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Paper: Applied Finance Code: 474A

General Instructions:

 The Student should submit this assignment in the handwritten form (not in the typed format)

 The Student should submit this assignment within the time specified by the exam dept

 The student should only use the Rule sheet papers for answering the questions.

 The student should attach this assignment paper with the answered papers.

 Failure to comply with the above Four instructions would lead to rejection of assignment.

Specific Instructions:

 There are four Questions in this assignment. The student should answer all the four questions. Marks
allotted 100.
 Each Question carries equal marks (25 marks) unless specified explicitly
Question No 1.

Mr. Kiran started at the paper in front of him. He has just finished projection for his startup company Export dotcom
Pvt Ltd. He was in need of money and intend to use his valuations for this purpose. He was almost convinced that he
would be able to influence leaders about the potential of this start up firm in online- export documentation. However,
he was not sure about whether the lenders would accept his valuations. He considered the options in front him.

He considered his projections to be reasonable, although he guessed that he only had a 30% chance of hitting those
numbers and an equal 30% chance of achieving half of the projected cash flows. He is also aware that there is a
relatively high probability (40%) of not getting any cash flow at all.

In estimating cash flow, Kiran thought that he would only need 5 million in cash to run the business. Anything above
Rs.5 million would be considered as excess cash. Because the firm was just getting off the ground, there was no
working capital and no fixed assets at the beginning of 2002. Any working capital and net fixed at the end of the year
2002 would be a net investment.

Mr. Kiran has made projections for the next six years (Exhibit I) and he thought that after sixth year the net earnings
firm is expected to grow at round 7% per year, although he wondered what a somewhat more modest growth rate is
of 4% would do the expected value of the firm.

Mr. Kiran thought if approaching venture capitalists too for raising money. He is fully aware that traditional lending
institutions are averse to lending in his kinds of business. But he was aware that venture capitalists are always
skeptical about any projections made by the prospective borrower and hence he has decided to show only the best
case projections to the venture capitalists. He approached one venture capitalist with his cash flow projections and
the venture capitalists has flatly said that they would require a 51% rate if return on their investment in his type of
firm.

Mr. Kiran knew that he would not be taking on any debt for the foreseeable future. However, he was wondering how
being an all equity firm would affect his cost of capital. The long-term equity risk premium is around 7.5%.
However, illiquid stocks carry 100 basis point more premium. Current 364-day treasury bills yield 7% on an
effective annual rate. A friend of Kiran has suggested that Export Dotcom might be able to take on debt later once it
has stabilized.

Kiran knew that in order to value a startup, he has to gather information on existing pure players or at least
comparable firms. He found that three publicity traded firms directly comparable to his kind of business (pure
players) (Exhibit 2). He wondered how he should use this information in determining value of his firm. The
following questions came to his mind:

(a) Should he use beta of these publicity trade firms? What about the fact that he was
still private?

(b) What is the value of the firm based on discounted cash flows. (use market value
weighted beta of the pure players )

(c) Does venture capital method valuation give any better insight? (Use average P/E
multiple-equity weighted)

Help Mr.Kiran find answer to these questions. (Refer Exhibits 1&2 given below):

Exhibit 1: Projected Financials (best case) of Export Doctom Pvt. Ltd.


(Figs in ‘000s)

2000 2003 2004 2005 2006 2007

Income Statement
Net Sales 42,50 75,000 1,77,500 2,30,000 2,60,000 3,00,000
Cost of goods sold 0 28,000 70,000 90,500 1,00,500 1,22,500
Selling and general 16,00 27,050 32,000 26,500 36,000 39,000
admn. Exp 0 12,500 20,500 27,000 32,500 35,000
R & D expenses 17,50 7,450 55,000 86,000 91,000 1,03,500
EBIT 0 2,607.5 19,250 30,100 31,850 36,225
Tax (35%) 5,500 4,842.5 35,750 55,900 59150 67275
Net earnings 3,500
1,225
2,275

