VALUATION OF BUSINESS

Q1

Valuation of business
Net assets method Mkt. value of assets Mkt value of liabilities
STATEMENT OF NET ASSETS
Land and building
Plant and Machinery
Investments
Stock
Debtors
Cash and bank
Creditors
Net Assets
No. of shares
NAV per share

96
100
10
20
15
5
(30)
216
10
21.6

Profit earning capacity or earning capitalization method capitalized future

maintainable profits
Statement of Future Maintainable profits
Current years operating profit
64
- extraordinary income
(4)
- Income from investments likely to recur
(1)
- Additional investment expenses
(5)
-Additional depreciation
(6)
Future maintainable profit before tax
48
Future maintainable profit after tax
33.6

Value on the basis of operating assets

33.6

0.15

224

Total value of shares = value as per operating assets + non operating assets
224 + 10 (investments)
=

234

Value per share as per earning capitalization method =

Value of share on the basis of fair price method

234
10

= 23.4

23.4

+ 21.6
2

= 22.5

Q2

Current value of business is capitalised value of all future maintainable profits

Statement of FMP

b.

PAT
PBT
Extrordinary income
Extraordinary exp
Income of new project
FMP before tax
Tax 35 %
FMP after tax

65
100
(10)
3
27
120
42
78

Value of business

78
0.15

FMP
Pref dividend
Profir for equity
No. of shares
EPS
MP

Q3

= 520

78
(11)
67 lac
40 lac
67
= 1.675
40

= EPS X PE
=
1.675 x 8
=
13.4

Range of valuation of company refers to Maximum and minimum value of business

Minimum value of business means premerger value of business i.e 1.5 cr x 400
600 cr
Maximum value of business is present value all future cash flows
1
250
0.893
223.25
2
300
0.797
239.1
3
400
0.712
284.84
747.15

Q4

Par value per share

Equity share cap
Number of shares
PAT
PAT per share

40 / sh
1300 crore
1300 / 40
=
290 crore
290 / 32.5
=

=
=
=
=
=

32.5 crore shares

8.92 / share

Value per share is PV of all future FCFE

FCFE

= PAT ( 1 - + )( CE depn + ch in WC)

= 8.92 (1 0.27) (47 -39 + 3.45)
= 0.5615
2

= RF + E (RM - RF)

Ke

= 8.7 + 0.1(10.3 8.7)

= 8.86 %
Value of share

=
=

Q5

1

0.5615 (1.08)
0.0886 0.08

= 70.51 / sh

Balancesheet for 2008

8% debentures
10% Bonds
Equity shares
Reserves & surplus
Short term loan (B/f)

125
50
100
300
25

a. Asset turnover ratio

Assets
Sales
Operating margin

assets

1.1
(sales / assets)
600
600 x 1.1 = 660
10% of 660 = 66
Income statement
66

EBIT

PAT
Interest
8% of 200
Profit for equity share holders
b. G = b.r
Retention ratio = b

R = Roe

= ( 1 d/p ratio)
= ( 1 0.1667)
= 0.8333

+ &
23.60

100+300

=
G

39.60
16
23.60

5.9%

=
=

0.8333 x 5.9
4.91%

600

c.

P0

Profit for equity = 23.6 lac

No. of shares
= 10 lac
Profit per share = 2.36
Div per share
= 2.36 x 0.1667
= 0.393
0.393 (1.049)

0.15 0.049

= 4.09

d. Fair price of share is Rs 4.09

Current market price = 14
Since current market price is more than fair price, share is overpriced.
So investment should not be made in such shares.
Q6

Statement of free cash flows

1
2
3
EBIT
360
432
518
EAT
252
302
363
+depn
240
288
346
- CE
336
403
484
- Ch in WC 100
120
144
56
67
81
Overall cost of capital for 1st 4 yrs
Ke
= RF + E (RM - RF)
= 10 + 1.15(8.8)
= 20.12
Kd
= 13% (1 0.3)
WACC

