FINANCIAL MANAGEMENT Prof K K Jindal

E1

Shobha Remedies is manufacturer of Gelatine capsules the demand for which at current price level is in excess of its ability to produce. The capacity of a particular machine is, now due for replacement, is limiting factor on productionThe possibilities exist either of acquiring a similar machine[Machine X]or of purchasing amore expensive machine with greater capacity[Machine Y]The company’s opportunity cost of capital is 10% after tax. The cash flow under each alternative have been estimated as underRs in lakhsCash flow year Machine X Machine Y Immediate outflow

0 27 40

Cash inflow 1 - 102 05 143 22 164 14 175 14 15

PVs @10% are1.00,0.91,0.83,0.75,0.68,0.62 for year 0,1,2,3,4,5 respectively

In deciding between the two alternatives, the MD of the company favours Payback method. The chief Accountant, however,that a more specific method should be used and he has calculated for each MachineA]the net present valueB]the profitability indexC] the discounted payback period Having made these calculations,he finds himself still uncertain about the machine to recommend

Assignment:

You are required to make these calculations and discuss their relevance to the decision to be taken

E 2

Vikas Ltd desire to acquire a DG Set costing Rs 20 lacs which has an economic life of 10 years with no residual value. The company is considering A] taking the DG Set on lease. Lessor requires the asset to be amortised in 10 years and a return of 10%B] purchasing the asset by raising loan@ 16%C] income tax rate is 50%

Straight line method of Depreciation is adopted

The present value discount factors over the number of years are given

Year 8% 10% 16%

1 0.91 0.91 0.86

2 1.78 1.74 1.60

       

3 2.58 2.49 2.25

4 3.31 3.17 2.80

5 3.99 3.79 3.27

6 4.62 4.35 3.68

       

7 5.20 4.87 4.04

8 5.75 5.33 4.34

9 6.25 5.76 4.61

10 6.71 6.14 4.83

       

Assignment:

What will be your financial advice to the company?E 3

Progressive industries Ltd , manufacturers of special purpose machines have 2 divisions which are periodically visited/assisted by visiting team of consultants on long term basis. The management is worried about the steady increase of expenses in this regard over the years. An analysis of the last year expenses is as under. The company proposes to set up a Guest house/centre which can provide facilities to consultants .The centre will additionally save the company Rs 50,000 in boarding charges and Rs 2,00,000 in the cost of Executive training programmes conducted outside the company’s premises every year

Consultant remuneration Rs 2,50,000Travel and conveyance Rs 1,50,000Accommodation expenses Rs 6,00,000Boarding charges Rs 2,00,000Special allowances Rs 50,000Accommodation expenses Rs 2,00,000+

annually

The following details are available regarding construction and maintenance of the Centre

A] Land: a t cost of Rs 800,000, already owned by the company will be usedB] construction cost: Rs 15,00,000 including fittings/furnishingsC] cost of Annual maintenance: Rs 1,50,000D] construction cost twill be written off over 5 years being the useful life

The company’s hurdle rate is 15%.Tax rate is 50% and write off of construction cost will be available for tax purposes

The relevant PV Factors are

Year 1 2 3 4 5PV Factor 0.87 0.76 0.66 0.57 0.50

Assignment:

Examine the feasibility of the proposal and make recommendations

E 4

The following financial data relate to Lakme Ltd a cosmetic and personal care Products Company in the TATA group of companies

Financial data for the year ending on 31st March,20X1 and 20X2[Rs in lakhs]

Financials 20X1 20X2Revenue 6561 9773Operating profit[EBITDA]

625 839

Depreciation 88 115Interest 216 376Tax 0 65Share capital 316 316Reserve & surplus 1130 1264LT Borrowings 1473 1530Gross fixed assets 1336 1589EPS 10.17 8.97DPS 5.0 5.0

Assignment;

Comment on Lakme’s performance

E 5

Calculate MPBF under Method II for Ritu Enterprises Ltd from the following details