Balance Sheet
Cash 5,000 5,000 23,965 69,535 1,23,495 1,85,210
Accounts receivable 7,085 12,500 29,585 38,335 43,335 50,000
Inventories 2,000 3,500 8,750 11,315 12,562 15,315
Other 1,770 3,125 7,400 9,585 10,835 12,500
Net fixed assets 4,530 11,500 16,000 20,000 21,500 22,500
Total assets 20,38 32,625 85,700 1,48,770 2,11,730 2,85,525
Accounts payable 5 4,665 11,665 15,085 16,750 20,415
Accrued expenses 2,665 5,355 12,680 16,430 185.70 21,430
Net worth 3,035 25,605 61,355 1,17,255 1,76,405 2,43,680
Total liabilities and 14,68 35,625 85,700 1,48,770 2,11,725 2,85,525
net worth 5
20,38
5

Exhibit 2: Financial details of pure players for the year 2001


(firs. in Rs.lakhs)
Player 1 Player 2 Player 3

Net
earnings
26.35 108.75 7.5
Debt
35.9 34 0.85
Net worth
60.5 1056 187.8
1.4 1.3 1.2
Equity
20 37 20
beta
P/E Ratio

Question No 2.

Discuss various aspects of computation of Economic Value Added and its application in business planning and
Valuation

a) Estimate the brand value of the following information technology firm:

(Rs. in crores)

Year Ended March 31, 2001 2000 1999

PBIT 696.03 325.65 155.86


Non- branded income 53.43 35.23 3.46
Inflation Compound factor @8% 1.000 1.087 1.181
Remuneration of Capital
(5% of average capital employed) 55.57
Tax @ 39.55% 158.58
Multiple applied 22.186

Question No 3:

The Cement industry has been through a very trying period in the last five years and the constraints on operations
have been removed in the early part of the year. The company hopes to improve its position in the years to come and
has plans to put up an additional plant in the neighborhood of the present factory. Increased profits due to expansion
in capacity are expected to be 25% of the additional capital investment after meeting interest charges but before
depreciation on the additional plant installed. Shares of this Cement company are widely distributed and there is a
large majority of holdings in the hands of middle class investors whose average holding do not exceed 500 shares.
The following data is also made available to you:

Last five years:

Particulars 1997-98 1998-99 1999-2000 2000-01 2001-02 2002-03 (current yr.)

Earning per share (Rs.) 6.00 5.00 4.50 4.50 4.00 17.50

Cash availability per share (Rs.)


7.50 6.00 5.00 4.00 4.00 20.00

Dividend /Share (Rs.) 3.00 3.00 3.00 2.00 Nil ?

Payout ratio (%) 50.00 60.00 67.00 45.00 Nil ?

Average Market price (Face value Rs.100)


80.00 70.00 70.00 70.00 60.00 150

P/E ratio 13.33 : 1 14 : 1 15.6 : 1 15.6 :1 15 : 1

Cement Company requires you to advise them with respect to the dividend policy they have to follow for the current
year. What recommendations would you make? Give reasons for your answers.

Question No 4.

a) Nimbus Ltd. has 1,000 shares of Rs. 10 each raised at a premium of Rs. 15 per share. The company's
retained earnings are Rs. 5,52,500. The company's stock sells for Rs. 20 per share.

If a 10% stock dividend is declared how many new shares would be issued? What would be the
market price after the stock dividend? How would the equity account change?

If the company instead declares a 5 : 1 stock split, how many shares will be outstanding? What would be
new par value? What would be the new market price?

Suppose if the company declares a 1 : 4 reverse split, how many shares will be outstanding? What would
be the new par value? What would be the new market value?

b) Discuss three ways a firm can increase its ROE. Make up an example to illustrate your discussion

c) It is widely known that Retail companies have low profit margins—on average they earn about 1 percent
on sales. How would you explain the fact that their ROE is about 12 percent? Does this seem logical?