= WEKE + W DKD
= 0.5 x 20.12 + 0.5 x 9.1
= 14.6
Overall cost of capital from 5th year
Ke
= RF + E (RM - RF)
= 9 + 1(8.8)
= 17.8
Kd
= 12.86 ( 1 0.3)
WACC
= WEKE + W DKD
= 3/5 x 17.8 + 2/5 x 9.002
= 14.28%

4
622
435
415
581
173
96

5
684
479
104
375

Statement of value of firm

Year

Cash flow

factor

PV

56

0.873

49

67

0.761

51

81

0.664

54

96

0.580

56

375

0.1428 0.10

= 8761 0.580

5082
5292

Q7

Analysis
a. This ques requires to ascertain Value of company or firm but further ask to
determine MP of share is correct or not.
Value of co = Value of equity + value of debt
From value of firm we vl deduct value of debt to get value of equity
b. Current value of firm is present value of all future free cash flows
But while computing value of firm we assume debt is not repaid i.e debt equity
ratio is maintained. However this ques mentions 30% debt is repaid in
2014(5th yr). it will be taken as normal cash outflow in 5th year and from 2015
ie 6 th year debt equity ratio will change so will WACC.

Statement of computation of tax rate

EBIT
Interest
EBT
PAT (given)
Tax paid
Rate of tax
Rate of interest on debt

245 lac
218.125 lac
26.875 lac
17.20 lac
9.675 lac
9.675/26.875 = 36%
218.125

1934

= 11.28%

Statement of WACC
WACC till 2014
=

=
WACC from 2015

=
WEKE + W DKD
75 66
x 16 +
4650 +1934

13.54%
=

WEKE + W DKD
5

1934
4650+1934

x 11.28(1-0.36)

75 66
4650 +1353.8
14.42%

x 16

1934

4650+1353.8

x 11.28(1-0.36)

Annual cash flows from 2015 are given

EBIT
PAT
Inc in Working cap
Debt repayment
FCFF

Statement of Free cash flow of firm

10
11
12
264.6
285.77
308.63
169.344
182.89
197.52
3.52
3.80
4.11
165.824
179.09
193.41

13
333.32
213.32
4.43
208.89

14
360
230.39
4.79
580.2
-354.6

Statement of value of firm

Year
2010
2011
2012
2013
2014
2014

Cash flows
165.824
179.09
193.41
208.89
-354.6
240.336
0.1442 0.06

Factor
0.8807
0.7757
0.6832
0.6017
0.53
0.53

PV
146.10
138.97
132.10
125.75
-187.93
1512.735
867.725

Value of equity

=
=
=

Value per share

value of company outstanding debt

867.725 - 1353.80
513.925 lac
513.925 / 75 =

6.852

Value determined 6.852 is lower than actual MP of share, so share is overvalued

Q8
EBIT
Tax (35%)
PAT
+Depn
Less CE

02
500(1.09)
= 545
190.75
354.25
200(1.09)
= 218

218(1.09)
= 237.62

237.62(1.09)
= 259

300(1.09)
= 327

327(1.09)
= 356.43

356.43(1.09) 388.51(1.09) 423.48(1.09)

= 388.51
= 423.48
= 461.59

7000(1.09)2
(0.2)-1526

7000(1.09)3
(0.2)-1663.4

= 137.34

= 149.6

= 163.17

= 177.86

= 86.17

129.95

141.74

154.39

168.27

433.83

Less Ch in WC 7000(1.09)
(0.2)-1400
= 126

FCFF

Statement of Free cash flow of firm

03
04
05
06
07
545(1.09)
594(1.09)
647.46(1.09) 705.73(1.09) 769.25(1.04)
= 594
= 647.46
= 705.73
= 769.25
= 800
207.9
226.61
247
269.25
280
386.1
420.85
458.73
500
520

119.25

259(1.09) 282.31(1.09)
= 282.31
= 307.72

7000(1.09)4
(0.2)-1813.04

CE = Depn

CE = Depn

7000(1.09)5 7000(1.09)5(1.04)
(0.2)- 1976.21 (0.2) 2154.07

Overall cost of capital from 2002 2006(5 yrs)

