INDEX 02

CHAPTER – 11
CHAPTER – 06 SECURITY VALUATION
RISK MANAGEMENT Topics Page No.
Topics Page No. Bond Pricing or Bond
Questions………………………………………………………..6.1 Valuation………………………………………………………11.1
Multiple Choice Bond Yield……………………………………………………..11.2
Questions………………………………………………………..6.5 Dirty Price & Clean
Price……………………………………………………………11.7
Bond Risk…………………………………………………….11.8
Bond Immunization………………………………………..11.17
CHAPTER – 07
Option Embedded
SECURITY ANALYSIS Bonds…………………………………………………………..11.20
Topics Page No. Convertible
Questions……………………………………………………… 7.1 Bonds…………………………………………………………..11.20
Multiple Choice Collable Bond or Bond
Questions…………………………………………………… 7.2 Refunding………………………………………………………..11.26
Extendable
Bonds…………………………………………………………….11.29
CHAPTER – 08
Yield
FINANCIAL POLICY Structures………………………………………………………11.30
Topics Page No. Dividend Growth
Questions……………………………………………………….8.1 Model………………………………………………………. 11.34
Multiple Choice Multiple Growth
Questions…………………………………………………… 8.5 Model…………………………………………………........ 11.40
Buy Back
CHAPTER – 10 Decision…………………………………………………………11.49
Valuation of
STARTUP FINANCE
Right……………………………………………………………...11.53
Topics Page No. Money Market
Questions……………………………………………………..10.1 Instruments………………………………………………….. 11.55
Residual…………………………………………………………11.59
Multiple Choice
Questions……..………………………………………………...11.63
CHAPTER – 13
INTERNATIONAL FINANCIAL
CHAPTER – 12
MANAGEMENT
ADVANCED CAPITAL BUDGETING
Topics Page No.
Topics Page No.
International Capital
Inflation in Capital
Budgeting……………………………………………………13.1
Budgeting…………………………………………………….12.1
ADR &
Risk in Capital
GDR………………………………………………………….13.19
Budgeting…………………………………………….......... 12.2
Adjusted Present
Statistical
Value…………………………………………………………13.21
Techniques…………………………………………………...12.2
Conventional
Techniques……………………………………………………12.7
Risk Adjusted Discounting
Rate…………………………………………………………….12.7
Certainty Equivalent CHAPTER – 14
Approach………………………………………………………12.9
BUSINESS VALUATION
Other
Topics Page No.
Techniques……………………………………………………12.10
Economic Value-Added
Sensitivity
[EVA]………………………………………………….…………14.1
Analysis………………………………………………………12.10
Valuation of
Scenario
Business………………………………………………...........14.8
Analysis………………………………………………………12.23
Comparable
Simulation……………………………………………………12.32
Method………………………………………………............14.18
Decision
Chop Shop
Tree……………………………………………………………12.33
Approach……………………………………………….........14.19
Replacement
FCFE
Decision………………………………………………………12.34
Approach………………………………………………..........14.20
Residual………………………………………………………12.42
Miscellaneous………………………………………………...14.23
Multiple Choice
Gearing of
Questions……..…………………………………………….12.46
Beta……………………………………………….................14.26
Multiple Choice
Questions……..…………………………………….............14.34

CHAPTER – 15
MERGER ACQUISITION & CORPORATE
RESTRUCTURING
Topics Page No.
Merger……………………………………………………………15.1
Stock
Deal………………………………………………………………15.1
Cash
Deal……………………………………………………………..15.20
Free Float Market
Capitalization…………………………………………….…..15.22
Merger of
Banks…………………………………………………………15.25
Minimum & Maximum Exchange
Ratio………………………………….........................…..15.26
Demerger…………………………………………………….15.29
True Cost of
Acquisition…………………………………………………..15.30
Capital
Restructuring……………………………………………….15.38
Residual………………………………………………………15.39
Multiple Choice
Questions…………………………………………………….15.45
 RISK MANAGEMENT

06 F RISK MANAGEMENT
4
Question – 01
I
10 Days VAR
You hold worth 2 crore shares of X Ltd. whose market price standard
deviation is 2% per day. Assuming 252 trading days a year, 10 Days S.D. = 4 √10 = ₹ 12.65
determine maximum loss level over the period of 1 trading day and
10 trading days with 99% confidence level. = 12.65 × 2.33
Solution: = ₹ 29.47 lacs
X Ltd. Shares = ₹ 200 lacs
Question – 02
S.D. = 2% per day Consider a portfolio consisting of a ₹ 20,000,000 investment in share
XYZ and a ₹ 20,000,000 investment in share ABC. The daily standard
1 year = 252 days deviation of both shares is 1% and that the coefficient of correlation
between them is 0.3. You are required to determine the 10-day 99%
At 99% confidence level.
value at risk for the portfolio?
(i) 1 day VAR Solution:

(ii) 10 days VAR XYZ = 200 lacs 0.5 1%

1 Day VAR ABC = 200 lacs 0.5 1%

400 lacs
VAR =x σz

= 200 × 2% × 2.33 σp = √σA 2 WA 2 + σB 2 WB 2 + 2 × WA × WB × σA × σB × rAB

=4 × 2.33 2 2
= √12 0.50 + 12 × 0.50 + 2 × 0.5 × 0.5 × 1 × 1 × 0.30
= ₹ 9.32 lacs
= 0.8062%

6.1
 RISK MANAGEMENT

1 Day VAR You are required to determine the maximum possible investment.

1 Day S.D. = ₹ 400 × 0.8062% Solution:

= ₹ 3.22 Lacs. Maximum possible investment

10 Days VAR Amount available = ₹ 7,00,000

(-) Minimum Balance = ₹ 1,000

10 Days S.D. = ₹ 3.22 √10
Possible loss for 4 days = ₹ 6,99,000
= ₹ 10.18 Lacs.

10 Days VAR = 10.18 × 2.33

4 Days VAR = ₹ 6,99,000
= ₹ 23.72 Lacs.
4 Days VAR = 4 days S.D. × 2.33
Question – 03
On Tuesday morning (before opening of the capital market) an ₹ 6,99,000 = 4 days S.D. × 2.33
investor, while going through his bank statement, has observed that
an amount of ₹ 7 lakhs is lying in his bank account. This amount is ₹ 6,99,000
4 days S.D. (₹) =
available for use from Tuesday till Friday. The Bank requires a 2.33
minimum balance of ₹ 1000 all the time. The investor desires to make
= ₹ 3,00,000
a maximum possible investment where Value at Risk (VaR) should
not exceed the balance lying in his bank account. The standard
1
deviation of market price of the security is 1.5 per cent per day. The 1 Day S.D. (₹) = ₹ 3,00,000 √
4
required confidence level is 99 per cent.
= ₹ 1,50,000
Given

Standard Normal probabilities 1 day S.D. (%) = 1.5%

Z 0.00 .01 .02 .03 0.04 .05 .06 .07 .08 .09
₹ 1,50,000
2.2 .9861 .9864 .9868 .09871 .9875 .9878 .9881 .9884 .9987 .9890 Maximum possible Investment = = ₹ 1,00,00,000
1.5%
2.3 .9893 .9896 .9998 .9901 .9904 .9906 .9909 .9911 .9913 .9916

2.4 9918 .9920 .9922 .9923 .9925 .9929 .9931 .9932 .9934 .9936

6.2
 RISK MANAGEMENT

Question – 04 Solution:
Mr. Bull is a rational risk taker. He takes his position in a single
stock for 4 days in a week. He does not take a position on Friday to Working Notes:
avoid weekend effect and takes position only for four days in a week
(1) Security X
i.e. Monday to Thursday. He transfers the amount on Monday
morning and withdraws the balance on Friday morning. He desires P x P (x) (x - x
̅) (x - x
̅)2 × Prob.
to make a maximum investment where Value At Risk (VAR) should
0.10 6 0.60 -2 0.40
not exceed the balance lying in his bank account. The position by his 0.25 7 1.75 1 0.25
manager, as per standing instructions, is taken on the free balance 0.30 8 2.40 0 0
lying in the bank account in the morning on each Monday. 0.25 9 2.25 1 0.25
0.10 10 1.00 2 0.40
On Monday morning (before opening of the capital market) he has 8.00 1.30
transferred an amount of ₹ 11 Crore to his bank account. A fixed
deposit also matured on this Monday. The maturity amount of ₹ Expected Return (Rx) = 8.00%
63,42,560 was also credited to his account by the bank in the
morning of the Monday. However, Mr. Bull received the intimation of Variance (σ2
x) = 1.30
the same in the evening. The bank needs a minimum balance of ₹
1,000 all the time. The value of Z score, at the required confidence Standard Deviation (σx ) = √1.30
level of 99 percent is 2.33.
= 1.14
The other information with respect to stocks X and Y, which are
under consideration for this week, is as under: (2) Security Y

X Y P y P (y) (y - y
̅) (y - y
̅)2 × Prob.
Return Probability Return Probability 0.10 4 0.40 -4 1.60
6 0.10 4 0.10 0.20 6 1.20 -2 0.80
7 0.25 6 0.20 0.40 8 3.20 0 0
8 0.30 8 0.40 0.20 10 2.00 2 0.80
9 0.25 10 0.20 0.10 12 1.20 4 1.60
10 0.10 12 0.10 8.00 4.80

You are required to recommend a single stock, where maximum Expected Return (RY) = 8.00%
investment can be made.
2
Variance (σY ) = 4.80
(Exam May – 2023) (8 Marks)

6.3
 RISK MANAGEMENT

Standard Deviation (σY ) = √4.80 Stock X

1 day S.D. (%) = 1.14%

= 2.19
₹ 24,966,000
Amount Maximum possible Investment =
1.14%

Amount Transferred ₹ 1,10,000,000 = ₹ 2,190,000,000

Maturity Proceeds of Fixed Deposit ₹ 63,42,560 Stock Y

Amount available in bank account ₹ 1,16,342,560 1 day S.D. (%) = 2.19%

Minimum balance to be kept ₹ 24,966,000

₹ 1,000 Maximum possible Investment =
2.19%
Available amount which can be used ₹ 1,16,341,560 = ₹ 1,140,000,000
for potential investment for 4 days
Recommendation: Position should be taken in X.
4 Days VAR = ₹ 1,16,341,560

4 Days VAR = 4 Days S.D. × 2.33

₹ 1,16,341,560 = 4 Days S.D. × 2.33

₹ 1,16,341,560
4 Days S.D. (₹) =
2.33

= ₹ 49,932,000

1
1 Day S.D. (₹) = ₹ 49,932,000√
4

= ₹ 24,966,000

6.4
 RISK MANAGEMENT

I. Available amount which can be used by Mr. B for potential

MULTIPLE CHOICE QUESTIONS
exposure for 4 days on Monday morning shall be………………
(a) 11,00,00,000 (b) 11,63,41,560
Case Scenario – 01 (c) 11,00,01,000 (d) 11,63,42,560
Mr. B is a rational risk taker. He takes his position in a single stock
for 4 days in a week. He does not take a position on Friday to avoid
weekend effect and takes position only for four days in a week i.e. II. The Z-score at a 99% confidence level for Mr. B’s Value at Risk
Monday to Thursday. He transfers the amount on Monday morning (VAR) is………….
and withdraws the balance on Friday morning. He desires to take a
(a) 1.64 (b) 1.96
maximum exposure in the single stock (not the portfolio) where Value
at Risk (VAR) should not exceed the balance lying in his bank (c) 2.33 (d) 2.58
account. The position by his manager, as per standing instructions, III. The expected return for the stocks X is……….
is taken on the free balance lying in the bank account in the morning
(a) 7% (b) 8%
on each Monday.
(c) 9% (d) 10%
On Monday morning (before opening of the capital market) he has
transferred an amount of ₹ 11 Crore to his bank account. A fixed
deposit also matured on this Monday. The maturity amount of ₹ IV. The expected return for the stocks Y is……….
63,42,560 was also credited to his account by the bank in the (a) 7% (b) 8%
morning of the Monday. However, Mr. B received the intimation of (c) 9% (d) 10%
the same in the evening. The bank needs a minimum balance of ₹
1,000 all the time. The other information with respect to stocks X
and Y, which are under consideration for this week, is as under: V. In which stock should Mr. B invest in to maximize his returns
while maintaining his Value at Risk (VAR) within acceptable
X Y
Return Probability Return Probability limits?
6 0.10 4 0.10 (a) Stock X
7 0.25 6 0.20
8 0.30 8 0.40 (b) Stock Y
9 0.25 10 0.20 (c) Both stocks are equally good
10 0.10 12 0.10
(d) Neither stock is suitable
From the information given above, choose the correct answer to the (RTP May – 2025)
following questions:

6.5
 RISK MANAGEMENT

Answer: Case Scenario – 01 The other information with respect to stocks A and B, which are
I. (b) 11,63,41,560 under consideration for this week, is as under:
II. (c) 2.33 A B
III. (b) 8% Return (%) Probability Return (%) Probability
IV. (c) 9% 6 0.10 4 0.10
V. (a) Stock X 7 0.25 6 0.20
8 0.30 8 0.40
Case Scenario – 02 9 0.25 10 0.20
Mr. Y is a rational risk taker. He takes his position in derivative 10 0.10 12 0.10
market of a single stock through margin trading for 4 days in a week.
He does not take a position on Friday to avoid weekend effect and From the information given above, choose the correct answer to
takes position only for four days in a week i.e. Monday to Thursday. the following questions:
He transfers the amount on Monday morning and withdraws the I. The amount that will not considered for taking position on
balance on Friday morning. He desires to take a maximum exposure Monday morning is………..
in the derivative market where Value at Risk (VAR) should not exceed (a) ₹ 63,41,560 (b) ₹ 63,42,560
the balance lying in his bank account. The position by his manager, (c) ₹ 11,00,00,000 (d) ₹ 10,99,99,000
as per standing instructions, is taken on the free balance lying in the
bank account in the morning on each Monday. II. Which stock has a wider dispersion of returns based on the
On Monday morning (before opening of the capital market) he has given probability distribution?
transferred an amount of ₹ 11 Crore to his bank account. A fixed (a) Stock A
deposit also matured on this Monday. The maturity amount of ₹ (b) Stock B
63,42,560 was also credited to his account by the bank in the (c) Both have equal dispersion
morning of the Monday. However, Mr. Y received the intimation of (d) Cannot be determined
the same in the evening. The bank needs a minimum balance of ₹
1,000 all the time.

6.6
 RISK MANAGEMENT

III. In Value at Risk (VaR) analysis, which factor directly increases

VaR for a given investment?
(a) Higher expected return
(b) Lower confidence level
(c) Higher standard deviation
(d) Shorter holding period

IV. Since Mr. Y invests in derivative of a single stock (not a

portfolio), the risk considered for VaR is…………
(a) Diversifiable risk
(b) Unsystematic risk only
(c) Total risk
(d) Market risk only
(RTP May – 2026)
Answer Case Scenario – 02
I. (b) ₹ 63,42,560
II. (b) Stock B
III. (c) Higher standard deviation
IV. (c) Total risk

6.7
 SECURITY ANALYSIS

07 FSECURITY ANALYSIS
4 I
Solution:
Question – 01
Closing Values of NIFTY Index from 3rd to 12th day of the month of (i) Value of exponent of 15 days EMA
January 2022 were as follows:
2
Days Date Closing Values of NIFTY =
n+1
Index
1 03/01/2022 17626 2
= = 0.125
2 04/01/2022 17805 15 + 1
3 05/01/2022 17925
4 06/01/2022 17746 (ii) Calculation of EMA
5 07/01/2022 17813
Date Closin EMA= Previous EMA + (Price – EMA
6 10/01/2022 18003
g Price Previous EMA) AF
7 11/01/2022 18056
03/1/22 17,626 17,174 + (17,626 – 17,174) 0.125 17,230.50
8 12/01/2022 18212 04/1/22 17,805 17,230.5 + (17,805 – 17,230.50) 0.125 17,302.31
05/1/22 17,925 17,302.31 + (179,25 – 17,302.31) 0.125 17,380.15
The simple moving average of NIFTY Index for the month of December 06/1/22 17,746 17,380.15 + (17,746 – 17,380.15) 0.125 17,425.88
2021 was 17174. 07/1/22 17,813 17,425.88 + (17,813 – 17,425.88) 0.125 17,474.27
10/1/22 18,003 17,474.27 + (18,000 – 17,474.27) 0.125 17,540.36
You are required to calculate 11/1/22 18,056 17,540.36 + (18,056 – 17,540.36) 0.125 17,604.82
12/1/22 18,212 17,604.82 + (18,212 – 17,604.82) 0.125 17,680.71
(i) The value of exponent for 15 days EMA.
(iii) Since EMA is upward trend, hence market is bullish, it is buy
(ii) The exponential moving average (EMA) of NIFTY during the signal.
above period. (Calculations to be done up to 2 decimals only)
Question – 02
(iii) Analyze the buy & sell signal on the basis of your calculations. Closing values of BSE Sensex from 6th to 17th day of the month of
January of the year 20XX were as follows:
(Exam May – 2022) (8 Marks)
Days Date Day Sensex
1 6 THU 29,522
2 7 FRI 29,925

7.1
 SECURITY ANALYSIS

3 8 SAT No Trading
4 9 SUN No Trading MULTIPLE CHOICE QUESTIONS
5 10 MON 30,222
6 11 TUE 31,000 Case Scenario – 01
7 12 WED 31,400 An American institutional investor is exploring investment
8 13 THU 32,000 opportunities in different countries. Before proceeding, they believe
9 14 FRI No Trading
a thorough analysis of options in the securities available to ensure a
10 15 SAT No Trading
11 16 SUN No Trading higher return while minimizing risk.
12 17 MON 33,000
To achieve this objective, it formed a team consisting of following
Compute Exponential moving Average (EMA) of Sensex during the persons with respective assigned tasks:
above period. The 30 days simple moving average of Sensex can be
Mr. A – He is entrusted with the task of analysing various Macro-
assumed as 30,000. The value of exponent for 30 days EMA is 0.062.
economic factors e.g. historical performance of the economies in the
Provide detailed analysis on the basis of your calculations. past/ present and expectations in future, growth of different sectors
of the economies in future with signs of stagnation/degradation at
(Exam May – 2018) (8 Marks) present. In addition to that he also analysed the trends in peoples’
income and expenditure.
Solution:
Ms. B – After receiving inputs/ recommendations from Mr. A she is
Date Closing EMA= Previous EMA + (Price – EMA
Price Previous EMA) AF
entrusted with the task of assessment regarding all the conditions
6 29522 30,000 + (29,522 – 30,000) 0.062 29,970.36 and factors relating to demand of the particular product, cost
7 29925 29,970.36 + (29,925 – 29,970.36) 0.062 29,967.55 structure of the industry and other economic and Government
10 30222 29,967.55 + (30,222 – 29,967.55) 0.062 29,983.33 constraints in the same country.
11 31000 29,983.33 + (31,000 – 29,983.33) 0.062 30,046.36
12 31400 30,046.36 + (31,400 – 30,046.36) 0.062 30,130.29
Mr. C – After receiving inputs/ recommendations from Ms. B he is
13 32000 30,130.29 + (32,000 – 30,130.29) 0.062 30,246.21
17 33000 30,246.21 + (33,000 – 30,246.21) 0.062 30,416.94 entrusted with the task of careful examination of the company's
quantitative and qualitative fundamentals. Which includes a
On the basis of EMA it is expected that market is bullish hence comparison of price earning ratios of different companies. Further,
investor should take long position on Sensex. In addition to examine the financial solvency, liquidity of the
company he is also advised for the evaluation of future growth
prospects of the company identified.

Based on the above case scenario, choose the correct answer to the
following questions:

7.2
 SECURITY ANALYSIS

I. If Mr. A want to evaluate the impact of macroeconomic trends (D) Decision Tree Analysis
on their potential investment. Which of the following factors is
least likely to influence their decision? IV. Mr. A while analyzing industry growth, finds that certain
(A) Growth rates of national income indicators tend to peak before the economy’s overall growth.
(B) Inflation rates These indicators are best classified as................
(C) Market speculation trends (A) Lagging indicators
(D) Barometer indicators (B) Leading indicators
(C) Coincidental indicators
II. The investor learns that inflation is expected to rise. Based on (D) Random indicators
economic analysis, how might this affect their stock
investment decision? V. Specifically the team of Mr. A, Ms. B, and Mr. C are entrusted
(A) Stock prices are expected to decline due to reduced with the task of carrying out...............
consumer demand (A) Fundamental Analysis
(B) Stock prices are expected to rise as stocks act as a (B) Technical Analysis
hedge against inflation (C) Market Analysis
(C) Stock prices will remain unaffected as inflation only (D) Security Analysis
affects bond markets (MTP APRIL: 2025)
(D) Stock prices will become highly volatile, but long-term Answer: Case Scenario – 01
growth remains unchanged I. (C) Market speculation trends
II. (B) Stock prices are expected to rise as stocks act as a
III. Which of the techniques shall be primarily used by Ms. B to hedge against inflation
carry out the required analysis at his part? III. (C) Input-Output Analysis
(A) Anticipatory Surveys IV. (B) Leading indicators
(B) Indicator Approach V. (A) Fundamental Analysis
(C) Input-Output Analysis

7.3
 SECURITY ANALYSIS

7.4
 FINANCIAL POLICY

08 FINANCIAL POLICY
4
Solution: (i) External Funds Requirement (EFR) :
Question – 01
The Balance Sheet of M/s. Sundry Ltd. as on 31-03-2023 is follows: (₹ in
(₹ in lakhs) lakhs)
Liabilities ₹ Assets ₹
Expected sales (₹ 6,000 + 20% of ₹ 6,000) 7,200.00
Share Capital 3,000 Fixed Assets 6,000
Reserves 2,000 Inventory 5,000 Profit margin @ 4% 288.00
Long Term Loan 4,000 Receivables 2,400 Dividend payout ratio @ 50% 144.00
Short Term Loan 3,000 Cash 600
Balance to be ploughed back (A) 144.00
Payables & 2,000
Provisions Additional funds required (₹ 14,000 − ₹ 2,000)
Total 14,000 Total 14,000 × 0.20 (B) 2,400.00
Sales for the year was ₹ 6,000 lakhs. The sales are expected to grow Balance to be met from external source (B − A) 2,256.00
by 20% during the year. The profit margin and dividend pay-out ratio
are expected to be 4% and 50% respectively. * As current liabilities shall also be increased proportionately
with increase in sales.
The company further desires that during the current year Sales to
Short Term Loan and Payables and Provision should be in the ratio
of 4 : 3. Ratio of fixed assets to Long Term Loans should be 1.5. Debt (ii) Amount to be raised from different sources with following
Equity Ratio should not exceed 1.5. conditions:
- Sales to short term loans and payables & provisions 4:3
You are required to determine: - Ratio of fixed assets to long term loans 1.5
- Debt equity ratio should not exceed 1.5
(i) The amount of External Fund Requirement (EFR)

(ii) The amount to be raised from Short Term, Long Term and Equity
funds.

(SM May – 2025)

8.1
 FINANCIAL POLICY

4,800
=
3,000 +1,456 + 2,000 + 144
(1) Amount to be raised from short term funds;
= 0.727
( ₹ in lakhs)
New amount of short-term loans and Thus, required condition is satisfied.
3
payable & provision ( × 7,200) 5,400 Question – 02
4
MNC Limited company’s financial statements for FY 2024-25 are
Less: Existing Amount of short-term loans provided:
and payables & provision (2,000 × 1.20 + 5,400
3,000) Income Statement (₹ in Crore)
Nil Sales revenues 7,500
Amount to be raised from short term Costs and expenses 7,300
funds. Income before taxes 200
Taxes (30%) 60
(2) Amount to be raised from long term funds: Net income 140
( ₹ in lakhs) MNC Limited’s Balance Sheet as at 31st March, 2025
New fixed assets (₹ 6,000 + 20% of ₹ 7,200
6,000) 4,800 Liabilities (₹ in Crore) Assets (₹ in Crore)
New long-term loans (₹ 7,200/1.5) 4,000 Equity 2,000 Net Fixed 4,000
Less: Existing long-term loans 800 Long term Debt 2,500 Assets 2,000
Amount to be raised from long term Current 1,500 Current Assets
funds Liabilities
6,000 6,000
(3) Amount to be raised from equity funds:
Additional Information:
( ₹ in
lakhs) (i) The company expects a 40% sales growth next financial year.
Amount to be raised from external sources 2,256.00
Less: Amount to be raised from short term funds ----- (ii) The company will have a 25% dividend payout ratio next year.
Less: Amount to be raised from long term funds 800.00
Balance amount to be raised from equity funds 1,456.00 (iii) All costs, current assets and current liabilities are expected to
increase with sales.
Debt
New DER =
Shareholder's Fund (iv) Except retained earnings no new Equity is to be raised.

8.2
 FINANCIAL POLICY

With only 95% Utilization, growth by 40% can be achieved by

corresponding increase in Fixed Assets of ₹ 1320 Crore (95%*1.4
Required: times = 1.33 times of existing Fixed Assets of ₹ 4000 Crore). Projected
Fixed Assets increase to ₹ 5,320 Crore.
Compute External Funding Requirement through raising Long-term
Debt: External Funding Requirement Through Long Term (₹ in
Debt Crore)
(1)If the company is operating at 65% capacity usage for fixed assets. 10,500
Expected Sales Revenue (7,500 × 1.4)
Costs and Expenses (7,300 × 1.4) 10,220
(2)If the company is operating at 95% capacity usage for fixed assets.
Income before taxes 280
(Exam Jan. – 2026) Taxes (30%) 84
Net Income 196
Solution: Dividend Payout@25% of ₹ 196 49
Retained Earnings/ Internal Sources of Funds 147
(i) External Funding Requirement in case of 65% capacity utilization Additional Funds Required (8,120 – 2,100 – 2,000 – 1,520
With only 65% Utilization, growth by 40% can be achieved 2500)
without any corresponding increase in Fixed Assets (65*1.4 times Balance to be met from Long Term Debt 1,373
= 91%)
Alternative Solution:
External Funding Requirement Through (₹ in Crore)
Long Term Debt (i) Computation of EFR if company is operating at 65% capacity
10,500 usage of Fixed Assets.
Expected Sales Revenue (7,500 × 1.4)
Costs and Expenses (7,300 × 1.4) 10,220
Full Capacity Sales
Income before taxes 280
Taxes (30%) 84 Actual Sales
Net Income 196 =
% of capacity at which fixed assets were operated
Dividend Payout@25% of ₹ 196 49
Retained Earnings/ Internal Sources of 147 ₹ 7,500 Crores
Funds = = ₹ 11,538.4615 Crore
0.65
Additional Funds Required (2,000 – 200
1,500)*0.4 ₹ 4,000 Crores
Balance to be met from Long Term Debt 53 Actual Fixed Assets Ratio should be = = 0.3467
₹ 11,538.4615 Crores

(ii) External Funding Requirement in case of 95% capacity

Revised Fixed Assets = ₹ 10,500 × 0.3467
utilization

8.3
 FINANCIAL POLICY

= ₹ 3640.35 crore = - 359.65 + 200 – 147 = - ₹ 306.65 Crore

Proforma Income Statement (ii) Computation of EFR if company is operating at 95% capacity
usage of Fixed Assets.
₹ in Crore
Sales Revenue 10,500
Full Capacity Sales
Less: Cost and Expenses 10,220
Income Before Tax 280
Actual Sales
Tax @ 30% 84 =
Profit after Tax 196 % of capacity at which fixed assets were operated
Less: Dividend paid 49
Retained Earning 147 ₹ 7,500 Crore
= = ₹ 7,894.7368 Crore
0.95
Proforma Balance Sheet
₹ 4,000 Crore
Actual fixed asset ratio should be = = 0.5067
₹ in Crores ₹ in Crores ₹ 7,894.7368 Crore
Equity 2,000.00 Fixed Assets 3,640.35
Retained 147.00 Current 2,800.00 Revised fixed asset = ₹ 10,500 × 0.5067 = ₹ 5,320.35 Crore
Earnings Assets
Long Term 2,193.35 Proforma Income Statement
Debt
(Bal. Figure) ₹ in Crores
Current 2,100.00 Sales Revenue 10,500
Liabilities Less: Cost and Expenses 10,220
6,440.35 6,440.35 Income Before Tax 280
Tax @ 30% 84
EFR = ₹ 2,193.35 Crore - ₹ 2,500 Crore = - ₹ 306.65 Crore Profit after Tax 196
Less: Dividend Paid 49
Alternatively, it can also be computed using the formula as follows: Retained Earning 147
F0 CA CL Proforma Balance Sheet
= [ × Revised Sales – F0] + [ − ] × ∆S – Net Profit (1
S0 S S
– d) ₹ in ₹ in Crores
Crores
2,000 1,500 Equity 2,000.00 Fixed Assets 5,320.35
= (3,640.35 – 4,000) +[ − ] × 3,000 – (196 – 49) Retained Earnings 147.00 Current 2,800.00
7,500 7,500
Assets

8.4
 FINANCIAL POLICY

Long Term Debt 3,873.35

(Bal. Figure) MULTIPLE CHOICE QUESTIONS
Current Liabilities 2,100.00
8,120.35 8,120.35 Case Scenario – 01
In a recent Board Meeting of N Ltd. following financials of N Ltd. for
EFR = ₹ 3,873.35 Crore - ₹ 2,500 Crore = - ₹ 1373.35 Crore
the year ending 31st March 2025 were presented:
Alternatively, it can also be computed using the formula as
Balance Sheet as on 31.03.2025
follows:
₹’000
F0 CA CL Liabilities Amount Assets Amount
= [ × Revised Sales – F0] + [ − ] × ∆S – Net Equity Capital 4,80,000 Fixed Assets 2,42,000
S0 S S
10% Bonds 92,000 Cash 88,000
Profit (1 – d) Sundry Creditors 66,000 Sundry 1,10,000
Bills Payable 88,000 Debtors 3,3,0000
2,000 1,500
= (5,320.35 – 4,000) +[ − ] × 3,000 – (196 – 49) Other Current 44,000 Closing Stock
7,500 7,500 Liabilities
Total Liabilities 7,70,000 Total Assets 7,70,000
= 1,320.35 + 200 – 147 = - ₹ 1,373.35 Crore
Income Statement for the Year ending 31.03.2025

Particular (₹’000) (₹’000)

Sales 11,77,000

Less: Cost of Goods Sold

Material 4,18,000

Wages 2,64,000

Factory Overheads 1,29,800 8,11,800

Gross Profit 3,65,200

Less: Selling & Distribution Cost 1,10,000

Administrative Cost 2,32,800

8.5
 FINANCIAL POLICY

(b) Sustainable Growth Rate

Earnings Before Interest and Taxes 1,22,800 1,32,400
(EBIT) (c) External Funding Requirements
9,200
Less: Interest Charges (d) External Growth Rate
1,23,200
Earnings Before Tax
61,600
Less: Taxes @ 50% 61,600 II. The Director B is talking about

Net Profit (PAT) (a) Internal Growth Rate

During the Board Meeting: (b) Sustainable Growth Rate

(i) Director A said that the company can maintain a certain (c) External Funding Requirements
growth even though the net profit margin remains constant,
(d) External Growth Rate
and assets increases proportionately to sales and it distributes
its 30% of its net profit. To maintain this growth rate, it will
not require any external funds.
III. The Director C is talking about______
(ii) Director B proposed that just by maintaining a target capital
structure and without issuing additional equity and (a) Internal Growth Rate
maintaining target dividend pay-out ratio as proposed by
(b) Sustainable Growth Rate
Director A, more growth rate can be achieved.
(c) External Funding Requirements
(iii) Director C though agreed with views of Director A and Director
B, but is to of the view that in the coming year it is expected (d) External Growth Rate
that sales is likely rise by 15%, hence if required we can go for
issue of equity shares, bonds or debentures to achieve the
same growth in sales.
IV. If we go by the proposal of Director C, then
From the information given above, choose the correct answer to approximately.......funds shall be raised from in form of equity
the following questions: or debt, assuming that dividend as proposed by Director A is
paid out and assets and current liabilities are increased in the
I. The Director A is talking about_________ same proportion as increase in sales.
(a) Internal Growth Rate

8.6
 FINANCIAL POLICY

(a) ₹ 1,15,500 thousand

(b) ₹ 85,800 thousand

(c) ₹ 79,332 thousand

(d) ₹ 36,212 thousand

(RTP SEP – 2025)

Answer Case Scenario – 01

I. (a) Internal Growth Rate

II. (b) Sustainable Growth Rate

III. (c) External Funding Requirements

IV. (d) ₹ 36,212 thousand

8.7
 STARTUP FINANCE

10 STARTUP FINANCE
4 Solution:
Question – 01
Valuation of Startup under different scenarios:
The ABC Startup has the following expected profits under different
scenarios along respective probabilities:
(i) Best Case Scenario
Year Best Case Base Case Worst Case
Revenue Expenses Revenue Expenses Revenue Expense Year 1 Year 2 Year 3
(₹) (₹) (₹) (₹) (₹) s Revenue ₹ 1,00,00,000 ₹ 120,00,000 ₹ 144,00,000
(₹)
Expenses ₹ 80,00,000 ₹ 92,40,000 ₹ 108,00,000
1 1,00,00,000 80,00,000 100,00,000 90,00,000 100,00,000 95,00,000
Cash ₹ 20,00,000 ₹ 27,60,000 ₹ 36,00,000
2 1,20,00,000 92,40,000 110,00,000 95,70,000 102,00,000 98,94,000
Flow/
3 1,44,00,000 1,08,00,000 121,00,000 102,85,000 104,04,000 101,95,920
Earnings
Probability 30% 60% 10%
Terminal ₹ 3,60,00,000
Value
You are required to suggest the value of ABC Startup using First PVF @ 0.8333 0.6944 0.5787 0.5787
20%
Chicago Method assuming that: PV ₹ 16,66,600 ₹ 19,16,544 ₹ 20,83,320 ₹ 2,08,33,200
Value of ₹ 2,64,99,664
(i) Applicable discounting rate is 20%.
Startup
(ii) Startup is located in Tax-free Zone.
(ii) Base Case Scenario
(iii) The multiple for Terminal is 10.
(iv) No depreciable assets are held by the ABC Startup. Year 1 Year 2 Year 3
Revenue ₹ 1,00,00,000 ₹ 110,00,000 ₹ 121,00,000
Expenses ₹ 90,00,000 ₹ 95,70,000 ₹ 102,85,000
Note: 1. Present Value Factor (PVF) Cash Flow/ ₹ 10,00,000 ₹ 14,30,000 ₹ 18,15,000
Earnings
Year 1 2 3 Terminal ₹ 1,81,50,000
PVF @ 20% 0.8333 0.6944 0.5787 Value
PVF @ 20% 0.8333 0.6944 0.5787 0.5787
2. Round off the calculation to whole numbers. PV ₹ 8,33,300 ₹ 9,92,992 ₹ 10,50,341 ₹ 1,05,03,405
Value of ₹ 1,33,80,038
(MTP October – 2024) Startup

10.1
 STARTUP FINANCE

(iii) Worst Case Scenario

Year 1 Year 2 Year 3

Revenue ₹ 1,00,00,000 ₹ 102,00,000 ₹ 104,04,000
Expenses ₹ 95,00,000 ₹ 98,94,000 ₹ 101,95,920
Cash Flow/ ₹ 5,00,000 ₹ 3,06,000 ₹ 2,08,080
Earnings
Terminal ₹ 20,80,800
Value
PVF @ 20% 0.8333 0.6944 0.5787 0.5787
PV ₹ 4,16,650 ₹ 2,12,486 ₹ 1,20,416 ₹ 12,04,159
Value of ₹ 19,53,711
Startup

Value of ABC Startup as per First Chicago Method

= 0.30 × ₹ 2,64,99,664 + 0.60 × ₹ 133,80,038 + 0.10 × ₹ 19,53,711

= ₹ 79,49,899 + ₹ 80,28,023 + ₹ 1,95,371

= ₹ 1,61,73,293

10.2
 SECURITY VALUATION

11 FSECURITY VALUATION
4 I
10 105 0.227 23.84
(I) BOND PRICING OR BOND VALUATION Issue Price 71.33

Question – 01 Question – 02
M/s Agfa Industries is planning to issue a debenture series on the Nominal value of 10% bonds issued by a company is ₹ 100. The bonds
following terms: are redeemable at ₹ 110 at the end of year 5. Determine the value of
Face Value ₹ 100 the bond if required yield is (i) 5%, (ii) 5.1%, (iii) 10% and (iv) 10.1%.
Term of maturity 10 years
(SM TYK – 19)
Yearly coupon rate
Solution:
Years
1–4 9% Case 1: Required yield rate = 5%
5–8 10%
9 – 10 14% Year Cash flow ₹ DF (5%) Present Value (₹)
1–5 10 4.3295 43.295
The current market rate on similar debentures is 15 per cent per 5 110 0.7835 86.185
annum. The Company proposes to price the issue in such a manner Value of bond 129.48
that it can yield 16 per cent compounded rate of return to the
Case 2: Required yield rate = 5.1%
investors. The Company also proposes to redeem the debentures at
5 per cent premium on maturity. Determine the issue price of the Year Cash flow ₹ DF (5.1%) Present Value(₹)
debentures. 1-5 10 4.3175 43.175
5 110 0.7798 85.778
Solution: Value of bond 128.95

Issue Price of Bond Case 3: Required yield rate = 10%

Years CF PVF (16%) PV Year Cash flow ₹ DF (10%) Present Value (₹)
1–4 ₹9 2.798 25.18 1-5 10 3.7908 37.908
5–8 ₹ 10 1.545 15.45 5 110 0.6209 68.299
9 – 10 ₹ 14 0.490 6.86 Value of bond 106.207

11.1
 SECURITY VALUATION

Case 4: Required yield rate = 10.1%

(II) BOND VIELD
Year Cash flow ₹ DF (10.1%) Present Value (₹)
1-5 10 3.7811 37.811 QUESTION – 04
5 110 0.6181 67.991 Based on the credit rating of bonds, Mr. Z has decided to apply the
Value of bond 105.802 following discount rates for valuing bonds:
Question – 03 Credit Rating Discount Rate
John inherited the following securities on his uncle’s death:
AAA 364 day T bill rate + 3% spread
Types of Security Nos. Annual Maturity Yield
Coupon Years %
% AA AAA + 2% spread
Bond A (₹ 1,000) 10 9 3 12
Bond B (₹ 1,000) 10 10 5 12 A AAA + 3% spread
Preference shares C (₹ 100) 100 11 * 13*
Preference shares D (₹ 100) 100 12 * 13* He is considering to invest in AA rated, ₹ 1,000 face value bond
currently selling at ₹ 1,025.86. The bond has five years to maturity
*Likelihood of being called at a premium over par. and the coupon rate on the bond is 15% p.a. payable annually. The
Compute the current value of his uncle’s portfolio. next interest payment is due one year from today and the bond is
redeemable at par. (Assume the 364 day T-bill rate to be 9%). You
Solution: are required to calculate the intrinsic value of the bond for Mr. Z.
Should he invest in the bond? Also calculate the current yield and
Value of Portfolio the Yield to Maturity (YTM) of the bond.