LIABILITIES Rs in Lakhs ASSETS Rs in Lakhs

Trade Creditors 100 Raw materials 150

Other creditors 50 Work in progress 20

Bank borrowings 200 Finished goods 80

Term liabilities 250 Sundry Debtors 50

Reserves 50 Fixed assets 300

NWC as per last audited BS: Rs 95 lakhs

MIS Department of The Progressive Bank has submitted the following Statistics from which you are required to estimate the likely Capital Funds required by the Bank as of March, 31st, 2010 taking into account the Basel II implementation compliance.i) Risk-Weighted Assets for Credit Risk is to be calculated as per table given below.ii) Capital Allocation for Market Risk to be Rs.200 croresiii) For Operational Risk following Data available. The bank is required to calculate Capital Charge for Operational Risk by Basic Indicator Approach.Year 31-03-2007 31-03-2008 31-03-2009Net Profit 5200.00 6000.00 6800.00 (Amount Rs in Crores)Capital Adequacy prescription of RBI as applicable to Indian Banks has to be considered for calculation. The bank’s present Capital [T1+T2] aggregates to Rs 11000 croresAsset Rating Amt. Rs in Crores Risk weight

prescribed by Supervisor

Loan to cooperates AAA 40000 20%A+ 70000 30%A 10000 50%

Loan to state Government

16000 0%

Retail 32000 75%Loan to SME [Rs 1600 crores covered by CGTSME]

3600 100%

E 6

Vikas Ltd has the following financials

Balance Sheet as on 31st March,2009Liabilities Amount[in Rs] Assets Amount[in Rs]Paid up Share capital[50000shares]

3,00,000 Land, Building, Machinery

3,50,000

Long term debt 1,00,000 Inventory 65,000Sundry Creditors 80,000 Sundry Debtors 60,000Other current liabilities

20,000 Cash/bank balance 25,000

5,00,000 5,00,000 Income StatementSales Rs 9,00,000

Cost of goods sold Rs4,00,000General, administrative &selling expenses Rs1,00,000Other expenses Rs2,50,000

EAT Rs1,50,000

Calculate1] Current liabilites2]Current assets3]Current ratio4]Net working capital5] operating cycle6] Market price if PE ratio is 8

E 7

With the help of the following information, complete the Balance Sheet of Tushar Enterprises

Owners equity Rs 100,000Current Debt to Total Debt 0.40Total Debt to Owners Equity 0.60Fixed Assets to Owners Equity 0.60Sales to Total Assets Turnover 2 timesInventory Turnover 8 times

Balance Sheet of Tushar Ltd

Liabilities Rs Assets RsOwners Equity 1,00,000 Fixed AssetsLong term Debt InventoryCurrent Debt CashTotal Total

E 8

Vivek Industries Ltd is investigating the feasibility of manufacturing one of the components needed for its finished product rather than purchasing it from an outside supplier. Its present supplier has just informed the company that the sale price of the component will have to be increased from Rs 100 to Rs 125 due to higher input costs. The minimum order must be for a quantity of 6000 units+

The manufacturing activity will encompassThe cost of the equipment -Rs 12,00,000Salvage value at the end of 6th year -Rs 3,00,000Fixed costs [excluding Depreciation] -Rs 1,00,000/yearVariable costs - Rs 30 per unitCost of capital -15%Tax rate -50%Depreciation Policy -Straight line method

The company requires 7500 components /year

Assignment:Advise the company whether to buy or manufacture? Will your advice change if the requirement is 6000 units only

E 9

Vikas Ltd has the following capital structure

Equity share capital [5000shares of Rs100 each] Rs 5,00,0009% Preference shares Rs 2,00,00010% Debentures Rs 3,00,000

The equity shares of the company are quoted at Rs 102 and the company is expected to declare a dividend of Rs 9 per share for the next year.The company has registered a dividend growth rate of 5% which is expected to be maintained

Assuming the tax rate is 50%,A] calculate WACC

The company can raise term loan of Rs 500,000 at 12% interest for its expansion. However the company expects market price to fall to Rs 96 due to business risk associated with the expansion

B] Calculate revised WACC

E 10

A simplified income statement of Zenith Lt is given belowIncome statement for the year ending 31st March 200X [amount in Rs]Sales 10,50,000Variable cost 7,67,000Fixed cost 75,000EBIT 2,08,000Interest 1,10,000Tax 30% 29,400EAT 68,600

Calculate and interpretA] Operating leverageB] Financial leverageC] Combined leverage