Ke
= RF + E (RM - RF)
= 7 + 1.2(5.5)
= 13.6
Kd
= 10%
WACC

= WEKE + W DKD
= 0.5 x 13.6 + 0.5 x 0.10(1 0.35)
= 10.05%
Overall cost of capital from 2007
Ke
= RF + E (RM - RF)
= 7 + 1(5.5)
= 12.5
Kd
= 9%
WACC
= WEKE + W DKD
= 0.75 x 12.5 + 0.25 x 0.10(1 0.35)
= 11%
Value of firm = PV of all future free cash flow of firm.
Year
1
2
3
4
5
65

FCFF
119.25
129.95
141.74
154.39
168.27

PV
108.40
107.34
106.31
105.14
104.16

0.619

3836.30
4367.65

433.83
0.110.04

= 6197.57

Q10

Factor
0.909
0.826
0.750
0.681
0.619

value of firm according to book value weights

FCFF1
G

=
=
=

Value of firm is present value of all future free cash flows

Po

750lac =
WACC =

30
0.05
30
+ 0.05
750

= 9%
WACC
9
X

= WEKE + W DKD
= x (12) + (1-x) 6
=
0.5
7

750 lac
30 lac
5%

Market value of equity = 3 Book value of equity

=
3 x 0.5
=
1.5
Market value of debt =
Book value of debt
=
0.5
WACC (Mkt value)
= WEKE + W DKD
1.5
0.5
x 12 +
x6
2

=
Po

30

=
Q11

a.

d0
EPS
MP

=
=
=

8.5
27.50
210.20

8.5 ( 1.075)
0.125 0.075

182.75

Fair price to BV ratio =

182.75

545.45

g = 7.5%
RF = 12.5%
BV = 130.55

0.105 0.05

Po

b.

10.5

= 1.40

130.55
210.20
130.55

= 1.61
0

1.4

1.4(0.05)

(1)(1+)

27.5 8.5
27.5

= 0.691

(10.691)(1+0.075)
0.125 0.075

ROE x 0.3322

ROE acc to fair price

0.2107

ROE according to existing price

0

1.61

(1)(1+)

(10.691)(1+0.075)
0.125 0.075

ROE

0.2423

Increase in ROE to justify existing price to BV ratio of 1.61 =

0.2423 0.2107

x 100 = 15%

0.2107

Q12

a.

Statement of PV of FCFF
Year
1
2
3
4
5

FCFF
213(1.15) = 245
245(1.15) = 281.75
281.75(1.15) = 324.01
324.01 (1.15) = 372.61
372.61(1.15) = 428.50
428.5 (1.05)

65

0.090.05

= 11,248.13

Factor
0.917
0.842
0.772
0.708
0.650

PV
224.665
237.23
250.14
263.81
278.53

0.650

7311.29
8565.665

b.

Q13

a.

value of firm

=
PV of FCFF
(PV of operating profit)
=
8575 + 650
=
9225

+
PV of non operating profit
(PV of future intt from market sec)

Value of firm
9225
VE

=
=
=
=

Ke

= RF + E (RM - RF)
= 6.25 + 1.05 (5.5)
= 12.025

Po

=
=

b.

Value of equity
VE + 2600
9225 2600
6625

Value of debt

1

1.7 ( 1+0.07)
0.12025 0.07

= 36.20

Value per share is PV of all future FCFE

FCFE = PAT ( 1 -

)( CE depn + ch in WC)

= 3.20 ( 1 = 3.2 (

1600

1600 + (160 51)

9760 1600
9760

) (0.78125)

= 2.55 / share
Value per shar =
=

1

2.55 (1.07)
0.12025 0.07

Value per share = 54.30

9

2.7285
0.05025

475

350

) ( 160 - 160 )

c.