Bond A = (900 × 2.402) + (10,000 × 0.712) = ₹ 9,282 Solution:

Bond B = (1,000 × 3.605) + (10,000 × 0.567) = ₹ 9,275 AA Rated:

₹ 1,100 Discounting Rate =9 +3+2 = 14%

Preference shares C = 10,000 × 11% = = ₹ 8,462
13%
(1) Calculation of IV0
₹ 1,200
Preference shares D = 10,000 × 12% = = ₹ 9,231
13% = (150 × PVAF, 14%, 5) + (1,000 × PVF, 14%, 5)
Value of portfolio = ₹ 36,250
= (150 × 3.433) + (1,000 × 0.5194)

11.2
 SECURITY VALUATION

= ₹ 1,034.35 (SM TYK – 21)

Sine bond is under priced, hence it should be purchased. Solution:

(2) Current Yield (i) Yield:

Coupon Assumed FV of bond is ₹ 100

= × 100
CMP
Interest Amount = ₹ 10
₹ 150
= × 100 Assumed Yield = Current Yield
₹ 1,025.86

= 14.62% ₹ 10
Existing Current Yield = × 100 = 9.09%
₹ 110
(3) YTM
F–P
Revised Yield = 9.09% + 1% = 10.09%
I +( )
n
= F+P × 100 ₹ 10
2
Bond price = = ₹ 99.11
₹ 10.09%
1,000 – 1,025.86
150 + (
5
) Note: Discounting rate के बढ़ने से Bond Price कम हो जाता है ।
= 1,000 + 1,025.86 × 100
2 (ii) Calculation of Value of Bond:
= 14.30% p.a.
Note: YTM Formula के Method से CMP Answer approx. में
Note: Alternative IRR method can be used. आता है & therefore don’t do from this formula for calculating
CMP.
Question – 05
Calculate Market Price of: CMP = (₹ 375 × PVAF, 4, 3%) + (1,000 × PVF, 4, 3%)
(i) 10% Government of India security currently quoted at ₹ 110, = (375 × 3.717) + (1,000 × 0.888)
but yield is expected to go up by 1%.
= ₹ 10,274
(ii) A bond with 7.5% coupon interest, Face Value ₹ 10,000 & term
to maturity of 2 years, presently yielding 6% Interest payable
half yearly.

11.3
 SECURITY VALUATION

Question – 06 = ₹ 97.62
An investor is considering the purchase of the following bond:
It the bond is selling at ₹ 97.60 which is more than the fair value, the
Face value ₹ 100 YTM of the bond would be less than 13%. This value is almost equal
to the amount price of ₹ 97.60.
Coupon rate 11%
Therefore, the YTM of the bond would be 12%.
Maturity 3 years
Alternatively
(i) If he wants a yield of 13% what is the maximum price he
(₹ 100 − ₹ 97.60)
should be ready to pay for? ₹ 11+
3
YTM = (₹ 100 + ₹ 97.60)
(ii) If the Bond is selling for ₹ 97.60, what would be his yield? 2

(SM TYK – 20) = 0.1194 or 11.94% say 12%

Solution: Note: अगर Question में Factors दिया है तो YTM दनकालने के दलए IRR
(i) Calculation of Maximum Price Method ही Use होगा, अगर Factor नहीीं दिया है तो दकसी भी Method से YTM
दनकाला जा सकता है ।
IV0 = ₹ 11 × PVIFA (13%,3) + ₹ 100 × PVIF (13%,3)
Question – 07
= (₹ 11 × 2.361) + (₹ 100 × 0.693) There is a 9% 5-year bond issue in the market. The issue price is ₹
90 and the redemption price ₹ 105. For an investor with marginal
= ₹ 25.97 + ₹ 69.30 income tax rate of 30% and capital gains tax rate of 10% (assuming
no indexation), what is the post-tax yield to maturity?
= ₹ 95.27
Solution:
(ii) Calculation of Yield
RV* − P
I (1−t) + ( )
n
At 12% the value = ₹ 11 × PVIFA (12%,3) + 100 × PVIF YTM =
RV* + P
× 100
(12%,3) 2

103.50 – 90
= (₹ 11 × 2.402) + (₹ 100 × 0.712) 9 (1 – 0.30) + (
5
)
= 103.50 + 90 × 100
2
= ₹ 26.42 + ₹ 71.20

11.4
 SECURITY VALUATION

= 9.30% p.a. Solution:

RV = 105 (i) Price of ZCB

Capital gain tax [105 – 90] × 10% = 1.50 Price = ₹ 10,000 × PVF, 7.5%, 10
RV* = 105 – 1.5 = 103.50 = 10,000 × 0.485
Question – 08 = ₹ 4,850
On 31st March, 2013, the following information about Bonds is
available: (ii) Annualized yield

Name of Face Maturity Date Coup Coupon Date 1,00,000 – 98,500 365
Security Value ₹ on (s) Annualized yield = × 100 ×
98,500 81
Rate
Zero coupon 10,000 31st March, 2023 N.A. N.A. = 6.86% p.a.
T-Bill 1,00,000 20th June, 2013 N.A. N.A.
10.71% GOI 2023 100 31st March, 2023 10.71 31st March (iii) Price of Bond
10% GOI 2018 100 31st March, 2018 10.00 31st March &
30th Price = (₹ 10.71 × PVAF, 8%, 10) + (₹ 100 × PVF, 8%, 10)
September
= (₹ 10.71 × 6.710) + (₹ 100 × 0.463)
Calculate:
= ₹ 118.16
(i) If 10 years yield is 7.5% p.a. what price the Zero Coupon Bond
would fetch on 31st March, 2013? (iv) Price of Bond

(ii) What will be the annualized yield if the T-Bill is traded @ 98500? Price = (₹ 5 × PVAF, 4%, 10) + (₹ 100 × PVF, 4%, 10)

(iii) If 10.71% GOI 2023 Bond having yield to maturity is 8%, what = (₹ 5 × 8.111) + (₹ 100 × 0.676)
price would it fetch on April 1, 2013 (after coupon payment on
31st March) = ₹ 108.16

(iv) If 10% GOI 2018 Bond having yield to maturity is 8%, what
price would it fetch on April 1, 2013 (after coupon payment on Question – 09
31st March)? Today being 1st January 2019, Ram is considering to purchase an
outstanding Corporate Bond having a face value of ₹ 1,000 that was
issued on 1st January 2017 which has 9.5% Annual Coupon and 20

11.5
 SECURITY VALUATION

years of original maturity (i.e. maturing on 31st December 2027). Prevailing invest rate of similar debenture should be 7.55% p.a.
Since the bond was issued, the interest rates have been on downside
and it is now selling at a premium of ₹ 125.75 per bond. Question – 10
Mr. X wants to invest ₹ 1,00,000 in the 7 years 8% bonds in the
Determine the prevailing interest on the similar type of Bonds if it is market (Face Value ₹ 100) which were issued 2 years ago.
held till the maturity which shall be at Par.
(i) You are requested to advise him what is the maximum price
PV Factors: for bonds to be paid in the following scenarios:

1 2 3 4 5 6 7 8 9 (1) If Mr. X is expecting minimum 9% return on the bonds

6 0.94 0.89 0.84 0.79 0.74 0.70 0.66 0.62 0.59
% 3 0 0 2 7 5 5 7 2 (2) If Mr. X is expecting minimum 7% return on the bonds
8 0.92 0.85 0.79 0.73 0.68 0.63 0.58 0.54 0.50
% 6 7 4 5 1 0 3 0 0 (3) If the present rate of similar bonds issued is 8.25%

(RTP November – 2020) (4) If the present rate of similar bonds issued is 7.75%

Solution: (ii) If the bonds are available at par and 1% is the transaction
cost, what is the effective yield?
Calculation of YTM
(iii) Find the number of days required to breakeven transaction
(6%) Price = (₹ 95 × 6.801) + (1,000 × 0.592) = ₹ 1,238.10 cost if the bonds are available at par and 2% is the transaction
cost.
(8%) Price = (₹ 95 × 6.246) + (1,000 × 0.500) = ₹ 1,093.37
(Exam Nov – 2022) (8 Marks)
Interpolation
Solution:
6% ------------- ₹ 1,238.10
(1) Value of Bond
8% ------------- ₹ 1,093.37
(i) Discount Rate = 9%
2% ₹ 144.73
IV0 = (₹ 8 × 3.890) + (100 × 0.650)
2
YTM =6 +( × (1,238.10 – 1,125.75)) = ₹ 96.12
144.73

= 7.55% p.a. (ii) Discount Rate = 7%

11.6
 SECURITY VALUATION

IV0 = (₹ 8 × 4.100) + (100 × 0.713) 2,000

No. of days = = 91 days
₹ 21.92
= ₹ 104.10

(iii) Discount Rate = 8.25% DIRTY PRICE & CLEAN PRICE

IV0 = (₹ 8 × 3.967) + (100 × 0.673) Question – 11

MP Ltd. issued a new series of bonds on January 1, 2010. The bonds
= ₹ 99.04
were sold at par (₹ 1,000), having a coupon rate 10% p.a. and mature
(iv) Discount Rate = 7.75% on 31st December, 2025. Coupon payments are made semiannually
on June 30th and December 31st each year. Assume that you
IV0 = (₹ 8 × 4.019) + (100 × 0.689) purchase an outstanding MP Ltd. bond on 1st March, 2018 when the
going interest rate was 12%. Required:
= ₹ 101.05
(i) What was the YTM of MP Ltd. bonds as on January 1, 2010?

(ii) What amount you should pay to complete the transaction? Of

(2) Effective Yield that amount how much should be accrued interest and how
much would represent bonds basic value.
Price of Bond = ₹ 100 + 1%
Solution:
= ₹ 101
(i) YTM as (01/01/2010)
YTM is a rate at which price of bond is ₹ 101 hence YTM =
100
7.75% YTM = × 100 = 10%
1,000
(3) Transaction Cost
or
= ₹ 1,00,000 × 2% = ₹ 2,000 1,000 – 1,000
₹ 50 + ( )
32
YTM = 1,000 + 1,000 × 100
Income per day = ₹ 1,00,000 × 8% = ₹ 8,000
2

8,000 ₹ 50
= = 21.92 = × 100
365 1,000

11.7
 SECURITY VALUATION

12 Redemption Value ₹ 1,000

= 5% × = 10%
6
Yield to Maturity 15%
(ii) Full Price (Dirty Price)
(Round-off your answers to 3 decimals)
Bond price as on 30/06/18
Calculate the following in respect of the bond:
= (₹ 50 × PVAF, 6%, 15) + (1,000 × PVF, 6%,15)
(i) Current Market Price.
= (₹ 50 × 9.712) + (1,000 × 0.417) (ii) Duration of the Bond.
= ₹ 902.60 (iii) Volatility of the Bond.

= ₹ 902.60 + 50 = ₹ 952.60 (iv) Expected market price if increase in required yield is by 100
basis points.
Bond price as on 01/03/18
(v) Expected market price if decrease in required yield is by 75
952.60
Full Price = 4 = ₹ 915.96 basis points.
[1 + 0.12 × ]
12
Solution:
2
Accrued Interest = (₹ 1,000 × 10% × 12
) = 16.67
(i) & (ii) Current Market Price & Duration of the Bond

Bond Basic Value = ₹ 915.96 – 16.67 = ₹ 899.29 Year CF YTM P.V. Weights W×
(15%) Year
1 110 0.870 95.70 0.113 0.113
(II) BOND RISK 2 110 0.756 83.16 0.098 0.196
3 110 0.658 72.38 0.085 0.255
4 110 0.572 62.92 0.074 0.296
Question – 12 5 110 0.497 54.67 0.064 0.32
The following data is available for a bond: 6 1,110 0.432 479.52 0.565 3.39
CMP 848.35 Duration 4.570
Face Value ₹ 1,000
(iii) Volatility of Bond
Coupon Rate 11%
D
Years to Maturity 6 Volatility =
1 + YTM

11.8
 SECURITY VALUATION

4.570 Year CF PVF PVCF Year × PV

= = 3.974
1.15 (16%)
1 x 0.862 0.862 x 0.862 x
(iv) If Yield Increases by 100 BP 2 x 0.743 0.743 x 1.486 x
3 x 0.641 0.641 x 1.923 x
BP
Effect = - MD × 4 x 0.552 0.552 x 2.208 x
100 5 x 0.476 0.472 x 2.380 x
100 6 1,00,000 + 0.410 0.410 x + 2.480 x +
= - 3.974 × x 41,000 2,46,000
100
3.684 x + 41,000 11.319 x +
= - 3.974% 2,46,000
Bond Price = 848.35 – 3.974% 11.319 x + 2,46,000
4.3202 =
3.684 x + 41,000
= ₹ 814.64

(v) Yield Decreases by 75 BP 15.9156 x + 1,77,128 = 11.319 x + 2,46,000

-75 4.5966 X = 68,872
Effective Duration = - 3.974 ×
100
68,872
x= = 14,983
= 2.9805% 4.5966

14,983
Bond Price = 848.35 + 2.9805% Coupon (%) = × 100 = 14.98% i.e. 15%
1,00,000
= ₹ 873.64
CMP = (15,000 × PVAF, 16%, 6) + (1,00,000 × PVF, 16%)
Question – 13
Find the current market price of a bond having face value ₹ 1,00,000 = (15,000 × 3.685) + (1,00,000 × 0.410)
redeemable after 6 year maturity with YTM at 16% payable annually
= ₹ 96,275
and duration 4.3202 years. Given 1.166 = 2.4364.

Solution:
Question – 14
Let assume interest amount be x XL Ispat Ltd. has made an issue of 14 per cent non-convertible
debentures on January 1, 2007. These debentures have a face value
of ₹ 100 and is currently traded in the market at a price of ₹ 90.

11.9
 SECURITY VALUATION

Interest on these NCDs will be paid through post-dated cheques (ii) Duration of NCD
dated June 30 and December 31st. Interest payments for the first 3
years will be paid in advance through post-dated cheques while for Year CF YTM (8.42%) PV Weights W × Year
the last 2 years post-dated cheques will be issued at the third year. 1 7 0.922 6.454 0.071 0.071
The bond is redeemable at par on December 31, 2011 at the end of 2 7 0.851 5.957 0.066 0.132
5 years. 3 7 0.785 5.495 0.061 0.183
4 7 0.724 5.068 0.056 0.224
Required: 5 7 0.667 4.669 0.051 0.255
6 7 0.616 4.312 0.047 0.282
(i) Estimate the current yield and YTM of the bond. 7 7 0.568 3.976 0.044 0.308
8 7 0.524 3.668 0.040 0.320
(ii) Calculate the duration of the NCD. 9 7 0.483 3.381 0.037 0.333
10 107 0.446 47.722 0.526 5.260
(iii) Assuming that intermediate coupon payments are, not ₹ 90.7 7.368
available for reinvestment calculate the realized yield on the
NCD. 7.368
Duration = = 3.684 Years
2
Solution:
(iii) Realized YTM
(i) Current Yield
I 12 Cash outflows = ₹ 90
Current Yield = × 100 ×
CMP 6
Cash inflows
₹7 12
= × 100 × (₹ 7 × 10) + 100 = ₹ 170
90 6

= 15.55% 90 (1 + r)10 = 170

F–P
I +( )
n
YTM = F+P × 100 170 1/10
n r = [( 90 ) − 1] × 100 =

₹ 7 +(
100 – 90
) 6.57%
10
= 100 + 90 = 8.42%
2
12
Realized YTM = 6.57 ×
6
12
= 8.42 × = 16.84% p.a. = 13.14% p.a.
6

11.10
 SECURITY VALUATION

Question – 15 = ₹ 1,000
(a) Consider two bonds, one with 5 years to maturity and the
other with 20 years to maturity. Both the bonds have a face YTM (6%)
value of ₹ 1,000 and coupon rate of 8% (with annual interest
payments) and both are selling at par. Assume that the yields
Present Value of Interest (80 × 4.212) = ₹ 337
of both the bonds fall to 6%, whether the price of bond will
Present Value of Principal (1,000 × 0.747) = ₹ 747
increase or decrease? What percentage of this
increase/decrease comes from a change in the present value = ₹ 1084
of bond’s principal amount and what percentage of this
increase/decrease comes from a change in the present value P.V. of Interest = ₹ 319 – ₹ 337 = ₹ 18
of bond’s interest payments?

(b) Consider a bond selling at its par value of ₹ 1,000, with 6 years P.V. of Principal = ₹ 681 – 747 = ₹ 66
to maturity and a 7% coupon rate (with annual interest
payment), what is bond’s duration? Market = ₹ 1,000 – 1,084 = ₹ 84

(c) If the YTM of the bond in (b) above increases to 10%, how it If yield decreases to 6% then price of bond will Increase
affects the bond’s duration? And why? by ₹ 84 due to

₹ 18
Solution: Change in P.V. of Interest = × 100 = 21.43%
84
(a) It bonds are selling at par & redeemed at par
₹ 66
Change in P.V. of Principal = × 100 = 78.57%
Then coupon = Current Yield YTM 84

5 Years Bond 20 Years Bond

P.V. of Interest P.V. Principal Market

P.V. of Interest + P.V. of Principal = Market Price
Price
Yield 8 (80 × 9.818) = (1,000 × 0.214) 1,000
YTM (8%)
% 786 = 214
Present Value of Interest (80 × 3.993) = ₹ 319 Yield 6 (80 × 11.470) = (1,000 × 0.312) 1,230
% 918 = 312
Present Value of Principal (1,000 × 0.681) = ₹ 681 132 98 230

If yield decreases to 6% then bond price will increase by ₹ 230

11.11
 SECURITY VALUATION

132 5 70 0.621 217.35

Due to P.V. of Interest = × 100 = 57.39% 6 1070 0.564 3,620.88
230
∑ ABC 4,366.45
98
Due to P.V. of Principal = × 100 = 42.61%
230 New Duration ₹ 4,366.45/ ₹ 868.85 = 5.025 years
(b) Duration in the average time taken to recollect back the
The duration of bond decreases, reason being the receipt of
investment
slightly higher portion of one’s investment on the same
Year Coupon Redempti Tota PVIF intervals.
(A)×(B)×(
s (A) Payme on (₹) l (₹) (₹) (𝐂) C) (₹)
nt (₹) Question – 16
(𝐁)
Mr. A is planning for making investment in bonds of one of the two
1 70 - 70 0.935 65.45
2 70 - 70 0.873 122.22 companies X Ltd. and Y Ltd. The detail of these bonds is as follows:
3 70 - 70 0.816 171.36
Company Face Value Coupon Rate Maturity Period
4 70 - 70 0.763 213.64
5 70 - 70 0.713 249.55 X Ltd. ₹ 10,000 6% 5 Years
6 70 1000 107 0.666 4,275.72 Y Ltd. 4% 5 Years
₹ 10,000
0 ∑ ABC 5,097.94
The current market price of X Ltd.’s bond is ₹10,796.80 and both
∑ ABC ₹ 5,097.94 bonds have same Yield to Maturity (YTM). Since Mr. A considers
Duration = = = 5.098 Years
Purchase Price ₹ 1,000 duration of bonds as the basis of decision making, you are required
to calculate the duration of each bond and you decision.
(c) If YTM goes up to 10%, current price of the bond will decrease
to Solution:

₹ 70 × PVIFA (10%,6) + ₹ 1000 PVIF (10%,6) To calculate duration of bond we need YTM, which shall be calculated
as follows:
₹ 304.85 + ₹ 564.00 = ₹ 868.85
Let us try NPV of Bond @ 5%
Years (A) Inflow (₹) PVIF (₹) (𝐂) (A) × (B) × (C) 600 600 600 600 10,600
(B) (₹) = 1 + 2 + 3 + 4 + − 10,796.80
(1.05) (1.05) (1.05) (1.05) (1.05)5
1 70 0.909 65.45
2 70 0.826 115.64
3 70 0.751 157.71 = ₹ 571.43 +₹ 544.22 +₹ 518.30 +₹ 493.62 +₹ 8,305.38 – ₹
4 70 0.683 191.24 10,796.80

11.12
 SECURITY VALUATION

= – ₹ 363.85 Duration of the Bond is 4.4878 years say 4.49 years.

Let us now try NPV @ 4% Duration of Y Ltd.’s Bond

600 600 600 600 10,600 Year Cash P.V. @ 4.2% Proportion Proportion
= 1 + 2 + 3 + 4 + 5 −10,796.80 flows bond value bond value
(1.04) (1.04) (1.04) (1.04) (1.05)
× time
= ₹ 576.92 +₹ 554.73 +₹ 533.40 +₹ 512.88 +₹ 8,712.43 – ₹ (Years)
10,796.80 1 400 0.9597 383.88 0.0387 0.0387
2 400 0.9210 368.40 0.0372 0.0744
= ₹ 93.56 3 400 0.8839 253.56 0.0357 0.1071
4 400 0.8483 339.32 0.0342 0.1368
Let us now interpolation formula 5 10400 0.8141 8,466.64 0.8542 4.2710
9,911.80 1.0000 4.6280
93.56
= 4% + × (5% − 4%) Duration of the Bond is 4.6280 years say 4.63 years.
93.56 − (-363.85)

93.56 Decision: Since the duration of Bond of X Ltd. is lower and also
= 4% + carrying higher interest rate hence it should be preferred.
93.56 − (-363.85)

93.56 Question – 17
= 4% + = 4.20%
The following data are available for a bond:
457.41
Face Value ₹ 10,000 to be redeemed at par on maturity

Coupon rate 8.5%

Duration of X Ltd.’ s Bond
Years to Maturity 5 years
Year Cash P.V. @ 4.2% Proportion Proportion
flows bond value bond value Yield to Maturity (YTM) 10%
× time
(Years) EVALUATE the change in the expected market price of the Bond, if
1 600 0.9597 575.82 0.0533 0.0533 there is a decrease in the YTM by 200 basis points based on
2 600 0.9210 552.60 0.0512 0.1024
3 600 0.8839 530.34 0.0491 0.1473 (i) By Macaulay’s Duration after making Convexity Adjustment.
4 600 0.8483 508.98 0.0472 0.1888
5 10600 0.8141 8,629.46 0.7992 3.9960 (ii) By Intrinsic Value Method.
10,797.20 1.0000 4.4878
Given

11.13
 SECURITY VALUATION

Years 1 2 3 4 5 = ₹ 10,204.05
PVIF (10%, n) 0.909 0.826 0.751 0.683 0.621
PVIF (8%, n) 0.926 0.857 0.794 0.735 0.681 Calculation of Convexity

P2 + P1 – 2 P0
(MTP April – 2022) C* =
2 P0 × ∆Y2
Solution:
10,204.05 + 8,734.25 – 2 × 9,431.50
=
Macaulay’s Duration 2 × 9,431.0 × (0.02)2

Year CF YTM P.V. Weights W× = 9.979

(10%) year
1 850 0.909 772.65 0.082 0.082 C.A = C* × 100 × ∆Y2
2 850 0.826 702.10 0.074 0.148
3 850 0.751 638.35 0.068 0.204 = 9.979 × 100 × (0.02)2
4 850 0.683 580.55 0.062 0.248
5 10,850 0.621 6737.85 0.714 3.570 = 0.399
9431.50 4.252
Bond price after CA
D
Macaulay’s Duration =
1 + YTM Yield ↓ 200 BP
4.252 -200
= = 3.865 Effective Duration = (-3.865 × ) + 0.399
1.10 100

Intrinsic Value = 8.129

Yield = 12% Price = 9,431.50 + 8.129% = 10,198

IV0 = (850 × 3.605) + (10,000 × 0.567) Yield ↓ 200 BP
= ₹ 8,734.25 * On the basis of Macaulay Duration after C.A.
Yield = 8% Price = ₹ 10,198

IV0 = (850 × 3.993) + (10,000 × 0.681) * On the basis of Intrinsic Value

11.14
 SECURITY VALUATION

Price = 10,204.05 = 383.89 + 593.15 = ₹ 977.04

Question – 18 (B) Duration of Bond
An investor, in the beginning of 2022, has purchased substantial
number of 8 year 7.50% ₹ 1,000 bond with 5% premium on maturity Year Cash P.V. @ 8.5% Proportion Proportion
at a required Yield to Maturity (YTM) of 8.50%. However, due to the Flow of Bond of Bond
Value Value ×
continuing war in Europe, the inflation is running very high in the Time (years)
economies of the countries. The yield on the bonds is decreasing. The 1 75 0.9217 69.128 0.071 0.071
risk averse investor wants to protect himself from further loss and 2 75 0.8495 63.713 0.065 0.130
3 75 0.7829 58.718 0.060 0.180
decides to sell the bonds in 2023. He has got a proposal from another
4 75 0.7216 54.120 0.055 0.220
investor who is willing to purchase these bonds by shelling out a 5 75 0.6650 49.875 0.051 0.255
maximum amount of ₹ 797.50 per bond. 6 75 0.6129 45.968 0.047 0.282
7 1125 0.5649 635.513 0.651 4.557
Investor follows intrinsic value method for valuation of the Bonds. 977.035 5.695

You are required to determine Duration of the Bond is 5.695 years.

(i) The market price, duration and volatility of the bond. Alternatively, it can also be calculated as follows:

(ii) Will it be a right decision of the new investor if he is looking Year Cash PVF (3) PV (4) (1) × (4)
for Required Yield to Maturity (YTM) as 12% p.a.? (1) flow (2)
1 75 0.9217 69.13 69.13
Period 1 2 3 4 5 6 7 2 75 0.8495 63.71 127.42
PVIF 0.921 0.849 0.782 0.721 0.665 0.612 0.564 3 75 0.7829 58.72 176.16
(8.50 7 5 9 6 0 9 9 4 75 0.7216 54.12 216.48
%, n) 5 75 0.6650 49.88 249.40
6 75 0.6129 45.97 275.82
(Exam May – 2023) (9 Marks) 7 1125 0.5649 635.51 4448.57
977.04 5562.98
Solution:
5,562.98
(i) (A) Market Price of Bond Duration of the Bond = = 5.69 years
977.04

= 1,000 × 7.50% × (PVIAF 8.50%,7) + 1,050 × (PVIF 8.5%,7) (C) Volatility of Bond

= 75 × 5.1185 + 1050 × 0.5649 Volatility = Duration/(1 + YTM)

11.15
 SECURITY VALUATION

= 5.695/ (1 + 0.085) = 5.249 (ii) Calculate NAV per unit of the Fund if number of units is 2.50
crore.
Or = 5.69/ (1 + 0.085) = 5.24
(iii) Suggest a suitable action to reduce risk by churning out
(ii) PV of Bond @ 12% YTM investment portfolio in the following scenario:

A. Interest rates are expected to lower by 25 basis points.

= ₹ 75 PVIAF (12%, 7) + ₹ 1050 × PVIF (12%, 7)
B. Interest rates are expected to raise by 75 basis points.
= ₹ 75 × 4.5637 + ₹ 1050 × 0.4523
Also calculate the revised duration of investment portfolio in each
= ₹ 342.28 + ₹ 474.92 = ₹ 817.20 scenario.

Since, Intrinsic Value of Bond is ₹ 817.20 the decision of new Note: Use simple average to make calculations.
investor is right at purchase price of ₹ 797.50.
(MTP April – 2026)

Solution:
Question – 19 (i) This type of Fund is a Gilt Fund as the amount of fund is
The investment portfolio of a fund is as follows: invested in dated Government Securities.
Government Coupon Purchase Rate Duration (ii) To calculate NAV per unit first we shall calculate of actual
Bond Rate (%) (FV ₹ 100 per (Years)
investment of Funds as follows:
Bond)
GOI 2026 11.68 106.50 3.50 Security Purchase Price Investment (₹ in
GOI 2030 7.55 105.00 6.50 lakhs)
GOI 2035 7.38 105.00 7.50 GOI 2026 106.50 532.50*
GOI 2042 8.35 110.00 8.75
GOI 2030 105.00 525.00
GOI 2052 7.95 101.00 13.00
GOI 2035 105.00 525.00
GOI 2042 110.00 550.00
Face value of total Investment is ₹ 5 crores in each Government Bond. GOI 2052 101.00 505.00
Total 2,637.50
Required:
₹ 5 crores
(i) Identify the type of the Fund. * × R’ 106.50
₹ 100 × 1,00,000

11.16
 SECURITY VALUATION

Accordingly, the NAV per units shall be: Thus, it can be said that the in first case the duration of
portfolio is revised from 7.85 years to 9.75 years. In second
₹ 2,637.50 lakhs case it stands revised from 7.85 years to 6.55 years.
= ₹ 10.55
250 lakhs

(iii) Suitable action to churn out investment portfolio in following

scenario is to reduce risk and to maximize profit or minimize
losses. BOND IMMUNIZAITON

3.5 + 6.5 + 7.5 + 8.75 + 13.00 39.25

Average Duration = = = Question – 20
5 5
7.85 years Mr. A will need ₹ 1,00,000 after two years for which he wants to make
one time necessary investment now. He has a choice of two types of
(A) Interest rates are expected to be lower by 25 basis bonds. Their details are as below:
points in such case increase the average duration by
purchasing GOI 2052 and disposing of GOI 2026. Bond X Bond Y
Face value ₹ 1,000 ₹ 1,000
39.25 – 3.5 + 13 Coupon 7% payable annually 8% payable annually
Revised average duration shall be = Years to maturity 1 4
5
Current price ₹ 972.73 ₹ 936.52
48.75 Current yield 10% 10%
= = 9.75 years
5
Advice Mr. A whether he should invest all his money in one type of
(B) Interest rates are expected to rise by 75 basis points in bond or he should buy both the bonds and, if so, in which quantity?
such case reduce the average duration by (*) Assume that there will not be any call risk or default risk.
Purchasing GOI 2030 and disposing of GOI 2052.
(SM TYK – 27, MTP March – 2021 & RTP November – 2021)
39.25 – 13 + 6.5
Revised average duration shall be =
5 Solution:
32.75
= = 6.55 years Bond Duration [Bond X]
5
YEAR CF PVF PV WEIGHT YEAR ×
(*) Purchasing of GOI 2026 is not beneficial as maturity period
(10%) W
is very short and 75 basis points is comparatively higher
1 1,070 0.909 972.63 1 1
change.
972.63 Bond Duration = 1

11.17
 SECURITY VALUATION

Bond Duration [Bond Y] = ₹ 50,386

YEAR CF PVF PV WEIGHT YEAR × ₹ 50,386

(10%)
No. = = 51.80
W 972.73
1 80 0.909 72.72 0.078 0.078
2 80 0.826 66.08 0.071 0.142 = 52 Bonds
3 80 0.751 60.08 0.064 0.192
4 1080 0.683 737.64 0.788 3.152 Investment in y = ₹ 1,00,000 × 0.39
936.52 Bond Duration = 3.564
= ₹ 39,000
Duration of Liability = 2 years, hence we have to invest in bond
having duration is 2 years but such bond is not available = ₹ 39,000 × 0.826
In this situation, we have to invest in both bonds in a proportion so = ₹ 32,214
that duration of bonds should be 2 years
₹ 32,214
No. = = 34.40
Immunization is a period at which 936.52

= 34 Bonds
DL = DA

2 = (1 × WA ) + (3.564 × WB ) Question – 21
The following data are available for three bonds A, B and C. These
2 = WA + 3.564 (1 – WA ) bonds are used by a bond portfolio manager to fund an outflow
scheduled in 6 years. Current yield is 9%. All bonds have face value
2 = WA + 3.564 – 3.564 WA of ₹ 100 each and will be redeemed at par. Interest is payable
annually.
WA = 0.61
Bond Maturity Coupon rate
WB = 0.39 (Years)
A 10 10%
Investment in x = ₹ 1,00,000 × 0.61 B 8 11%
C 5 9%
= ₹ 61,000
(i) Calculate the duration of each bond.
= ₹ 61,000 × 0.826

11.18
 SECURITY VALUATION

(ii) The bond portfolio manager has been asked to keep 45% of Year Cash P.V. @ 9% Proportion Proportion
the portfolio money in Bond A. Calculate the percentage flow of bond of bond
amount to be invested in bonds B and C that need to be value value ×
purchased to immunize the portfolio. time
(years)
(iii) After the portfolio has been formulated, an interest rate 1 10 0.917 9.17 0.086 0.086
change occurs, increasing the yield to 11%. The new duration 2 10 0.842 8.42 0.079 0.158
of these bonds are: Bond A = 7.15 years, Bond B = 6.03 years 3 10 0.772 7.72 0.073 0.219
4 10 0.708 7.08 0.067 0.268
and Bond C = 4.27 years.
5 10 0.650 6.50 0.061 0.305
6 10 0.596 5.96 0.056 0.336
Is the portfolio still immunized? Why or why not?
7 10 0.547 5.47 0.051 0.357
8 10 0.502 5.02 0.047 0.376
(iv) Determine the new percentage of B and C bonds that are
9 10 0.460 4.60 0.043 0.387
needed to immunize the portfolio. Bond A remaining at 45% 10 110 0.4224 46.46 0.437 4.370
of the portfolio. 106.40 1.000 6.862

Present values be used as follows: Duration of the bond is 6.862 years or 6.86 year

Present t1 t2 t3 t4 t5 Bond B
Values
PVIF0.09,t 0.917 0.842 0.772 0.708 0.650 Year Cash P.V. @ 9% Proportion Proportion
flow of bond of bond
value value ×
Present Values t6 t7 t8 t9 t10
time
PVIF0.09,t 0.596 0.547 0.502 0.460 0.4224 (years)
1 11 0.917 10.087 0.091 0.091
(MTP March – 2021) 2 11 0.842 9.262 0.083 0.166
3 11 0.772 8.492 0.076 0.228
Solution: 4 11 0.708 7.788 0.070 0.280
5 11 0.650 7.150 0.064 0.320
(i) Calculation of Bond Duration 6 11 0.596 6.556 0.059 0.354
7 11 0.547 6.017 0.054 0.378
Bond A 8 111 0.502 55.772 0.502 4.016
111.224 1.000 5.833

11.19
 SECURITY VALUATION

Duration of the bond B is 5.833 years or 5.84 years. 0.45 × 7.15 + 0.36 × 6.03 + 0.19 × 4.27 = 6.20 year

Bond C No portfolio is not immunized as the duration of the portfolio

has been increased from 6 years to 6.20 years.
Year Cash P.V. @ 9% Proportion Proportion
flow of bond of bond
value (iv) New percentage of B and C bonds that are needed to
value ×
immunize the portfolio.
time
(years)
DL = DA
1 9 0.917 8.253 0.082 0.082
2 9 0.842 7.578 0.076 0.152
3 9 0.772 6.948 0.069 0.207 6.00 = (7.15 × 0.45) + 6.03 WB + 4.27 (0.55 – WB)
4 9 0.708 6.372 0.064 0.056
5 109 0.650 70.850 0.709 3.545 6.00 = 3.218 + 6.03 WB + 2.348 – 4.27 WB
100.00 1.000 4.242
0.434 = 1.76 WB
Duration of the bond C is 4.242 years or 4.24 years
WB = 0.2466 (24.66%)
(ii) Amount of Investment required in Bond B and C
WC = 1 – 0.45 – 0.2466
DL = DA
= 0.3034 (30.34%)
6 = (6.86 × 0.45) + 5.84 WB + 4.24 (0.55 – WB)

6 = 3.087 + 5.84 WB + 2.332 – 4.24 WB (IV) OPTION EMBEDDED BONDS

0.581 = 1.6 WB
(1) CONVERTIBLE BONDS
WB = 0.3631 (36.31%)
Question – 22
WC = 1 – 0.45 – 0.3631 The following data is related to 8.5% Fully Convertible (into Equity
shares) Debentures issued by JAC Ltd. at ₹ 1,000.
= 0.1869 (18.69%)
Market Price of Debenture ₹ 900
(iii) With revised yield the Revised Duration of Bond stands
Conversion Ratio 30

11.20
 SECURITY VALUATION

Straight Value of Debenture ₹ 700 ₹ 900

= = ₹ 30
30
Market Price of Equity share on the date of Conversion ₹ 25
(c) Conversion Premium per share
Expected Dividend Per Share ₹1
Market Conversion Price – Market Price of Equity Share
You are required to calculate:
= ₹ 30 – ₹ 25 = ₹ 5
(a) Conversion Value of Debenture
(d) Ratio of Conversion Premium
(b) Market Conversion Price
Conversion premium per share ₹5
= = 20%
(c) Conversion Premium per share Market Price of Equity Share ₹ 25

(d) Ratio of Conversion Premium (e) Premium over Straight Value of Debenture

(e) Premium over Straight Value of Debenture Market Price of Convertible Bond ₹ 900
−1 = − 1 = 28.6 %
Straight Value of Bond ₹ 700
(f) Favorable income differential per share
(f) Favorable income differential per share
(g) Premium pay back period
Coupon Interest from Debenture − Conversion Ratio × Dividend Per Share
(RTP November – 2021) Conversion Ratio

Solution: ₹ 85−30 × ₹ 1
= ₹ 1.833
30
(a) Conversion Value of Debenture
(g) Premium pay back period
= Market Price of one Equity Share × Conversion Ratio Conversion premium per share 5
= = 2.73 years
Favourable Income Differential per Share 1.833
= ₹ 25 × 30 = ₹ 750
(b) Market Conversion Price Question – 23
Market Price of Convertible Debenture Following information is related to the Convertible Bond of A Ltd.
= which is currently priced at ₹ 1060 per Bond:
Conversion Ratio

(1) Conversion Parity Price - ₹ 53

11.21
 SECURITY VALUATION

(2) Conversion Premium – 10.41667% The current market price of share of A Ltd. shall be = ₹ 960/
20 = ₹ 48 per share
(3) Percentage of Downside Risk with respect to Straight Value of
Bond – 12.766% (iii) To determine the Straight Value of Bond we shall use
Percentage of Downside Risk as follows:
Calculate:
Percentage of Downside Risk
(i) No. of shares on Conversion.
Market Price of Bond – Straigth Value of Bond
(ii) Current Market Price Per Share of A Ltd. =
Straight Value of Bond
(iii) Straight Value of Bond 1060 – Straigth Value of Bond
0.12766 =
Straight Value of Bond
(MTP October – 2023)

Solution: Straight Value of Bond = ₹ 940 per Bond

(i) The No. of share on Conversion shall be computed as follows: Question – 24

Following information is related to the 7.50% Convertible bond of S
Bond Price Ltd. which is currently priced at ₹ 5,300 per bond:
Conversion Parity Price =
[Link] Shares on Conversion
● Conversion Parity Price = ₹ 265
1060
₹ 53 =
[Link] Shares on Conversion ● Conversion Premium (Based on Market Price) = 10.41667%
Accordingly, No. of shares on Conversion = 20 ● Percentage of Downside Risk based on Straight Value of Bond
= 12.766%
(ii) To determine current Market Price Per Share of A Ltd. we
shall use Conversion Premium as follows: Required:
Market Price of Bond – Conversion Value of Bond
Conversion Premium = (i) Calculate No. of shares on Conversion.
Conversion Value of Bond

1060 – Conversion Value of Bond (ii) Analyze Current Market Price Per Share of S Ltd.
0.1041667 =
Conversion Value of Bond
(iii) Assess the Straight Value of Bond.
Conversion Value of Bond = ₹ 960

Since the No. of share on Conversion = 20

11.22
 SECURITY VALUATION

(iv) Based on straight value of bond computed above, determine (₹ 5,300 – Straight Value of Bond)
12.766% = × 100
the approximate required rate of return by an investor on Straight Value of Bond
similar category of bonds.
Straight Value of Bond = ₹ 4,700
Note: Use following Present Value Factors (PVFs) for various
calculations: (iv) To determine the required return, we shall discount related
cash flows as follows:
1 2 3 4 5
PVF @ 8% 0.9259 0.8573 0.7938 0.7350 0.6806 PV@8%
PVF @ 10% 0.9091 0.8264 0.7513 0.6830 0.6209 Year Cash Flow PVF PV
0 -4,700 1 -4,700
(MTP April – 2025) 1 375 0.9259 347.21
Solution: 2 375 0.8573 321.49
3 375 0.7938 297.68
Bond Price 4 375 0.7350 275.63
(i) Conversion Parity Price = 5 5,375 0.6806 3,658.23
No. of Shares on Conversion
200.23
5,300
₹ 265 =
No. of Shares on Conversion PV@10%
Year Cash Flow PVF PV
No. of Shares on Conversion = 20 Shares 0 -4,700 1 -4,700
1 375 0.9091 340.91
(Conversion Parity Price – Market Price
(ii) Conversion Premium = × 100 2 375 0.8264 309.90
Market Price
3 375 0.7513 281.74
(₹ 265 – Market Price) 4 375 0.6830 256.13
10.41667% = × 100 5 5,375 0.6209 3,337.34
Market Price
-173.99
Market Price = ₹ 240
Calculation of Required return using IRR
(iii) Percentage of Downside Risk 200.23
= 8% + × 2%
200.23 + 173.99
Market Price of Bond – Straight Value of Bond
= × 100
Straight Value of Bond 200.23
= 8% + × 2% = 8% + 1.07% = 9.07%
374.22

11.23
 SECURITY VALUATION

Question – 25 convertible preference shares of ₹ 50 each at par. The preference

Saranam Ltd. has issued convertible debentures with coupon rate shares are convertible into 2 shares for each preference shares held.
12%. Each debenture has an option to convert to 20 equity shares at The equity share has a current market price of ₹ 21 per share.
any time until the date of maturity. Debentures will be redeemed at
₹ 100 on maturity of 5 years. An investor generally required a rate of (i) What is preference share’s conversion value?
return of 8% p.a. on a 5-year security. As an investor when will you
(ii) What is conversion premium?
exercise conversion for given market prices of the equity share of (i)
₹ 4, (ii) ₹ 5 and (iii) ₹ 6. (iii) Assuming that total earnings remain the same, calculate the
effect of the issue on the basic earning per share (a) before
Cumulative PV factor for 8% for 5 years : 3.993 conversion (b) after conversion.
PV factor for 8% for year 5 : 0.681 (iv) If profits after tax increases by ₹ 1 million what will be the
basic EPS (a) before conversion and (b) on a fully diluted
(SM TYK – 23)
basis?
Solution:
Solution:
Intrinsic Value of Debenture
(i) Conversion Value = ₹ 21 ×2 = ₹ 42
IV0 = (12 × 3.993) + (100 × 0.681) ₹ 50 – 42
(ii) Conversion Premium = × 100 = 19.05%
= ₹ 116.016 42

(iii) EPS
Conversion Value
Before After Conversion
Price = ₹ 4 [20 × 4] = ₹ 80 Conversion
EAT 15,00,000 15,00,000
Price = ₹ 5 [20 × 5] = ₹ 100 (-) PD [40,000 × 50 × 1,40,000 -
7%]
Price = ₹ 6 [20 × 6] = ₹ 120 Earnings 13,60,000 15,00,000
÷ No. 5,00,000 5,80,000
Investor will exercise option when price of share is ₹ 6
[5,00,000 + 40,000 ×
2]
Question – 26
EPS 2.72 2.586
XYZ company has current earnings of ₹ 3 per share with 5,00,000
shares outstanding. The company plans to issue 40,000, 7%

11.24
 SECURITY VALUATION

EPS Reduced by 0.28 (3 – 0.414 (ii) Minimum market price of equity share at which bond holder
2.72) should exercise conversion option; and

(iv) Revise EPS (iii) Duration of the bond.