E 11

Vikas Ltd need Rs 12 lacs for the installation of a new factory which is expected to earn an EBIT of Rs 2, 00,000p.a. The company has the objective of maximizing the earnings per share. It is considering the possibility of equity shares plus raising a debt of Rs 200,000 or Rs 6, 00,000 or Rs 10, 00,000. The Merchant banker has advised that the shares can be issued at Rs 40 and the issue price ha to be dropped to Rs 25, if the borrowing exceeds Rs7, 50,000. The cost of borrowing is indicated as under:

Up to Rs2, 50,000 10%Rs250, 000-Rs6, 25,000 14%Rs6, 25,000-Rs10, 00,000 16%

Assume the tax rate to be 50%, find out the EPS under different options

E 12The relevant financial information for a new project is given hereunder. Find out the debt-service coverage ratio. (DSCR)

Financial Information of a New Project

(Rs. In lakhs)

Year EBDIT* Deprn EBIT Int PBT Tax PAT Loan Instalment

1 13.80 6.00 7.80 8.80 -1.00 - -1.00 10.002 22.20 5.40 16.80 8.80 8.00 3.50 4.50 10.003 37.39 4.86 32.53 8.53 24.00 12.00 12.00 10.004 41.80 4.37 37.43 7.43 30.00 15.00 15.00 10.005 40.27 3.94 36.33 6.33 30.00 15.00 15.00 10.006 48.77 3.54 45.23 5.23 40.00 20.00 20.00 10.007 47.32 3.19 44.13 4.13 40.00 20.00 20.00 10.008 55.90 2.87 53.03 3.03 50.00 25.00 25.00 10.009 54.51 2.58 51.93 1.93 50.00 25.00 25.00 10.0010 53.16 2.33 50.83 0.83 50.00 25.00 25.00 10.00

* EBDIT stands for Earnings before depreciation interest and taxes.

PBT = Profit before tax. PAT = Profit after tax

Solution to Exercise on DSCR

Financial Information of a New Project ( Rs. In lakhs)

Year EBDIT Deprn EBIT Int PBT Tax PAT Loan Instalment

1 13.80 6.00 7.80 8.80 - 1.00 - -1.00 10.002 22.20 5.40 16.80 8.80 8.00 3.50 4.50 10.003 37.39 4.86 32.53 8.53 24.00 12.00 12.00 10.004 41.80 4.37 37.43 7.43 30.00 15.00 15.00 10.005 40.27 3.94 36.33 6.33 30.00 15.00 15.00 10.006 48.77 3.54 45.23 5.23 40.00 20.00 20.00 10.007 47.32 3.19 44.13 4.13 40.00 20.00 20.00 10.008 55.90 2.87 53.03 3.03 50.00 25.00 25.00 10.009 54.51 2.58 51.93 1.93 50.00 25.00 25.00 10.0010 53.16 2.33 50.83 0.83 50.00 25.00 25.00 10.00

Sum 415.12 39.08 376.04 55.04 321.00 160.50 160.50 100.00

DSCR is defined as = n∑ (PAT ị + D ị + I ị )i =1__________________ = 160.50 + 39.08 + 55.04 = 254.62 = 1.64 n∑ (I ị + LR ị ) 55.04 + 100 155.04i =1 where PAT ị = Profit after tax for year ịD ị = depreciation for year ịI ị = Interest on long-term loans of financial institutions for year ịLRI ị = loan repayment instalment for year ịn = period over which the loan has to be repaid

Calculation of Net Present Value

NPV of a project is equal to the sum of the present value of all the cash flows associated with the project. Symbolically,

NPV = CF o + CF 1 + ……. CFn = n∑ CF t (1 + k)° ( 1+k) ı (1+k) n t=o (1 + k) t

where NPV = net present value

CFt = cash flow occurring at the end of year t (t =0, … n). A cash inflow has a positive sign, whereas a cash outflow has a negative sign n = life of the project k = cost of capital used as the discount rate

E 13 Calculate NPV for a project which has the following cash flow stream :

Year Cash flow0 - 10,00,0001 2,00,0002 2,00,0003 3,00,0004 3,00,0005 3,50,000

The cost of capital k for the firm is 10%.

Solution to the exercise on NPV

NPV =

- 10,00,000 + 2,00,000 + 2,00,000 + 3,00,000 + 3,00,000 + 3,50,000 0 1 2 3 4 5 (1.10) (1.10) (1.10) (1.10) (1.10) (1.10)

= - 5273