Q14

under a dividend discount model, future dividends payable to equity are capitalized to
determine current market price i.e total earning or EPS is not discounted for
determination of Market price.
Under FCFE method total cash flow available for equity is discounted to determine
current market price.
Market price according to FCFE shall be considered as a benchmark to compare with
actual market price.
P0
=
38.5
EPS
=
1.36
DPS
=
0.64
PE
=
28.3
Price/BV
=
7.1
Price/sales
=
2.9
ROE
=
27%
Profit margin on sales
Rf
Rm Rf

=
=
=
=

10.9%
4.9%
5.5%
1.2

a. According to CAPM
Required return on equity
= RF + (RM - RF)
= 4.9 + 1.2 ( 5.5%)
= 11.5%
b. g = 9%
PE ratio

=
=

=
=

=
P/B ratio

=
=

( 0 )

Po

( 1+)(1)

( 1+0.09)( 0.47)
0.115 0.09

20.49
(1)(1+)

0.27 ( 0.47)(1.09)

5.53

10

0 ( 1+)(1)

0.115 0.09

EPS = 1.36

Div = 0.64
D/P ratio (1-b)=

0.64
1.36

0.47

If ROE is based on expected earnings of next time period

PB ratio can b calculated as
PB ratio

P/S ratio

=
=

=
=
=
b.
PE ratio
PB ratio
P/S ratio

0 ( 1+)(1)

( 1+)(1)

( 1+)(1)

0.109 (1.09)(0.47)
0.115 0.09
0.05584
0.025

= 2.2336

Statement of evaluation
existing
Required
28.3
20.49
existing > required = under
7.10
5.53
existing > required = under
2.90
2.2336 existing > required = under

Thus according to PE ratio and PB ratio and PS ratio, security is underpriced

Q16
S. Capital
Reserves
L.T.Loan
ST.Loan
Creditors
Provisions

Balance sheet
2002 2003
200 1080
Fixed assets
140
Stock
360
Debtors
200
Cash / Bank
120 144
80
96
1100 1320

Amount of finance =
=
=
Revised sales value =
For 2003
Profit for 2003
=
Dividend
=
Retention
=

2002
500
300
240
60

2003
600
360
288
72

1100 1320

Revised Eq & Debt Existing Eq & Debt

1080 - ( 200 + 140 + 360 + 200)
180
600 x 120% =
720 lac
720 x 4%
=
50% of profit =
14.40

11

28.80
14.40

Amount of External Finance = Total finance Addition to retained earnings

=
180 14.4 =
165.6
Current ratio

1.33

Revised ST loan

Additional ST loan =

144+96+

301.35
Revised Existing

301.35 200

101.35

600

Revised LT loan
Additional LT loan

External finance

. + .
360 +288+72

1.5

1.5

400

=
=
=

Revised - Existing
400 360
40

165.60

Additional ST Loan + Additional LT loan + Additional EQ = 165.60

101.35 + 40 + Additional Eq = 165.60
Additional Eq

=
Q17

24.25
360 +40
200+140+14.4+24.25
400
378.65

= 1.05

Statement of free cash flow

Sales
Less : COGS
EBIT
Tax
Free cash flow

12

Alpha

Beta

96,000
72,000
24,000
9600
14,400

48,000
28,800
19,200
7680
11,520

Value of firms before merger

alpha

14,400 (1.04)
0.10 0.04

Beta

11,520 (1.06)

0.120.06

Combined value of firm with no synergy =

= 2,49,600
= 2,03,520

4,53,120

Value of firm with synergy effect on combining the two firms, the cost of goods
sold is reduced from 70% to 65% of sales.
sales of combined firm
Cost of goods sold

= Rs 96,000 + Rs 48,000 =
= Rs 1,44,000 x 0.65
=

WACC of combined firm

0.10 x

2,49,600
4,53,120

Rs 1,44,000
Rs 93,600
2,03,520

+ 0.12 x 4,53,120 = 11%

Weighted average expected growth rate for the combined firm

=
0.04 x 0.550847 + 0.06 x 0.4491525
=
0.022 + 0.027
=
5%
Statement of Free cash flow
Firm with no synergy
1,44,000
1,00,800
43,200
5%
11%
25,929

Sales
COGS
EBIT
G
Cost of cap
Free cash flow EBIT x (1 0.4)

Q19

Value of firm without synergy

Value of firm with synergy

Financial leverage

1.4

1.4

25,920 (1.05)
0.110.05
30,240 (1.05)
0.11 0.05

1.4

EBIT
= 1.4 EBIT - 1.4 x 40
0.4 EBIT = 56
EBIT
= 140
WACC

= WEKE + W DKD
170 + 130
400
= 300 + 400 17.5 + 700 x 10 (1 0.3)
= 11.5
13

Firm with synergy

1,44,000
93,600
50,400
5%
11%
30,240
= 4,53,600
= 5,29,200

EVA

Q20

c.