Before After Conversion Solution:

Conversion
EAT 25,00,000 25,00,000 (i) Current Market Price of Bond
(-) PD [40,000 ×7%] 1,40,000 -
Earnings 23,60,000 25,00,000 Time CF PVIF 8% PV (CF) PV (CF)
5,00,000 5,80,000 1 14 0.926 12.964
÷ No. 2 14 0.857 11.998
[5,00,000 + 40,000 × 3 14 0.794 11.116
2] 4 14 0.735 10.290
EPS 4.72 4.31 5 114 0.681 77.634
P0 = 124.002

Question – 27 Say ₹ 124.00

A Ltd. has issued convertible bonds, which carries a coupon rate of
14%. Each bond is convertible into 20 equity shares of the company (ii) Minimum Market Price of Equity Shares at which
A Ltd. The prevailing interest rate for similar credit rating bond is Bondholder should exercise conversion option:
8%. The convertible bond has 5 years maturity. It is redeemable at
124.00
par at ₹ 100. The relevant present value table is as follows. = ₹ 6.20
20.00

Present t1 t2 t3 t4 t5 (iii) Duration of the Bond

Values
PVIF0.14,t 0.877 0.769 0.675 0.592 0.519 Year Cash P.V. @ 8% Proportion Proportion
PVIF0.08, t 0.926 0.857 0.794 0.735 0.681 flow of bond of bond
value value ×
You are required to estimate: time
(years)
(Calculations be made upto 3 decimal places)
1 14 0.926 12.964 0.105 0.105
2 14 0.857 11.998 0.097 0.194
(i) Current market price of the bond, assuming it being equal to
3 14 0.794 11.116 0.089 0.267
its fundamental value, 4 14 0.735 10.290 0.083 0.332

11.25
 SECURITY VALUATION

5 114 0.681 77.634 0.626 3.130 2

124.002 1.000 4.028
YTM = 11 +( × 91)
103.40

Question – 28 Spread of yield = 12.76 – 11.80

A hypothetical company ABC Ltd. issued a 10% Debenture (Face
= 0.96%
Value of ₹ 1000) of the duration of 10 years, currently trading at ₹
850 per debenture. The bond is convertible into 50 equity shares
being currently quoted at ₹ 17 per share.
(2) CONVERTIBLE BONDS OR BOND REFUNDING
If yield on equivalent comparable bond is 11.80%, then calculate the
spread of yield of the above bond from this comparable bond. Question – 29
M/s Trans India Ltd. is contemplating calling ₹ 3 crores of 30 years,
The relevant present value table is as follows. ₹ 1,000 bond issued 5 years ago with a coupon interest rate of 14 per
cent. The bonds have a call price of ₹ 1,140 and had initially collected
Prese t1 t2 t3 t4 t5 t6 t7 t8 t9 t10
proceeds of ₹ 2.91 crores due to a discount of ₹ 30 per bond. The
nt
Valu initial floating cost was ₹ 3,60,000. The Company intends to sell ₹ 3
es crores of 12 per cent coupon rate, 25 years bonds to raise funds for
PVIF0 0.9 0.8 0.7 0.6 0.5 0.5 0.4 0.4 0.3 0.3 retiring the old bonds. It proposes to sell the new bonds at their par
.11,t 01 12 31 59 93 35 82 34 91 52 value of ₹ 1,000. The estimated floatation cost is ₹ 4,00,000. The
PVIF0 0.8 0.7 0.6 0.6 0.5 0.4 0.4 0.3 0.3 0.2 company is paying 40% tax and its after tax cost of debt is 8 per cent.
.13, t 85 83 93 13 43 80 25 76 33 95
As the new bonds must first be sold and their proceeds, then used to
(RTP November – 2019) retire old bonds, the company expects a two months period of
overlapping interest during which interest must be paid on both the
Solution: old and new bonds. What is the feasibility of refunding bonds?

(1) Yield of Bond (YTM) Solution:

11% = (₹ 100 × 5.580) + (1,000 × 0.352) = ₹ 941 Incremental Cash Outflows

13% = (₹ 100 × 5.426) + (1,000 × 0.295) = ₹ 887.60 Repayment of old bond (30,000 Bonds × 1,140) = ₹ 3,42,00,000
Issue of new bonds = (₹ 3,00,00,000)
2% ₹ 103.40
Floatation cost of new bonds = ₹ 4,00,000

11.26
 SECURITY VALUATION

Tax savings on call premium (42,00,000×40%) = (16,80,000) Question – 30

ABC Ltd. has ₹ 300 million, 12 per cent bonds outstanding with six
Tax saving on unamortized expenses of old bonds years remaining to maturity. Since interest rates are falling, ABC Ltd.
is contemplating of refunding these bonds with a ₹ 300 million issue
9,60,000 + 3,00,000
[ × 25] = 10,50,000 × 40% = (4,20,000) of 6 year bonds carrying a coupon rate of 10 per cent. Issue cost of
30
the new bond will be ₹ 6 million and the call premium is 4 per cent.
Interest on overlapping period [After Tax] ₹ 9 million being the unamortized portion of issue cost of old bonds
can be written off no sooner the old bonds are called off. Marginal tax
2
(3,00,00,000 × 14% × 12) (1 – 0.40) = 4,20,000 rate of ABC Ltd. is 30 per cent. You are required to analyze the bond
refunding decision.
Incremented cash outflows = ₹ 29,20,000
(SM TYK – 25 & RTP May – 2020)
Incremented Cash Inflows
Solution:
Old (14%) New (12%)
Incremental Cash Outflows (Millions)
Interest on (3,00,00,000 × 14%) (3,00,00,000 × 12%)
bonds [After (1-0.40) (1 – 0.40) = 21,60,000
Tax] Repayment of old bond (₹ 300 million × 1.04) = ₹ 312
= 25,20,000
Tax savings on 12,60,000 4,00,000 Issue of new bonds = (₹ 300)
floatation cost
( × 40%) ( ) × 40%
30 25
(16,800) (6,400) Issue cost of new bonds =₹6
25,03,200 21,53,600

Incremented Cash Inflows (25,03,200 – 21,53,600) = 3,49,600 p.a.

Tax savings on call premium (300 × 4% × 30%) = (₹ 3.60)

Tax saving on unamortized expenses of old bonds

PVCI = 3,49,600 × PVAF, 8%, 25
(9 × 30%) = (₹ 2.70)
= 3,49,600 × 10.675 = ₹ 37,31,980
Incremental cash outflows =11.70 Million
(-) PVCO = ₹ 29,20,000
Incremented Cash Flows
NPV = ₹ 8,11,980
Old (12%) New (10%)
Since NPV is positive, hence bond should be refunded. Interest [After Tax] (300 × 12%) (1 – (300 × 10%) (1 –
0.30) 0.30)

11.27
 SECURITY VALUATION

= 25.20 = 21.00 PVF @ 10% & 8% are as under —

Tax Savings on 9 6
Amortization
(6 × 30%) (0.45) (6 × 30%) (0.30) Rate 1 2 3 4 5
expenses 8% 0.93 0.86 0.79 0.74 0.68
24.75 20.70 10% 0.91 0.83 0.75 0.68 0.62

Incremented cash Inflows 24.75 – 20.70 = 4.05 Million p.a.

Calculation up to 2 decimal points.
Kd = I (1 - t)
(Exam September – 2025)
= 10 (1-0.30)
Solution:
= 7%
(i) Calculation of initial outlay:- ₹ (Lakh)
PVCI = 4.05 × PVAF, 6, 7%
a. Face value 600
= 4.05 × 4.767 = 19.31
Add: Call premium 30
(-) PVCO = 11.70
Less: Tax on Premium of Redemption 6
NPV = 7.61
Cost of calling old bonds 624
Since NPV is positive, hence bond should be refunded.
b. Gross proceed of new issue 600
Question − 31
TK Ltd. has ₹ 600 Lakh 12% Debenture outstanding with 5 years Less: Issue costs 10
remaining to redemption. Since interest rates are decreasing,
Net proceeds of new issue 590
company is planning to redeem these debentures with a ₹ 600 Lakh
issue of 5 years 10% Debenture at par. Issued Cost of 10% Debenture ∴ Initial outlay = ₹ 624 Lakh – ₹ 590 Lakh = ₹ 34 Lakh
will be ₹ 10 Lakh. Premium paid on redemption of 12% Debenture is
(ii) Calculation of net present value of refunding the bond:
5% Tax rate applicable to company 15, is 20%

You are required to advise on the 12% Debenture Redemption Saving in annual interest expenses ₹ (Lakh)
Decision.
[600 × (0.12 – 0.10)] 12.00

11.28
 SECURITY VALUATION

Less: Tax saving on interest (0.20 × 12) Add: Tax Saving on Issue Expenses 2
2.40
Net proceeds of new issue 592
Add: Tax Saving on Issue Exp. (10/5) × 0.20 0.40 ∴ Initial outlay = ₹ 624 Lakh – ₹ 592 Lakh = ₹ 32 Lakh

Annual net cash saving 10.00 (ii) Calculation of net present value of refunding the bond:-

PVIFA (8%, 5 years) 4.00 Saving in annual interest expenses ₹ (Lakh)

∴ Present value of net annual cash saving ₹ 40.00 Lakh

[600 × (0.12 – 0.10)] 12.00
Less: Initial outlay ₹ 34.00 Lakh
Less: Tax saving on interest (0.20 × 12)
Net present value of refunding the bond ₹ 6.00 Lakh 2.40

Decision: 12% Debentures should be redeemed and new 10% Annual net cash saving 9.60
Debentures should be issued because NPV of Bond Refunding
decision is positive. PVIFA (8%, 5 years) 4.0

Alternative Solution: Since in the Question specifically nothing has ∴Present value of net annual cash saving ₹ 38.40 Lakh
been mentioned about the writing off Issue Expenses for 10% Less: Initial outlay ₹ 32.00 Lakh
Debentures, if students have assumed it to be written off at the time
of issue in one go then solution will be as follows: Net present value of refunding the bond ₹ 6.40 Lakh

(i) Calculation of initial outlay:- ₹ (Lakh) Decision: 12% Debentures should be redeemed and new 10%
Debentures should be issued because NPV of Bond Refunding
a. Face value 600
decision is positive.
Add: Call premium 30

Less: Tax on Premium of Redemption 6

(3) EXTENDABLE BONDS
Cost of calling old bonds 624
QUESTION – 32
b. Gross proceed of new issue 600 Pet feed plc has outstanding, a high yield Bond with following
features:
Less: Issue costs 10

11.29
 SECURITY VALUATION

Face Value £ 10,000 Expected loss = £ 10,923 − £ 9,181

Coupon 10% = £ 1,742
Maturity Period 6 Years

Special Feature Company can extend the life of Bond to (V) YIELD STRUCTURE OR TERM STRUCTURE OF
12 years. INTERESR RATE
Presently the interest rate on equivalent Bond is 8%.

(a) If an investor expects that interest will be 8%, six years from Question – 33
now then how much he should pay for this bond now. From the following data for Government securities, calculate the
forward rates:
(b) Now suppose, on the basis of that expectation, he invests in
the Bond, but interest rate turns out to be 12%, six years from Face Value Interest Rate Maturity Current Price
(₹) (Year) (₹)
now, then what will be his potential loss/ gain if the company
1,00,000 0% 1 91,500
extents the life of Bond for another 6 years.
1,00,000 10% 2 98,500
1,00,000 10.5% 3 99,000
Solution:
Solution:
Investor expects that after 6 years, interest rate will be 8%. In this
situation, company will not extend [Market में कम Rate पर company 1 Year Rate
को पैसे दमल जाएगा]
1,00,000
91,500 =
PVCI = (£ 1,000 × PVAF, 8%, 6) (£ 1,000 × PVF, 8%, 6) (1 + r)1

1,00,000
= (£ 1,000 × 4.623) × (£ 1,000 × 0.630) r= ( – 1) × 100 = 9.29%
91,500
= £ 10,923 1 Year FR after 1 Year
Value of bond at the end of 6th year if yield (12%) 10,000 1,10,000
98,500 = +
(1.0929) (1.0929) (1 + r)
= (£ 1,000 × 4.111) × (£ 1,000 × 0.507)
r = 12.65%
= £ 9,181

11.30
 SECURITY VALUATION

1 Year FR after 2 Years (ii) Expected Price of Bond

10,500 10,500 1,10,500 = ₹ 942.47 × 1.02

99,000 = + +
1.0929 (1.0929)(1.1265) (1.0929) (1.1265 )(1 + r)
= 961.32
r = 11% p.a.
Question – 35
Question – 34 ABC Ltd. wants to issue 9% Bonds redeemable in 5 years at its face
ABC Ltd. issued 9%, 5 year bonds of ₹ 1,000/- each having a value of ₹ 1,000 each. The annual spot yield curve for similar risk
maturity of 3 years. The present rate of interest is 12% for one year class of Bond is as follows:
tenure. It is expected that Forward rate of interest for one year tenure
is going to fall by 75 basis points and further by 50 basis points for Year Interest Rate
every next year in further for the same tenure. This bond has a beta 1 12%
value of 1.02 and is more popular in the market due to less credit 2 11.62%
risk. 3 11.33%
4 11.06%
Calculate: 5 10.80%

(i) Intrinsic value of bond. (i) Evaluate the expected market price of the Bond if it has a Beta
value of 1.10 due to its popularity because of lesser risk.
(ii) Expected price of bond in the market.
(ii) Interpret the nature of the above yield curve and reasons for
Solution: the same.

(i) Forward Rate Note: Use PV Factors upto 4 decimal points and value in ₹ upto 2
decimal points.
1 year = 12%
(MTP April – 2021)
2nd Year = 12 – 0.75 = 11.25%

3rd year = 11.25 – 0.5 = 10.75%

Solution:
₹ 90 ₹ 90 ₹ 1,090
IV0 = + +
1.12 (1.12) (1.1125) (1.12) (1.1125) (1.1075) (i) Market price

= ₹ 942.47 ₹ 90 ₹ 90 ₹ 90 ₹ 90 ₹ 1,090
=
(1.12)1
+ (1.1162)2
+ (1.1133)3
+ (1.1106)4
+ (1.1080)5

11.31
 SECURITY VALUATION

= ₹ 929.70 (1.12)3
=[
(1.1125)2
− 1] × 100 = 13.52%
Expected Price = ₹ 929.70 × 1.10
(ii) R.V. = 1,000 (1.12)5 = 1,762.34
= ₹ 1,022.67
If yield (12 + 0.5) = 12.5%
(ii) Inverted yield curve due to upcoming recession.
1762.34
Question – 36 = = ₹ 977.97
(1.125)5
The following is the Yield structure of AAA rated debenture:
% Decrease in Bond Price
Period Yield (%)
3 Months 8.5% 1,000 – 977.97
6 Months 9.25
= × 100 = 2.20%
1,000
1 Year 10.50
2 Years 11.25 Question – 37
3 Years and above 12.00 Following are the yields on Zero Coupon Bonds (ZCB) having a face
value of ₹ 1,000 :
(i) Based on the expectation theory calculate the implicit one-
year forward rates in year 2 and year 3. Maturity (Years) Yield to Maturity (YTM)
1 10%
(ii) If the interest rate increases by 50 basis points, what will be 2 11%
the percentage change in the price of the bond having a 3 12%
maturity of 5 years? Assume that the bond is fairly priced at
the moment at ₹ 1,000. Assume that the term structure of interest rate will remain the same.

Solution: You are required to

(i) Forward Rate (i) Calculate the implied one year forward rates

1 year FR in year 2 (ii) Expected Yield to Maturity and prices of one year and two year
Zero Coupon bonds at the end of the first year.
(1.1125)2
= = 12%
1.1050 (Exam January – 2021) (4 Marks)
1 year FR in year 3

11.32
 SECURITY VALUATION

Solution:

(i) 1 year FR after 1 year 1 year ZCB

1.10 Price at the end of year 1

₹ 1,000
=
1.1201

= ₹ 892.78
(1.11)2
Expected yield = 12.01%
(1.11)2
=[ − 1] × 100 1 year ZCB
1.10
₹ 1,000
= 12.01% Price =
(1.1403)(1.1201)

(ii) 1 year FR after 2 years = 782.93

(1.11)2 = 782.93 (1 + r)2

= 1,000
2 3
₹ 1,000 1/2
=( )
(1.12)3 782.93

= 13.02%
(1.12)3
=[
(1.11)2
− 1] × 100

= 14.03%

ZCB
1 2 3

1.1201 1,000 1,000

(1.1403)
(1.1201)

11.33
 SECURITY VALUATION

= ₹ 91.87
DIVIDEND GROWTH MODEL OR, DIVIDEND
DISCOUNT MODEL OR, GORDEN’S MODEL Walter’s Model

MPS
P/E =
Question – 38 EPS
A company has a book value per share of ₹ 137.80. Its return on
No Growth Model
equity is 15% and it follows a policy of retaining 60% of its earnings.
If the Opportunity Cost of Capital is 18%, compute is the price of the EPS
share today using both Dividend Growth Model and Walter’s Model.
Ke =
MPS

(SM TYK – 01) EPS

Ke =
EPS × P/E
Solution:
1
BVPS = 137.80 Ke =
P/E Ratio

EPS = 137.80 × 15% 0.15

8.268 + (20.67 – 8.268)
= 20.67 [Expected EPS]
P0 = 0.18
0.18

D1 = 20.67 × 40% = ₹ 103.35

= ₹ 8.268 Question – 39
ABC Ltd. has been maintaining a growth rate of 10 percent in
g =b ×r dividends. The company has paid dividend @ ₹3 per share. The rate
of return on market portfolio is 12 percent and the risk free rate of
= 0.60 × 0.15 = 0.09 return in the market has been observed as 8 percent. The Beta co-
efficient of company’s share is 1.5.
Gordon’s Model
You are required to calculate the expected rate of return on
D1 company’s shares as per CAPM model and equilibrium price per
P0 =
Ke −g share by dividend growth model.
8.268 (SM TYK – 08)
=
0.18 – 0.09

11.34
 SECURITY VALUATION

Solution: = 15%

CAPM Equation D1
P0 =
Ke – g
Ke = Rf + (Rm − Rf ) β
2 (1.07)
=
=8 + (12 – 8) 1.5 0.15 – 0.07

= ₹ 26.75
= 14%
Likely Value of Shares
EQUILIBRIUM PRICE

D1 Ke = Rf + (Rm − Rf ) β
P0 =
Ke – g
=9 + (13 – 9) 1.75
3 (1.10)
=
0.14 – 0.10 = 16%

= ₹ 82.50 D1
P0 =
Ke – g
Question – 40
A Company pays a dividend of ₹ 2.00 per share with a growth rate of 2 (1.07)
=
7%. The risk-free rate is 9% and the market rate of return is 13%. 0.16 – 0.07
The Company has a beta factor of 1.50. However, due to a decision
= ₹ 23.78
of the Finance Manager, beta is likely to increase to 1.75. Find out
the present as well as the likely value of the share after the decision. Question – 41
(SM TYK – 09) Shares of Voyage Ltd. are being quoted at a price-earning ratio of 8

Solution:
times. The company retains 45% of its earnings which are ₹5 per
share.
Present Value
You are required to compute
Ke = Rf + (Rm − Rf ) β
(1) The cost of equity to the company if the market expects a
growth rate of 15% p.a.
=9 + (13 – 9) 1.5

11.35
 SECURITY VALUATION

(2) If the anticipated growth rate is 16% per annum, calculate the (3) Market Price
indicative market price with the same cost of capital.
D1
P0 = +g
(3) If the company's cost of capital is 20% p.a. & the anticipated Ke – g
growth rate is 19% p.a., calculate the market price per share.
6.11
= = ₹ 611
(SM TYK – 11) 0.20 – 0.19

Solution: Question – 42
M/s X Ltd. has paid a dividend of ₹ 2.5 per share on a face value of
(1) Cost of Equity ₹ 10 in the financial year ending on 31st March, 2009. The details are
as follows:
Retention Ratio (b) = 45%
Current market price of share ₹ 60
5
EPS = = ₹ 11.11
45% Growth rate of earnings and dividends 10%
D1 = ₹ 11.11 – ₹ 5 = ₹ 6.11 Beta of share 0.75

P0 (MPS) = EPS × P/E Average market return 15%

= 11.11 × 8 = 88.88 Risk free rate of return 9%

D1 Calculate the intrinsic value of the share.

Ke = +g
P0 (SM TYK – 13)
6.11
= + 0.15 Solution:
88.88

= 21.87% Ke = Rf + (Rm − Rf ) β

(2) Market Price =9 + (15 – 9) 0.75

D1 = 13.5%
P0 = +g
Ke – g
D1
6.11
P0 =
Ke – g
= = ₹ 104.09
0.2187 – 0.16

11.36
 SECURITY VALUATION

2.5 (1.10) 1 (1 + g)
= 17.50 = = ₹ 8.50
0.135 – 0.10 0.14 – g

= ₹ 78.57 2.45 – 17.50 g =1 + 1g

Question – 43
g = 7.84%
A company has an EPS of ₹ 2.5 for the last year and the DPS of ₹ 1.
The earnings is expected to grow at 2% a year in long run. Currently Question – 44
it is trading at 7 times its earnings. If the required rate of return is Following are the details of X Ltd. and Y Ltd.:
14%, compute the following:
Particulars X Ltd. Y Ltd.
(i) An estimate of the P/E ratio using Gordon growth model. Dividend per Share ₹4 ₹4
Growth Rate 10% 10%
(ii) The Long-term growth rate implied by the current P/E ratio. Beta 0.9 1.2
Current Market Price per Share ₹ 150 ₹ 70
(MTP March – 2021)
Other Information:
Solution:
Risk Free Rate of Return 7%
(i) Implicit P/E Ratio Market Rate of Return 14%
D1
P0 = (i) Calculate the price of shares of both the companies.
Ke – g
(ii) Write the comment on the valuation on the basis of price
1 (1.02)
= = ₹ 8.50 calculated and current market price.
0.14 – 0.02

MPS 8.50 (iii) As an investor what course of action should be followed?

P/E = = = 3.4 times
EPS 2.50
(Exam December – 2021) (8 Marks)
(ii) Implicit Growth Rate
Solution:
MPS (P0 ) = EPS × P/E (i) Calculation of Prices of Shares of both Companies

= 2.50 ×7 = 17.50 X Ltd. Y Ltd.

Beta 0.9 1.20

11.37
 SECURITY VALUATION

(ii) Is its stock overvalued if stock price is ₹ 35, ROE = 9% and

Cost of Equity 7% + 0.9[14% − 7% + 1.20 [14% − EPS = ₹ 2.25? Show detailed calculation.
using CAPM 7%] 7%]
= 13.30% = 15.40% (SM TYK – 04 & MTP – 2022)
Growth Rate
10% 10% Solution:

4 × 1.10 4 × 1.10 4.40 (1) Present Value of Stock

Price of Share = =
0.133 − 0.10 0.154 - 0.10 0.054
4.40 D1
= ₹ 81.48
P0 =
0.033 Ke – g

= ₹ 133.33 2.50 (1.02)

=
0.105 – 0.02

(ii) and (iii) = ₹ 30

Name of Current Value Valuation Action of (2) Present Value of Stock

Company Market of the the
Price Share Investor (a) P/E Model
X Ltd. ₹ 150.00 ₹ Overvalued/ Not to
1
133.33 overpriced Invest/to P/E =
be sold Ke
Y Ltd. ₹ 70.00 Undervalued/ Invest/to
1
₹ underpriced be = = 11.11
81.48 purchased 9%

Question – 45 MPS = EPS × P/E Ratio

On the basis of the following information:
= ₹ 2.25 × 11.11
Current dividend (Do) = ₹ 2.50
= ₹ 25
Discount rate (k) = 10.5%
Actual price is more than intrinsic value, hence share
Growth rate (g) = 2% is overpriced.

(i) Calculate the present value of stock of ABC Ltd.

11.38
 SECURITY VALUATION

(b) Earning Growth Model Ke = Rf + β (Rm − Rf )

EPS (1 + g)
P0 = =9 + 1.2 (13 – 9)
Ke – g

2.25 (1.02) = 13.8%

= = ₹ 32.79
0.09 – 0.02 2 (1.07)
P0 =
Stock is overpriced 0.138 – 0.07

= ₹ 31.47
Question – 46
The risk free rate of return Rf is 9 percent. The expected rate of return (2) Assumption 1
on the market portfolio Rm is 13 percent. The expected rate of growth
for the dividend of Platinum Ltd. is 7 percent. The last dividend paid Each factor independently
on the equity stock of firm A was ₹ 2.00. The beta of Platinum Ltd.
equity stock is 1.2. * Inflation premium ↑ 2%
(i) What is the equilibrium price of the equity stock of Platinum Ke = 11 + 1.2 (15 – 11) =15.8%
Ltd.?
2 (1.07)
(ii) How would the equilibrium price change when
P0 = = ₹ 24.32
0.158 – 0.07

- The inflation premium increases by 2 percent? * Growth Rate ↑ 3%

- The expected growth rate increases by 3 percent? 2 (1.10)
P0 = = ₹ 57.89
0.138 – 0.10
- The beta of Platinum Ltd. equity rises to 1.3?
* Beta = 1.30
(SM TYK – 15)

Solution:
Ke =9 + 1.30 (13 – 09) = 14.2%

2 (1.07)
(1) Equilibrium Price P0 =
0.142 – 0.07
= ₹ 29.72

D1 Assumption II [All Factors Change Simultaneously]

P0 =
Ke – g
Ke = 11 + 1.30 (15 – 11) = 16.20%

11.39
 SECURITY VALUATION

2 (1.10) 12
P0 =
0.162 – 0.10
= ₹ 35.48 = × 100 = 40%
30

SGR =b ×r
Question – 47
= 0.625 × 0.40 = 25%
Mr. X has submitted the following data:

Particulars (₹) in Lakhs Sales will increment by 25% i.e. 100 × 25% = ₹ 25 lacs
Total Assets 250
Total Liabilities 220
Net Income 12 MULTIPEL GROWTH MODEL
Dividend Paid 4.5
Sales 100 Question – 48
MNP Ltd. has declared and paid annual dividend of ₹ 4 per share. It
Mr. X wants to know to what extent sales can be increased without
is expected to grow @ 20% for the next two years and 10% thereafter.
going for additional borrowings by using Sustainable Growth Rate
The required rate of return of equity investors is 15%. Compute the
(SGR) Concept?
current price at which equity shares should sell.
(Exam Nov – 2022) (4 Marks)
Note: Present Value Interest Factor (PVIF) @ 15%:
Solution:
For year 1 = 0.8696;
SGR
For year 2 = 0.7561
Equity = 250 – 220 = ₹ 30 lacs
(SM TYK – 03)
Retain Earning = 12 – 4.50
Solution:
= 7.50 lacs
D0 = ₹ 4
7.50
Retention Ratio (b) = × 100 = 62.5% D1 = ₹ 4 (1.20) = ₹ 4.80
12

NI D2 = ₹ 4 (1.20)2 = ₹ 5.76
ROE (r) = × 100
Equity
D3 = ₹ 4 (1.20)2 (1.10) = ₹ 6.336

11.40
 SECURITY VALUATION

D3 6.336 Stage I
TV =
(ke − g)
= = 126.72
0.15 − 0.10
P.V. = (2.75 × 0.862) + (3.025 × 0.743) + (3.328 × 0.641)
4.80 5.76 126.72
P = + (1 + (1
(1 + 0.15) + 0.15)2 + 0.15)2 = ₹ 6.751

= 4.80 × 0.8696 + 5.76 × 0.7561 + 126.72 × 0.7561 Stage II

= 104.34 D4
P3 =
Ke − g
Question – 49
M/s. B Ltd. has declared dividend of ₹ 2.50 per share on the EPS of 5.758
=
₹ 7. Earnings of the company are expected to grow at the rate of 10% 0.16 – 0.03

for the next 3 years and to be stabilized at 3% thereafter. = ₹ 44.29

The pay-out ratio is expected to remain at the same level during 3
= ₹ 44.29 × 0.641 = 28.39
years and then will increase to 60%. If required rate of return is 16%
calculate: P0 = 6.751 + 28.39
(i) The current price of the share.
= ₹ 35.141
(ii) The expected price of share of B Ltd. At the end of 3rd year.

Following table may be used for calculations.

Question – 50
Present Value t1 t2 t3 t4 t5 X Limited, just declared a dividend of ₹14.00 per share Mr. B is
PVIF0.16,t 0.862 0.743 0.641 0.553 0.477 planning to purchase the share of X Limited, anticipating increase in
growth rate from 8% to 9%, which will continue for three years. He
(Exam Jan – 2021) (5 Marks) also expects the market price of this share to be ₹ 360.00 after three
years.
Solution:
You are required to determine:
EPS & DPS
(i) the maximum amount Mr. B should pay for shares, if he
1 2 3 4
7.70 8.47 9.317 9.597 requires a rate of return of 13% per annum.
EPS (₹ 27)
DPS (2.50) 2.75 3.025 3.328 5.758

11.41
 SECURITY VALUATION

(ii) the maximum price Mr. B will be willing to pay for share, if he P0 = 15.26(0.885) + 16.63(0.783) + 18.13(0.693) +
is of the opinion that the 9% growth can be maintained 360(0.693)
indefinitely and require 13% rate of return per annum.
P0 = 13.50 + 13.02 + 12.56 + 249.48
(iii) the price of share at the end of three years, if 9% growth rate
is achieved and assuming other conditions remaining same as P0 = ₹ 288.56
in (ii) above.
(ii) If growth rate 9% is achieved for indefinite period, then
Calculate rupee amount up to two decimal points. maximum price of share should Mr. A willing be to pay is
Year-1 Year-2 Year-3 D1 ₹ 15.26 ₹ 15.26
P0 = = = = ₹ 381.50
(1 − ke ) (0.13 – 0.09) 0.04
FVIF @ 9% 1.090 1.188 1.295
(iii) Assuming that conditions mentioned above remain same, the
FVIF @ 13% 1.130 1.277 1.443 price expected after 3 years will be:
PVIF @ 13% 0.885 0.783 0.693 D4 D3 (1.09) 18.13 × 1.09 19.76
P3 = = = = = ₹ 494
ke − g 0.13 − 0.09 0.04 0.04
(SM TYK – 05)
Question – 51
Solution: XYZ Ltd. paid a dividend of ₹ 2 for the current year. The dividend is
expected to grow at 40% for the next 5 years and at 15% per annum
(i) Expected dividend for next 3 years.
thereafter. The return on 182 days T-bills is 11% per annum and the
Year 1 (D1) ₹ 14.00 (1.09) = ₹ 15.26 market return is expected to be around 18% with a variance of 24%.

Year 2 (D2) ₹ 14.00 (1.09)2 = ₹ 16.63 The co-variance of XYZ's return with that of the market is 30%. You
are required to calculate the required rate of return and intrinsic
Year 3 (D3) ₹ 14.00 (1.09)3 = ₹ 18.13 value of the stock.

Required rate of return = 13% (Ke) (SM TYK – 17)

Market price of share after 3 years = (P3) = ₹ 360 Solution:

The present value of share Covxm

Beta =
σm2
15.26 16.63 18.13 360
P0 = + + +
(1 + 0.13) (1 + 0.13)2 (1 + 0.13)3 (1 + 0.13)3

11.42
 SECURITY VALUATION

30 Question – 52
= = 1.25
24 Mr. A is thinking of buying shares at ₹ 500 each having face value of
Required Rate of Return ₹ 100. He is expecting a bonus at the ratio of 1:5 during the fourth
year. Annual expected dividend is 20% and the same rate is expected
Ke = Rf + β (Rm − Rf ) to be maintained on the expanded capital base. He intends to sell the
shares at the end of seventh year at an expected price of ₹ 900 each.
= 11 + 1.25 (18 – 11) Incidental expenses for purchase and sale of shares are estimated to
be 5% of the market price. He expects a minimum return of 12% per
= 19.75%
annum.
Year PVF Amount P.V.
(19.75%) Should Mr. A buy the share? If so, what maximum price should he
Dividend pay for each share? Assume no tax on dividend income and capital
2 (1.40)1 1 0.835 2.80 2.34 gain.
2 0.697 3.92 2.73
2.80 × 1.40 (SM TYK – 14 & RTP November – 2019)
3 0.582 5.488 3.19
3.92 × 1.40 4 0.486 7.683 3.73
5.488 × 1.40 5 0.406 10.756 4.37 Solution:
7.683 × 1.40 5 0.406 260.41 105.77
NPV
Terminal value
(W.N.1) Year PVF (12%) Amount P.V.
P0 122.13 Dividend
₹ 100 × 20% 1 0.893 20.00 17.86
Terminal Value 2 0.797 20.00 15.94
3 0.712 20.00 14.24
D6 ₹ 100 × 20% × 1.2 shares 4 0.636 24.00 15.26
P5 = 5 0.567 24.00 13.61
Ke – g 6 0.507 24.00 12.17
7 0.452 24.00 10.85
10.756 (1.15) Sell Share 900 × 1.20 × 7 0.452 1026.00 463.75
=
0.1975 – 0.15 0.95
P.V. CI = ₹ 563.68
= ₹ 260.41
NPV = ₹ 563.68 – 500 × 1.05
= ₹ 38.68

11.43
 SECURITY VALUATION

Since NPV is positive, hence share should be purchased. Before 2008

₹ 563.68 Ke = 6.25 + 1.40 × 5.5 = 13.95

Maximum price =
1.05
After 2008
= ₹ 536.84
Ke = 6.25 + 1.10 × 5.5 = 12.30
Question – 53 (1) Expected price at the end of 2008
Seawell Corporation, a manufacturer of do-it-yourself hardware and
house wares, reported earnings per share of € 2.10 in 2003, on which D6
P5 =
it paid dividends per share of €0.69. Earnings are expected to grow Ke − g
15% a year from 2004 to 2008, during this period the dividend
2.910
payout ratio is expected to remain unchanged. After 2008, the = = € 46.19
0.1230 – 0.06
earnings growth rate is expected to drop to a stable rate of 6%, and
the payout ratio is expected to increase to 65% of earnings. The firm (2) Present Value of stock
has a beta of 1.40 currently, and is expected to have a beta of 1.10
after 2008. The market risk premium is 5.5%. The Treasury bond Stage I
rate is 6.25%.
P.V. = (0.794 × 0.878) + (0.913 × 0.770) + (1.049 ×
(a) What is the expected price of the stock at the end of 2008? 0.676) + (1.207 × 0.593) + (1.388 × 0.521)
(b) What is the value of the stock, using the two-stage dividend = € 3.548
discount model? Stage II
(RTP May – 2019)
= € 46.19 × 0.521
Solution:
= € 24.065
Working Note 1: Calculation of EPS & EPS
P0 = € 3.548 + € 24.065
2004 2005 2006 2007 2008 2009
EPS (2.10) 2.415 2.777 3.194 3.673 4.224 4.477 = € 27.613
DPS (0.69) 0.794 0.913 1.049 1.207 1.388 2.910

Ke = Rf + β (Rm − Rf )

11.44
 SECURITY VALUATION

Question – 54 EPS 5.6 7.8 10. 15. 21. 28. 36. 45. 52. 57.
The current EPS of M/s VEE Ltd. is ₹ 4. The company has shown an (4) 0 4 976 366 513 827 899 017 220 441
extraordinary growth of 40% in its earnings in the last few years this DPR 10 10 10 10 10 18 26 34 42 50
high growth rate is likely to continue for the next 5 years after which % % % % % % % % % %
growth rate in earnings will decline from 40% to 10% during the next DPS 0.5 0.7 1.0 1.5 2.1 5.1 9.5 15. 21. 28.
5 years and remain stable at 10% thereafter. The decline in the 6 84 98 37 51 89 94 306 932 721
growth rate during the 5 years transition period will be equal and PVF 0.8 0.7 0.6 0.5 0.4 0.3 0.3 0.2 0.2 0.2
linear. Currently, the company’s pay-out ratio is 10%. It is likely to 55 31 25 34 56 90 33 85 94 09
remain the same for the next five years and from the beginning of the
sixth year till the end of the 10th year, the pay-out will linearly Stage I: Present value of dividend = ₹ 24.47
increase and stabilize at 50% at the end of the 10th year. The post tax
Stage II: Present value of terminal value
cost of capital is 17% and the PV factors are given below:
D11
Year 1 2 3 4 5 6 7 8 9 10 P10 =
Ke − g
s
PVIF 0.8 0.7 0.6 0.5 0.4 0.3 0.3 0.2 0.2 0.2 28.721 (1.10)
@17 55 31 25 34 56 90 33 85 44 09 =
0.17 – 0.10
%
= ₹ 451.33 × 0.209
You are required to Calculate the intrinsic value of the company’s
stock based on expected dividend. if the current market price of the = 94.328
stock is ₹ 125, suggest if it is advisable for the investor to invest in
the company’s stock or not. IV0 = 24.47 + 94.328
(Exam November – 2019) (8 Marks) = ₹ 118.798

Solution: As Intrinsic Value of the share is lower than its selling price of ₹ 125,
it is overprized and can not be acquired.
Calculation of EPS & DPS
Question – 55
1 2 3 4 5 6 7 8 9 10
An investor is considering to purchase the equity shares of LX Ltd.,
whose current market price (CMP) is ₹ 112. The company is
Gro 40 40 40 40 40 34 28 22 16 10
wth % % % % % % % % % % proposing a dividend of ₹ 4 for the next year. LX Ltd. is expected to
grow @ 20 per cent per annum for the next four years. The growth
will decline linearly to 16 per cent per annum after first four years.

