1342.50 | 0.8696 | 1167.44 |
| 1619.62 | 0.7561 | 1224.59 |
| 1953.47 | 0.6575 | 1284.41 |
| 676.44 |
Computation of PV of the terminal cash flows:
= \(\frac{2680.13}{0.15-0.08} \times \frac{1}{(1.15)^3}\) = ₹ 38,287.57 Crore × 0.6575 = ₹ 25,174.08 Crore
The value of the firm is:
= ₹ 3676.44 Crores + ₹ 25174.08 Crores = ₹ 28,850.52 Crores Working Note
Existing CAPEX (Net of Dep.) = ₹ 750 – ₹ 600 = ₹ 150 Crores.
Increase in CAPEX (Year 1) = ₹ 150 × 1.15 = ₹ 172.50 Crores.
Increase in CAPEX (Year 2) = ₹ 172.50 × 1.15 = ₹ 198.38 Crores.
Increase in CAPEX (Year 3) = ₹ 198.38 × 1.15 = ₹ 228.13 Crores.
Question 23.
Mr. X, a financial analyst, intends to value the business of PQR Ltd. in terms of the future cash generating capacity. He has projected the following after tax cash flows:
It is further estimated that beyond 5th year, cash flows will perpetuate at a constant growth rate of 8% per annum, mainly on account of inflation. The perpetual cash flow is estimated to be Rs. 10,260 lakh at the end of the 5th year.
Required:
(i) What is the value of the firm in terms of expected future cash flows, if the cost of capital of the firm is 20%.
(ii) The firm has outstanding debts of Rs. 3,620 lakh and cash/bank balance of Rs. 2,710 lakh.
Calculate the share holder value per share if the number of outstanding shares is 151.50 lakh.
(iii) The firm has received a takeover bid from XYZ Ltd. of Rs. 225 per share. Is it a good offer ?
[Given : PVIF at 20% for year 1 to Year 5 : 0.833, 0.694, 0.579, 0.482, 0.402] [Nov. 2019] [8 Marks]
Answer:
(i) Calculation of Present Value of Cash flows upto 5 years.
Present Value of Cash flows after the forecast period of 5 Years.
= \(\frac{\text { Rs. } 10,260}{0.20-.08}\) × PVF
= \(\frac{\mathrm{Rs} \cdot 10,260}{0.12}\) × .402 = Rs. 34,371
Value of Firm on the basis of Cash Flows
| PV of CF (1-5 Years) | 3054.62 |
| PV of Perpetuity of CF after 5 years | 34,371.00 |
| 37,425.62 |
(ii) Determination of Shareholder value per share
= \(\frac{\text { Rs. } 37,425.62+\text { Rs. } .2,710-\text { Rs. } 3,620}{151.50 \text { lakh Share }}\)
= \(\frac{{Rs} .36,515.62}{151.5}\) = Rs. 241.03
(iii) Since the intrinsic Value of the Share (Rs. 241.03) on the basis of future cash flows in more than the offer price (Rs. 225), it is not a good offer & should not be accepted.
Question 24.
A valuation done of an established company by a well-known analyst has estimated a value of D 500 lakhs, based on the expected free cash flow for next year of D 20 lakhs and an expected growth rate of 5%. While going through the valuation procedure, you found that the analyst has made the mistake of using the book values of debt and equity in his calculation. While you do not know the book value weights he used, you have been provided with the following information:
(i) Company has a cost of equity of 12%,
(ii) After tax cost of debt is 6%,
(iii) The market value of equity is three times the book value of equity, while the market value of debt is equal to the book value of debt.
You are required to estimate the correct value of the company. [Nov. 2010] [8 Marks]
Answer:
Step-1: To ascertain the K0 taken by the water
Value of firm:
V0 = \(\frac{\mathbf{F C F F}_1}{\mathbf{K}_{\mathrm{o}}-\mathrm{g}}\)
Where
= Value of Firm
FCFF1 = Expected FCFF at the end of year 1
K0 = Cost of capital
g = Growth rate till perpetuity
By putting the given values in the above formula:
D 500 lakhs = \(\frac{\text { Rs. } 20 \text { lakhs }}{K_o-0.05}\)
K0 = 0.09 or 9%
Step-2 Determination of book value weights taken by the valuer
New, let X be the weight of debt taken bv the valuer.
Then, (1-X) must be the weight of equity.
It is given that the cost of equity = 12% and cost of debt (after tax) = 6%. Therefore,
12% (1 – X) + 6% (X) = 9%
Hence, X = 0.50, so book value weight for debt was 50%. It means equal proportion of debt and equity has been taken by the valuer.
Step-3 Determination of Market value weights
The market value of equity is 3 times the book value and that of debt is equal to book value. The book value weights are 0.5 for both. The calculation of market value weights can be done in the following manner:
Step-4 Determination of correct KQ based on market value weights
Cost of capital = K0 – 12% (0.75) + 6% (0.25) = 10.50%
Step-5 Correct Value of the firm
Correct firm’s value = V0 = \(\frac{\mathbf{F C F F}_1}{\mathbf{K}_{\mathrm{o}}-\mathrm{g}}\) = \(\frac{\text { Rs. } 20 \text { lakhs }}{0.105-0.05}\) = ₹ 363 64 lakhs
Question 25.
The valuation of Hansel Limited has been done by an investment analyst. Based on an expected free cash flow of D 54 lakhs for the following year and an expected growth rate of 9 per cent, the analyst has estimated the value of Hansel Limited to be D 1,800 lakh. However, he committed a mistake of using the book values of debt and equity.
The book value weights employed by the analyst are not known, but you know that Hansel Limited has a cost of equity of 20 per cent and post-tax cost of debt of 10 per cent. The market value of equity is thrice its book value, whereas the market value of its debt is nine-tenths of its book value. What is the correct value of Hansel Ltd? [Nov. 2014] [6 Marks]
Answer:
Step-1 To ascertain the Kg taken by the Valuer
Value of firm
V0 = \(\frac{\mathbf{F C F F}_{\mathbf{1}}}{\mathbf{K}_{\mathbf{0}}-\mathbf{g}}\)
Where
V0 = Value of Firm
FCFF1 = Expected FCFF at the end of year 1
K0 = Cost of capital
g = Growth rate till perpetuity
By putting the given values in the above formula:
D1, 800 lakhs = \(\frac{\text { Rs.54 lakhs }}{K_o-0.09}\)
K0 = 0.12 or 12%
Step-2 Determination of book value weights taken by the Valuer
New, let X be the weight of debt taken by the valuer.
Then, (1 – X) must be the weight of equity.
It is given that the cost of equity = 20% and cost of debt (after tax) = 10%. Therefore,
20% (1 – X) + 10% (X) = 12%
Hence, X = 0.80, so book value weight for debt was 80%. It means 80% and 20% of debt and equity have been taken by the valuer.
Step-3 Determination of Market value weights
The market value of equity is thrice its book value and that of debt is equal to nine-tenth of its book value. The book value weights are 0.8 for debt and 0.2 for equity. The calculation of market value weights can be done in the following manner:
Step-4 Determination of correct Kg based on market value weights
Cost of capital = K0 = 10% (0.5455) + 20% (0.4545) = 14.545%
Step-5 Correct Value of the firm
Correct Value of the firm = V0 = \(\frac{\mathrm{FCFF}_1}{\mathbf{K}_0-\mathrm{g}}\) = \(\frac{\text { Rs. } 54 \text { lakhs }}{0.14545-0.09}\) = ₹ 973.85 lakhs.