EBIT (1 tax rate)

140lac (1 0.3) -

0.115 x 700 lac

17.5 lac

WACC x Total Investment

WACC

WEKE + W DKD

Orange

0.2 x 26 + 0.8 x 16(1 0.35)

13.52

Grape

0.5 x 22 + 0.5 x 13 (1 0.35)

15.225%

Apple

0.2 x 20 + 0.8 x 15 (1 0.35)

17.95%

EVA

EBIT (1 tax rate)

Orange

25,000(1 0.35) 0.1352 x 1,00,000

2,730

Grape

25,000 (1 0.35) 0.15225 x 1,00,000 =

1,025

Apple

25,000 ( 1 0.35) 0.1795 x 1,00,000

- 1700

WACC x Total Investment

Since EVA of orange is highest and its WACC is lower, so orange is considered as
best investment

d.

Statement of EPS
Orange

Grape

Apple

EBIT

25,000

25,000

25,000

Interest

12,800

6,500

3,000

EBT

12,200

18,500

22,000

EAT 65%

7930

12,025

14,300

Shares

6100

8300

10,000

EPS

1.3

1.45

1.43

14.3

15.94

15.73

1,32,302

1,57,300

MP
E

EPS X PE

Market cap(MP x No. of sh) 87,230

Q21

Statement of EBIT
PAT
PBT 15 / 0.6
Interest
EBIT ( 25 lac + 15 lac)

EVA

EBIT (1 tax rate)

14

15 lacs
25 lac
15 lac
40 lac

WACC x Total Investment

=
=
=

40 lac x 0.6 0.126 x 100,00,000

24,00,000 12,60,000
11,40,000

Cost of funds of Delta Ltd is 12.6%, i.e on total capital employed of 10,00,000
delta has to yield 12,60,000 to keep its market value unchanged. Thus capital
employed should remain 10,00,000
Company has surplus funds of 11,40,000, which company can use either to
pay dividend to shareholders or can be reivested to increase earnings.
Maxmum dividend co. can pay without affecting existing cap employed and
affecting value of firm is 11,40,000 / 2,50,000 = 4.56/share
If dividend is not paid additional funds of can be use to earn higher returns
next year
Q22

Surplus cash
Distributed
a.
.

=
=

100 lacs
27% of 100 lac

27 lac

Market cap after buyback = No. of shares after Buyback x MP after

buyback
210 lac

210 lac
239.7 lac
X

( 10,00,000 =
=
=

b.

No. of shares bought

c.

EPS after buyback

=
=

27,00,000

) 1.1x

11 lac x 29.7 lac

11 lac x
21.79
27,00,000
21.79

= 1,23,910 shares

.
10 3
10,00,0001,23,910

= 3.424

After buyback EPS per share is increased by 0.424/3 = 14.13%

Q23

EVA

EBIT (1 tax rate)

WACC x Total Investment

Statement of total investment

Working capital

20 lac

Property, plant and equipment

80 lac

Patent rights

40 lac

EVA =
=

12 - (0.15 x 140)
9 lac
15

140 lac

Q24

Same as 21

Q25

same as 10

Q26 Cost of advertisement, benefit of which will last for 3 years has been completely
written off.
Statement of profit
Operating profit

20,20,00,000

+ Advertisement exp of coming 2 years 2,00,00,000

22,20,00,000
Capital invested
84,00,00,000
EVA

=
=
=
=

EBIT (1 tax rate) - WACC x Total Investment

22,20,00,000 - 84 crore x 0.11
22.2 crore 9.24 crore
12.96 crore

16