11.45
 SECURITY VALUATION

Thereafter, it will stabilize at 16 per cent per annum infinitely. The 4.00 4.80 5.76 6.91 8.22
P = + 2 + 3 + 4 + +
investor requires a return of 20 per cent per annum. (1 + 0.20) (1 + 0.20) (1 + 0.20) (1 + 0.20) (1 + 0.20)5

9.70 11.35 329.25

You are required 6 + 7 +
(1 + 0.20) (1 + 0.20) (1 + 0.20)7

(i) To calculate the intrinsic value of the share of LX Ltd.

= 4.00 × 0.833 + 4.80 × 0.694 + 5.76 × 0.579 + 6.91 ×
(ii) Whether it is worth to purchase the share at this price. 0.482 + 8.22 × 0.402 + 9.70 × 0.335 + 11.35 × 0.279 +
Period 1 2 3 4 5 6 7 329.25 × 0.279
PVIF 0.833 0.694 0.579 0.482 0.402 0.335 0.279
(20%,n) (i) Intrinsic Value = ₹ 114.91

(Exam November – 2020) (8 Marks) (ii) As Intrinsic Value of the share is higher than its selling price
of ₹ 112, it is underpriced and can be acquired. However, other
Solution: factors need to be taken into consideration since difference is
only slightly higher.
D1 =₹4
Question – 56
D2 = ₹ 4 (1.20) = ₹ 4.80
SAM Ltd. has just paid a dividend of ₹ 2 per share and it is expected
2 to grow @ 6% p.a. After paying dividend, the Board declared to take
D3 =₹4 (1.20) = ₹ 5.76
up a project by retaining the next three annual dividends. It is
expected that this project is of same risk as the existing projects. The
D4 =₹4 (1.20)3 = ₹ 6.91
results of this project will start coming from the 4th year onward from
D5 = ₹ 6.91 (1.19) = ₹ 8.22 now. The dividends will then be ₹ 2.50 per share and will grow @ 7%
p.a.
D6 = ₹ 6.91 (1.19) (1.18) = ₹ 9.70
An investor has 1,000 shares in SAM Ltd. and wants a receipt of at
D7 = ₹ 6.91 (1.19) (1.18) (1.17) = ₹ 11.35
least ₹ 2,000 p.a. from this investment.
D8 = ₹ 6.91 (1.19) (1.18) (1.17) (1.16) = ₹ 13.17
Show that the market value of the share is affected by the decision
D8 13.17 of the Board. Also show as to how the investor can maintain his
TV7 = = = ₹ 329.25 target receipt from the investment for first 3 years and improved
ke – g 0.20 – 0.16
income thereafter, given that the cost of capital of the firm is 8%.

11.46
 SECURITY VALUATION

(SM TYK – 16)

Solution: 2nd Year

₹ 250
Market Price (P0 ) P2 = = ₹ 231.48
(1.08)1
(i) If not accept the project
₹ 2,000
No. of shares = = 8.64 shares i.e. [9 shares]
D1 ₹ 231.48
P0 =
Ke − g
3rd Year
₹ 2 (1.06)
=
0.08 – 0.06 P3 = ₹ 250

= ₹ 106 ₹ 2,000
No. of shares = = 8 shares
250
(ii) If accept the project
Remaining shares = 1,000 – 10 – 9 – 8
D4
P3 = = 973 shares
Ke − g

₹ 2.50 At the end of 3rd year, he would be having 973 shares valued @ ₹ 250
= = ₹ 250
0.08 – 0.07 each i.e. ₹ 2,43,250. On these 973 shares, his dividend income for
₹ 250
year 4 would be @ ₹ 2.50 i.e. ₹ 2,432.50.
P0 = = ₹ 198.46
(1.08)3 So, if the project is taken up by the company, the investor would be
able to maintain his receipt of at least ₹ 2,000 for first three years
Since value of share will increase hence accept the project.
and would be getting increased income thereafter.
If investor wants receipt of ₹ 2,000 p.a., then he should sell shares.
Question – 57
1st Year Piyush Loonker and Associates presently pay a dividend of Re. 1.00
per share and has a share price of ₹ 20.00.
₹ 250
P1 = = ₹ 214.33
(1.08)2 (i) If this dividend were expected to grow at a rate of 12% per
annum forever, what is the firm’s expected or required return
₹ 2,000
No. of shares = = 9.33 shares i.e. [10 shares] on equity using a dividend-discount model approach?
214.33

11.47
 SECURITY VALUATION

(ii) Instead of this situation in part (i), suppose that the dividends 18% 20.21.
were expected to grow at a rate of 20% per annum for 5 years
and 10% per year thereafter. Now what is the firm’s expected, 20% 16.00
or required, return on equity? 2% 4.21
(SM TYK – 06) 2
Ke = 18 +( ) × 0.21 = 18.10%
4.21
Solution:
Question – 58
(1) Cost of Equity
An investor is considering purchasing equity shares of Alpha Ltd.,
D1 whose current Market price is ₹ 172.45. The company is proposing a
Ke = +g dividend of ₹ 6 for the year ending 31st march, 2024. Alpha Ltd. is
P0
expected to grow @ 20 percent per annum for the next four years.
1(1.12)
= + 0.12 Thereafter, the growth, over the next three years, will decline linearly
20
by 100 basis points per annum. Thereafter, it will stabilize at a
= 17.60% certain growth rate per annum infinitely. The required rate of return
for the investor is 20%.
(2) Required Rate of Return
Dividend value is to be taken in 2 decimal points only.
Assume Ke = 18%
You are required:
1.20 1.440 1.728 2.074 2.488 2.488 (1.10)
P0 =
(1.18)1
+ (1.18)2
+ (1.18)3
+ (1.18)4
+ (1.18)5
+ 0.18-0.10 (i) To calculate the stable growth rate of Alpha Ltd. after the end
1 of 7 years.
× (1.18)5
(ii) To advise whether it is worth to purchase the share at this
= ₹ 20.21 price if the investor has a stable target growth rate of 15% per
annum.
Assume Ke = 20%
Period 1 2 3 4 5 6 7
1.20 1.440 1.728 2.074 2.488 2.488 (1.10)
P0 =
(1.20)1
+ (1.20)2 + (1.20)3
+ (1.20)4
+ (1.20)5
+ 0.20-0.10
PVIF 0.83 0.694 0.578 0.482 0.401 0.334 0.279
(20%, 33 4 7 3 9 9 1
1
× (1.20)5 n)

= ₹ 16.26 (Exam May – 2023) (8 Marks)

11.48
 SECURITY VALUATION

Solution: g = 0.16 i.e. 16%

(i) Working Notes: Thus, the stable growth rate after the end of the 7 years shall
be 16%.
D1 = ₹ 6
(ii) Since growth rate is more than target growth rate it is
D2 = 6 (1.20) = ₹ 7.20 worth to purchase the share.
D3 = 6 (1.20) 2 = ₹ 8.64

D4 = 6 (1.20) 3 = ₹ 10.37 BUY BACK DECISION

D5 = 10.37(1.19) = ₹ 12.34 Question – 59
Rahul Ltd. has surplus cash of ₹ 100 lakhs and wants to distribute
D6 = 10.37 (1.19) (1.18) = ₹ 14.56
27% of it to the shareholders. The company decides to buy back
D7 = 10.37 (1.19) (1.18) (1.17) = ₹ 17.04 shares. The Finance Manager of the company estimates that its share
price after re-purchase is likely to be 10% above the buyback price-
Price at the end of 7th year if the buyback route is taken. The number of shares outstanding at
present is 10 lakhs and the current EPS is ₹ 3.
Year Dividend (₹) PVF @ 20% PV (₹)
1 6.00 0.8333 5.00 You are required to determine:
2 7.20 0.6944 5.00
3 8.64 0.5787 5.00 (i) The price at which the shares can be re-purchased, if the
4 10.37 0.4823 5.00 market capitalization of the company should be ₹ 210 lakhs
5 12.34 0.4019 4.96 after buyback,
6 14.56 0.3349 4.88
7 17.04 0.2791 4.76 (ii) The number of shares that can be re-purchased, and
Total 34.60
(iii) The impact of share re-purchase on the EPS, assuming that
Current Market Price ₹ 172.45 net income is the same.
Less: PV of Dividends upto the year ending 7th ₹ 34.60
year ₹ 137.85 (SM TYK – 18)
PV of Expected Market Price at the end of 7th
year Solution:

17.04 (1 + g) (i) Amount Available For Dividend

Let g be growth rate then: 137.85= × 0.2791
0.20 − g

11.49
 SECURITY VALUATION

= ₹ 100 lakh × 27% the post buy back Earnings Per Share (EPS). The company’s
corporate tax rate is 30%.
= ₹ 27 lakh
(MTP March – 2021)
Let Assume buy back price be x
Solution:
No. of shares × MPS = Market Capitalization 1,500 Cr.
No. of Shares =
27 lakh 1,500
(10 lakh − ) × 1.10x = 210
x
= 1 Cr.
11x – 29.70 = 210
No. of shares buy back = 1 Cr. × 20%
x = ₹ 21.79
= 0.20 Cr.
(ii) No. of Shares Bought Back

27,00,000
Buy Back Price = ₹ 1,500 × 1.10
No. = = 1,23,910 shares
21.79 = ₹ 1,650
(iii) Impact on EPS Due to Buy Back
Amount of buy back = ₹ 1,650 × 0.2 Cr.
EPS before buy back =₹3
= ₹ 330 Cr.
₹ 30,00,000
After buy back =
10,00,000 − 1,23,910 Interest = ₹ 330 Cr. × 16%
= ₹ 3.424 = 52.80 Cr.

EPS increases to ₹ 3.424 Post Buy Back EPS =

200 Cr. – 52.80 (1 − 0.30)
0.8 Cr.
Question – 60
= ₹ 203.80
Eager Ltd. has a market capitalization of ₹ 1,500 crores and the
current market price of its share is ₹ 1,500. It made a PAT of 200 Question – 61
crores and the Board is considering a proposal to buy back 20% of High Growth Ltd. (HGL) was having an excellent growth over a
the shares at a premium of 10% to the current market price. It plans number of years. The Board of Directors is considering a proposal to
to fund this through a 16% bank loan. You are required to calculate reward its shareholders by buying back 20% shares at a premium.

11.50
 SECURITY VALUATION

The premium is to be paid by raising a loan from the Bank. The MPS
Post buy back EPS =
interest on loan is to be serviced by internal accruals as supported P/E
by the financials of HGL. The company has a market capitalization
10,000
of ₹ 15,000 crore and the current Earnings Per Share (EPS) is ₹ 600 = = 400
25
with a Price Earning Ratio (PER) of 25. The Board expects a post buy
back Market Price per Share (MPS) of ₹ 10,000. The PER, post buy PAT before buy back = EPS × No.
back will remain the same. The loan can be availed at an interest rate
of 16% p.a. = 600 × 1 Cr. = ₹ 600 Cr.
Applicable corporate tax rate is 30%. Let assume interest amount be x
You are required to calculate: 600 – x (1 – 0.3)
= = 400 Cr.
0.8
(i) The interest amount which can be paid for availing the bank
loan. Interest amount = 400 Cr.

(ii) The loan amount to be raised. 400

(ii) Loan Amount = = ₹ 2,500 Cr.
16%
(iii) Buy back premium per share.
(iii) Buy Back Premium per Share
(Exam May – 2023) (10 Marks)
2,500 Cr.
Solution: Premium per share =
0.2 Cr.

(i) Interest Amount = ₹ 12,500

MPS before buy back = EPS × P/E Buy back price = 12,500 + 15,000 = 27,500

= 600 × 25 = ₹ 15,000 ICAI SOLUTION:

No. of shares before buy back (i) The interest amount which can be paid for availing the bank
loan
₹ 15,000 Cr.
= 1 Cr.
15,000 Current Market Price per Share = ₹ 600 × 25 = ₹ 15,000
No. of shares buy back = 1 Cr. × 20% = 0.2 Cr. Market Capitalization
No. of Shares before Buyback =
Market Price of Share

11.51
 SECURITY VALUATION

15,000 Crore Pre Buy back Market Capitalization (A) ₹ 15,000

= = 1 Crore
15,000 Pre Buy back EPS (B) crore
Pre Buy back PER (C) ₹ 600
No. of Shares proposed to Buyback = 20% of 1 crore = 20
Pre Buy back Market Price Per Share (₹ 25
lakh
600 × 5) D = B × C ₹15,000
Total No. of Share after Buyback = 1 crore – 20 lakh = 80 Pre Buy back No. of Shares (A)/ (D)
lakh Post Buy back EPS (A) (₹ 10,000/ 25) 1 Crore
Post Buy back No. of shares (B) ₹ 400
Post Buy back Market Price per Share = ₹ 10,000 80 Lakh
× (B)
Post Buy back Earning (C) = (A)
₹ 320 crore
PE Ratio = 25 Pre Buy back Earning 1 Crore × ₹ 600 (D)
₹ 600 crore
10,000 Post Tax Earning available for interest ₹ 280 Crore
Post Buyback EPS = = ₹ 400 payment (D) – (C)
25 ₹ 400 Crore
280 Crore
Pre- Tax amount of Interest
EAT before Buyback = ₹ 600 × 1 crore = ₹ 600 crore 1 – 0.30

600 400 Crore

EBT before Buyback = = ₹ 857.1429 crore (ii) Loan Amount raised = = ₹ 2,500 Crore
(1 – 0.30) 0.16

(iii) Buyback Premium per Share

EAT after Buyback = ₹ 400.00 × 80 lakh = ₹ 320 crore
320 Amount of Loan for Buyback of 20 % Shares = ₹ 2,500 crore
EBT after Buyback = = ₹ 457.1429 crore
(1 – 0.30)
No. of Shares Buyback = 20 Lakh
Interest which can be paid for availing bank loan:
Buyback price per Share = ₹ 2,500 Crore/ 20 Lakh = ₹
EBT before Buyback ₹ 857.1429 crore 12,500

(-) EBT after Buyback ₹ 457.1429 crore Market Price after Buyback = ₹ 10,000

₹ 400.0000 crore Buyback Premium Per Share = ₹ 12,500 – ₹ 10,000 = ₹ 2,500

Alternatively, it can also be computed as follows:
Alternatively, it can also be computed as follows:

11.52
 SECURITY VALUATION

Amount of Loan (A) ₹ 2,500 crore ₹ 2,00,00,000

Offer price = =₹4
No. of Shares to be bought back (B) 20 Lakh 5,00,000
Price Per Share to be paid (C) = (A)/ (B) ₹ 12,500
(10,00,000 × 13) + (5,00,000 × 4)
Post Buy back Share Price (D) ₹ 10,000 Ex-Right price = = ₹ 10
15,00,000
Buy Back Premium per share (C) – (D) ₹ 2,500
Value of right per shares = 13 – 10 = 3

Value of right =3 ×2=₹6

VALUATION OF RIGHT

Question – 62 (ii) One share for every 4 shares

ABC Limited’s shares are currently selling at ₹ 13 per share. There
are 10,00,000 shares outstanding. The firm is planning to raise ₹ 20 1
One of shares = 10,00,000 × = 2,50,000 shares
4
lakhs to Finance a new project.
₹ 20,00,000
Required: Offer price = =₹8
2,50,000

What are the ex-right price of shares and the value of a right, if Ex-Right =
(10,00,000 × 13) + (2,50,000 × 8)
= 12
12,50,000
(i) The firm offers one right share for every two shares held.
Value of right per shares = 13 – 12 = ₹ 1
(ii) The firm offers one right share for every four shares held.
Value of right = ₹ 1 × 4 shares = ₹ 4
(iii) How does the shareholders’ wealth change from (i) to (ii)? How
does right issue increases shareholders’ wealth? Before right = 100 share × 13 = ₹ 1,300
(SM TYK – 02) One share for 2 shares
Solution:
Value of shares [150 × 10] = ₹ 1,500
(i) One share for every 2 shares
(-) Buy right shares [50 × 4] = ₹ 200
1
Right shares = 10,00,000 × = 5,00,000 shares
= ₹ 1,300
2

11.53
 SECURITY VALUATION

One share for 4 shares S = Subscription price

Value of shares (125 × 12) = ₹ 1,500 R = Right share offer

₹ 36 × 4 + ₹ 24 × 1
(-) Buy right shares (25 × 8) = ₹ 200 = [ ]
4+1
= ₹ 1,300 = ₹ 33.60
No change in wealth. (ii) Calculation of theoretical value of the rights alone:

= Ex-right price – Cost of rights share

Question – 63
AMKO Limited has issued 75,000 equity shares of ₹ 10 each. The = ₹ 33.60 − ₹ 24 = ₹ 9.60
current market price per share is ₹ 36. The company has a plan to
make a rights issue of one new equity share at a price of ₹ 24 for Or,
every four shares held.
₹ 33.60 − ₹ 24
You are required to: = = ₹ 2.40
4
(i) Calculate the theoretical post-rights price per share. Question – 64
Aggressive Ltd. is proposing to fund its expansion plan of ₹ 12 crore
(ii) Calculate the theoretical value of the right alone.
by making a rights issue. The current market price (CMP) is ₹ 40.
(Exam November – 2018) (4 Marks) The Board is willing to offer a discount of 20% on the CMP for the
rights issue. The Board is also desirous that the fall in Ex-right price
Solution: of the shares be restricted to 10% of CMP.
(i) Calculation of theoretical Post-rights (ex-right) price per CALCULATE:
share:
(1) The number of new equity shares to be offered for each rights
MN + SR
Ex-right value = [ ] held,
N+R
(2) Theoretical value of right and
Where,
(3) The total number of equity shares to be issued.
M = Market price,
(MTP Oct – 2022)
N = Number of old shares for a right share

11.54
 SECURITY VALUATION

Solution: ₹ 5,000 – X 360

= × = 0.035
₹ 5,000 91
(1) Let assume number of right shares be x
= ₹ 5,000 −X
(1 × 40) + (x × 32)
= 36
x+1
= ₹ 44.24
36 + 36x = 40 + 32x
X = ₹ 4,955.76
x=1
Question – 66
It means 1:1 RBI sold a 91-day T-bill of face value of ₹ 100 at an yield of 6%. What
was the issue price?
(2) Value of right
(SM TYK – 28)
= CMP – Ex right
Solution:
= 40 – 36 = 4
Let the issue price be X
(3) No. of shares to be issued

1,20,00,000 By the terms of the issue of the T-bills:

= = 0.375 Cr.
32
100 − x 365
6% =
x
× 91
× 100

MONEY MARKET INSTRUMENTS 6 × 91 × X

36,500
= (100 − x)
Question – 65
Suppose Govt. Pays ₹ 5,000 at maturity for 91 days Treasury bill. If 0.01496x =100 −x
Mr. Y is desirous to earn an annualized discount rate of 3.5%, then
100
how he can pay for it. x = = ₹ 98.53
1.01496

Solution: Question – 67
Wonderland Limited has excess cash of ₹ 20 lakhs, which it wants to
Suppose X be the maximum amount Mr. Y can pay for Treasury bill. invest in short term marketable securities. Expenses relating to
Then, investment will be ₹ 50,000.

11.55
 SECURITY VALUATION

The securities invested will have an annual yield of 9% Calculate :

The company seeks your advice i Face value of the Bond and

(i) as to the period of investment so as to earn a pre-tax income ii. Bond Equivalent yield
of 5%. (discuss)
(Exam May – 2019) (4 Marks)
(ii) the minimum period for the company to breakeven its
investment expenditure overtime value of money. Solution:

(SM TYK – 29) (i) Face Value of the Bond

Solution: 45
(6%) 45 days discount yield =6 × 360 = 0.75
(i) Pre-tax Income required on investment of ₹ 20,00,000
45
(8%) 45 days discount yield =8 × 360 = 1.00
Let the period of Investment be ‘P’ and return required on
investment ₹ 1,00,000 (₹ 20,00,000 × 5%) Change in discount yield = 1 – 0.75 = 0.25%

Accordingly, Change in bond price = ₹ 2.50

9 P
(₹ 20,00,000 × 100
× 12
) − ₹ 50,000 = ₹ 1,00,000 Hence, face value of bond =
Change in Price
Change in Discount Yield

P =10 months
₹ 2.50
=
(ii) Break-Even its investment expenditure 2.5%

9 P = ₹ 1,000
(₹ 20,00,000 × × ) − ₹ 50,000 =0
100 12
(ii) Bond Equivalent Yield
P = 3.33 months
Current market price of bond
Question – 68
A bond is held for period of 45 days. The current discount yield is 6
If discount yield is 6% p.a. then ₹ 1,000 – 0.75% = ₹ 992.50
per cent per annum. It is expected that current yield will increase by
200 basis points and current market price will come down by ₹ 2.50. If discount yield is 8% p.a. then ₹ 1,000 – 1.00% = ₹ 900.00

11.56
 SECURITY VALUATION

At the rate of 6% 1,000 – 992.50 360 6.05 Cost of funds to the company
× ×
992.50 45
100 † Effective interest rate = 10.05%
At the rate of 8% 1,000 – 990.00 360 8.08
× ×
990.00 45 Brokerage (0.15 × 4) = 0.6%
100 †
Rating charges = 0.5%
Question – 69
From the following particulars, calculate the effective rate of interest
p.a. as well as the total cost of funds to Bhaskar Ltd., which is
Stamp duty (0.175 × 4) = 0.75%
planning a CP issue:
Total cost of Funds to Bhaskar Ltd. = 11.9% p.a.
Issue Price of CP ₹ 97,550
Question – 70
Face Value ₹ 1,00,000 Bank A enter into a Repo for 14 days with Bank B in 10%
Government of India Bonds 2018 @ 5.65% for ₹ 8 crore. Assuming
Maturity Period 3 Months that clean price be ₹ 99.42 and initial margin be 2% and days of
accrued interest be 262 days. You are required to determine.
Issue Expenses:
(i) Dirty Price
Brokerage 0.15% for 3 months
(ii) Repayment at maturity. (Consider 360 days in a year)
Rating Charges 0.50% p.a.
(SM TYK – 31, MTP March & April – 2021)
Stamp Duty 0.175% for 3 months
Solution:
(MTP October – 2020)
(i) Dirty Price
Solution:

F–P 12 = Clean Price + Interest Accrued

Effective Interest =(
P
)× M
× 100
10 262
= 99.42 + 100 × 100 × 360 = 106.70
Substituting the given values of F, P and M we get,

1,00,000 – 97,550 12 (ii) First Leg (Start Proceed)

Effective Interest = ( )× × 100 = 10.05%
97,550 3

11.57
 SECURITY VALUATION

Dirty Price 100 – Initial Margin Solution:

= Nominal Value × 100
× 100

106.70 100 – 2 (1) Second Leg = Start Proceed × (1 +

= ₹ 8,00,00,000 × 100
× 100
= ₹ 8,36,52,800
[Link] days
Repo Rate × )
Second Leg (Repayment at Maturity) 360

= Start Proceed × (1 + Repo Rate ×

No. of Days
) ₹ 2,00,31,759 = ₹ 2,00,06,750 × (1 +
360
9
Repo Rate × )
14 360
= ₹ 8,36,52,800 × (1 + 0.0565 × 360
)
9
1.00125 = (1 + Repo Rate × )
= ₹ 8,38,36,604 360

Question – 71 Repo Rate = 0.05 = 5%

The Bank BK enters into a Repo for 9 days with Bank NE in 6%
Government bonds 2022 for an amount of ₹ 2 crore. The other
relevant details are as follows: (2) First Leg (Start Proceed)

First Leg Payment (Start Proceed) ₹ 2,00,06,750 Dirty Price

Second Leg Payment (Repayment ₹ 2,00,31,759 = Nominal Value × ×
100
Proceed) 100 – Initial Margin
Initial Margin 1.25% 100
Days of accrued interest 240
Dirty Price 100 – 1.25
Assume 360 days in a year.
₹ 2,00,06,750 = ₹ 2,00,00,000 × ×
100 100

CALCULATE: 10003.375 = 98.75 × Dirty Price

(1) Repo Rate Dirty Price = ₹ 101.30
(2) Dirty Price and
(3) Dirty Price = Clean Price + Interest Accrued
(3) Clean Price
240
101.30 = Clean Price + 100 × × 6%
(MTP Oct – 2022) 360

11.58
 SECURITY VALUATION

Clean Price = ₹ 97.30 Solution:

(i) Income Statement

RESIDUAL
Sales (600 × 1.10) ₹ 660
Question – 72
(-) Operating Ratio (660 × 90%) ₹ 594
Following Financial data are available for PQR Ltd. for the year 2008:

(₹ in lakh) EBIT ₹ 66
8% debentures 125
10% bonds (2007) 50 (-) Interest [(125 + 50) × 8%] ₹ 14
Equity shares (₹ 10 each) 100
Reserves and Surplus 300 EBT ₹ 52
Total Assets 600
Assets Turnovers ratio 1.1 (-) Tax 40% ₹ 20.80
Effective interest rate 8%
Effective tax rate 40%
Operating margin 10% EAT 31.20
Dividend payout ratio 16.67
Current market Price of Share 14
(÷) No. of Shares 10
Required rate of return of investors 15%
EPS 3.12
You are required to:
DPS (16.67%) 0.52
(i) Draw income statement for the year
(ii) Sustainable Growth Rate
(ii) Calculate its sustainable growth rate of earnings
g =b ×r
(iii) Calculate the fair price of the Company's share using dividend
discount model, and b = 1 – 0.1667 = 0.8333

EAT
(iv) What is your opinion on investment in the company's share at ROE (r) = × 100
Equity
current price?
31.20
(SM TYK – 12 & RTP May – 2020) = × 100
300 + 100

11.59
 SECURITY VALUATION

= 7.8 % Calculate the change in interest coverage ratio after the additional
borrowing is effected and comment on the arrangement made.
g = 0.8333 × 0.078 = 0.065
Solution:
= 6.5%
EBIT
Interest Coverage Ratio =
Interest

90
(iii) Price (P0 ) Present =
77
D1
P0 = = 1.69
Ke – g

0.52 × (1.065) Proposed = 90 × 1.15

=
0.15 − 0.065
= 103.50
= ₹ 6.52
Interest = 77 + 100 × 16 %
(iv) Actual Price = 14
= 93
Share is overpriced hence should not be purchased.
103.50
Interest Coverage = = 1.113
Question – 73 93
Tiger Ltd. is presently working with an Earning Before Interest and
Since interest coverage ratio is decreasing hence proposal should be
Taxes (EBIT) of ₹ 90 lakhs. Its present borrowings are as follows:
accepted.
₹ in lakhs
Question – 74
12% term loan 300
Working capital borrowings: Capital structure of Sun Ltd., as at 31.3.2003 was as under:
From Bank at 15% 200
Public Deposit at 11% 100 (₹ lakhs)

The sales of the company are growing and to support this, the Equity share capital 80
company proposes to obtain additional borrowing of ₹ 100 lakhs 8% Preference share capital 40
expected to cost 16%.The increase in EBIT is expected to be 15%.
12% Debentures 64

11.60
 SECURITY VALUATION

Reserves 32 (-) Tax @ 35% 8,51,200

Sun Ltd., earns a profit of ₹ 32 lakhs annually on an average before EAT 15,80,800
deduction of income-tax, which works out to 35%, and interest on
debentures. (-) PD (40,00,000 × 8 %) 3,20,000

Normal return on equity shares of companies similarly placed is 9.6% Earning 12,60,800
provided:
Dividend (8,000,000 × 8%) 6,40,000
(a) Profit after tax covers fixed interest and fixed dividends at least (Distributed Profit)
3 times.
Undistributed Profit 6,20,800
(b) Capital gearing ratio is 0.75.
Yield (Income) = (6,40,000 × 50%) + (6,20,800 × 5%)
(c) Yield on share is calculated at 50% of profits distributed and
at 5% on undistributed profits. = 3,51,040

Sun Ltd., has been regularly paying equity dividend of 8%. Required Rate of Return after Risk Adjustment

Compute the value per equity share of the company. (1) Coverage Ratio

(i) 1% for every time of difference for interest and fixed dividend PAT + INTEREST
=
coverage ratio. INTEREST + PD

(ii) 2% for every time of difference for capital gearing ratio. 15,50,800 + 7,68,000
=
7,68,000 + 3,20,000
(SM TYK – 07)
= 2.16
Solution:
Coverage ratio is less than 3 times it means higher risk.
Income Statement
(2) Capital Gearing Ratio
EBIT 32,00,000
PSC + Debt
=
(-) Interest (64,00,000 × 12 %) 7,68,000 ESC + R & S

40,00,000 + 64,00,000
EBT 24,32,000 =
80,00,000 + 32,00,000

11.61
 SECURITY VALUATION

= 0.93 Particulars Proposal Proposal

No. 1 No. 2
Capital gearing ratio is more than 0.75. It means higher risk. Target Assets to Sales Ratio 0.65 0.62

Required Yield Target Net Profit Margin (%) 4 5

Similar Yield 9.6% Target Debt Equity Ratio (DER) 2:3 4:1

(+) Risk Adjustment Target Retention Ratio (of Earnings) (%) 75 -

Coverage Ratio Annual Dividend (₹ In Lakhs) - 0.30

(3 – 2.16) = 0.84 ×1 0.84% New Equity Raised (₹ in Lakhs) - 1

You are required to calculate sustainable growth rate for both the
(+) Risk Adjustment for Capital Gearing Ratio
proposals.
(0.93 – 0.75) = 0.18 ×2 0.36% (Exam November – 2020) (8 Marks)

10.80% Solution:

Value per Share Proposal I:

Yield on Equity 1 5
P0 = × per share ROE =4 × ×
Required Yield 0.65 3

3,51,040 = 10.26%
Yield = × 100 = 4.368%
8,00,000
g =b ×r
4.388%
P0 = × 100 = ₹ 40.63 Assume = ₹ 100 (FV)
10.80% = 0.75 × 0.1026
Question – 75
= 0.0770
AB Industries has Equity Capital of ₹ 12 Lakhs, total Debt of ₹ 8
Lakhs, and annual sales of ₹ 30 Lakhs. Two mutually exclusive = 7.70%
proposals are under consideration for the next year. The details of
the proposals are as under:

11.62
 SECURITY VALUATION

Proposal II:
MULTIPEL CHOICE QUESTIONS
1 5
ROE =5 × ×
0.65 1
Case Scenario – 01
= 40.32% Bank A is in need of fund for a period of 14 days. To meet this
financial need on 20th September 2023 Bank A enters into an
Target Equity = 12 + 1 = 13 lakh agreement with Bank B under which it will sell 10% Government of
India Bonds issued on 1st January 2023 @ 5.65% for ₹ 8 crore (Face
Debt = 13 × 4 = 52 lakh
value is ₹ 10,000 per Bond).
Total Asset = 13 lakh + 52 lakh = 65 lakh The clean price of same Bond is ₹ 9,942 and the Initial Margin be 2%
65 and the maturity date of Bond is 31st December 2028. Consider 360
TA to Sales = = 104.84 days in a year and interest is payable annually.
0.62

Based on above Case Scenario, answer the following questions:

Net Profit = 104.84 × 5%
I. The arrangement entered between Bank A and Bank B will be
= 5.242
called ……….
5.242 – 0.30
b = × 100 (a) Call Money Arrangement
5.242

= 0.943 (b) Commercial Bill Arrangement

(c) Commercial Paper

g = 0.943 × 0.4032
(d) Repurchase Option
= 38%

II. Dirty Price of the Bond will approximately

be……………………….

(a) ₹ 10,353 (b) ₹ 10,670

(c) ₹ 10,499 (d) ₹ 10,816

11.63
 SECURITY VALUATION

III. The start proceeds of the transaction shall be approximately Case Scenario – 02
……………… Suppose you are a financial consultant and following 3 clients have
approached to you seeking advise on the investment to be made in
(a) ₹ 8,38,36,804 (b) ₹ 8,36,53,000 securities. All these clients have different background and risk
appetite as well as perception to the market.
(c) ₹ 8,36,52,800 (d) ₹ 8,48,52,585
❖ Client A wants to invest in Fixed income avenues and therefore
he is looking at the credit rating of the securities as well as
IV. The second leg of the transaction shall be financial ratios such as interest coverage, earning power etc
approximately.………………. and the general prospect of the industry.

(a) ₹ 8,38,36,604 (b) ₹ 8,36,53,000 ❖ Client B wants to earn a fixed income over a period of time by
(c) ₹ 8,58,36,804 (d) ₹ 8,48,52,585 holding the security till its maturity.

❖ Client C wants to earn more by taking more risk. Therefore,

he is more interested to invest in stocks. He believes that Price
V. The amount of Accrued Interest per Bond shall be reflects all information found in the record of past prices and
approximately …………… volumes.
(a) ₹ 728 (b) ₹ 720 On the basis of above information, choose the most appropriate
answer to the MCQs.
(c) ₹ 734 (d) ₹ 714
I. The main factor to be considered in selecting fixed income
(MTP September – 2024)
avenue for client A shall be………………..
Answer: Case Scenario – 01
(a) Yield to maturity
I. (d) Repurchase Option
(b) Risk of Default
II. (b) ₹ 10,670
(c) Tax Shield
III. (c) ₹ 8,36,52,800
(d) Liquidity
IV. (a) ₹ 8,38,36,604

V. (a) ₹ 728

11.64
 SECURITY VALUATION

II. The main factor that have to be evaluated in the selection of No. of share per bond 25
Bond for Client B shall be……………….. Market price of share ₹ 20
Straight value of bond ₹ 400
(a) Yield to maturity Market price of convertible bond ₹ 550

(b) Risk of Default Based on the above information answer the following questions:

(c) Tax Shield I. The stock value of bond would be _____

Answer-1 : ₹ 500 Answer-2 : ₹ 400

(d) Liquidity
Answer-3 : ₹ 550 Answer-4: ₹ 450
III. If Weak form efficiency is prevailing in the market then which
approach is best for selection of Equity Shares?

(a) Technical Analysis II. The percentage of downside risk based on market price of
convertible bond is ________
(b) Fundamental Analysis
Answer-1 : 10 % Answer-2 : 27.27%
(c) Random selection Analysis
Answer-3 : 18.18% Answer-4: 11.11%
(d) None of the above.

(MTP March – 2024)

III. The conversion premium is _______
Answer: Case Scenario – 02
Answer-1 : 10 % Answer-2 : 27.27%
I. (b) Risk of Default
Answer-3 : 18.18% Answer-4: 11.11%
II. (a) Yield to maturity
III. (b) Fundamental Analysis
IV. The conversion parity price of the stock is ________
Case Scenario – 03
The data given below relates to a convertible bond of x Ltd: Answer-1 : ₹ 25 Answer-2 : ₹ 20

Face value ₹ 450 Answer-3: ₹ 22 Answer-4: ₹ 24

Coupon rate 15%

11.65
 SECURITY VALUATION

(MTP December – 2025) (a) Short-term yields are higher than long-term yields.

Answer: Case Scenario – 03 (b) Short-term yields are lower than long-term yields.

I. Answer-1: ₹ 500 (c) Yields remain the same across all maturities.

II. Answer-2: 27.27% (d) Yields fluctuate randomly over different maturities.

III. Answer-1: 10 %

IV. Answer-3: ₹ 22 II. Based on the revised yield data, what is the yield spread
between the 10- year bond and the 1-year bond?
Case Scenario – 04
You are an investment analyst working for a financial advisory firm. (a) 2.0% (b) 3.5%
You have been asked to analyze the bond market's yield curve to
(c) 4.0% (d) 5.0%
assist your clients in making investment decisions. The yield curve
represents the relationship between theinterest rates (yield) and the
time to maturity for debt securities, usually government bonds.
III. An inverted yield curve typically indicates………………
For simplicity, assume the following yield data for government bonds
over various maturities (measured in years): (a) Economic growth

Yield Curve Table (b) Economic uncertainty

Maturity (Years) Yield (%) (c) An upcoming recession

1 Years 3.00%
2 Years 4.00% (d) Inflationary pressure
3 Years 5.00%
5 Years 6.00%
7 Years 6.40% IV. If an investor is looking to invest for 2 years starting 3 years
10 Years 7.00%
from now, the forward rate he would expect shall be………
15 Years 7.40%
30 Years 7.60% (a) 7.41% (b) 7.52%
Based on above case scenario answer the following questions: (c) 7.76% (d) 7.93%
I. The main characteristic of a normal yield curve is……………….

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 SECURITY VALUATION

V. If an investor is looking to invest for 2 years starting 5 years Maturity Period 3 Months
from now, the forward rate he would expect shall be………
Issue Expense
(a) 7.41% (b) 7.52%
Brokerage 0.15%for 3 months
(c) 7.76% (d) 7.93%
Rating charges 0.50% p.a.
(MTP October – 2024 & July – 2025)
Stamp Duty 0.175% for 3 months
Answer: Case Scenario – 04
Based on above case scenario answer the following questions:
I. (b) Short-term yields are lower than long-term yields.
I. The Bond Equivalent yield of the same Commercial Paper shall
II. (c) 4.0% be approximately……………..

(a) 2.51% (b) 10.05%

III. (c) An upcoming recession
(c) 7.53% (d) 11.05%
IV. (b) 7.52%

V. (a) 7.41%
II. The Effective Interest Rate per annum of same CP shall
approximately be…………………

(a) 10.44% (b) 10.05%

Case Scenario – 05
XYZ Ltd. is in need of funds for a short tenure. Some functional level (c) 2.51% (d) 11.05%
manager suggested about the Bank Loan option. On conforming from
Finance Department, it was found that company exhausted its bank
loan limited due to recent huge Capex. Then CA X, CFO suggested III. The total cost of funds to the company shall approximately
the idea of floating Commercial papers by XYZ Ltd. be………………………
Accordingly, XYZ Ltd. is planning to issue Commercial Paper (CP), (a) 11.27% (b) 11.85%
the details of which is given below:
(c) 12.24% (d) 10.88%
Issue Price of CP ₹ 97,550

Face Value ₹ 1,00,000

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 SECURITY VALUATION

IV. Which of the following instruments cannot be used by a bank (₹ in lakh)

to meet its short-term funding requirements? 8% Debentures 125
10% Bonds (2022) 50
(a) Call/Notice Money Equity Shares (₹ 10 each) 100
Reserves and Surplus 300
(b) Commercial Paper Total Assets 600
Assets Turnovers ratio 1.1
(c) Certificate of Deposit Effective interest rate 8%
Effective tax rate 40%
(d) Repurchase Agreement (Repo) Operating margin 10%
Dividend payout ratio 16.67%
V. The period of Commercial Paper ranges from……………….
Current market Price of Share ₹14
Required rate of return of investors 15%
(a) 14 days to 364 days

(b) 3 months to 6 months From the information given above, choose the correct answer to the
following questions:
(c) 7 days to 1 year
I. 10% Bonds must have issued in the month of……………
(d) 1 year to 3 years
(a) May 2022 (b) June 2022
Answer: Case Scenario – 05
(c) July 2022 (d) August 2022
I. (b) 10.05%

II. (a) 10.44%

II. Amount of retained earning for the financial year 2023
III. (c) 12.24% approximately is…………..

IV. (b) Commercial Paper (a) 52.00 lakh (b) 31.20 lakh

V. (c) 7 days to 1 year (c) 26.00 lakh (d) 5.20 lakh

Case Scenario – 06
Following Financial data are available for PQR Ltd. for the financial III. Return on Equity (ROE) of PQR Ltd. is…………..
year ending 2023: (a) 15.00% (b) 6.50%

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 SECURITY VALUATION

(c) 10.00% (d) 7.80% deviation of market return and Z Ltd. shares is 12% and 18%
respectively.

Round off to two decimal places.

IV. Sustainable Growth Rate of PQR Ltd. shall be
approximately………….. From the information given above, choose the correct answer to the
following questions:
(a) 15.00% (b) 6.50%
MULTIPLE CHOICE QUESTIONS
(c) 10.00% (d) 7.80%
I. What is the expected return of Z Ltd shares?

(a) 15% (b) 23.92%

V. Fair price of share of PQR Ltd. using Dividend Discount Model
shall be approximately…………. (c) 16.92% (d) 16.5%

(a) 10 (b) 14

(c) 6.12 (d) 6.51 II. The intrinsic value of Z Ltd. shares approximately is……………

(a) ₹ 156.75 (b) ₹ 303.14

Answer: Case Scenario – 06
(c) ₹ 349.62 (d) ₹ 341.30
I. (b) June 2022
II. (c) 26.00 lakh
III. (d) 7.80% III. If current market price of the shares is ₹ 315 than stock
IV. (b) 6.50% is…………………….

V. (d) 6.51 (a) Over valued

(b) Under valued

Case Scenario – 07
Z Ltd. paid a dividend of ₹ 5 for the current year. The dividend is (c) Fairley valued
expected to grow at 25% for the next 6 years and at 10% per annum
thereafter. The return of government bond is 13% per annum and (d) Cannot be determined
market return is expected to be around 20%. The correlation between
(EXAM NOVEMBER 2024)
market return and Z Ltd. share return is 0.3733. The standard

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 SECURITY VALUATION

Answer: Case Scenario – 07 II. The price and duration of the Bond A shall be approximately
………………respectively.
I. (c) 16.92%
(a) ₹ 848.34 and 4.41
II. (a) ₹ 156.75
(b) ₹ 811.09 and 4.38
III. (a) Over valued
(c) ₹ 1,227.44 and 4.41

Case Scenario – 08 (d) ₹ 658.15 and 3.90

The following information is available in respect of Bond A and Bond
B.

Bond A Bond B III. The price sensitivity of the portfolio approximately

Face value, redeemable at par ₹1000 ₹ 1000 is……………………..
Coupon rate, payable annually (%) 6% 10%
Time to maturity (years) 5 3 (a) -4.03

An investor has the portfolio consisting of 75% of Bond A and 25% of (b) -2.49
Bond B. The current YTMs prevailing in the market is 10%. (c) -3.63
Year (n) : 1 2 3 4 5 (d) -3.98
PVIF (10%,n) : 0.9091 0.8264 0.7513 0.6830 0.6209
(EXAM NOVEMBER 2025)
From the information given above, choose the correct answer to the
following questions: Answer: Case Scenario – 08

MULTIPLE CHOICE QUESTIONS I. (b) ₹ 1,000 and 2.74

I. The price and duration of the Bond B shall be approximately II. (a) ₹ 848.34 and 4.41
………………..respectively.
III. (d) - 3.98
(a) ₹ 826.43 and 2.49 (b) ₹ 1,000 and 2.74
Case Scenario – 09
(c) ₹ 924.85 and 2.74 (d) ₹ 1,000 and 2.49 XYZ Ltd., a medium-sized company in the renewable energy sector,
is experiencing steady sales growth. The company’s management,
however, is concerned about balancing rapid growth with long-term

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sustainability. In the past year, XYZ’s growth objectives have led to (a) Harry Markowitz
aggressive expansion plans, but management now realizes that such
growth might not be financially sustainable in the long run. This (b) William Sharpe
raises concerns about how to maintain the company's financial
(c) Black Scholes
health while meeting its ambitious growth targets.
(d) Robert C. Higgins
The CFO of XYZ Ltd. highlights the importance of Sustainable
Growth Rate (SGR).
II. The Sustainable Growth Rate (SGR) represents.................
The company now needs to ensure that its operational and financial
(a) the rate at which the company can grow by issuing more
policies align with its growth goals. XYZ must avoid expanding too
equity.
quickly, which could strain its financial resources and lead to
excessive borrowing. Moreover, management must also consider the (b) the maximum rate of growth in sales that can be achieved
long-term implications of resource consumption, particularly in the without borrowing additional funds.
renewable energy industry, where sustainability is key to both
current and future stakeholders. (c) the growth rate determined by market demand for XYZ’s
products.
XYZ Ltd. also realizes that it needs to focus on building its growth
capability alongside its growth strategy. Without the necessary (d) the rate of growth determined by inflationary pressures.
infrastructure and financial planning in place, the company’s efforts
to achieve long-term, sustainable growth could be in jeopardy.
Furthermore, the company is aware of the risks of relying too much
on external financing and recognizes the need for a balance between III. According to the case scenario the risk associated with growing
maintaining sufficient equity and minimizing debt. too quickly is that...........

Given the importance of these considerations, XYZ’s management (a) the company might not be able to retain competent staff.
team must now review their growth strategy and financial policies to
(b) the company could face liquidity issues due to over-
ensure they are consistent with the firm’s sustainable growth
expansion.
objectives.
(c) the company’s stock price might decline.
From the information given above, choose the correct answer to the
following questions: (d) it could reduce the company's market share.

I. The concept of Sustainable Growth Rate introduced by...................

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 SECURITY VALUATION

IV. Which of the following twin cornerstones are necessary for Case Scenario – 10
XYZ Ltd. to achieve sustainable growth? ABC Ltd. is planning to expand its business and therefore raising
fund by issuing a convertible bond of ₹ 10 crore. An investor “Mr. X”
(a) Market conditions and competition. is interested to invest in the bond of ABC Ltd. Mr. X has following
data related to the convertible bond.
(b) Growth capability and growth strategy
The data given below relates to a convertible bond:
(c) Product innovation and marketing strategy.
Face Value ₹ 250
(d) Cost-cutting measures and increased sales. Coupon Rate 12%
No. of shares per bond 20
V. In an inflationary condition if creditors require that XYZ Ltd.’s Market price of share ₹ 12
historical cost debt-to-equity ratio stay constant, the Straight value of bond ₹ 235
inflation...... Market price of convertible bond ₹ 265
Maturity 5 Years
(a) Reduces the need for external financing.
You, being an expert of the matter, are required to answer his
(b) Increases the sustainable growth rate by lowering costs. questions. Select the most appropriate alternative:

(c) Lowers the sustainable growth rate. I. The percentage of downside risk of the bond is
approximately……………..
(d) It has no effect on the company's growth rate.
(a) 10.42% (b) 6.38%
(MTP July – 2025)
(c) 2.13% (d) 12.77%
Answer: Case Scenario – 09

I. (d) Robert C. Higgins

II. (b) the maximum rate of growth in sales that can be II. The conversion premium in percentage term of the bond
achieved without borrowing additional funds. is……………..

III. (b) the company could face liquidity issues due to (a) 12.77% (b) 10.42%
overexpansion.
(c) 2.18% (d) 13.45%
IV. (b) Growth capability and growth strategy
V. (c) Lowers the sustainable growth rate.

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 SECURITY VALUATION

III. The conversion parity price of the stock is……………. Equity Shares (₹ 10 each) 100
Reserves and Surplus 300
(a) ₹ 11.75 (b) ₹ 12.00 Total Assets 600
Assets Turnovers ratio 1.1
(c) ₹ 13.25 (d) ₹ 12.50 8%
Effective interest rate
Effective tax rate 40%
Operating margin 10%
IV. If he wants a yield of 15% the maximum price he should be Dividend payout ratio 16.67%
ready to pay for is……………. Current market Price of Share ₹ 14
Required rate of return of investors 15%
(a) 217.41 (b) 224.81
From the information given above, choose the correct answer to the
(c) 240.00 (d) 232.32 following questions:
I. Amount of retained earnings for the financial year 2023
(MTP March – 2024) approximately is…………..

Answer: Case Scenario – 10 (A) ₹ 26.00 lakh (B) ₹ 5.20 lakh

I. (d) 12.77% (C) ₹ 52.00 lakh (D) ₹ 31.20 lakh

II. (b) 10.42%

III. (c) ₹ 13.25

II. 10% Bonds must have been issued in the month of…………….
IV. (b) 224.81 (A) July 2022 (B) June 2022

(C) August 2022 (D) May 2022

Case Scenario – 11
Following Financial data are available for PQR Ltd. for the financial
year ending 2023: III. Fair price of share of PQR Ltd. using Dividend Discount Model
shall be approximately………….
Events (₹ in lakhs)
8% Debentures 125 (A) ₹ 6.12 (B) ₹ 6.51
10% Bonds (2022) 50

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 SECURITY VALUATION

(C) ₹ 10 (D) ₹ 14 To optimise returns, Mr. R is considering three different investment

strategies for clients having ₹ 10 crore of fund and are interested in
Fixed Income Portfolio. Each strategy is designed to align with the
IV. Sustainable Growth Rate of PQR Ltd. shall be approximately
client’s risk appetite and future liquidity needs.
…………..
Strategy A: Investing the entire ₹ 10 crore in a single bond with a 7-
(A) 10.00% (B) 6.50%
year maturity to match a specific financial obligation in the future.
(C) 15.00% (D) 7.80%
Strategy B: Allocating ₹ 5 crore in short-term bonds (1-year
maturity) and ₹ 5 crore in long term bonds (7-year maturity) to
V. Return on Equity (ROE) of PQR Ltd. is………….. balance risk and return.

(A) 7.80% (B) 6.50%

Strategy C: Spreading the ₹ 10 crore investment equally across
(C) 10.00% (D) 15.00% bonds with maturities of 1 to 5 years to ensure periodic liquidity.
(MTP March: 2025)
Meanwhile, Mr. R is also considering forecasting models to predict
Answer: Case Scenario – 11 interest rate movements. He is evaluating economic indicators such
as inflation, historical rate trends, and a combination of multiple
I. (A) ₹ 26.00 lakh II. (B) June 2022 economic factors to enhance the firm's forecasting accuracy.

III. (B) ₹ 6.51 IV. (B) 6.50% Mr. R suggested Strategy B for Mr. H (a HNI) having a sum of ₹ 10
crore for investment in Fixed Income Portfolio. As per the strategy
V. (A) 7.80%
half amount on fund is proposed to be invested in 7-year bonds
yielding 8% per annum and balance in 1-year short term bond
Case Scenario – 12 yielding 6% per annuam. Interest on these bonds is compounded
Zenith Capital, a boutique investment firm, manages portfolios for annually.
high-net-worth individuals (HNIs). Their lead portfolio manager, Mr.
R, has been closely analyzing market trends to optimize returns for Based on the above case scenario, choose the correct answer to the
their fixed-income portfolio. Over the past few months, he has following questions:
observed fluctuations in interest rates and anticipates a significant
shift in the near future. I. What is the primary objective of an active bond portfolio strategy?

(A) To maintain a fixed return irrespective of market conditions

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 SECURITY VALUATION

(B) To outperform the market by making informed investment IV. In the ladder Strategy, the funds are typically
decisions allocated………………….

(C) To minimize volatility and ensure steady returns (A) by making entire investment in bonds with the same
maturity period.
(D) To invest in government bonds only
(B) by dividing investment equally between short-term and
long-term bonds.

II. If any HNI follows Strategy A, then ………………of fixed-income (C) by dividing equal amount in bonds with different maturity
portfolio strategy is being followed. periods.

(A) Barbell Strategy (D) by investing only in short-term bonds.

(B) Ladder Strategy V. It is expected that interest rate in coming 8 years are expected
to fall by 25 bps each year and if Mr. H does not withdraw any
(C) Bullet Strategy amount from the Fund during these 7 years the total value of
the investment at the end of the 7th year shall be
(D) Duration Matching approximately………………

(A) ₹ 15.036 crore (B) ₹ 15.721 crore

III. In the Barbell Strategy, the funds are typically
allocated…………….. (C) ₹ 15.739 crore (D) ₹ 15.829 crore

(A) by making entire investment in bonds with the same (MTP APRIL: 2025)
maturity period.
Answer: Case Scenario – 12
(B) by dividing investment equally between short-term and I. (B) To outperform the market by making informed
long-term bonds. investment decisions
II. (C) Bullet Strategy
(C) by dividing equal amount in bonds with different maturity
III. (B) by dividing investment equally between short-term and
periods.
long-term bonds.
(D) by investing only in short-term bonds. IV. (C) by dividing equal amount in bonds with different
maturity periods.
V. (B) ₹ 15.721 crore

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 SECURITY VALUATION

Case Scenario – 13 (C) ₹ 7,954 and ₹ 1,07,374

Short Bank Ltd. need funds for a period of 7 days. To meet this
financial need, on 20th September, 2025, Short Bank Ltd. entered (D) ₹ 7,954 and ₹ 91,466
into an agreement with Long Bank Ltd. under which, Short Ban Ltd.
will sell 8% GOI Bonds @ 6% p.a. for ₹ 5 crores (Face Value) with
initial margin 2%. Each Bond Face Value is ₹ 1,00,000. III. The proceeds of the 1st Leg of the transaction shall be
approximately ₹_________ and the 2nd Leg proceeds of the
The maturity of this 8% GOI Bond is 31st December, 2029, originally
transaction shall be ₹________.
issued on 1st January, 2025. Interest payable annually. The clean
price of the bond is ₹ 99,420. (A) ₹ 5,15,52,000 and ₹ 5,16,12,150

Note: Assume 360 days in a year. (B) ₹ 5,15,68,580 and ₹ 5,16,28,743

From the information given above, choose the correct answer to the (C) ₹ 5,15,52,000 and ₹ 5,61,12,150
Question No. 1 to 3:
(D) ₹ 5,51,52,000 and ₹ 5,61,12,150
I. The arrangement entered by Long Bank Ltd. is _________ and
that by Short Bank Ltd. is _________. (EXAM JANUARY – 2026)

(A) Repo, Reverse Repo Answer Case Scenario – 13

(B) Lending, Repo I. (D) Reverse Repo, Repo

(C) Reverse Repo, Borrowing II. (A) ₹ 5,822 and ₹ 1,05,242

(D) Reverse Repo, Repo III. (B) ₹ 5,15,68,580 and ₹ 5,16,28,743

Case Scenario – 14
II. Accrued Interest and dirty price of the bond as on 20 th XYZ Ltd. is planning to expand its business and therefore raising
September, 2025 will approximately be ₹_________ and fund by issuing a Convertible Bond of ₹ 10 crore. An investor “Mr. A”
₹_________ respectively. is interested to invest in the bond of XYZ Ltd. Mr. A has following
data related to the Convertible Bond.
(A) ₹ 5,822 and ₹ 1,05,242
The data given below relates to a convertible bond:
(B) ₹ 5,788 and ₹ 93,632

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 SECURITY VALUATION

(c) Straight value of bond

Face value ₹ 1,000 (d) Face value of bond

Coupon rate 12%
No. of shares per bond 20
Market price of share ₹ 48 IV. The upside potential of the convertible bond primarily depends
Straight value of bond ₹ 940 on……………..
Market price of convertible bond ₹ 1,060
Maturity 5 Years (a) Coupon rate of the bond

(b) Face value of the bond

From the information given above, choose the correct answer to the
following questions: (c) Market price movement of the equity shares

I. The conversion value of the convertible bond is…………….. (d) Remaining maturity of the bond

(a) ₹ 960 (b) ₹ 1000

(c) ₹ 1060 (d) ₹ 940 V. By approximately what percentage the market price of the
share should rise so that the investor is indifferent between
buying the share from the market and taking conversion
II. The conversion premium of the bond in absolute terms route.
is…………….. (a) 12.77% (b) 10.42%
(a) ₹ 60 (b) ₹ 100 (c) 5.11% (d) 9.23%
(c) ₹ 120 (d) ₹ 80 Answer Case Scenario – 14

I. (a) ₹ 960
III. The floor value of the convertible bond is represented II. (b) ₹ 100
by…………
III. (c) Straight value of bond
(a) Market price of share
IV. (c) Market price movement of the equity shares
(b) Conversion value

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 SECURITY VALUATION

V. (b) 10.42% (c) Two-stage Dividend Discount Model

(d) Price–Earnings valuation model

Case Scenario – 15
A Ltd. paid a dividend of ₹ 5 for the last year. The dividend is expected IV. If the market price of A Ltd. share is higher than its intrinsic
to grow at 25% for the next 6 years and at 10% per annum thereafter. value, the share is said to be………………..
The standard deviation of market return and A Ltd.’s share is 12% (a) Under-valued (b) Over-valued
and 18% respectively. The correlation between market return and A
Ltd. share return is 0.3733. The return of government bond is 13% (c) Fairly valued (d) Speculative
per annum and market return is expected to be around 20%.
Answer Case Scenario – 15
From the information given above, choose the correct answer to the
following questions: I. (b) 0.56

I. The beta (β) of A Ltd.’s share is closest to…………………… II. (c) 7%

(a) 0.42 (b) 0.56 III. (c) Two-stage Dividend Discount Model

(c) 0.67 (d) 0.84 IV. (b) Over-valued

Case Scenario – 16
II. The equity risk premium as per the given data XYZ Ltd. needs funds for a short tenure. Some functional level
is………………………… manager suggested about the bank credit/ overdraft option. On
conforming from Finance Department, it was found that company
(a) 5% (b) 6% exhausted its credit limits due to meeting recent contingency fund
(c) 7% (d) 8% requirements. Then CA X, CFO suggested the idea of floating
Commercial papers by XYZ Ltd.

Accordingly, XYZ Ltd. is planning to issue Commercial Paper (CP),

III. The valuation approach can be used to compute the intrinsic the details of which is given below:
value of A Ltd. shares is……
Issue Price of CP ₹ 97,550
(a) Single-stage Dividend Discount Model
Face Value ₹ 1,00,000
(b) CAPM valuation model

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 SECURITY VALUATION

Maturity Period 3 Months IV. Which of the following instruments cannot be used by a bank
to meet its short-term funding requirements?
Issue Expense
(a) Call/Notice Money
Brokerage 0.15% for 3 months
(b) Commercial Paper
Rating charges 0.50% p.a.
(c) Certificate of Deposit
Stamp Duty 0.175% for 3 months
(d) Repurchase Agreement (Repo)
From the information given above, choose the correct answer to the
following questions: V. The period of Commercial Paper ranges from……………….

I. The Bond Equivalent yield for an investor of the same (a) 14 days to 364 days
Commercial Paper shall be approximately……………..
(b) 3 months to 6 months
(a) 2.51% (b) 10.05%
(c) 7 days to 1 year
(c) 7.53% (d) 11.05%
(d) 1 year to 3 years

Answer Case Scenario – 16

II. The Effective Interest Rate per annum of same CP shall
approximately be………………… I. (b) 10.05%

(a) 10.44% (b) 10.05% II. (a) 10.44%

(c) 2.51% (d) 11.05% III. (c) 12.24%

IV. (b) Commercial Paper

III. Based on effective interest rate the total annual cost of funds V. (c) 7 days to 1 year
to the company shall approximately be………………………

(a) 11.27% (b) 11.85%

(c) 12.24% (d) 10.88%

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11.80
 ADVANCED CAPITAL BUDGETING

12 ADVANCED CAPITAL BUDGETING

PART 1: INFLATION IN CAPITAL BUDGETING 30 40 30

NPV =
(1.155)1
+ (1.155)2
+ (1.155)3
– 70

Question – 01 = 5.429 lakh

A firm has projected the following cash flows from a project under
evaluation: Since NPV is positive hence project is viable.

Year ₹ lakhs Question – 02

KLM Ltd. requires ₹ 15,00,000 for a new project.
0 (70)
Useful life of project is 3 years.
1 30
Salvage value - NIL. Depreciation is ₹ 5,00,000 p.a.
2 40
Given below are projected revenues and costs (excluding
3 30 depreciation) ignoring inflation:

The above cash flows have been made at expected prices after Year 1 2 3
recognizing inflation. The firm’s cost of capital is 10%. The expected Revenues in ₹ 10,00,000 13,00,000 14,00,000
annual rate of inflation is 5%. Costs in ₹ 5,00,000 6,00,000 6,50,000

Show how the viability of the project is to be evaluated. Applicable tax rate is 35%. Assume nominal cost of capital to be 14%
(after tax). The inflation rates for revenues and costs are as under:
(SM TYK – 17)
Year Revenues % Costs %
Solution: 1 9 10
2 8 9
Nominal Cash Flows & Nominal Discounting Rate
3 6 7
NDR = [(1.10 × 1.05) – 1] × 100
PVF at 14%, for 3 years = 0.877, 0.769 and 0.675
= 15.5%
Show amount to the nearest rupee in calculations.

12.1
 ADVANCED CAPITAL BUDGETING

You are required to calculate net present value of the project. Initial Outlay of project ₹ 40,000

(SM TYK – 19) Annual revenues (Without inflation) ₹ 30,000

Solution: Annual costs excluding depreciation (Without inflation) ₹ 10,000

अगर Revenue & Cost का Inflation rate अलग अलग है तो NCF & NDR ही Useful life 4 years
हमें लेना होगा।
Salvage value Nil
Nominal CF
Tax Rate 50%
1 2 3 Cost of Capital (Including inflation premium of 10%) 12%
10,00,000 13,00,000 14,00,000
Revenue (1.09) (1.09) (1.08) (1.09) (1.08) Solution:
=10,90,000 = 15,30,360 (1.06)
= 17,46,965 Alternative 1: RCF & RDR
5,00,000 6,00,000 6,50,000
(-) Cost (1.10) (1.10) (1.09) (1.10) (1.09) CFAT
5,50,000 7,19,400 (1.07)
8,33,905 Sales = 30,000
CFBT – (i) 5,40,000 8,10,960 9,13,060
(-) Depreciation 5,00,000 5,00,000 5,00,000 (-) cost = 10,000
PBT 40,000 3,10,960 4,13,060
Tax @ 35% – (ii) 14,000 1,08,836 1,44,571 CFBT (i) = 20,000
CFAT (i – ii) 5,26,000 7,02,124 7,68,489
40,000
(x) PVF (14%) 0.877 0.769 0.675 (-) Dep. ( ) = 10,000
4

PVCI = ₹ 15,19,965 PBT = 10,000

(-) PVCO = ₹ 15,00,000 Tax @ 50% (ii) = 5,000
NPV = ₹ 19,965 CFAT (i – ii) = 15,000

Since NPV is positive hence project should be accepted. 1.12

RDR =[ – 1] × 100 = 1.82%
1.10
Question – 03
Determine NPV of the project with the following information: NPV = (15000 × 3.824) = 40,000

12.2
 ADVANCED CAPITAL BUDGETING

= 17,360 Advise the company whether the machine should be purchased or

not.
Alternative 2: NCF & NDR
Show your NPV calculation in real term.
Since inflation rate is 10% a year, real cash flows may be stated in
nominal cash flows as follows: PV Factor at 10% & 6% are as under –
Nominal Cash Flow = (1 + Inflation Rate) Real Cash Flows PV Factor 1 2 3 4 5
At 10% 0.909 0.826 0.751 0.683 0.621
Year Real Cash Flows Nominal Cash Flows
At 6% 0.943 0.890 0.840 0.792 0.747
1 15,000 15,000 × 1.10 = 16,500
2 15,000 15,000 × (1.10)2 = 18,150
3 15,000 15,000 × (1.10)3 = 19,965 (Exam May – 2025) (6 Marks)
4 15,000 15,000 × (1.10)4 = 21,962
Solution:
NPV using nominal discounting rate 12%
Working Notes:
16,500 18,150 19,965 21,962
+ + + − 40,000 (1) Cash Outflow (Initial Outlay) = ₹ 70,00,000 + ₹ 10,00,000 = ₹
(1.12)1 (1.12)2 (1.12)3 (1.12)4
80,00,000
= ₹ 14,732 + ₹ 14,469 + ₹ 14,211 + ₹ 13,957 – ₹40,000
(2) Cash Flow After Tax and Present Value
= ₹ 17,369 (Approx)
Particulars (₹)
Question – 04 Incremental cash operating income 25,00,000
BC Ltd. is contemplating on buying a new machine at ₹ 70,00,000 Less: Taxes (0.35) 8,75,000
with an additional working capital requirement of ₹ 10,00,000. The CFAT 16,25,000
Cum. PV Factor for 5 years at 10% 3.790
machine is expected to have an economic useful life of 5 years, with
Present Value 61,58,750
no salvage value. The company follows the straight line method of
depreciation and same is accepted for tax purposes. The machine is (3) PV of tax shield due to Depreciation
expected to generate an incremental increase in the before tax cash
operating income of ₹ 25,00,000 (in real terms) per year for a period Tax saving due to Depreciation per year 14,00,000
of 5 years. The relevant tax rate is 35%. Inflation is expected to be Tax rate 35%
6% per year and the firms cost of capital in real term is 10% per year. Tax saving per year for five years 4,90,000
Assuming that the working capital requirement will remain
unchanged throughout the period, in spite of inflation. PV of tax shield due to Depreciation

12.3
 ADVANCED CAPITAL BUDGETING

Years Tax Inflation Real PVF PV (₹)

Saving Factor Tax @ PART 2: RISK IN CAPITAL BUDGETING
(Nominal) at 6% saving 10%
1 4,90,000 0.943 4,62,070 0.909 4,20,021.63
2 4,90,000 0.890 4,36,100 0.826 3,60,218.60
(I) STATISTICAL TECHNIQUES
3 4,90,000 0.840 4,11,600 0.751 3,09,111.60
4 4,90,000 0.792 3,88,080 0.683 2,65,058.64
5 4,90,000 0.747 3,66,030 0.621 2,27,304.63 Question – 05
Present value of tax shield due to depreciation 15,81,715.10 Shivam Ltd. is considering two mutually exclusive projects A and B.
Project A costs ₹ 36,000 and project B ₹ 30,000. You have been given
(4) PV of release of Working Capital below the net present value probability distribution for each project.
(₹) Project A Project B
Release of Working Capital at the end of 10,00,000 NPV Probability NPV Probability
5th year 0.747 Estimates (₹) Estimates (₹)
Inflation factor at 6% at the end of 5th year 7,47,000 15,000 0.2 15,000 0.1
Cash inflow in real terms 0.621 12,000 0.3 12,000 0.4
6,000 0.3 6,000 0.4
PVF @ 10% at the end of 5th year 4,63,887
3,000 0.2 3,000 0.1
Present value of inflow
(i) Compute the expected net present values of projects A and B.
Calculation of NPV
(ii) Compute the risk attached to each project i.e. standard
Particulars Present Value deviation of each probability distribution.
(₹)
Initial Outlay (80,00,000) (iii) Compute the profitability index of each project.
Present Value of CFAT 61,58,750
(iv) Which project do you recommend? State with reasons.
Present Value tax shield on 15,81,715.10
depreciation 4,63,887 (SM TYK – 06)
Present Value release of working
2,04,352.10 Solution:

Recommendation: The Company should purchase the (i) Expected NPV

machine as the NPV of real cash flow is positive.
Project A

12.4
 ADVANCED CAPITAL BUDGETING

= (15,000 × 0.2) + (12,000 × 0.3) + (6,000 × 0.3) + (3,000 × PVCI

PI = PVCO
0.2)
36,000 + 9,000
= 9,000 A = = 1.25
36,000
Project B 30,000 + 9,000
B = = 1.30
30,000
= (15,000 × 0.1) + (12,000 × 0.4) + (6,000 × 0.4) + (3,000 ×
0.1) (iv) Coefficient of Variation =
σ
x
̅
= 9,000 4,450
A = = 0.49
9,000
(ii) Standard Deviation
3,795
Project A B = 9,000
= 0.42

Project B should be accepted due to lower risk (C.V.)

(15,000 – 9,000)2 0.2 + (12,000 – 9,000)2 0.3 +
σx =√
(6,000 – 9,000)2 0.3 + (3,000 – 9,000)2 0.2 Question – 06
KLM Ltd., is considering taking up one of the two projects-Project-K
= 4,450 and Project-So Both the projects having same life require equal
investment of ₹ 80 lakhs each. Both are estimated to have almost the
Project B
same yield. As the company is new to this type of business, the cash
flow arising from the projects cannot be estimated with certainty. An
(15,000 – 9,000)2 0.1 + (12,000 – 9,000)2 0.4 +
σB = √ attempt was therefore, made to use probability to analyze the pattern
(6,000 – 9,000)2 0.4 + (3,000 – 9,000)2 0.1
of cash flow from other projects during the first year of operations.
This pattern is likely to continue during the life of these projects. The
results of the analysis are as follows:
σB = 3,795
Project K Project S
A B Cash Flow Probability Cash Flow Probability
(in ₹) (in ₹)
NPV 9,000 9,000
11 0.10 09 0.10
S.D. 4,450 3,795 13 0.20 13 0.25
15 0.40 17 0.30
(iii) Profitability Index 17 0.20 21 0.25
19 0.10 25 0.10

12.5
 ADVANCED CAPITAL BUDGETING

Required: = 17

(i) Calculate variance, standard deviation and co-efficient of σ2 = (9 – 17)2 0.10 + (13 – 17)2 0.25 + (17 – 17)2 0.3 +
variance for both the projects. (21 – 17)2 0.25 +
(25 – 17)2 0.10
(ii) Which of the two projects is riskier?
= 20.8
(SM TYK – 04)
σ = √20.8 = 4.56
Solution:
σ 4.56
Calculation of Variance & SD, EV. C.V. = x̅
= 17
= 0.268

Project K Project S is riskier as it has higher Coefficient of Variation.

Expected Cash Flows Question – 07

A company is considering Projects X and Y with following
= (11 × 0.10) + (13 × 0.20) + (15 × 0.40) + (17 × 0.20) + (19 information:
× 0.10)
Project Expected NPV (₹) Standard Deviation
= 15 X 1,22,000 90,000
2
σ = (11 – 15)2 0.10 + (13 – 15)2 0.20 + (15 – 15)2 0.4 + Y 2,25,000 1,20,000
(17 – 15)2 0.20 +
(19 – 15)2 0.10 (i) Which project will you recommend based on the above data?

= 4.8 (ii) Explain whether your opinion will change, if you use
coefficient of variation as a measure of risk.
σ = √4.8 = 2.19.
(iii) Which measure is more appropriate in this situation and why?
σ 2.19
C.V. = = = 0.146
x̅ 15 (SM TYK – 03)
Project S Solution:
Expected Cash Flows (i) On the basis of NFV project Y is better due to higher NPV.
= (9 × 0.10) + (13 × 0.25) + (17 × 0.30) + (21 × 0.25) + (25 × On the basis of standard deviation, project x is better due to
0.10) lower standard deviation.

12.6
 ADVANCED CAPITAL BUDGETING
σ Coefficient of Risk-Adjusted Rate P.V. Factor 1 to 5
(ii) Coefficient of Variation =
x Variation of Return years At risk
adjusted rate of
90,000
X = = 0.738 discount
1,22,000 0.0 10% 3.791
0.4 12% 3.605
1,20,000
Y = = 0.533 0.8 14% 3.433
2,25,000 1.2 16% 3.274
1.6 18% 3.127
Project Y is better due to lower (C.V.) 2.0 22% 2.864
More than 2.0 25% 2.689
(iii) However, the NPV method in such conflicting situation is best
because the NPV method is in compatibility of the objective of (SM TYK – 15)
wealth maximization in terms of time value.
Solution:

Risk adjusting NPV

(II) CONVENTIONAL TECHNIQUES
Project X
(i) Risk Adjusted Discounting Rate
RADR = 16%
Question – 08
Determine the risk adjusted net present value of the following RANPV = (70,000 × 3.274) – 2,10,000 = 19,180
projects:
Project Y
X Y Z
Net cash outlays (₹) 2,10,000 1,20,000 1,00,000 RADR = 14%
Project life 5 years 5 years 5 years
Annual Cash inflow (₹) 70,000 42,000 30,000
= (42,000 × 3.433) – 1,20,000 = 24,186
Coefficient of variation 1.2 0.8 0.4
Project Z
The Company selects the risk-adjusted rate of discount on the basis
of the coefficient of variation: RADR = (30,000 × 3.605) – 1,00,000 = 8,150

12.7
 ADVANCED CAPITAL BUDGETING

Question – 09 For P-III : RADR = 0.10 + (0.15 – 0.10) 0.60 = 13 %

New Projects Ltd. is evaluating 3 projects, P-I, P-II, P-III. Following
information is available in respect of these projects: (ii) The three projects can now be evaluated at 19%, 15% and 13%
discount rate as follows:
P-I P-II P-III
Cost ₹ 15,00,000 ₹ 11,00,000 ₹ 19,00,000
Inflow-Year 6,00,000 6,00,000 4,00,000
1 6,00,000 4,00,000 6,00,000 Project P-I
Year 2 6,00,000 5,00,000 8,00,000
Annual Inflows ₹ 6,00,000
Year 3 6,00,000 2,00,000 12,00,000
Year 4 1.80 1.00 0.60
PVAF (19%, 4) 2.639
Risk Index
PV of Inflows (₹ 6,00,000 × 2.639) ₹ 15,83,400
Minimum required rate of return of the firm is 15% and applicable
tax rate is 40%. The risk free interest rate is 10%. Less: Cost of Investment ₹ 15,00,000
Required: Net Present Value ₹ 83,400
(i) Find out the risk-adjusted discount rate (RADR) for these Project P-II
projects.
Year Cash PVF PV (₹)
(ii) Which project is the best? Inflow (₹) (15%,n)
1 6,00,000 0.870 5,22,000
(SM TYK – 16) 2 4,00,000 0.756 3,02,400
3 5,00,000 0.658 3,29,000
Solution:
4 2,00,000 0.572 1,14,400
(i) The risk free rate of interest and risk factor for each of the Total Present Value 12,67,800
Less: Cost of 11,00,000
projects are given. The risk adjusted discount rate (RADR) for
Investment
different projects can be found on the basis of CAPM as Net Present Value 1,67,800
follows:
Project P-III
Required Rate of Return = IRf + (K0 − IRF ) Risk Factor
Year Cash PVF PV (₹)
For P-I : RADR = 0.10 + (0.15 – 0.10 ) 1.80 = 19% Inflow (₹) (15%,n)
For P-II : RADR = 0.10 + (0.15 – 0.10 ) 1.00 = 15 % 1 4,00,000 0.885 3,54,000

12.8
 ADVANCED CAPITAL BUDGETING

2 6,00,000 0.783 4,69,800 (i) Which project should be accepted?

3 8,00,000 0.693 5,54,400
(ii) If risk adjusted discount rate method is used, which project
4 12,00,000 0.613 7,35,600 would be appraised with a higher rate and why?
Total Present Value 21,13,800
(SM TYK – 14)
Less: Cost of 19,00,000
Investment
Solution:
Net Present Value 2,13,800
(i) Statement Showing the Net Present Value of Project M
Project P-III has highest NPV. So, it should be accepted by the firm.
Ye Cash C.E Adjusted Present Total
ar Flow . Cash flow value Present
en (₹) (a) (₹) (c) = (a) factor value (₹)
(ii) Certainty Equivalent Approach d (b) × (b) at 6% (e) = (c) ×
(d) (d)
Question – 10
The Textile Manufacturing Company Ltd., is considering one of two 1 4,50,000 0.8 3,60,000 0.943 3,39,480
mutually exclusive proposals, Projects M and N, which require cash 2 5,00,000 0.7 3,50,000 0.890 3,11,500
3 5,00,000 0.5 2,50,000 0.840 2,10,000
outlays of ₹ 8,50,000 and ₹ 8,25,000 respectively. The certainty-
8,60,980
equivalent (C.E) approach is used in incorporating risk in capital Less: Initial 8,50,000
budgeting decisions. The current yield on government bonds is 6% Investment 10,980
and this is used as the risk free rate. The expected net cash flows Net Present Value
and their certainty equivalents are as follows:
Statement Showing the Net Present Value of Project N
Project M Project N
Year-end Cash Flow ₹ C.E. Cash Flow ₹ C.E. Year Cash C.E. Adjusted Present Total
1 4,50,000 0.8 4,50,000 0.9 end Flow Cash flow value Present
2 5,00,000 0.7 4,50,000 0.8 (₹) (a) (b) (₹) (c) = factor value (₹)
3 5,00,000 0.5 5,00,000 0.7 (a) × (b) at 6% (e) = (c) ×
(d) (d)
Present value factors of ₹ 1 discounted at 6% at the end of year 1, 2
and 3 are 0.943, 0.890 and 0.840 respectively. 1 4,50,000 0.9 4,05,000 0.943 3,81,915
2 5,00,000 0.8 3,60,000 0.890 3,20,400
Required: 3 5,00,000 0.7 3,50,000 0.840 2,94,000
9,96,315

12.9
 ADVANCED CAPITAL BUDGETING

Less: Initial Investment 8,25,000 (III) OTHER TECHNIQUES

Net Present Value 1,71,315
(i) Sensitivity Analysis
Decision: Since the net present value of Project N is higher,
so the project N should be accepted.
Question – 11
(ii) Certainty - Equivalent (C.E.) Co-efficient of Project M (2.0) is From the following details relating to a project, analyze the sensitivity
lower than Project N (2.4). This means Project M is riskier than of the project to changes in initial project cost, annual cash inflow
Project N as "higher the riskiness of a cash flow, the lower will and cost of capital:
be the CE factor". If risk adjusted discount rate (RADR)
method is used, Project M would be analyzed with a higher Initial Project Cost (₹) 1,20,000
rate.
Annual Cash Inflow (₹) 45,000
RADR is based on the premise that riskiness of a proposal may
be taken care of, by adjusting the discount rate. The cash Project Life (Years) 4
flows from a more risky proposal should be discounted at a Cost of Capital 10%
relatively higher discount rate as compared to other proposals
whose cash flows are less risky. Any investor is basically risk To which of the three factors, the project is most sensitive? (Use
averse. However, he may be ready to take risk provided he is annuity factors: for 10% 3.169 and 11% 3.103).
rewarded for undertaking risk by higher returns. So, more
risky the investment is, the greater would be the expected (SM TYK – 10)
return. The expected return is expressed in terms of discount
Solution:
rate which is also the minimum required rate of return
generated by a proposal if it is to be accepted. Therefore, there Calculation of NPV
is a positive correlation between risk of a proposal and the
discount rate. PV of cash inflows (₹ 45,000 × 3.169) 1,42,605

Initial Project Cost 1,20,000

NPV 22,605

If initial project cost is varied adversely by 10%*

NPV (Revised) (₹ 1,42,605 − ₹ 1,32,000) ₹ 10,605

Change in NPV (₹ 22,605 – ₹ 10,605)/₹ 22,605 i.e. 53.08 %

12.10
 ADVANCED CAPITAL BUDGETING

If annual cash inflow is varied adversely by 10%* (b) Unit cost

Revised annual inflow ₹ 40,500 (c) Sales volume

NPV (Revised) (₹ 40,500 × 3.169) – (₹ 1,20,000) (+)₹ 8,345 (d) Initial outlay and

Change in NPV (₹ 22,605 – ₹ 8,345)/₹ 22,605 63.08 % (e) Project lifetime Taxation may be ignored.

If cost of capital is varied adversely by 10%* (SM TYK – 09)

NPV (Revised) (₹ 45,000 × 3.103) – ₹ 1,20,000 (+) ₹19,635 Solution:

Change in NPV (₹ 22,605 – ₹19,635)/₹ 22,605 13.14 % Approach I

Conclusion: Project is most sensitive to ‘annual cash inflow’. NPV = PVCI – PVCO

*Note: Students may please note that they may assume any other 20,000 30,000 30,000
= 20 × [(1.10)1 + (1.10)2 + (1.10)3 ] – 10,00,000
percentage rate other than 10 % say 15%, 20 % 25 % etc.

Question – 12 = 20 × 65,514.65 – 10,00,000

XYZ Ltd. is considering a project for which the following estimates
= ₹ 3,10,293
are available:
(a) Selling Price = 10% ↓ [60 × 10% = 6]
₹
Initial Cost of the project 10,00,000 20,000 30,000 30,000
Sales price/unit 60 = 14 × [(1.10)1 + (1.10)2 + (1.10)3 ] – 10,00,000
Cost/unit 40
Sales volumes = - 82,795
Year 1 20000 units
Year 2 30000 units 3,10,293 − (-82,795)
Year 3 30000 units Sensitivity = × 100 = 126.68%
3,10,293

Discount rate is 10% p.a. (b) Unit Cost 10% ↑

You are required to measure the sensitivity of the project in relation = 40 × 10% = 4
to each of the following parameters:
= 16 × 65,514.65 – 10,00,000 = 48,234
(a) Sales Price/unit

12.11
 ADVANCED CAPITAL BUDGETING

3,10,293 – 48,234 145.28

Sensitivity = × 100 = 84.46% = × 10 = 43.59%
3,10,293 33.33

(c) Sales Volume 10% ↓ Approach II

18,000 27,000 27,000 (a) Selling Price

= 20 × [(1.10)1 + (1.10)2 + (1.10)3] – 10,00,000
20,000 30,000 30,000
0 =X × + + – 10,00,000
= 1,79,264 (1.10)1 (1.10)2 (1.10)3

3,10,293 – 1,79,264 65,514.65 x = 10,00,000

Sensitivity = × 100 = 42.23%
3,10,293
10,00,000
(d) Initial Outlays 10% ↑ x = = ₹ 15.26
65,514.65

= 10,00,000 + 10% = 11,00,000 Contribution = S.P. – VC

NPV = 20 × 65,514.65 – 11,00,000 15.26 = x – 40
= 2,10,293
x = 55.26
3,10,293 – 2,10,293
Sensitivity = × 100 = 32.22% 60 – 55.26
3,10,293 Sensitivity in selling price = × 100 = 7.90%
60
Project life 33.33% ↓
(b) Sensitivity in Unit Cost
Life = 3 Years
Contribution = 15.26
Life = 3 – 33.33%
Contribution = S.P. – VC
= 2 years
15.26 = 60 – x
20,000 30,000
NPV = 20 ×
(1.10)1
+ (1.10)2
– 10,00,000
x = 44.74
44.74 – 40
= -1,40,496 Sensitivity in unit cost = × 100
40
3,10,293 – (-1,40,496)
Sensitivity = × 100 = 145.28% = 11.85%
3,10,293

12.12
 ADVANCED CAPITAL BUDGETING

(c) Sensitivity in Sales Volume 3,10,293

= × 100 = 23.68%
13,10,293
Alternative 1

Let assume no. of units be x

(d) Initial Outlays
2x 3x 3x
= 20 ×
(1.10)1
+ (1.10)2
+ (1.10)3
– 10,00,000 = 0 NPV
Sensitivity in project cost = × 100
Initial Outlays
= 20 × 6.5515 x = 10,00,000
3,10,293
10,00,000 = × 100 =
x = = 7,631.84 units 10,00,000
20×6.5515 31.03%
1 Year = 7,631.84 × 2 = 15,263.68 (e) Project Life
2 Year = 7,631.84 × 3 = 22,895.52 Life 3 years NPV = 3,10,293
1 Year = 7,631.84 × 3 = 22,895.52 Life 2 years NPV = -1,40,496
= 61,054.72 2 years ---------- (1,40,496)
80,000 – 61,054.72
Sensitivity in units = × 100 = 23.68% 3 years ---------- 3,10,293
80,000
1 year (4,50,789)
Alternative II (Best)
1
Assume P.V. of units be x 2 years + ( × 1,40,496)
4,50,789

= 20 × x – 10,00,000 = 0 2.31 years

x = 50,000 units Sensitivity in life =

3 – 2.31
× 100 = 22.97%
3
65,514.65 – 50,000
Sensitivity in units = × 100 = 23.68% Question – 13
65,514.65
Red Ltd. is considering a project with the following Cash flows:
ICAI

12.13
 ADVANCED CAPITAL BUDGETING

Years Cost of Plant Recurring Savings Year 0 Less: P.V. of Cash Outflow ₹ 10,000 × 1 = ₹ 10,000
Cost
0 10,000 NPV = ₹ 4,914
1 4,000 12,000
2 5,000 14,000 Sensitivity Analysis

The cost of capital is 9%. Measure the sensitivity of the project to (i) Increase of Plant Value by ₹ 4,914
changes in the levels of plant value, running cost and savings
4,914
(considering each factor at a time) such that the NPV becomes zero. ∴ × 100 = 49.14%
10,000
The P.V. factor at 9% are as under:
(ii) Increase of Running Cost by ₹ 4,914
Year Factor
4,914 4,914
0 1 = × 100 = 62.38%
3,668 + 4,210 7,878
1 0.917
(iii) Fall in Saving by ₹ 4,914
2 0.842 4,914 4,914
= × 100 = 21.56%
Which factor is the most sensitive to affect the acceptability of the 11,004 +11,788 22,792
project?
Hence, savings factor is the most sensitive to affect the acceptability
of the project as in comparison of other two factors a slight % change
(SM TYK – 11)
in this fact shall more affect the NPV than others.
Solution:
Question – 14
P.V. of Cash Flows R Ltd. is considering a project with the following Cash flows:
In ₹
Year 1 Running Cost ₹ 4,000 × 0.917 = (₹ 3,668)
Years Cost of Plant Recurring Cost Savings
0 20,000
Savings ₹ 12,000 × 0.917 = ₹ 11,004
1 8,000 24,000
Year 2 Running Cost ₹ 5,000 × 0.842 = (₹ 4,210) 2 10,000 28,000

Savings ₹ 14,000 × 0.842 = ₹ 11,788 The cost of capital is 9%.

= ₹ 14,914 Evaluate the sensitivity of the project in respect of all factors except
time such that:

12.14
 ADVANCED CAPITAL BUDGETING

(i) NPV become zero and 9,828

∴ × 100 = 49.14%
20,000
(ii) adversely varying factors value by 10%.
(2) Increase of Running Cost by ₹ 9,828
The P.V. factor at 9% are as under:
9,828 9,828
Years Cost of Plant = × 100 = 62.38%
7,336 + 8,420 15,756
0 1
1 0.917 (3) Fall in Saving by ₹ 9,828
2 0.842
9,828 9,828
Note: Round off calculation upto 2 decimal points. = × 100 = 21.56%
22,008 + 23,576 45,584

(MTP April – 2024) Hence, savings factor is the most sensitive to affect the
acceptability of the project as in comparison of other two
Solution:
factors a slight % change in this fact shall more affect the
Working Note: NPV than others.

Year 1 Running Cost ₹ 8,000 × 0.917 = (₹ 7,336) (ii) Sensitivity Analysis if there is a variation of 10% in the
factors.
Savings ₹ 24,000 × 0.917 = ₹ 22,008
(1) If the initial project cost is varied adversely by say 10%.
Year 2 Running Cost ₹ 10,000 × 0.842 = (₹ 8,420)
NPV (Revised) (₹ 9,828 – ₹ 2,000) = ₹ 7,828
Savings ₹ 28,000 × 0.842 = ₹ 23,576
₹ 9,828 − ₹ 7,828
Change in NPV = = 20.35%
₹ 9,828
= ₹ 29,828
(2) If Annual Running Cost is varied by say 10%.
Year 0 Less: P.V. of Cash Outflow ₹ 20,000 × 1 = ₹ 20,000
NPV (Revised) (₹ 9828 – ₹ 800 × 0.917 – ₹ 1000 ×
NPV = ₹ 9,828
0.842)
(i) Sensitivity Analysis (by making NPV Zero) = ₹ 9,828 – ₹ 733.60 – ₹ 842 = ₹ 8,252.40
(1) Increase of Plant Value by ₹ 9,828

12.15
 ADVANCED CAPITAL BUDGETING

₹ 9,828 − ₹ 8,252.40 (ii) Net Present Value of the Project

Change in NPV = = 16.03%
₹ 9,828
(iii) Annual Fixed Cost
(3) If Saving is varied by say 10%.
(iv) Estimated annual unit of sales
NPV (Revised) (₹ 9,828 – ₹ 2400 × 0.917 – ₹ 2800 ×
0.842) (v) Break Even Units

Cumulative Discounting Factor for 5 years

= ₹ 9,828 – ₹ 2,200.80 – ₹ 2,357.60 = ₹ 5,269.60
8% 9% 10 11 12 13 14 15 16 17 18
₹ 9,828 − ₹ 5,269.60
Change in NPV = × 100 = 46.38% % % % % % % % % %
₹ 9,828
3.3 3.8 3.7 3.6 3.6 3.5 3.4 3.3 3.2 3.1 3.1
Hence, savings factor is the most sensitive to affect the 39 90 91 96 05 17 33 52 74 99 27
acceptability of the project. (SM TYK – 12)
Question – 15 Solution:
The Easygoing Company Limited is considering a new project with
initial investment, for a product “Survival”. It is estimated that IRR (i) Initial Investment
of the project is 16% having an estimated life of 5 years.
IRR = 16% (Given)
Financial Manager has studied that project with sensitivity analysis
and informed that annual fixed cost sensitivity is 7.8416%, whereas At IRR, NPV shall be zero, therefore
cost of capital (discount rate) sensitivity is 60%. Initial Cost of Investment = PVAF (16%,5) × Cash Flow
Other information available are: (Annual)

Profit Volume Ratio (P/V) is 70%, = 3.274 × ₹ 57,500 = ₹ 1,88,255

Variable cost ₹ 60/- per unit (ii) Net Present Value (NPV)

16−X
Annual Cash Flow ₹ 57,500/- Let Cost of Capital be X, then = 60% X = 10%
X
Ignore Depreciation on initial investment and impact of taxation.
Thus NPV of the project
Calculate
= Annual Cash Flow × PVAF (10%, 5) – Initial Investment
(i) Initial Investment of the Project

12.16
 ADVANCED CAPITAL BUDGETING

= ₹ 57,500 × 3.791 – ₹ 1,88,255 X = ₹ 1,00,000

= ₹ 2,17,982.50 – ₹ 1,88,255 (iv) Estimated Annual Units of Sales

= ₹ 29,727.50 ₹ 60
Selling price per unit = = ₹ 200
100% – 70%
(iii) Annual Fixed Cost
Annual Cash Flow + Fixed Cost
= Sales Value
Alternative I P/V Ratio

Let change in the Fixed Cost which makes NPV zero is X. ₹ 57,500 + ₹ 1,00,000
= ₹ 2,25,000
Then, 0.70

₹ 29,727.50 – 3.791X = 0 ₹ 2,25,000

Sales in Units = = 1,125 units
₹ 200
Thus X = ₹ 7,841.60
(v) Break Even Units
Let original Fixed Cost be Y then,
Fixed Cost 1,00,000
= = 714.285 units
Y × 7.8416% = ₹ 7,841.60 Contribution Per Unit 140

Y = ₹ 1,00,000 Question – 16
Unnat Ltd. is considering investing ₹ 50,00,000 in a new machine.
Thus Fixed Cost is equal to ₹ 1,00,000 The expected life of machine is five years and has no scrap value. It
is expected that 2,00,000 units will be produced and sold each year
Alternative II at a selling price of ₹ 30.00 per unit. It is expected that the variable
NPV costs to be ₹ 16.50 per unit and fixed costs to be ₹ 10,00,000 per
Sensitivity in FC = year. The cost of capital of Unnat Ltd. is 12% and acceptable level of
PV of FC
risk is 20%.
29,727.50
7.8416% =
PV of FC You are required to measure the sensitivity of the project’s net
present value to a change in the following project variables:
PV of FC = ₹ 3,79,100
(a) Sale Price;
PV of FC = Annual FC × PVAF
(b) Sales Volume;
3,79,100 = X × 3.791

12.17
 ADVANCED CAPITAL BUDGETING

(c) Variable Cost; 86,05,000

x = = 11.93
7,21,000
(d) On further investigation it is found that there is a significant
chance that the expected sales volume of 2,00,000 units per CPU = SP – VC
year will not be achieved. The sales manager of Unnat Ltd.
11.93 = x – 16.50
suggests that sales volumes could depend on expected
economic states which could be assigned the following x = ₹ 28.43
probabilities:
30 – 28.43
State of Annual Sales Probability Sensitivity = × 100 = 5.23%
30
Economy (in Units)
Poor 1,75,000 0.30 Alternative
Normal 2,00,000 0.60
Good 2,25,000 0.10 Let the sale price/Unit be S so that the project would break
even with 0 NPV.
Calculate expected net present value of the project and give your
decision whether company should accept the project or not. ∴ ₹ 50,00,000 = [2,00,000 (S – ₹ 16.50) – ₹ 10,00,000] PVIAF
(12%,5)
(SM TYK – 13)
₹ 50,00,000 = [2,00,000 S – ₹ 33,00,000 – ₹ 10,00,000] 3.605
Solution:
₹ 50,00,000 = [2,00,000S – ₹ 43,00,000] 3.605
NPV Calculation
₹ 13,86,963 = 2,00,000S – ₹ 43,00,000
NPV = (30 – 16.50) × 2,00,000 unit × 3.605 – 10,00,000 × 3.605 –
50,00,000 ₹ 56,86,963 = 2,00,000S

= 13.50 × 7,21,000 – 36,05,000 – 50,00,000 S = ₹ 28.43 which represents a fall of (30 − 28.43)/30 or
0.0523 or 5.23%
= ₹ 11,28,500
(b) Sales Volume
(a) Sales Price
Let assume present value of sales volume be x
Let assume contribution per unit be x
13.50 x – 36,05,000 – 50,00,000 = 0
x × 7,21,000 – 86,05,000 – 50,00,000 = 0

12.18
 ADVANCED CAPITAL BUDGETING

86,05,000 Let the variable cost be V so that the project would break even
x = = 6,37,407
13.50 with 0 NPV.
7,21,000 – 6,37,407 ₹ 50,00,000 = [2,00,000 (₹ 30 – V) – ₹ 10,00,000]
Sensitivity = × 100 = 11.59%
7,21,000 PVIAF(12%,5)
Alternative ₹ 50,00,000 = [₹ 60,00,000 – 2,00,000 V – ₹10,00,000] 3.605
Let V be the sale volume so that the project would break even ₹ 50,00,000 = [₹ 50,00,000 – 2,00,000 V] 3.605
with 0 NPV.
₹ 13,86,963 = ₹ 50,00,000 – 2,00,000 V
∴ ₹ 50,00,000= [V (₹ 30 – ₹ 16.50) – ₹ 10,00,000] PVIAF (12%,5)
₹ 36,13,037 = 2,00,000V
₹ 50,00,000 = [V (₹ 13.50) – ₹ 10,00,000] PVIAF (12%,5)
V = ₹ 18.07 which represents a fall of (18.07 – 16.50)/16.50
₹ 50,00,000 = [₹ 13.50V – ₹ 10,00,000] 3.605
or 0.0951 or 9.51%
₹ 13,86,963 = ₹ 13.50V – ₹ 10,00,000
(d) Expected Net Present Value
₹ 23,86,963 = ₹ 13.50V (1,75,000 × 0.30) + (2,00,000 × 0.60) + (2,25,000 × 0.10)
V = 1,76,812 which represents a fall of (2,00,000 – =1,95,000
1,76,812)/2,00,000 or 0.1159 or 11.59% NPV = [1,95,000 × ₹ 13.50 – ₹ 10,00,000] 3.605 – ₹
(c) Variable Cost 50,00,000

Let assume variable cost per unit be x = ₹ 8,85,163

CPU = SP – VC Further NPV in worst and best cases will be as follows:

11.93 = 30 – x Worst Case:

x = 18.07 [1,75,000 × ₹ 13.50 – ₹ 10,00,000] 3.605 – ₹ 50,00,000 = - ₹

88,188
18.07 – 16.50
Sensitivity = × 100 = 9.51% Best Case:
16.50

Alternative

12.19
 ADVANCED CAPITAL BUDGETING

[2,25,000 × ₹ 13.50 – ₹ 10,00,000] 3.605 – ₹ 50,00,000 = ₹ (2) Expected Expenses Excluding Depreciation
23,45,188
Year Expenses
Thus, there are 30% chances that the rise will be a negative 1 ₹ 40 lakhs
NPV and 70% chances of positive NPV. Since acceptable level 2 ₹ 48 lakhs
of risk of Unnat Ltd. is 20% and there are 30% chances of 3 ₹ 56 lakhs
negative NPV hence project should not be accepted. 4 ₹ 64 lakhs
5 ₹ 72 lakhs
Question – 17
(3) Cash Inflow from the Project
PQ Ltd. expects sales of ₹ 100 lakhs in the year 1. The same will
Let P be the cost of the plant then chargeable depreciation for
increase by ₹ 20 lakhs per year over the next four years. At the end
each year shall be 0.20P. Accordingly, annual cash flow from
of 5 years the project would be wound up. The Deprecation will be
the project shall be computed as follows:
charged at 20% p.a. on straight line method. The expenses excluding
the depreciation will be 40% of the sales. There will be no salvage Yea Expect Exp Dep Profit Tax @ Profit
value of the plant. PQ Ltd. proposes to invest in the plant an amount r ed . . Before 30% After
where the Net Present Value will be Zero. Sales ₹ (3) Tax Tax
₹ lakhs lak
Corporate Tax rate is 30%. hs
1 100 40 0.20 60 – 18 – 42 –
You are required to calculate the investment which can be made in P 0.20P 0.06P 0.14P
the plant. 2 120 48 0.20 72 – 21.6 – 50.4 –
P 0.20P 0.06P 0.14P
(Exam November – 2024) (8 Marks) 3 140 56 0.20 84 – 25.2 – 58.8 –
P 0.20P 0.06P 0.14P
Solution: 4 160 64 0.20 96 – 28.8 – 67.2 –
P 0.20P 0.06P 0.14P
Working Notes: 5 180 72 0.20 108 – 32.4 – 75.6 –
P 0.20P 0.06P 0.14P
(1) Expected Sales

Year Expected Sales Year Profit After Dep. Added Cash Inflow
1 ₹ 100 lakhs Tax Back
2 ₹ 120 lakhs 1 42 – 0.14P 0.20P 42 + 0.06P
3 ₹ 140 lakhs 2 50.40 – 0.14P 0.20P 50.40 + 0.06P
3 58.80 – 0.14P 0.20P 58.80 + 0.06P
4 ₹ 160 lakhs
4 67.20 – 0.14P 0.20P 67.20 + 0.06P
5 ₹ 180 lakhs

12.20
 ADVANCED CAPITAL BUDGETING

5 75.60 – 0.14P 0.20P 75.60 + 0.06P (3) Cash Inflow from the Project
Total 294 + 0.30P
Let P be the cost of the plant then chargeable depreciation for
Since NPV will be Zero the required comes as follows: each year shall be 0.20P. Accordingly, annual cash flow from
the project shall be computed as follows:
Sum of Cash Inflows – Plant Cost = 0
Yea Expect Exp. Dep. Profit Tax @ Profit
294 + 0.30P – P = 0 r ed ₹ (3) Before 30% After Tax
Sales lakh Tax
₹ lakhs s
P = 420
1 100 40 0.20 60 – 18 – 42 – 0.14P
P 0.20P 0.06P
Thus, the required investment to be made in plant shall be ₹ 2 120 48 0.20 72 – 21.6 – 50.4 –
420 lakhs. P 0.20P 0.06P 0.14P
3 140 56 0.20 84 – 25.2 – 58.8 –
Alternative solution if a discount rate of 10% is applied, though P 0.20P 0.06P 0.14P
4 160 64 0.20 96 – 28.8 – 67.2 –
students may solve the question using a rate other than 10%.
P 0.20P 0.06P 0.14P
5 180 72 0.20 108 – 32.4 – 75.6 –
Working Notes: P 0.20P 0.06P 0.14P

(1) Expected Sales Y Profit After Dep. Cash Inflow PVF @ PV of Cash Inflow
ea Tax Added 10%
Year Expected Sales r Back
1 ₹ 100 lakhs 1 42 – 0.14P 0.20P 42 + 0.06P 0.909 38.178 + 0.05454P
2 50.40 – 0.14P 0.20P 50.40 + 0.06P 0.826 41.6304 + 0.04956P
2 ₹ 120 lakhs
3 58.80 – 0.14P 0.20P 58.80 + 0.06P 0.751 44.1588 + 0.04506P
3 ₹ 140 lakhs 4 67.20 – 0.14P 0.20P 67.20 + 0.06P 0.683 45.8976 + 0.04098P
4 ₹ 160 lakhs 5 75.60 – 0.14P 0.20P 75.60 + 0.06P 0.621 46.9476 + 0.03726P
5 ₹ 180 lakhs Total 216.8124 + 0.2274P

(2) Expected Expenses Excluding Depreciation Since NPV will be Zero the required comes as follows:

Year Expenses Sum of Cash Inflows – Plant Cost = 0

1 ₹ 40 lakhs
2 ₹ 48 lakhs 216.8124 + 0.2274P – P = 0
3 ₹ 56 lakhs
4 ₹ 64 lakhs P = 280.63
5 ₹ 72 lakhs

12.21
 ADVANCED CAPITAL BUDGETING

Thus, the required investment to be made in plant shall be ₹ Calculation of Net Present Value (NPV) of the Project
280.63 lakhs.
Year Year Cash PV factor @ Present Value (PV)
Question – 18 Flow (₹ in Cr.) 6% (₹ in Cr.)
X Ltd. is considering its new project with the following details: 0 (400.00) 1.000 (400.00)
1 200.00 0.943 188.60
Sr. No. Particulars Figures 2 200.00 0.890 178.00
1 Initial capital cost ₹ 400 Cr. 3 200.00 0.840 168.00
2 Annual unit sales 5 Cr. Net Present Value 134.60
3 Selling price per unit ₹ 100
4 Variable cost per unit ₹ 50 Here, NPV represent the most likely outcomes and not the actual
5 Fixed costs per year ₹ 50 Cr. outcomes. The actual outcome can be lower or higher than the
6 Discount Rate 6% expected outcome.

Required: 2. Sensitivity Analysis considering 2.5% Adverse Variance in

each variable
1. Calculate the NPV of the project.
Particulars Base Initial Selling Variable Fixed Units
2. Compute the impact on the project’s NPV considering a 2.5 capital Price Cost Per Cost Per sold
cost per Unit Unit per
per cent adverse variance in each variable. Which variable is increas Unit increase increase year
having maximum effect? ed to ₹ Reduce d to ₹ d to ₹ reduce
410 d to ₹ 51.25 51.25 d to
crore 97.5 4.875
Consider Life of the project as 3 years. crore
(₹) (₹) (₹) (₹) (₹) (₹)
Solution: A Selling 100 100 97.5 100 100 100
price per
1. Calculation of Net Cash Inflow per Year unit
B Variable 50 50 50 51.25 50 50
Particulars Amount (₹) cost per
unit
A Selling price per unit 100 C Contributio
B Variable cost per unit 50 n per unit 50 50 47.5 48.75 50 50
C Contribution per unit (A − B) 50 (A – B)
(₹in (₹in Cr.) (₹in Cr.) (₹in Cr.) (₹in Cr.) (₹in
D Number of units sold per year 5 Cr. Cr.) Cr.)
E Total Contribution (C × D) ₹ 250 Cr. D Number of
F Fixed cost per year ₹ 50 Cr. units sold 5 5 5 5 5 4.875
G Net cash inflow per year (E - F) ₹ 200 Cr. per year

12.22
 ADVANCED CAPITAL BUDGETING

(units in Assuming the cost of capital as 9%, determine NPV in each scenario.
Crores)
If XYZ Ltd is certain about the most likely result in first two years
E Total but uncertain about the third year’s cash flow, analyze what will be
Contributio 250 250 237.5 243.75 250 243.75
n (C × D) the NPV expecting worst scenario in the third year.
F Fixed cost 50 50 50 50 51.25 50
per year Solution:
G Net Cash
Inflow per 200 200 187.5 193.75 198.75 193.75 The possible outcomes will be as follows:
year (E – F)
H PV of Net
cash Inflow 534.60 534.60 501.19 517.89 531.26 517.89 Year PVF Worst Case Most likely Best case
per year @ 9% Cash PV Cash PV Cash PV
(G × 2.673) Flow Flow Flow
I Initial 400 410 400 400 400 400
capital cost
J NPV (H – I) 134.60 124.60 101.19 117.89 131.26 117.89
(₹ (₹ (₹ (₹ (₹ (₹
K Percentage ‘000) ‘000) ‘000) ‘000) ‘000) ‘000)
Change in - -7.43% -24.82% -12.41% -2.48% -12.41% 0 1 (1,400) (1,400) (1,400) (1,400) (1,400) (1,400)
NPV 1 0.917 450 412.65 550 504.35 650 596.05
2 0.842 400 336.80 450 378.90 500 421.00
The above table shows that by changing one variable at a time by 3 0.772 700 540.40 800 617.60 900 694.80
2.5% (adverse) while keeping the others constant, the impact in NPV - 100.85 311.85
percentage terms on the NPV of the project can be calculated. Thus, 110.15
the change in selling price has the maximum effect on the NPV by
24.82%. If XYZ Ltd. is certain about the most likely result in first two years
but uncertain about the third year’s cash flow, then, NPV expecting
(ii) Scenario Analysis worst case scenario is expected in the third year will be as follows:

Question – 19 ₹ 5,50,000 ₹ 4,50,000 ₹ 7,00,000

= - ₹ 14,00,000 + + +
XYZ Ltd. is considering a project “A” with an initial outlay of ₹ (1 + 0.09) (1 + 0.09)2 (1 + 0.09)3
14,00,000 and the possible three cash inflow attached with the
project as follows: = − ₹ 14,00,000 + ₹ 5,04,587 + ₹ 3,78,756 + ₹ 5,40,528

Particulars Year 1 Year 2 Year 3 = ₹ 23,871

Worst case 450 400 700
Most likely 550 450 800
Best case 650 500 900

12.23
 ADVANCED CAPITAL BUDGETING

Question – 20 Solution:
A firm has an investment proposal, requiring an outlay of ₹ 80,000.
The investment proposal is expected to have two years economic life (i) The decision tree diagram is presented in the chart, identifying
with no salvage value. In year 1, there is a 0.4 probability that cash various paths and outcomes, and the computation of various
inflow after tax will be ₹ 50,000 and 0.6 probability that cash inflow paths/outcomes and NPV of each path are presented in the
following tables:
after tax will be ₹ 60,000. The probability assigned to cash inflow
after tax for the year 2 is as follows:

The cash inflow ₹ 50,000 ₹ 60,000

year 1
The cash inflow Probability Probability
year 2
₹ 24,000 0.2 ₹ 40,000 0.4
₹ 32,000 0.3 ₹ 50,000 0.5
₹ 44,000 0.5 ₹ 60,000 0.1

The firm uses a 10% discount rate for this type of investment.

Required:

(i) Construct a decision tree for the proposed investment project

and calculate the expected net present value (NPV).
The Net Present Value (NPV) of each path at 10% discount rate
(ii) What net present value will the project yield, if worst outcome
is given below:
is realized? What is the probability of occurrence of this NPV?
Path Year 1 Cash Year 2 Cash Total Cash Inflows NPV
(iii) What will be the best outcome and the probability of that Flows Flows Cash
occurrence? (₹) (₹) Inflows (₹) (₹)
(PV) (₹)
(iv) Will the project be accepted? 1 50,000 × 24,000 × 0.826 65,274 80,000 (-)
0.909 = = 19,824 14,726
(Note: 10% discount factor 1 year 0.909; 2 year 0.826) 45,450
2 45,450 32,000 × 0.826 71,882 80,000 (-) 8,118
= 26,432
(SM TYK – 20)
3 45,450 44,000 × 0.826 81,794 80,000 1,794
= 36,344

12.24
 ADVANCED CAPITAL BUDGETING

4 60,000 × 40,000 × 0.826 87,580 80,000 7,580 (₹)

0.909 = = 33,040
54,540 Year 1 Year 2 Year 3
5 54,540 50,000 × 0.826 95,840 80,000 15,840 CFAT Probability CFAT Probability CFAT Probability
= 41,300 14,00,000 0.1 15,00,000 0.1 18,00,000 0.2
6 54,540 60,000 × 0.826 1,04,10 80,000 24,100 18,00,000 0.2 20,00,000 0.3 25,00,000 0.5
= 49,560 0 25,00,000 0.4 32,00,000 0.4 35,00,000 0.2
40,00,000 0.3 45,00,000 0.2 48,00,000 0.1

Statement showing Expected Net Present Value ₹

The Company wishes to take into consideration all possible risk
z NPV (₹) Joint Probability Expected NPV factors relating to airline operations. The company wants to know:
1 -14,726 0.08 -1,178.08
(i) The expected NPV of this venture assuming independent
2 -8,118 0.12 -974.16
3 1,794 0.20 358.80 probability distribution with 6 per cent risk free rate of
4 7,580 0.24 1,819.20 interest.
5 15,840 0.30 4,752.00
6 24,100 0.06 1,446.00 (ii) The possible deviation in the expected value.
6,223.76
(iii) How would standard deviation of the present value
distribution help in Capital Budgeting decisions?
(ii) If the worst outcome is realized the project will yield NPV of –
₹ 14,726. The probability of occurrence of this NPV is 8% and
(SM TYK – 01)
a loss of ₹ 1,178 (path 1).
Solution:
(iii) The best outcome will be path 6 when the NPV is at ₹ 24,100.
The probability of occurrence of this NPV is 6% and a expected (i) Expected NPV
profit of ₹ 1,446. (₹ in lakhs)

(iv) The project should be accepted because the expected NPV is Year I Year II Year III
positive at ₹ 6,223.76 based on joint probability. CFA P CF × CFA P CF × CFA P CF × P
T P T P T
Question – 21 14 0.1 1.4 15 0.1 1.5 18 0.2 3.6
Skylark Airways is planning to acquire a light commercial aircraft for 18 0.2 3.6 20 0.3 6.0 25 0.5 12.5
flying class clients at an investment of ₹ 50,00,000. The expected 25 0.4 10.0 32 0.4 12.8 35 0.2 7.0
cash flow after tax for the next three years is as follows: 40 0.3 12.0 45 0.2 9 48 0.1 4.8
x̅ or 27.0 x̅ or 29.3 x̅ or CF
CF CF 27.9

12.25
 ADVANCED CAPITAL BUDGETING

NPV PV factor @ 6% Total PV 35-27.9 7.1 50.41 0.2 10.082

27 0.943 25.461 48-27.9 20.1 404.01 0.1 40.401
29.3 0.890 26.077 74.29
27.9 0.840 23.436
PV of cash inflow 74.974 σ3 √74.29 = 8.619
Less: Cash outflow 50.000
NPV 24.974 Standard deviation about the expected value:

(ii) Possible deviation in the expected value 85.4 98.61 74.29

σ √(1.06)2 + (1.06)4 + (1.06)6 = 14.3696
Year I
X −X ̅ X −X ̅ 2 P1 2 (iii) Standard deviation is a statistical measure of dispersion; it
X −X ̅ X −X̅ P1
14 – 27 -13 169 0.1 16.9 measures the deviation from a central number i.e. the mean.
18 – 27 -9 81 0.2 16.2
25 – 27 -2 4 0.4 1.6 In the context of capital budgeting decisions especially where
40 – 27 13 169 0.3 50.7 we take up two or more projects giving somewhat similar mean
85.4 cash flows, by calculating standard deviation in such cases,
we can measure in each case the extent of variation. It can
σ1 √85.4 = 9.241 then be used to identify which of the projects is least risky in
terms of variability of cash flows.
Year II
X −X ̅ ̅
X −X ̅ )2
(X − X P2 (X − X ̅ )2 A project, which has a lower coefficient of variation will be
P2 preferred if sizes are heterogeneous.
15-29.3 -14.3 204.49 0.1 20.449
20-29.3 -9.3 86.49 0.3 25.947 Besides this, if we assume that probability distribution is
32-29.3 2.7 7.29 0.4 2.916 approximately normal we are able to calculate the probability
45-29.3 15.7 246.49 0.2 49.298 of a capital budgeting project generating a net present value
98.61
less than or more than a specified amount.
σ2 √98.61 = 9.930 Question – 22
Project X and Project Y are under the evaluation of XY Co. The
Year III
̅ ̅ ̅ )2 ̅ )2 estimated cash flows and their probabilities are as below:
X −X X −X (X − X 𝐏𝟑 (X − X
𝐏𝟑 Project X : Investment (year 0) ₹ 70 lakhs
18-27.9 -9.9 98.01 0.2 19.602
25-27.9 -2.9 8.41 0.5 4.205

12.26
 ADVANCED CAPITAL BUDGETING

Probability 0.30 0.40 0.30 1-3 (40 × 0.2) + (45 × 0.5) + 45.5 2.487 113.16
Weights (50 × 0.3) (+) 33.16
Years ₹ lakhs ₹ lakhs ₹ lakhs NPV (113.16 – 80.00)=
1 30 50 65
2 30 40 55 (b) Calculation of Standard deviation σ
3 30 40 45
As per Hiller’s model
Project Y: Investment (year 0) ₹ 80 lakhs.
Project X
Probability Weighted Annual cash flows through
life Year
₹ lakhs
1
0.20 40
0.50 45 √(30 − 48.5)2 0.30 + (50 − 48.5)2 0.40 + (65 − 48.5)2 0.30
0.30 50
= √185.25 = 13.61
(a) Which project is better based on NPV, criterion with a discount
rate of 10%? 2
√(30 − 41.5)2 0.30 + (40 − 41.5)2 0.40 + (55 − 41.5)2 0.30
(b) Compute the standard deviation of the present value
distribution and analyze the inherent risk of the projects. = √95.25 = 9.76

(SM TYK – 05) 3

√(30 − 38.5)2 0.30 + (40 − 38.5)2 0.40 + (45 − 38.5)2 0.30
Solution:

(a) Calculation of NPV of XY Co.: = √35.25 = 5.94

Project X Cash PVF PV Standard Deviation about the expected value

flow
Year 185.25 95.25 35.25
1 (30 × 0.3) + (50 × 0.4) + (65 × 0.3) 48.5 0.909 44.09 =√ + (1+0.10)4 + (1+0.10)6
(1+0.10)2
2 (30 × 0.3) + (40 × 0.4) + (55 × 0.3) 41.5 0.826 34.28
3 (30 × 0.3) + (40 × 0.4) + (45 × 0.3) 38.5 0.751 28.91
107.28 185.25 95.25 35.25
NPV: (107.28 – 70.00) = (+) =√ + 1.4641 + 1.7716
1.21
37.28

= √153.10 + 65.06 + 19.90

Project Y (For 1-3 Years)

12.27
 ADVANCED CAPITAL BUDGETING

= √238.06 The project life is 5 years and the desired rate of return is 20%. The
estimated terminal values for the project assets under the three
= 15.43 probability alternatives, respectively, are ₹ 0, 20,000 and 30,000.
Project Y (For 1-3 Years) You are required to:

√(40 − 45.5)2 0.20 + (45 − 45.5)2 0.50 + (50 − 45.5)2 0.30 (i) Find the probable NPV;

= √12.25 = 3.50 (ii) Find the worst-case NPV and the best-case NPV; and

Standard Deviation about the expected value (iii) State the probability occurrence of the worst case, if the cash
flows are perfectly positively correlated over time.
12.25 12.25 12.25
= √(1+0.10)2 + (1+0.10)4 + (1+0.10)6 (SM TYK – 08)

12.25 12.25 12.25

Solution:
= √ 1.21 + 1.4641 + 1.7716
(i) NPV based on expected cash flows would be as follows:
= √10.12 + 8.37 + 6.91
Worst Case:
= √25.4 ₹ 20,000 ₹ 20,000 ₹ 20,000 ₹ 20,000
= ₹ 1,00,000 + + + + +
(1 + 0.20)1 (1 + 0.20)2 (1 + 0.20)3 (1 + 0.20)4
= 5.03 ₹ 20,000
(1 + 0.20)5
Analysis: Project Y is less risky as its Standard Deviation is less than
Project X. = - ₹ 1,00,000 + ₹ 16,666.67 + ₹ 13,888.89 + ₹ 11,574.07 + ₹
9,645.06
Question – 23
XY Ltd. has under its consideration a project with an initial + ₹ 8037.76
investment of ₹ 1,00,000. Three probable cash inflow scenarios with
NPV = - ₹ 40,187.76
their probabilities of occurrence have been estimated as below:

Annual cash inflow (₹) 20,000 30,000 40,000 Base Case:

₹ 30,000 ₹ 30,000 ₹ 30,000 ₹ 30,000
Probability 0.1 0.7 0.2 = -₹ 1,00,000 + (1 + 0.20)1
+ (1 + 0.20)2
+ (1 + 0.20)3
+ (1 + 0.20)4

12.28
 ADVANCED CAPITAL BUDGETING
₹ 30,000 ₹ 20,000 For the best case, the cash flows from the cash flow column
+ (1 + 0.20)5
+ (1 + 0.20)5
farthest on the right are used to calculated NPV
NPV = -₹ 2,244.08 ₹ 40,000 ₹ 40,000 ₹ 40,000 ₹ 40,000
= ₹ 1,00,000 + (1 + 0.20)1
+ (1 + 0.20)2
+ (1 + 0.20)3
+ (1 + 0.20)4
Best Case:
₹ 40,000 ₹ 30,000
₹ 40,000 ₹ 40,000 ₹ 40,000 ₹ 40,000 + (1 + 0.20)5
+ (1 + 0.20)5
= ₹ 1,00,000 + + + +
(1 + 0.20)1 (1 + 0.20)2 (1 + 0.20)3 (1 + 0.20)4
= - ₹ 1,00,000 + ₹ 33,333.33 + ₹ 27,777.78 + ₹ 23,148.15 + ₹
₹ 40,000 ₹ 30,000
+ (1 + 0.20)5
+ (1 + 0.20)5
19,290.12

= - ₹ 1,00,000 + ₹ 33,333.33 + ₹ 27,777.78 + ₹ 23,148.15 + ₹ + ₹ 16,075.10 + ₹ 12,056.33

19,290.12 NPV = ₹31,680.81
+ ₹ 16,075.10 + ₹ 12,056.33
(iii) If the cash flows are perfectly dependent, then the low cash
NPV = ₹ 31,680.81 flow in the first year will mean a low cash flow in every year.
Thus, the possibility of the worst case occurring is the
Expected NPV probability of getting ₹20,000 net cash flow in year 1 is 10%.

= (- ₹ 40,187.76 × 0.1) + (-₹ 2,244.08 × 0.7) + (₹ 31,680.81 × Question – 24

0.2) Following are the estimates of the net cash flows and probability of a
new project of M/s X Ltd.:
= ₹ 746.52
Year P = 0.3 P = 0.5 P = 0.2
(ii) For the worst case, the cash flows from the cash flow column Initial investment 0 4,00,000 4,00,000 4,00,000
farthest on the left are used to calculate NPV Estimated net after tax 1 to 5 1,00,000 1,10,000 1,20,000
cash inflows per year
₹ 20,000 ₹ 20,000 ₹ 20,000 ₹ 20,000
= ₹ 1,00,000 + + + + + Estimated salvage 5 20,000 50,000 60,000
(1 + 0.20)1 (1 + 0.20)2 (1 + 0.20)3 (1 + 0.20)4
value (after tax)
₹ 20,000
(1 + 0.20)5
Required rate of return from the project is 10%. Find:
= - ₹ 1,00,000 + ₹ 16,666.67 + ₹ 13,888.89 + ₹ 11,574.07 + ₹
(i) The expected NPV of the project.
9,645.06 + ₹ 8037.76
(ii) The best case and the worst case NPVs.
NPV = - ₹ 40,187.76

12.29
 ADVANCED CAPITAL BUDGETING

(iii) The probability of occurrence of the worst case if the cash = ₹ 92,060/-.
flows are perfectly dependent overtime and independent
overtime. Expected NPV

(iv) Standard deviation and coefficient of variation assuming that = 0.30 × (-) 8,580 + 0.5 × 47,950 + 92,060 × 0.20
there are only three streams of cash flow, which are
= ₹ 39,813/-
represented by each column of the table with the given
probabilities. (ii) ENPV of The Worst Case
(v) Coefficient of variation of X Ltd. on its average project which 1,00,000 × 3.790 = ₹ 3,79,000
is in the range of 0.95 to1.0. If the coefficient of variation of
the project is found to be less risky than average, 100basis (Students may have 3.791 also the values will change
points are deducted from the Company’s cost of Capital accordingly)

Should the project be accepted by X Ltd? 20,000 × 0.621 = ₹ 12,420/-

(SM TYK – 07) ENPV = (-)4,00,000 + 3,79,000 + 12,420 = (-) ₹ 8,580/-

Solution: ENPV of the best case

(i) Expected NPV ENPV = (-)4,00,000 + 1,20,000 × 3.790 + 60,000 × 0.621

Worst Case = ₹ 92,060/-.

ENPV = (-)4,00,000 + 1,00,000 × 3.790 + 20,000 × 0.621 (iii) (a) Required probability = 0.3

= -₹ 8,580/- (b) Required probability = (0.3)5 = 0.00243

Base Case (iv) The base case NPV = (-) 4,00,000 + (1,10,000 × 3.79) +
(50,000 × 0.621)
ENPV = (-)4,00,000 + 1,20,000 × 3.790 + 60,000 × 0.621
= ₹ 47,950/-
= ₹ 92,060/-.
ENPV = 0.30 × (-) 8,580 + 0.5 × 47,950 + 92,060 × 0.20
Best Case
= ₹ 39,813/-
ENPV = (-)4,00,000 + 1,20,000 × 3.790 + 60,000 × 0.621

12.30
 ADVANCED CAPITAL BUDGETING

Therefore, expected to have a life of 5 years. Under three possible situations

their annual cash flows and probabilities are as under:
σENPV =
Cash Flow (₹)
0.3(−8,580 − 39,813)2 + 0.5(47,950 − 39,813)2 + 0.2
√ Situation Probabilities Project A Project B
+(92,060 − 39,813)2
Good 0.3 6,00,000 5,00,000
Normal 0.4 4,00,000 4,00,000
= ₹ 35,800/- Worse 0.3 2,00,000 3,00,000

Therefore, CV = 35,800/39,813 The cost of capital is 7 per cent, which project should be accepted?
Explain with workings.
= 0.90
(SM TYK – 02)
(v) Risk adjusted out of cost of capital of X Ltd. = 10% - 1% = 9%.
Solution:
NPV
Expected Cash Flows & Standard Deviation
Expected Cash Flows
Project A
1 to 5 = (1,00,000 × 0.3 +1,10,000 × 0.5 + 1,20,000 × 0.2)
Expected Cash Flows
= 1,09,000
= (6,00,000 × 0.3) + (4,00,000 × 0.4) + (2,00,000 × 0.3)
Expected Salvage Value [5th year]
= 4,00,000
= (20,000 × 0.3 + 50,000 × 0.5 + 60,000 × 0.2)

= 43,000 (6,00,000 – 4,00,000)2 0.3 + ( 4,00,000 – 4,00,000) 2

+
σx =√
( 2,00,000 – 4,00,000)2 0.3
NPV = (1,09,000 × 3.890) + (43,000 × 0.650) – 4,00,000
= ₹ 1,54,919
= ₹ 51,960
Project B
Therefore, the project should be accepted.
ENCF = 0.3 (5,00,000) + 0.4 (4,00,000) + 0.3 (3,00,000)
Question – 25
Cyber Company is considering two mutually exclusive projects. = 4,00,000
Investment outlay of both the projects is ₹ 5,00,000 and each is

12.31
 ADVANCED CAPITAL BUDGETING

σ2 = 0.3 (5,00,000 – 4,00,000)2 + 0.4 (4,00,000 – 30,000 0.30 7 0.15

4,00,000)2 + 0.3 (3,00,000 – 4,00,000)2 35,000 0.20 8 0.10
40,000 0.15 9 0.03
σ = √6,00,00,00,000 10 0.02

Random Number
σ = 77,459.66
53479 81115 98036 12217 59526
Expected NPV
97344 70328 58116 91964 26240
66023 38277 74523 71118 84892
A = (4,00,000 × PVAF 7 % 5) – 5,00,000
99776 75723 03172 43112 83086
= (4,00,000 × 4.100) – 5,00,000 = 11,40,000 30176 48979 92153 38416 42436
81874 83339 14988 99937 13213
B = (4,00,000 × 4.100) – 5,00,000 = 11,40,000 19839 90630 71863 95053 55532
09337 33435 53869 52769 18801
Project B should be accepted due to lower risk. 31151 58295 40823 41330 21093
67619 52515 03037 81699 17106
Recommendation: NPV in both projects being the same, the project
should be decided on the basis of standard deviation and hence Take beginning two digit random number. One for annual cash flows
project ‘B’ should be accepted having lower standard deviation, & second for project life.
means less risky.
Solution:

Annual Cash Flow Project Life

Value Probab Cumula- Tow Value Probabi Cumula- Two
(iii) Simulation (₹) il-ity tive Digit (Year) l-ity tive Digit
Probabil- Rando Probabil Rando
Question – 26 ity m No. -ity m No.
Cost of Machine = ₹ 1,30,000 10,000 0.02 0.02 00 – 01 3 0.05 0.05 00 – 04
15,000 0.03 0.05 02 – 04 4 0.10 0.15 05 – 14
Discounting Rate = 10% p.a. 20,000 0.15 0.20 05 – 19 5 0.30 0.45 15 – 44
25,000 0.15 0.35 20 – 34 6 0.25 0.70 45 – 69
Annual Cash Flow Project Life 30,000 0.30 0.65 35 – 64 7 0.15 0.85 70 – 84
35,000 0.20 0.85 65 – 84 8 0.10 0.95 85 – 94
Value (₹) Probability Value (Year) Probability 40,000 0.15 1.00 85 - 99 9 0.03 0.98 95 – 97
10,000 0.02 3 0.05 10 0.02 1.00 98 - 99
15,000 0.03 4 0.10
20,000 0.15 5 0.30
25,000 0.15 6 0.25

12.32
 ADVANCED CAPITAL BUDGETING

Simulation Results

Annual Cash Flow Project Life

Run Random Corres. Random Corres. PVAF @ NPV (1) ×
No. Value of No. Value of 10% (2) (2) –
Annual Project 1,30,000
Cash Flow Life
(1)
1 53 30,000 97 9 5.759 42,770
2 66 35,000 99 10 6.145 85,075
3 30 25,000 81 7 4.868 (8,300)
4 19 20,000 09 4 3.170 (66,600)
5 31 25,000 67 6 4.355 (21,125)
6 81 35,000 70 7 4.868 40,380
7 38 30,000 75 7 4.868 16,040
8 48 30,000 83 7 4.868 16,040
9 90 40,000 33 5 3.791 21,640 At Decision Point D2
10 58 30,000 52 6 4.355 650
4,00,000
Option 1: If investment NPV = − 20,00,000 = 20,00,000
10%
(iv) Decision tree Option 2: No investment NPV =0
Question – 27 No investment is better
L & R Limited wishes to develop new virus-cleaner software. The cost
of the pilot project would be ₹ 2,40,000. Presently, the chances of the At Decision Point D3
product being successfully launched on a commercial scale are rated
1,00,000
at 50%. In case it does succeed. L&R can invest a sum of ₹20 lacs to Option 1: Investment NPV = − 12,00,000 = -2,00,000
10%
market the product. Such an effort can generate perpetually, an
annual net after tax cash income of ₹4 lacs. Even if the commercial Option 2: No investment NPV = 0
launch fails, they can make an investment of a smaller amount of
Investment is better due to higher NPV
₹12 lacs with the hope of gaining perpetually a sum of ₹1 lac.
Evaluate the proposal, adopting decision tree approach. The discount Calculation of EMV at Point C
rate is 10%.
EMV = (20,00,000 × 0.5) + (0 × 0.5)
Solution:
= 10,00,000
Decision tree diagram is given below:
At Decision Point D1

12.33
 ADVANCED CAPITAL BUDGETING

Option 1: Testing NPV = (10,00,000 – 2,40,000) = ₹ 7,60,000 Machine B

Option 2: No Testing NPV = 0 PVCO = 1,00,000 + (60,000 × 1.735)

Testing is better due to higher NPV 2,04,100

EA PVCO = = 1,17,637
1.735

Question – 29
A Company named Roby’s cube decided to replace the existing
PART 3: REPLACEMENT DECISION
Computer system of their organization. Original cost of old system
Question – 28 was ₹ 25,000 and it was installed 5 years ago. Current market value
Company X is forced to choose between two machines A and B. The of old system is ₹ 5,000. Depreciation of the old system was charged
two machines are designed differently but have identical capacity with life of 10 years with Estimated Salvage value as Nil. Depreciation
and do exactly the same job. Machine A costs ₹ 1,50,000 and will last of the new system will be charged with life over 5 years Present cost
for 3 years. It costs ₹ 40,000 per year to run. Machine B is an of the new system is ₹ 50,000. Estimated Salvage value of the new
‘economy’ model costing only ₹ 1,00,000, but will last only for 2 years, system is ₹1,000. Estimated cost savings with new system is ₹ 5,000
and costs ₹ 60,000 per year to run. These are real cash flows. The per year. Increase in sales with new system is assumed at 10% per
costs are forecasted in rupees of constant purchasing power. Ignore year based on original total sales of ₹ 1,00,000. Company follows
tax. Opportunity cost of capital is 10 per cent. Which machine straight line method of depreciation. Cost of capital of the company
company X should buy? is 10% whereas tax rate is 30%.

(SM TYK – 24) Solution:

Solution: Calculation of NPV

Calculation of EAPVCO Year PVF Amount P.V.

(10%)
Machine A (A) Cash outflows
Cost of new machine 0 1,000 50,000 50,000
PVCO = 1,50,000 + (40,000 × 2.487) Sale of old machine 0 1,000 (7,250)
(W.N.1) (7,250)
= 2,94,474 42,750
PVCO 2,49,480
(B) Cash inflows
EA PVCO = = = 1,00,314 Incremental CFAT 1-5 3.791 12,690 48,108
PVAF 2.487
(W.N.2)
5 0.621 1,000 621

12.34
 ADVANCED CAPITAL BUDGETING

Incremental T.V. PBT = ₹ 7,700

[2,000 – 0]
Tax @ 30% = ₹ 2310 ……….(ii)

Incremental CFAT (i + ii) = 12,690

48,729
(B) Question – 30
5,979 A company has an old machine having book value zero – which can
NPV (B – A)
be sold for ₹ 50,000. The company is thinking to choose one from
Since NPV is positive, hence old machine should be replaced. following two alternatives:

W.N. 1: Sale of Old Machine (i) To incur additional cost of ₹ 10,00,000 to upgrade the old
existing machine.
Sales consideration = ₹ 5,000 ………(i)
(ii) To replace old machine with a new machine costing ₹
(-) B.V. = ₹ 12,500 20,00,000 plus installation cost ₹ 50,000.

Capital loss = ₹ 7,500 Both above proposals envisage useful life to be five years with salvage
value to be nil.
Tax saving @ 30% = 2,250 ………(ii)
The expected after tax profits for the above three alternatives are as
Net (i + ii) = 7,250
under :
W.N. 2: Incremental CFAT
Year Old existing Upgraded New Machine
Increase in sales [₹ 1,00,000 × 10%] = ₹ 10,000 Machine (₹) Machine (₹) (₹)
1 5,00,000 5,50,000 6,00,000
Saving in Exp = ₹ 5,000 2 5,40,000 5,90,000 6,40,000
3 5,80,000 6,10,000 6,90,000
Incremental CFAT = ₹ 15,000 ……….(i) 4 6,20,000 6,50,000 7,40,000
5 6,60,000 7,00,000 8,00,000
(-) Incremental depreciation
The tax rate is 40 per cent.
[Depreciation of new – Depreciation of old]
The company follows straight line method of depreciation. Assume
50,000 – 1,000 25,000 cost of capital to be 15 per cent.
[( )− ] = ₹ 7,300
5 10

12.35
 ADVANCED CAPITAL BUDGETING

P.V.F. of 15%, 5 = 0.870, 0.756, 0.658, 0.572 and 0.497. You are (-) CFAT (old) 5,00,000 5,40,000 5,80,000 6,20,000 6,60,000
required to advise the company as to which alternative is to be Incremental 5,10,000 5,10,000 5,20,000 5,30,000 5,50,000
CFAT
adopted.
(×) PVF 0.870 0.756 0.658 0.572 0.497
(SM TYK – 23)
Working Note 1:
Solution:
Sale of old machine
Option 1: Upgraded Machine
Sale consideration = 50,000
Calculation of NPV
(-) B.V. =0
1 2 3 4 5
Upgrade
Capital gain = 50,000
PAT 5,50,000 5,90,000 6,10,000 6,50,000 7,00,000
(+) 2,00,000 2,00,000 2,00,000 2,00,000 2,00,000 Tax @ 40% = 20,000
Depreciation
CFAT 7,50,000 7,90,000 8,10,000 8,50,000 9,00,000 = 30,000
(-) CFAT (old) 5,00,000 5,40,000 5,80,000 6,20,000 6,60,000
Incremental 2,50,000 2,50,000 2,30,000 2,30,000 2,40,000 PVCI = 17,47,930
CFAT
(×) PVF 0.870 0.756 0.658 0.572 0.497 (-) PVCO = 20,20,000 [20,50,000 – 30,000]

PVCI = 8,08,680 NPV = (2,72,070)

(-) PVCO = 10,00,000 Since NPV is negative in both option, hence old machine without up
gradation is better
NPV = (1,91,320)
Question – 31
Option 2: New Machine A machine used on a production line must be replaced at least every
four years. Costs incurred to run the machine according to its age
1 2 3 4 5
New Machine
are:
PAT 6,00,000 6,40,000 6,90,000 7,40,000 8,00,000
Age of the Machine (years)
(+)
0 1 2 3 4
Depreciation 4,10,000 4,10,000 4,10,000 4,10,000 4,10,000
20,50,000 Purchase price (in ₹) 60,000
5 Maintenance (in ₹) 16,000 18,000 20,000 20,000
CFAT 10,10,00 10,50,00 11,00,00 11,50,00 12,10,00 Repair (in ₹) 0 4,000 8,000 16,000
0 0 0 0 0

12.36
 ADVANCED CAPITAL BUDGETING

Scrap Value (in ₹) 32,000 24,000 16,000 8,000 1 - (16,000) - (16,000)

2 - (22,000) - (22,000)
Future replacement will be with identical machine with same cost. 3 - (28,000) 16,000 (12,000)
Revenue is unaffected by the age of the machine. Ignoring inflation
and tax, determine the optimum replacement cycle. PV factors of the Four years replacement cycle ₹
cost of capital of 15% for the respective four years are 0.8696,
Replacement Maintenance Residual Net Cash
0.7561, 0.6575 and 0.5718. Year Cost & Repair Value Flow
(SM TYK – 26) 0 (60,000) - - (60,000)
1 - (16,000) - (16,000)
Solution: 2 - (22,000) - (22,000)
3 - (28,000) - (28,000)
Working Notes 4 - (36,000) 8,000 (28,000)

First of all, we shall calculate cash flows for each replacement cycle Now we shall calculate NPV for each replacement cycles
as follows:
1 Year 2 Years 3 Years 4 Years
Yea PVF Cash PV Cash PV Cash PV Cash PV
One year replacement cycle ₹ r @ Flows Flows Flows Flows
15%
Year Replacement Maintenance Residual Net Cash 0 1 -60,000 -60,000 -60,000 -60,000 -60,000 -60,000 -60,000 -60,000
Cost & Repair Value Flow 1 0.8696 16,000 13,914 -16,000 -13,914 -16,000 -13,914 -16,000 -13,914
2 0.7561 - - 2,000 1,512 -22,000 -16,634 -22,000 -16,634
0 (60,000) - - (60,000) 3 0.6575 - - - 0 -12,000 -7,890 -28,000 -18,410
1 - (16,000) 32,000 16,000 4 0.5718 - - - 0 0 -28,000 -16,010
- - - -
Two years replacement cycle ₹ 46,08 72,40 98,43 1,24,9
6 2 8 68
Year Replacement Maintenance Residual Net Cash
Cost & Repair Value Flow
0 (60,000) - - (60,000) Replacement Cycle EAC (₹)
1 - (16,000) - (16,000) 1 Year 46,086 52,997
2 - (22,000) 24,000 2,000 0.8696
2 Years 72,402 44,536
Three years replacement cycle ₹ 1.6257
3 Years 98,438 43,114
Year Replacement Maintenance Residual Net Cash 2.2832
Cost & Repair Value Flow
4 Years 1,24,968 43,772
0 (60,000) - - (60,000)
2.855

12.37
 ADVANCED CAPITAL BUDGETING

Since EAC is least in case of replacement cycle of 3 years hence Total (A) 70,000 72,720
machine should be replaced after every three years. Cash
inflows
Note: Alternatively, Answer can also be computed by excluding initial CFAT 1-3 2.487 80,000 1,98,960 - -
1 0.909 - - 40,000 36,360
outflow as there will be no change in final decision.
2-4 2.261 - - 80,000 1,80,880
Total (B) 1,98,960 2,17,240
Question – 32 NPV (B-A) 1,28,960 1,44,520
Company Y is operating an elderly machine that is expected to
produce a net cash inflow of ₹ 40,000 in the coming year and ₹ Machine should be replaced in year 1 due higher NPV.
40,000 next year. Current salvage value is ₹ 80,000 and next year’s
value is ₹ 70,000. The machine can be replaced now with a new Question – 33
machine, which costs ₹ 1,50,000, but is much more efficient and will X Ltd. is a taxi operator. Each taxi cost to company ₹ 4,00,000 and
provide a cash inflow of ₹ 80,000 a year for 3 years. Company Y wants has a useful life of 3 years. The taxi’s operating cost for each of 3
to know whether it should replace the equipment now or wait a year years and salvage value at the end of year is as follows:
with the clear understanding that the new machine is the best of the
Year 1 Year 2 Year 3
available alternatives and that it in turn be replaced at the optimal Operating ₹ 1,80,000 ₹ 2,10,000 ₹ 2,38,000
point. Ignore tax. Take opportunity cost of capital as 10 per cent. Cost
Advise with reasons. Resale Value ₹ 2,80,000 ₹ 2,30,000 ₹ 1,68,000

(SM TYK – 25) You are required to determine the optimal replacement period of taxi
if cost of capital of X Ltd. is 10%.
Solution:
Solution:
Calculation of NPV
NPV if taxi is kept for 1 Year
Year PVF Replace New Replace on year
(10%) Amount P.V. Amount P.V.
= – ₹ 4,00,000 + ₹ 1,00,000 (0.909)
Cash
outflows
Cost of 0 1.000 1,50,000 1,50,000 - -
= – ₹ 3,09,100
new
machine NPV if taxi is kept for 2 Year
1 0.909 - - 1,50,000 1,36,350
Sale of 0 1.000 (80,000) (80,000) - - = – ₹ 4,00,000 – ₹ 1,80,000 × 0.909 + ₹ 20,000 × 0.826
old
machine = – ₹ 5,47,100
1 0.909 - - (70,000) (63,630)

12.38
 ADVANCED CAPITAL BUDGETING

NPV if taxi is kept for 3 Year of replacing the bike every three year is optimal or not. It is of believe
that as new models are entering into market on yearly basis, it wishes
= – ₹ 4,00,000 – ₹ 1,80,000 × 0.909 – ₹ 2,10,000 × 0.826 – ₹ 70,000 to consider whether a replacement of either one year or two years
× 0.751 would be better option than present three year period. The fleet of
bike is due for replacement shortly in near future.
= – ₹ 7,89,650
The purchase price of latest model bike is ₹ 55,000. Resale value of
Since above NPV figures relate to different periods, there are not
used bike at current prices in market is as follows:
comparable. to make them comparable we shall use concept of EAC
as follows: Period ₹
EAC of 1 year 1 Year old 35,000
3,09,100
= ₹ 3,40,044 2 Year old 21,000
0.909

EAC of 2 year 3 Year old 9,000

5,47,100
= ₹ 3,15,331 Running and Maintenance expenses (excluding depreciation) are as
1,735
follows:
EAC of 3 year
Year Road Taxes Insurance Petrol Repair Maintenance
7,89,650 etc. etc. (₹)
2,486
= ₹ 3,17,639 (₹)
1 3,000 30,000
Since lowest EAC incur if taxi for 2 year; Hence the optimum 2 3,000 35,000
replacement cycle to replace taxi in 2 years. 3 3,000 43,000

Question – 34 Using opportunity cost of capital as 10% you are required to

Trouble Free Solutions (TFS) is an authorized service center of a determine optimal replacement period of bike.
reputed domestic air conditioner manufacturing company. All
(SM TYK – 27)
complaints/service related matters of Air conditioner are attended by
this service center. The service center employs a large number of Solution:
mechanics, each of whom is provided with a motor bike to attend the
complaints. Each mechanic travels approximately 40,000 kms per NPV if Bike is kept for 1 Year
annum. TFS decides to continue its present policy of always buying
= – ₹ 55,000 + ₹ 2,000 (0.909)
a new bike for its mechanics but wonders whether the present policy

12.39
 ADVANCED CAPITAL BUDGETING

= – ₹ 53,182 is not considered for the purpose of depreciation). The other expenses
to be incurred for the New Machine are as under:
NPV if Bike is kept for 2 Year
(a) Installation Charges ₹ 9,000
= – ₹ 55,000 – ₹ 33,000 × 0.909 − ₹ 17,000 × 0.826
(b) Fees paid to the consultant for his advice to buy New Machine
= – ₹ 99,039
₹ 6,000.
NPV if Bike is kept for 3 Year
(c) Additional Working Capital required ₹ 17,000. (will be released
= – ₹ 55,000 – ₹ 33,000 × 0.909 – ₹ 38,000 × 0.826 – ₹ 37,000 × after 8 years)
0.751
The written down value of the existing machine is ₹ 76,000, and its
= – ₹ 1,44,172 Cash Salvage Value is ₹ 12,500. The dismantling of this machine
would cost ₹ 4,500. The Annual Earnings (before tax but after
EAC of 1 year
depreciation) from the New Machine would amount to ₹ 3,15,000.
53,182 Income tax rate is 35%. The Company's required Rate of Return is
0.909
= ₹ 58,506
13%.
EAC of 2 year You are required to advise on the viability of the proposal.
99,039
1,735
= ₹ 57,083 PVIF (13%, 8) = 0.376 PVIFA (13%, 8) = 4.80

EAC of 3 year (MTP August – 2025)

1,44,172
Solution:
2,486
= ₹ 57,993
Working Notes:
Thus, from above table it is clear that EAC is least in case of 2 years,
hence bike should be replaced every two years. 1. Computation of Annual Depreciation-

Question – 35 Particulars ₹
Purchase Price 26,00,000
SS Company is considering the replacement of its existing machine
Add: 1. Installation Charges 9,000
with a new machine. The Purchase price of the New machine is ₹ 26
2. Fees Paid to Consultant for 6,000
Lakhs and its expected Life is 8 years. The company follows straight- Advice
line method of depreciation on the original investment (scrap value Total Cost of New Machine 26,15,000

12.40
 ADVANCED CAPITAL BUDGETING

Useful Life 8 Years (c) Working 8 17,000 0.376 6,392

Annual Depreciation (Total Cost/No. of 3,26,875 Capital
Years) Realized
Present Value of 25,89,992
2. Computation of Annual Cash Savings- Cash Inflows
Less: 1. Initial 0 26,15,000 1.0 26,15,000
Particulars ₹ Investment
Annual Earnings 3,15,000 2. Initial 0 17,000 1.0 17,000
Less: Tax @ 35% 1,10,250 Working
Earnings after Tax 2,04,750 Capital
Add: Depreciation on New Machine 3,26,875 NPV of the (42,008)
Annual Cash Saving 5,31,625 Proposal

3. Tax effect on sale of Old Machine- Decision: Since NPV of the project is negative it is not viable.

Particulars ₹ Question – 36
Proceeds of Sale 12,500 A & Co. is contemplating whether to replace an existing machine or
Less: Cost of Removal 4,500 to spend money on overhauling it. A & Co. currently pays no taxes.
Net Proceeds 8,000 The replacement machine costs ₹ 90,000 now and requires
Less: WDV 76,000 maintenance of ₹ 10,000 at the end of every year for eight years. At
Net Loss due to Sale 68,000
the end of eight years it would have a salvage value of ₹ 20,000 and
Tax savings due to Loss on Sale @ 35% 23,800
Total Cash Inflow due to Sale (₹ 8,000 + ₹ 31,800 would be sold. The existing machine requires increasing amounts of
23,800) maintenance each year and its salvage value falls each year as
follows:
4. Computation of Net Present Value-
Year Maintenance Salvage
Particulars Period Cash PVF PV (₹) (₹) (₹)
Flow (₹) @ Present 0 40,000
13% 1 10,000 25,000
(a) Annual 1-8 5,31,625 4.8 25,51,800 2 20,000 15,000
Cash inflow 3 30,000 10,000
after Tax 4 40,000 0
(b) Net 0 31,800 1.0 31,800
Salvage Value of The opportunity cost of capital for A & Co. is 15%.
Existing
Machine Required:

12.41
 ADVANCED CAPITAL BUDGETING

When should the company replace the machine? 1 (10,000) 0.870 (8,700)
1 25,000 0.870 21,750
(Notes: Present value of an annuity of Re. 1 per period for 8 years at (11,832)
interest rate of 15% : 4.4873; present value of Re. 1 to be received Replace in two years 1 (10,000) 0.870 (8,700)
after 8 years at interest rate of 15% : 0.3269). 2 (28,600) 0.756 (21,622)
2 (20,000) 0.756 (15,120)
(SM TYK – 22) 2 15,000 0.756 11,340
(34,102)
Solution: Replace in three years 1 (10,000) 0.870 (8,700)
2 (20,000) 0.756 (15,120)
A & Co. 3 (28,600) 0.658 (18,819)
3 (30,000) 0.658 (19,740)
Equivalent cost of (EAC) of new machine 3 10,000 0.658 6,580
(55,799)
₹ Replace in 4 years 1 (10,000) 0.870 (8,700)
(i) Cost of new machine now 90,000 2 (20,000) 0.756 (15,120)
Add: PV of annual repairs @ ₹ 10,000 per 3 (30,000) 0.658 (19,740)
annum for 8 years 44,873 4 (28,600) 0.572 (16,359)
(₹ 10,000 × 4.4873) 1,34,873 4 (40,000) 0.572 (22,880)
(82,799)
6,538
Less: PV of salvage value at the end of 8 years Advice: The company should replace the old machine immediately
(₹ 20,000 × 0.3269) 1,28,335 because the PV of cost of replacing the old machine with new
28,600 machine is least.
Equivalent annual cost (EAC) (₹
1,28,355/4.4873)
RESIDUAL
PV of cost of replacing the old machine in each of 4 years with new
machine Question – 37
Jumble Consultancy Group has determined relative utilities of cash
Scenario Year Cash PV @ PV
flows of two forthcoming projects of its client company as follows:
Flow 15%
₹ ₹ Cash - - - 0 15,00 10,00 5,00 1,00
Replace Immediately 0 (28,600) 1.00 (28,600) Flow in 15,00 10,00 4,00 0 0 0 0
40,000 1.00 40,000 ₹ 0 0 0
11,400 Utilities -100 -60 -3 0 40 30 20 10
Replace in one year 1 (28,600) 0.870 (24,882)

12.42
 ADVANCED CAPITAL BUDGETING

The distribution of cash flows of project A and Project B are as 5,000 0.25 20 5
follows: 10,000 0.10 30 3
17.55
Project A
Cash Flow (₹) -15,000 -10,000 15,000 10,000 5,000 Project B should be selected as its expected utility is more.
Probability 0.10 0.20 0.40 0.20 0.10
Question – 38
Project B D and Co. is a company which installs pipes for supply of oxygen in
Cash Flow (₹) -10,000 -4,000 15,000 5,000 10,000 the hospitals as per their specifications. It is planning to invest ₹ 40
Probability 0.10 0.15 0.40 0.25 0.10 crore in a new facility to convert vans and trucks into ambulance.
Each ambulance will be designed and built according to customer
Which project should be selected and why ? requirements. D and Co. expects ambulance production and sales in
the first four years of operation to be as follows:
(SM TYK – 21)
Year 1 2 3 4
Solution: Ambulances produced and 250 300 450 450
sold
Evaluation of project utilizes of Project A and Project B
The selling price for an ambulance depends on the van or truck
which is converted, the quality of the units installed and the extent
Project A of conversion work required. D and Co. has undertaken research into
Cash Flow Probability Utility Utility Value likely sales and costs of different kinds of ambulances which could
(in ₹) be selected by customers, as follows:
-15,000 0.10 -100 -10
-10,000 0.20 -60 -12 Ambulance Type Basic Standard Deluxe
15,000 0.40 40 16 Probability of 20% 45% 35%
10,000 0.20 30 6 selection
5,000 0.10 20 2 Selling price 3,00,000 42,00,000 72,00,000
2 (₹/unit)
Conversion cost 23,00,000 29,00,000 40,00,000
Project B (₹/unit)
Cash Flow Probability Utility Utility Value
(in ₹) Fixed costs of the production facility are expected to depend on the
-10,000 0.10 -60 -6 volume of ambulance production as follows:
-4,000 0.15 -3 -0.45
15,000 0.40 40 16

12.43
 ADVANCED CAPITAL BUDGETING

Production volume 200-299 300-399 400-499 1. Average selling price

(units/year)
Fixed costs (₹ crore/year) 40 50 55 = (30,00,000 × 0·20) + (42,00,000 × 0·45) + (72,00,000 ×
0·35)
The applicable tax rate for D and Co. is 28% per year, being settled
in the year in which it arises. The company can claim tax allowable = ₹ 50,10,000 per unit
depreciation on the cost of the investment on a straight-line basis
over ten years. 2. Average conversion cost

D and Co. evaluates investment projects using an after-tax discount = (23,00,000 × 0·20) + (29,00,000 × 0·45) + (40,00,000 ×
rate of 11%. 0·35)

Required: = ₹ 31,65,000 per unit

(i) Advise the company on the financial viability of the planned 3. Computation of Sales Income
investment for the first four years of operation if tax benefit on
Year 1 2 3 4
unabsorbed depreciation for the remaining period will not
Sales volume 250 300 450 450
available. (units/year)
Average 50,10,000 50,10,000 50,10,000 50,10,000
(ii) Advise the company on the financial viability of the planned selling price
investment continuing to produce and sell ambulances (₹ /unit)
beyond the first four years if after the fourth year of operation, Sales income 125.25 150.30 225.45 225.45
(₹ crore/year)
D and Co. expects to continue to produce and sell 450
ambulances per year for the foreseeable future. 4. Computation of Conversion Cost

Note: (1) Use PV Factors rounded off upto three decimal points. Year 1 2 3 4
Sales volume 250 300 450 450
(2) Present all calculation in ₹ Crore rounded off upto three (units/year)
Average 31,65,00 31,65,000 31,65,000 31,65,000
decimal points.
conversion 0
cost
(MTP April – 2026) (₹ /unit)
Conversion 79.125 94.950 142.425 142.425
Solution: cost
(₹
Working Notes: crore/year)

12.44
 ADVANCED CAPITAL BUDGETING

5. Tax allowable depreciation = ₹ 40 crore/10 = ₹ 4 crore per year Advice: If only the first four years of operation are considered,
the NPV of the planned investment is negative and so it would
Benefit of tax allowable depreciation = ₹ 4 crore × 0·28 = ₹ 1.12 not be financially acceptable.
crore per year
(ii) Ignoring tax allowable depreciation, after-tax cash flow from
(i) Calculation of NPV over four years year five onwards will be:

Year 1 2 3 4 ₹ 28.025 crore – ₹ 7.847 crore = ₹ 20.178 crore per year

₹ crore ₹ crore ₹ crore ₹ crore
Sales income 125.25 150.30 225.45 225.45 Present value of this cash flow in perpetuity
Conversion (79.125) (94.95) (142.425) (142.425)
cost = (₹ 20.178 crore /0·11) × 0·659 = ₹ 120.885 crore
Contribution 46.125 55.35 83.025 83.025
Fixed cost (40) (50) (55) (55) There would be a further six years of tax benefits from tax
Before-tax 6.125 5.35 28.025 28.025
allowable depreciation. The present value of these cash flows
cash flow
would be:
Tax liability (1.715) (1.498) (7.847) (7.847)
at 28%
Tax allowable 1.120 1.120 1.120 1.120 ₹ 1.12 crore × 2.787 = ₹ 3.121 crore
depreciation
benefits Increase in NPV of production and sales continuing beyond
After-tax cash 5.53 4.972 21.298 21.298 the first four years would be:
flow
Discount at 0.901 0.812 0.731 0.659 ₹ 120.885 crore + ₹ 3.121 crore = ₹ 124.006 crore
11%
Present 4.983 4.037 15.569 14.035 In other words, NPV of the planned investment would be:
values
Total present 38.624 ₹ 122.632 crore (₹ 124.006 crore – ₹ 1.376 crore)
value of
inflows Advise: If production and sales beyond the first four years are
Initial 40.000 considered, the NPV is strongly positive and so the planned
investment investment is financially acceptable.
NPV (1.376)

12.45
 ADVANCED CAPITAL BUDGETING

II. The sale price per unit so that the project would break even
MULTIPLE CHOICE QUESTIONS with zero NPV shall be approximately…………..
(a) ₹ 40.00 (b) ₹ 55.26
Case Scenario – 01 (c) ₹ 60.00. (d) ₹ 44.74
XYZ Ltd. is a mid-sized manufacturing company that produces
industrial equipment. The company is considering a new investment III. The cost per unit so that the project would break even with
project—a state-of-theart automated production line, which is zero NPV shall be approximately…………..
expected to improve production efficiency. The details of the same (a) ₹ 40.00 (b) ₹ 55.28
project are as follows: (c) ₹ 60.00. (d) ₹ 44.74
₹
Initial Cost of the project 10,00,000 IV. Overall …………in the sale volume will lead to the project to
Sales price/unit 60 break even with zero NPV.
Cost/unit 40 (a) increase of 23.68% (b) fall of 23.68%
Sales volumes (c) Increase of 31.03% (d) fall of 31.03%
Year 1 20,000 units
Year 2 30,000 units V. A/an …………in the initial outlay will lead to the project to
Year 3 30,000 units break even with zero NPV.
(a) increase of 23.68% (b) fall of 23.68%
The applicable discount rate is 10% p.a.
(c) Increase of 31.03% (d) fall of 31.03 %
Based on above case scenario answer the following questions:
(MTP October – 2024 & November – 2025)
I. Sensitivity analysis helps to identify…………………..
(a) the exact profitability of the project
Answer: Case Scenario – 01
(b) the break-even point.
I. (c) the degree to which a change in each variable
(c) the degree to which a change in each variable affects
affects the NPV.
the NPV.
II. (b) ₹ 55.26
(d) the amount of investment required

12.46
 ADVANCED CAPITAL BUDGETING

III. (d) ₹ 44.74 4 7% 8%

IV. (b) fall of 23.68% From the information given above, choose the correct answer to the
V. (c) Increase of 31.03% following questions:
[Link] depreciation tax benefit for the project per year shall
be……………
Case Scenario – 02
(a) ₹ 1,20,000 (b) ₹ 1,50,000
XYZ Ltd. plans to invest ₹ 8,00,000 in a new unit. The project is
(c) ₹ 2,00,000 (d) ₹ 1,80,000
expected to have a useful life of 4 years, with no salvage value at the
end of its life. The annual depreciation charge for the project is ₹
II. The inflation-adjusted revenue in Year 2 shall be…………….
2,00,000.
(a) ₹ 7,00,000 (b) ₹ 8,39,300
Projected revenues and costs for the project, ignoring inflation, are
(c) ₹ 4,92,800 (d) ₹ 5,01,760
provided as follows:
Year Revenues (₹) Costs (₹)
III. The total cash inflow in Year 1 after adjusting for inflation and
1 6,00,000 3,00,000
tax benefit on depreciation shall be…………
2 7,00,000 4,00,000
(a) ₹ 3,30,000 (b) ₹ 3,36,000
3 8,00,000 4,00,000
(c) ₹ 2,49,600 (d) ₹ 4,92,800
4 8,00,000 4,00,000
XYZ Ltd. is subject to a corporate tax rate of 60%, and the cost of
IV. The inflation-adjusted cost in Year 2 shall be……………
capital for the project, including inflation premium, is 10%.
(a) ₹ 7,00,000 (b) ₹ 8,39,300
Depreciation provides a tax benefit, and inflation rates for revenues
(c) ₹ 4,92,800 (d) ₹ 5,01,760
and costs over the project’s lifespan are as follows:
Year Revenue Inflation Cost Inflation
V. The present value of cash inflow for the year 3 shall be
approximately……
1 10% 12%
(a) ₹ 213,604 (b) ₹ 226,299
2 9% 10%
(c) ₹ 226,886 (d) ₹ 239,949
3 8% 9%

12.47
 ADVANCED CAPITAL BUDGETING

(MTP August – 2025) (EXAM SEPTEMBER - 2025)

I. If cost of capital is varied adversely by 10%, what is the
Answer: Case Scenario – 02 percentage change in NPV ?
I. (a) ₹ 1,20,000 (a) 11.00% (b) 12.10%

II. (b) ₹ 8,39,300 (c) 13.14% (d) 14.45%

III. (c) ₹ 2,49,600

II. If initial project cost is varied adversely by 10%, what is the
IV. (c) ₹ 4,92,800 percentage change in NPV?
(a) 42.42% (b) 52.80%
V. (d) ₹ 239,949
(c) 53.09% (d) 63.09%

Case Scenario − 03
P Ltd is considering a new project with the following details: III. If annual cash inflow is varied adversely by 10%, what is the

Initial project cost ₹ 4,80,000 percentage change in NPV ?

Annual projected sales ₹ 4,00,000 (a) 33.38% (b) 53.09%

Annual projected variable cost ₹ 1,60,000 (c) 63.09% (d) 52.80%

Annual projected fixed cost ₹ 60,000

Project life 4 years Answer: Case Scenario – 03

Cost of capital 10% p.a. I. (c) 13.14%

Consider Cumm. PVF for 4 years @ 10% = 3.169 and @ 11%/ = II. (c) 53.09%

3.103 III. (c) 63.09%

Note: (a) Ignore depreciation on initial project cost and taxation.

(b) Calculation up to 2 decimal places. Case Scenario – 04

From the information given above, choose the correct answer to the PQR Ltd. is considering two new products A and B, only one of which

following question No. I to III: can be added to its production line. Product A is sure seller. It is
certain that 2,00,000 units of product A with the firm’s maximum

12.48
 ADVANCED CAPITAL BUDGETING

capacity can be manufactured and sold each year with a contribution (A) ₹ 2,00,000 (B) ₹ 4,00,000
margin of ₹ 5 per unit. (C) ₹ 8,00,000 (D) ₹ 10,00,000

Product B with a contribution margin of ₹ 10 per unit is potentially

(EXAM JANUARY – 2026)
more profitable. However, there is uncertainty about its marketability
Answer Case Scenario – 04
and following sales forecast has been prepared:
I. (B) ₹ 4,00,000
Sales units of B (per annum) Probability
II. (B) ₹ 8,00,000
50,000 0.25
III. (B) ₹ 4,00,000

1,00,000 0.50
Case Scenario – 05
1,50,000 0.25 ABC Ltd. of plans its to invest ₹ 16,00,000 in a new unit. The project
is expected to have a useful life of 4 years, with no salvage value at
Fixed cost per year is ₹ 6,00,000.
the end of its life. The annual depreciation charge for the project is
From the information given above, choose the correct answer to the
₹ 400,000.
following Question No. 13 to 15:
Projected revenues and costs for the project, ignoring inflation, are
I. If Company select product A, the profit of the company is –
provided as follows:
(A) ₹ 2,00,000 (B) ₹ 4,00,000
Year Revenues (₹) Costs (₹)
(C) ₹ 6,00,000 (D) ₹ 10,00,000
1 12,00,000 6,00,000
II. If company select product B and sale 1,40,000 units, the profit
2 14,00,000 8,00,000
of the company is –
3 16,00,000 8,00,000
(A) ₹ 4,00,000 (B) ₹ 8,00,000
4 16,00,000 8,00,000
(C) ₹ 10,00,000 (D) ₹ 12,00,000
III. If company select product B, the expected value of profit of the ABC Ltd. is subject to a corporate tax rate of 60%, and the cost of
company is – capital for the project, including inflation premium, is 10%.

12.49
 ADVANCED CAPITAL BUDGETING

Depreciation provides a tax benefit, and inflation rates for revenues (a) ₹ 16,78,600 (b) ₹14,00,000
and costs over the project’s lifespan are as follows: (c) ₹ 10,03,520 (d) ₹ 9,85,600
Year Revenue Inflation Cost Inflation
1 10% 12% V. The present value of cash inflow for the year 3 shall be
2 9% 10% approximately_________
3 8% 9% (a) ₹ 4,52,598 (b) ₹ 4,27,208
4 7% 8% (c) ₹ 4,79,898 (d) ₹ 4,53,772
(RTP Sep – 2025)
Based on above information, answer the following questions:
Answer Case Scenario – 05
I. The depreciation tax benefit for the project per year shall
I. (b) ₹ 240,000
be_______
II. (a) ₹ 16,78,600
(a) ₹ 300,000
III. (d) ₹ 499,200
(b) ₹ 240,000
IV. (d) ₹ 9,85,600
(c) ₹ 360,000
V. (c) ₹ 4,79,898
(d) ₹ 400,000
II. The inflation-adjusted revenue in Year 2 shall be_________
(a) ₹ 16,78,600 (b) ₹ 14,00,000
(c) ₹ 10,03,520 (d) ₹ 9,85,600

III. The total cash inflow in Year 1 after adjusting for inflation and
tax benefit on depreciation shall be______
(a) ₹ 6,72,000 (b) ₹ 660,000
(c) ₹ 985,600 (d) ₹ 499,200

IV. The inflation-adjusted cost in Year 2 shall be

12.50
 ADVANCED CAPITAL BUDGETING

12.51
 INTERNATIONAL FINANCIAL MANAGEMENT

13 INTERNATIONAL FINANCIAL MANAGEMENT

4 Year Cash Flow PV Factor @ P.V.
PART I: INTERNATIONAL CAPITAL BUDGETING
(Million) 9.9%
US$
Question – 01 1 2.00 0.910 1.820
ABC Ltd. is considering a project in US, which will involve an initial 2 2.50 0.828 2.070
investment of US $ 1,10,00,000. The project will have 5 years of life. 3 3.00 0.753 2.259
Current spot exchange rate is ₹ 48 per US $. The risk free rate in US 4 4.00 0.686 2.744
5 5.00 0.624 3.120
is 8% and the same in India is 12%. Cash inflow from the project is
12.013
as follows: Less: Investment 11.000
NPV 1.013
Year Cash in flow
1 US $ 20,00,000 Therefore, Rupee NPV of the project is = ₹ (48 × 1.013) Million
2 US $ 25,00,000
3 US $ 30,00,000 = ₹ 48.624 Million
4 US $ 40,00,000
5 US $ 50,00,000 Question – 02
X Ltd., an Indian company, is considering a proposal to make an
Calculate the NPV of the project using foreign currency approach.
investment of USD 1,65,00,000 in Latin America. The project will
Required rate of return on this project is 14%.
have a life of 5 years. The current spot exchange rate is INR/USD 72.
(SM TYK – 01) All investments and revenues will occur in USD. The USD and INR
risk free rates are 8% and 12% respectively.
Solution:
The following cash flow is expected from the project.
1.14
RADR of USA = [(1.12 × 1.08) − 1] × 100
Year Cash Inflows (USD)
= 9.9% 1 30,00,000
2 37,50,000
Calculation of NPV 3 45,00,000
4 60,00,000
5 75,00,000

13.1
 INTERNATIONAL FINANCIAL MANAGEMENT

Assume required rate of return on the project as 14%. (-) PVCO = $ 1,65,00,000

You are required to calculate: NPV = - $ 2,97,975

(i) The viability of the project using foreign currency approach. NPV in (₹) = - $ 2,97,975 × 72

(ii) What will be the impact if there is a withholding tax of 10% = - ₹ 2,14,54,200
applicable on the project.
NPV is negative project should be rejected.
(Exam January – 2021) (8 Marks)
Question – 03
Solution: DK Ltd. is considering as investment proposal in Sri Lanka involving
an initial investment of LKR 25 billion. The current spot exchange
(i) NPV
rate is INR/LKR 0.37. The risk free rate in India is 6% and the same
1.14 is Sri Lanka is 5.02%. The project will generate a cash flow of LKR 5
RADR of USA = [(1.12 × 1.08) − 1] × 100
billion in the first year. The cash flow will increase by LKR 1 billion
each year for the next 4 years. The project will bind up on completion
= 9.93%
of 5 years with no salvage value.
NPV = ($ 30,00,000 × 0.910) + ($ 37,50,000 ×
The required rate of return for the project is 8%
0.827) + ($ 45,00,000 × 0.753) + ($ 60,00,000
× 0.685) + ($ 75,00,000 × 0.623) – 1,65,00,000 (i) You are required to find out the investment worth of the
project by
= $ 15,02,250
(a) Home Currency Approach
NPV in (₹) = $ 15,02,250 × 72
(b) Foreign Currency Approach
= ₹ 10,81,62,000
(ii) Compare the outcome under both the approaches.
Since NPV is positive hence project should be accepted.
Given :
(ii) Withholding Tax
t 1 2 3 4 5
PVCI (15,02,250 + 1,65,00,000) = 18,00,02,250
PVIF (8%, t) 0.92593 0.85734 0.79383 0.75503 0.68058
(-) withholding tax = 10% PVIF (7%, t) 0.93457 0.87344 0.81630 0.76290 0.71299

PVCI = $ 1,62,02,025 (Exam December – 2021) (8 Marks)

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 INTERNATIONAL FINANCIAL MANAGEMENT

Solution: (ii) Foreign Currency Approach

Working Notes : (1 + 0.06) (1 + Risk Premium) =1.08

Calculation of Forward Exchange Rates
1 + Risk Premium = 1.08/1.06 = 1.01887
End of ₹ ₹/KR
Year Therefore, Risk adjusted LKR Rate = 1.01887× 1.0502 – 1 =
1 0.37 ×
1.06 0.373 0.07
1.052
2 0.373 ×
1.06 0.376 Calculation of NPV
1.052

1.06 Year Cash Flow PVF @ 7% PV (Billion

3 0.376 × 0.380
1.052 (Billon LKR) LKR)
4 1.06 0.384 1 5 0.93457 4.6729
0.379 × 1.052 2 6 0.87344 5.2406
1.06 3 7 0.81630 5.7141
5 0.382 × 0.388
1.052 4 8 0.76290 6.1032
5 9 0.71299 6.4169
(i) Home Currency Approach 28.1477
Less: 25.0000
Year Cash ₹/LKR Cash PVF @ PV Investment NPV 3.1477
Flow Flow 8% Billion
Billon Billon ₹ ₹ Thus, Rupee NPV of the project = 0.37 × 3.1477 = 1.1646
LKR billion
1 5 0.373 1.865 0.92593 1.7269
2 6 0.376 2.256 0.85734 1.9342 Decision: NPV is positive in the approach so, project will worth
3 7 0.380 2.660 0.79383 2.1116 investment.
4 8 0.384 3.072 0.73503 2.2580
5 9 0.388 3.492 0.68058 2.3766 Question – 04
10.4073 PQR Ltd. is considering a project in US, which involve an initial
Less: investment of ₹ 124.50 Crore. The project will have useful life of 5
Investment 25 0.37 9.2500
years Current spot exchange rate is INR/USD is 83. The risk free rate
NPV 1.1573
in US is 4.186% and the same in India is 6.9768%. Cash inflows in
*Alternatively if students have used the PVIF (8%, 4) as given in the USD from the project are as follows:
question paper then answer NPV would be 1.2188 instead of 1.1573

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Year 1 2 3 4 5 Year PVF @ 12% Cash Flow in ₹ PV in ₹ Lakh

Cash 30,00,000 40,00,000 50,00,000 60,00,000 70,00,000 Lakh
Inflow 0 1.00 - 12450.00 - 12450.00
1 0.893 30.00F 26.79F
PQR Ltd. is expecting net surplus of ₹ 1858.08 lakh to be received 2 0.797 40.00F 31.88F
after closure of the project. There is no salvage value. PQR Ltd. want 3 0.712 50.00F 35.60F
to take a forward cover to protect itself from exchange rate 4 0.636 60.00F 38.16F
fluctuations. 5 0.567 70.00F 39.69F
172.12F –
N 1 2 3 4 5 12,450
PVIF (6.976%, n) 0.935 0.874 0.817 0.764 0.714
PVIF (4.186%, n) 0.959 0.921 0.884 0.849 0.815 Since expected surplus after closure of the project is ₹ 1,858.08 Lakh,
PVIF (12%, n) 0.893 0.797 0.712 0.636 0.567 we can compute the value of F as follows:
PVIF (15%, n) 0.870 0.756 0.658 0.572 0.497
1,858.08 = 172.12F – 12,450
You are required to recommend the INR/USD rate for the forward
cover? F = 83.13

(Exam November – 2024) Thus, for forward cover the rate of ₹ 83.13/ USD is recommended.
Solution:
Alternatively, if students have assumed discounting rate as 15%
Let F be the recommended INR/USD rate for the forward cover. then answer will be as follows:
Accordingly, year-wise equivalent cash inflows in Indian Rupees shall
be as follows: Let F be the recommended INR/USD rate for the forward cover.
Accordingly, year-wise equivalent cash inflows in Indian Rupees shall
Year Cash Inflow in USD Cash Inflow in ₹ be as follows:
Lakh Lakh
1 30.00 30.00F Year Cash Flow in Cash Inflow in ₹ Lakh
2 40.00 40.00F USD Lakh
3 50.00 50.00F 1 30.00 30.00F
4 60.00 60.00F 2 40.00 40.00F
5 70.00 70.00F 3 50.00 50.00F
4 60.00 60.00F
Now let us compute Net Present Value of project assuming a discount 5 70.00 70.00F
rate of 12% as follows:

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 INTERNATIONAL FINANCIAL MANAGEMENT

Now let us compute Net Present Value of project assuming a discount = 0.12
rate of 15% as follows:
Calculation of NPV
Year PVF @ 15% Cash Flow in ₹ PV in ₹ Lakh
Lakh Year Cash Flow US$ PV Factor at PV
0 1.00 - 12,450.00 - 12,450.00 Lakh 12% (US$ Lakh)
1 0.870 30.00F 26.10F 1 30.00 0.893 26.79
2 0.756 40.00F 30.24F 2 40.00 0.797 31.88
3 0.658 50.00F 32.90F 3 50.00 0.712 35.60
4 0.572 60.00F 34.32F 4 60.00 0.636 38.16
5 0.497 70.00F 34.79F 5 70.00 0.567 39.69
158.35F – 12,450 172.12
Less: Investment 150.00
Since expected surplus after closure of the project is ₹ 18,58.08 Lakh, NPV 22.12
we can compute the value of F as follows:
Since PQR Ltd. is expecting a net surplus of ₹ 1,858.08 lakh after the
1,858.08 = 158.35F – 12,450 closure of the project the recommended rate of INR/ USD is (₹
1,858.08 lakh/ USD 22.12 lakh) ₹ 84.00.
F = 90.36
Question – 05
Thus, for forward cover the rate of ` 90.36/ USD is recommended. XY Limited is engaged in large retail business in India. It is
contemplating for expansion into a country of Africa by acquiring a
Alternative Solution if students have assumed that the group of stores having the same line of operation as that of India.
discounting rate 15% for the given cash inflows then applicable
discounting rates for the project is – The exchange rate for the currency of the proposed African country
is extremely volatile. Rate of inflation is presently 40% a year.
(1 + 0.06978) / (1 + Risk Premium) = (1 + 0.15) Inflation in India is currently 10% a year. Management of XY Limited
expects these rates likely to continue for the foreseeable future.
Or, 1 + Risk Premium = 1.15/1.06978
Estimated projected cash flows, in real terms, in India as well as
= 1.075 African country for the first three years of the project are as follows:

Therefore, Risk adjusted dollar rate is = (1.0750 × 1.04186) – 1 Year – 0 Year – 1 Year – 2 Year – 3
Cash flows in −50,000 −1,500 −2,000 −2,500
= 1.1199 – 1 Indian ₹ (000)

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Cash flows in −2,00,000 +50,000 +70,000 +90,000 1.40

Year 3 = 9.719 × = 12.3696
African Rands 1.10
(000)
0 1 2 3
XY Ltd. assumes the year 3 nominal cash flows will continue to be Real CF (AR) - + 50,000 + 70,000 + 90,000
2,00,000
earned each year indefinitely. It evaluates all investments using
Nominal CF (40%) - + 70,000 + +
nominal cash flows and a nominal discounting rate. The present 2,00,000 1,37,200 2,46,960
exchange rate is African Rand 6 to ₹ 1. Exchange rate 6 7.6364 9.7191 12.3696
(AR/€)
You are required to calculate the net present value of the proposed Nominal CF (₹) (1) - 33,333 + 9167 +14,117 + 19,965
investment considering the following: Real CF (India) - 50,000 - 1,500 - 2,000 - 2,500
NCF (2) - 50,000 - 1,650 - 2,420 - 3,328
(i) African Rand cash flows are converted into rupees and
discounted at a risk adjusted rate. Total CF (1) + (2) - 83,333 + 7517 + 11,697 + 16,637
(×) PVF @ 20% 1.000 0.833 0.694 0.579
(ii) All cash flows for these projects will be discounted at a rate of
PV - 83,333 + 6,262 + 8,118 + 9,633
20% to reflect it’s high risk.
Present Value = - 59,320
(iii) Ignore taxation.
16,637
Year – 1 Year - 2 Year - 3 (+) PV of TV =( ) × 0.579 = 48,164
20%

PVIF @ 20% .833 .694 .579 NPV = -11,156 Reject

(SM TYK – 03 & Exam May – 2013) (6 Marks) Question – 06

XY Limited is engaged in large retail business in India. It is
Solution: contemplating for expansion into a country of Africa by acquiring a
group of stores having the same line of operation as that of India.
Step 1: Calculation of Exchange Rate
The exchange rate for the currency of the proposed African country
1+i is extremely volatile. Rate of inflation is presently 40% a year.
FR = SR ×
1+i Inflation in India is currently
1.40
Year 1 FR =6× = 7.6364 10% a year. Management of XY Limited expects these rates likely to
1.10
continue for the foreseeable future.
1.40
Year 2 = 7.6364 × = 9.7191 Estimated projected cash flows, in nominal terms, in India as well as
1.10
African country for the first three years of the project are as follows:

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 INTERNATIONAL FINANCIAL MANAGEMENT

Year – 0 Year – 1 Year – 2 Year – 3 (1.083) (1.108) = (1 + Required Rate)

Cash flows in −2,00,000 −6,600 −10,000 −13,000
Indian(000) Required Rate = 0.20 i.e. 20%
Cash flows in
African Rands 8,00,000 +2,80,000 +5,50,000 +10,00,000 Calculation of NPV
(000)
Year 0 1 2 3
XY Ltd. assumes the year 3 nominal cash flows will continue to be Inflation factor in 1.00 1.10 1.21 1.331
earned each year indefinitely. It evaluates all investments using India
nominal cash flows and a nominal discounting rate. The present 1.00 1.40 1.96 2.744
exchange rate is African Rand 6 to ₹ 1. Inflation factor in
Africa 6.00 7.6364 9.7190 12.3696
You are required to calculate the net present value of the proposed
investment considering the fact that the company uses discounting Exchange Rate
rate of 10.80% to evaluate any project but to reflect high risk of this (as per IRP)
project it is considering to adjust a risk premium of 8.30% - -6,600 -10,000 -13,000
Cash Flows in ₹ 2,00,000
Note: - ‘000

1. Use PV Factors upto 3 decimal points. Nominal (1)

2,80,000 5,50,000 10,00,000
2. Use Exchange Rates upto 4 decimal points. Cash Flows in -
African Rand 8,00,000 36,666 56,590 80,843
3. Compute final calculation in multiple of ₹ 000 and round off
‘000
them upto zero. - 30,066 46,590 67,843
Nominal 1,33,333
4. Ignore taxation.

(MTP April – 2025) In Indian ₹ ‘000 - 0.833 0.694 0.579

(2) 3,33,333
25,045 32,333 39,281
Solution:
Net Cash Flows
in ₹ ‘000 (1) + (2) 1
First, we shall compute the discount rate to calculate the NPV of the
project. -3,33,333
PVF @ 20%
(1 + Risk Premium) (1 + Normal Discounting Rate) = (1 + Required PV
Rate)
NPV of 3 years = -2,36,674 (₹ ‘000)

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 INTERNATIONAL FINANCIAL MANAGEMENT

67,843 Assuming that you are the finance manager of XYZ Ltd., calculate
NPV of Terminal Value = × 0.579 = 1,96,405 (₹ ‘000)
0.20
the net present value (NPV) and modified internal rate of return
Total NPV of the Project = -2,36,674 (₹ ‘000) + 1,96,405 (₹ ’000) (MIRR) of the proposal.

You may use following values with respect to discount factor for ₹ 1
= - 40,269 (₹ ’000)
@9%.
Question – 07
Present Value Future Value
XYZ Ltd., a company based in India, manufactures very high quality
Year 1 0.917 1.188
modem furniture and sells to a small number of retail outlets in India Year 2 0.842 1.090
and Nepal. It is facing tough competition. Recent studies on Year 3 0.772 1
marketability of products have clearly indicated that the customers
are now more interested in variety and choice rather than exclusivity (SM TYK – 05 & Exam November – 2015) (6 Marks)
and exceptional quality. Since the cost of quality wood in India is very
Solution:
high, the company is reviewing the proposal for import of woods in
bulk from Nepalese supplier. (i) Calculation of NPV
The estimate of net Indian (₹) and Nepalese Currency (NC) cash flows Step 1: Forward Rates
in Nominal terms for this proposal is shown below:
1.09
1 = NC 1.60 × = 1.6148
1.08
Year Net Cash Flow (in millions)
0 1 2 3 1.09
2 = NC 1.6148 × = 1.6298
NC -25.000 2.600 3.800 4.100 1.08
Indian (₹) 0 2.869 4.200 4.600
1.09
3 = NC 1.6298 × 1.08
= 1.6449
The following information is relevant:
Step 2: NPV
(i) XYZ Ltd. evaluates all investments by using a discount rate of
9% p.a. All Nepalese customers are invoiced in NC. NC cash 0 1 2 3
flows are converted to Indian (₹) at the forward rate and CF (NC) - 25.000 + 2.600 + 3.800 + 4.100
discounted at the Indian rate. Exchange rate 1.60 1.6148 1.6298 1.6449
(NC/₹)
(ii) Inflation rates in Nepal and India are expected to be 9% and CF (₹) - 15.625 + 1.6101 + 2.3316 + 2.4926
8% p.a. respectively. The current exchange rate is ₹ 1= NC 1.6 CF India 0 + 2.869 + 4.200 + 4.600
Total CF - 15.625 4.4791 6.5316 7.0926
X PVF (9%) 1 0.917 0.842 0.772

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 INTERNATIONAL FINANCIAL MANAGEMENT

PV - 15.625 + 4.1073 + 5.4996 + 5.4755 If not imported cost of leather to be 400 450 500 600
purchased in India (in ₹)
NPV = - 0.5426
Other information:
(ii) Modified IRR
(i) DD Ltd. evaluates all investments by using discount rate of
Terminal value 9% p.a.

(1) 4.4791 (1.09)2 = 5.3216 (ii) All US customers are invoiced in US $. US $ Cash flows
converted into ` at the forward rate and discounted at Indian
(2) 6.5316 × 1.09 = 7.1194 Rate.

(3) = 7.0926 (iii) Inflation in USA and India are expected to be 9% and 8%
respectively.
= 19.53
(iv) The current exchange rate 1 US $ = ₹ 74
15.625 (1 + r) 3
= 19.53
You are required to Calculate Net Present Value and recommend the
19.53 1/3 decision. Present value factor @ 9% are as under:
r = [(15.625) − 1] × 100
1 Year 2 Year 3 Year
= 7.72% 0.917 0.842 0.772

Question – 08 (Exam December – 2021) (8 Marks)

DD Ltd. a company based in India manufactures good quality of
leather bags and sells to retail outlets in India and USA. The cost of Solution:
quality leather in India is very high, the company is reviewing the
Calculation of Forward Rates
proposal of importing of leather in bulk from USA supplier. The
estimate of net US $ and Indian ₹ Currency Cash Flows in nominal Forward Rate
terms for this proposal is given below:
1.08
1 = 74 × = 73.321
1.09
Net Cash Flow (in Lakh)
Year 0 1 2 3 1.08
2 = 73.321 × = 72.65
In US $ (25) 5 7 8 1.09
In ₹ 0 60 80 90 1.08
3 = 72.65 × 1.09
= 71.98

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 INTERNATIONAL FINANCIAL MANAGEMENT

0 1 2 3 (iv) Expected useful life of the proposed plant is five years with no
CF ($) - 25 5 7 8 salvage value;
Exchange rate 74 73.321 72.65 71.98
(NC/₹) (v) Existing working capital investment for production & sale of
CF (₹) - 1,850 366.6 508.55 575.84 two million units through exports was US $ 15 million;
CF India - 60 80 90
Cost of leather in - 400 - 450 -500 -600 (vi) Export of the product in the coming year will decrease to 1.5
India million units in case the company does not open subsidiary
CF - 2250 - 23.40 88.55 65.84 company in India, in view of the presence of competing MNCs
X PVF (9%) 1.000 0.917 0.842 0.772 that are in the process of setting up their subsidiaries in India;
-2250 -21.46 74.56 50.83
(vii) Applicable Corporate Income Tax rate is 35%, and
NPV = - 2146.07 Reject
(viii) Required rate of return for such project is 12%.
Question – 09
A multinational company is planning to set up a subsidiary company Assuming that there will be no variation in the exchange rate of two
in India (where hitherto it was exporting) in view of growing demand currencies and all profits will be repatriated, as there will be no
for its product and competition from other MNCs. The initial project withholding tax, estimate Net Present Value (NPV) of the proposed
cost (consisting of Plant and Machinery including installation) is project in India.
estimated to be US$ 500 million. The net working capital
Present Value Interest Factors (PVIF) @ 12% for five years are as
requirements are estimated at US$ 50 million. The company follows
below:
straight line method of depreciation. Presently, the company is
exporting two million units every year at a unit price of US$ 80, its Year 1 2 3 4 5
variable cost per unit being US$ 40. PVIF 0.8929 0.7972 0.7118 0.6355 0.5674

The Chief Financial Officer has estimated the following operating cost (SM TYK – 04 & Exam May – 2014) (8 Marks)
and other data in respect of proposed project:
Solution:
(i) Variable operating cost will be US $ 20 per unit of production;
W.N. 1: CFAT (Millions)
(ii) Additional cash fixed cost will be US $ 30 million p.a. and
project's share of allocated fixed cost will be US $ 3 million Sales [5 million × $ 80] $ 400
p.a. based on principle of ability to share;
(-) VC [5 million × $ 20] $ 100
(iii) Production capacity of the proposed project in India will be 5
(-) additional FC $ 30
million units;

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 INTERNATIONAL FINANCIAL MANAGEMENT

CFBT $ 270 …….(i) (B) Incremental cash

inflow
$ 500
(-) Dep ( ) $ 100 Incremental CFAT (WN 1-5 3.6048 $ 171.50 $ 618.22
5
1)
PBT $ 170 WC recovered 5 0.5674 $ 35 $ 19.859
(Incremental)
Tax @ 33% $ 59.5 …….(ii) Total $
638.079
CFAT (i − ii) $ 210.5 NPV (B-A) $ 103.079

CFAT (Export) Since NPV is positive hence project should be accepted.

Sales $ 120 Question – 10

A US company wants to setup a manufacturing plant in India which
[1.5 × $ 80]
requires an initial outlay of ₹ 8 Million. It is expected to have a useful
(-) VC (1.5 × $ 40) $ 60 life of 5 years with a salvage of ₹ 2 Million. The company follows
straight line method of depreciation. To support additional level of
CFBT $ 60 activity, investment would require one time additional working
capital of ₹ 1 Million.
Tax @ 35% $ 21
Since the cost of production lower in India, the variable cost of
CFAT $ 39
production would be ₹ 30 per unit. Additional fixed cost per annum
Incremental CFAT ($ 210.50 – $ 39) = $ 171.50 is estimated at ₹ 0.5 Million. The company is projecting its annual
sales to 80000 units at the price of ₹ 100 per unit. Applicable tax rate
Calculation of NPV to the company is 34% and its cost of capital is 8%.

(Millions) Inflation rates in US and India are expected to be 8% and 9%

Year PVF Amount P.V. respectively. The current exchange rate is ₹ 72 per US Dollar.
(A) Incremental cash
outflow Assuming that all profit will be repatriated every year and there will
Cost of plant 0 1.000 $ 500 $ 500 be no withholding taxes, estimate the net present value of the
Working capital 0 1.000 $ 35 $ 35 proposed project in India and evaluate its feasibility.
($ 50 - $15)
Total $ 535 PVF @ 8% for the five years are as under:

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 INTERNATIONAL FINANCIAL MANAGEMENT

Rate 1 Year 2 Year 3 Year 4 Year 5 Year CFAT (i – ii) = 37,74,000

8% 0.926 0.857 0.794 0.735 0.681
NPV
(Exam December – 2021) (8 Marks)
0 1 2 3 4 5
Cost of - - - - - -
Solution:
plant 80,00,000
Working - - - - - +
Forward Rate capital 10,00,000 10,00,000
Salvage - - - - - +
1.09 20,00,000
1 year = ₹ 72 × = 72.67
1.08 CFAT - + 37,74,000 37,74,000 37,74,000 37,74,000
37,74,000
1.09 CF (₹) - 37,74,000 37,74,000 37,74,000 37,74,000 67,74,000
2 year = 72.67 × = 73.34
1.08 90,00,000
Exchange 72 72.67 73.34 74.02 74.71 75.40
1.09 rate
3 year = 73.34 × = 74.02
1.08 CF ($) - 51,933.40 51,458.96 50,986.22 50,515.32 89,840.85
1,25,000
1.09 (×) PVF 1.000 0.926 0.857 0.794 0.735 0.681
4 year = 74.02 × = 74.71
1.08

1.09
NPV = $ 1,05,984.09 Accept.
5 year = 74.71 × = 75.40
1.08
Question – 11
W.N. 2: CFAT (₹) A USA based company is planning to set up a software development
unit in India. Software developed at the Indian unit will be bought
Sales (80,000 units × 100) = 80,00,000
back by the US parent at a transfer price of US $10 millions. The unit
VC (80,000 × 30) = 24,00,000 will remain in existence in India for one year; the software is expected
to get developed within this time frame.
FC = 5,00,000
The US based company will be subject to corporate tax of 30 per cent
CFBT (i) = 51,00,000 and a withholding tax of 10 per cent in India and will not be eligible
for tax credit in the US. The software developed will be sold in the US
80,00,000 – 20,00,000
(-) Dep ( )= 12,00,000 market for US $ 12.0 millions. Other estimates are as follows:
5

PBT = 39,00,000 Rent for fully furnished unit with necessary hardware in India
₹ 15,00,000
Tax @ 34% (ii) = 13,26,000
Man power cost (80 software professional will be working

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 INTERNATIONAL FINANCIAL MANAGEMENT

for 10 hours each day) ₹ 400 per man hour ₹ 22,76,50,000

In $ =
48
Administrative and other costs ₹ 12,00,000
= $ 4.743 Millions
Advise the US Company on the financial viability of the project. The
Software will be sold at $ 12 Millions & Cost is 4.743 Millions hence
rupee-dollar rate is ₹48/$.
Project Should be Accepted.
Note: Assume 365 days a year.
Question – 12
(SM TYK – 02, RTP Nov – 2021 & Exam May – 2017) (8 Marks) VK Ltd. is an Indian company which is planning to set up a
manufacturing plant through its subsidiary in the small country
Solution: Farland, (where hitherto it was exporting) in view of growing demand
for its product and competition from other MNCs. The currency of
Cost of Software in India
Farland is the Farroh (Fr.).
Rent ₹ 15,00,000
An initial investment of Fr. 80 million in plant and machinery would
Manpower (80 × 10 × 400 × 365) ₹ 11,68,00,000 be required. In addition to that the initial investment in working
capital of Fr. 6 million would be also required which shall be financed
Administration ₹ 12,00,000 through a loan from a local bank of Farland, at interest rate of 10%
[Link] working capital shall also be subject to inflation. At the end
Cost ₹ 11,95,00,000
of 5 years, the subsidiary would be taken over by the Govt. of Farland
Tax Amount for a price of Fr. 2 million. The part of the proceeds would be used to
pay off the bank loan.
Sales ($ 1,00,00,000 × 48) ₹ 48,00,00,000
It is expected that subsidiary shall produce Net Cash Flows from
(-) Cost ₹ 11,95,00,000 Operations of Fr. 30 million per year at current price level over the
five-year period, before allowing for Farland inflation of 8% per year.
Profit ₹ 36,05,00,000 Depreciation on Plant and Machinery shall be charged at 20% per
year on straight line basis. As a result of setting up the subsidiary,
Tax @ 30% ₹ 10,81,50,000
VK Ltd. expects to lose after-tax export income from Farland of INR
Total Cost of Software 8,00,000 per year in current price terms, before allowing for India
inflation of 3%. Profits in Farland are taxed at a rate of 20% after
= ₹ 11,95,00,000 + 10,81,50,000 allowing deduction for interest and depreciation. All after-tax cash
profits are remitted to the India at the end of each year. Indian tax @
= ₹ 22,76,50,000
30% is charged on profit earned, but due to tax treaty between

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 INTERNATIONAL FINANCIAL MANAGEMENT

Farland and the India the tax paid in Farland is allowed to be set off 1 2 3 4 5
against any India Tax liability. Taxation is paid in the year in which EBITDA (30,000) 32,400 34,992 37,791 40,815 44,080
the liability arises. VK Ltd. requires foreign investments to be (−) Depreciation 16,000 16,000 16,000 16,000 16,000
discounted at 12%. The current exchange rate is Fr.2.5/INR and the (−) Interest (6,000 600 600 600 600 600
Farroh is expected to depreciate against INR by 5% per year. × 10%)
PBT 15,800 18,392 21,191 24,215 27,480
Advise should VK Ltd. undertake the investment in Farland or not. Tax @ 20% 3,160 3,678 4,238 4,843 5,496
PAT 12,640 14,714 16,953 19,372 21,984
Note:- (+) Depreciation 16,000 16,000 16,000 16,000 16,000
CFAT (Fr) 28,640 30,714 32,953 35,372 37,984
1. Present Figures in thousands multiple.
WC Requirement
2. Round off all calculations.
0 1 2 3 4 5
3. PVF @12% WC 6,000 6,480 6,998 7,558 8,163 ---
Additional WC --- 480 518 560 605 ---
Year 1 2 3 4 5 (Fr)
PVF 0.893 0.797 0.712 0.636 0.567
(“000”)
(MTP October – 2023)
0 1 2 3 4 5
Solution: Cost (Fr) (80,000) --- --- --- --- ---
CFAT --- 28,640 30,714 32,953 35,372 37,984
(i) Forward Rate Additional --- (480) (518) (560) (605) ---
WC
Fr/₹ = 2.5 Salvage --- --- --- --- --- 2,000
Recovered --- --- --- --- --- 2,163
1 year = 2.5 × 1.05 = 2.625 WC
CF (Fr) -80,000 28,160 30,196 32,393 34,767 42,147
2 year = 2.625 × 1.05 = 2.7563 Exchange 2.5 2.625 2.7563 2.8941 3.0388 3.1907
Rate (Fr/₹)
3 year = 2.7563 × 1.05 = 2.8941 CF (₹) -32,000 10,728 10,955 11,193 11,441 13,209
(-) Tax --- (602) (667) (732) (797) (861)
4 year = 2.8941 × 1.05 = 3.0388 Loss of --- (824) (849) (874) (900) (927)
Export
5 year = 3.0388 × 1.05 = 3.1907 CFAT -32,000 9,302 9,439 9,587 9,744 11,421
PVF 1.000 0.893 0.797 0.712 0.636 0.567
CFAT (Fr ‘000’)

13.14
 INTERNATIONAL FINANCIAL MANAGEMENT

NPV = 3,328 --- 2000

- 2816 3019 3239 3476 3333
Working Tax in India 80000 0 6 3 7 1

1 2 3 4 5 (2) Expected Exchange Rates

PBT (Fr) 15,800 18,392 21,191 24,215 27,480
Exchange Rate 2.625 2.7563 2.8941 3.0388 3.1907 Year Rate
Fr/₹ 0 2.50
PBT (₹) 6,019 6,673 7,322 7,969 8,613 1 2.50 × 1.05 = 2.63
Tax @ 10% 602 667 732 797 861 2 2.50 × (1.05)2 = 2.76
3 2.50 × (1.05)3 = 2.89
ICAI SOLUTION: 4 2.50 × (1.05)4 = 3.04
5 2.50 × (1.05)5 = 3.19
Working Notes:
(3) Calculation of Tax paid in India
(1) Calculation of the project cash flows for VK Ltd.’s subsidiary
in Farland Year 1 2 3 4 5
PBT (fr) 15,800 18,392 21,191 24,215 27,480
Fr.’000 Tax @ 10 % 1,580 1,839 2,119 2,422 2,748
Exchange Rate 2.63 2.76 2.89 3.04 3.19
Year 0 1 2 3 4 5 Tax in India 601 666 733 797 861
Cash flow from 32,40 34,99 37,79 40,81 44,08 (INR’ 000)
operating 0 2 1 5 0
Depreciation 16,00 16,00 16,00 16,00 16,00 Calculation Net Present Value (NPV) for VK Ltd.’s subsidiary at
Interest 0 0 0 0 0
600 600 600 600 600 parent company level
Profit after tax 15,80 18,39 21,19 24,21 27,48
Farland tax 0 2 1 5 0 Year 0 1 2 3 4 5
3,160 3,678 4,238 4,843 5,496 Project cash - 28,160 30,196 32,393 34,767 33,331
Profit after tax 12,64 14,71 16,95 19,37 21,98 flow (Fr.’000) 80,000
Add back 0 4 3 2 4 2.63 2.76 2.89 3.04 3.19
depreciation 16,00 16,00 16,00 16,00 16,00 Exchange 2.50
0 0 0 0 0 Rate (Fr./INR) -- -- -- -- --
28,64 30,71 32,95 35,37 37,98 -
Initial investment - 0 4 3 2 4 Cash Invested 32,000
Change in W.C. 80,00 from India 10,707 10,941 11,209 11,437 10,449
Loan capital 0 -480 -518 -560 -605 -653 (INR '000)
Sales on Subsidiary - --
--- --- --- --- 6000 601 666 733 797 861

13.15
 INTERNATIONAL FINANCIAL MANAGEMENT

Cash Received - 10,106 10,275 10,476 10,640 9,588 Spot Rate for 1 Mauritian Dollar (MUR) = 1.88 Indian Rupee (INR)
in India (INR 32,000
'000) 824 849 874 900 927 The inflation in India is 6% and in Mauritius is 5%.
Tax in India - 9,282 9,426 9,602 9,740 8,661 It is expected that this inflation rate will remain unchanged for the
(INR '000) 32,000 0.893 0.797 0.712 0.636 0.567
next 4 years.
1 8,289 7,513 6,837 6,195 4,911
-
Lost export 32,000 INR 8 Crore out of initial investment shall be required for setting up
after tax a plant. The useful life of the plant is 4 years. At the end of 4th year
(INR '000) estimated salvage value of this plant shall be INR 80 lakhs.
Parent Cash
Depreciation of the plant shall be charged on the basis of straight-
Flow
PVF line method.
NPV 1,745
40 % of the investment shall be through debt funds from Mauritius
Decision: Since NPV of the project is positive it should be accepted. at the cost of 10% (post tax) while remaining funds shall be arranged
by him and his friends. They expect a rate of return of 12% on their
Question – 13 funds.
Mr. Vishwas, a friend of Mr. Pramod who is one of the Directors of
Ashirwad Limited, is a citizen of Mauritius. His immediate family Expected revenues & costs (excluding depreciation) in real term are
members including his parents, born in India are residing in India. as under:
He has many friends in different parts of India, due to which he
Year 1 2 3 4
happens to visit India on frequent basis. He along with Mr. Pramod
Revenues (₹ Crore) 6.00 7.00 8.00 8.00
evince interest in setting up business in India and formally Costs (₹ Crore) 3.00 4.00 4.00 4.00
incorporate a company to commence their operations. Accordingly, a
company is called “Aerious Private Ltd.” got incorporated in Mumbai. Assume that applicable tax rate in India is 30%. Since there is Double
tax avoidance agreement between India and Mauritius, the company
To start with he received a business proposal from one of his friends
is not required to pay tax in Mauritius if tax has been paid in India.
Nimish a consultant. It is estimated that in equivalent terms the
business shall require an initial investment of MUR 100 Million and The applicable inflation rates for revenues & costs are as follows:
thereafter MUR 2 Million each year will be needed as working capital
fund. Year Revenues Costs
1 10% 12%
He wished to evaluate whether the business proposal is viable or not. 2 9% 10%
The information related to exchange rate and inflation rate is as 3 8% 9%
follows: 4 7% 8%

13.16
 INTERNATIONAL FINANCIAL MANAGEMENT

He wants an expert opinion for the same investment proposal. 1. 3 × 1.12 = 3.36 Cr.

Demonstrate whether investment in this project is viable option or 2. 4 × 1.12 × 1.10 = 4.928 Cr.
not.
3. 4 × 1.12 × 1.10 × 1.09 = 5.3715 Cr.
Note:
4. 4 × 1.12 × 1.10 × 1.09 × 1.08 = 5.8012 Cr.
1. Round off calculations upto 4 decimal points.
(iii) Calculation of CFAT (₹)
2. Show INR calculations in Crore and MUR calculations in Million.
1 2 3 4
Solution: Revenue 6.60 8.393 10.3594 11.0845
(-) Cost 3.36 4.928 5.3715 5.8012
(i) Forward Rate CFBT (i) 3.24 3.465 4.9879 5.2833
(-) Depreciation 1.80 1.80 1.80 1.80
1.06 8 − 0.8
1. = ₹ 1.88 × = 1.8979
1.05 4
PBT 1.44 1.665 3.1879 3.4833
1.06
2. = ₹ 1.8979 × = 1.9160 Tax @ 30% (ii) 0.4320 0.4995 0.9564 1.0450
1.05
CFAT [(i) – (ii)] 2.808 2.9655 4.0315 4.2383
1.06
3. = ₹ 1.9160 × = 1.9342 (iv) Calculation of Working Capital (₹)
1.05

1.06
4. = ₹ 1.9342 × = 1.9526 1st Year MUR 2m × 1.8979 = 0.3796 Cr.
1.05
2nd Year MUR 2m × 1.9160 = 0.3832 Cr.
(ii) Nominal Cash Flows
3rd Year MUR 2m × 1.9342 = 0.3868 Cr.
Revenue:
4th Year MUR 2m × 1.9526 = 0.3905 Cr.
1. 6 × 1.10 = 6.60 Cr.
Total Working Capital = 1.5401 Cr.
2. 7 × 1.10 × 1.09 = 8.393 Cr.
(v) WACC
3. 8 × 1.10 × 1.09 × 1.08 = 10.3594 Cr.
WACC = (0.4 × 10) + (0.6 × 12)
4. 8 × 1.10 × 1.09 × 1.08 × 1.07 = 11.0845 Cr.
= 11.2%
Cost:

13.17
 INTERNATIONAL FINANCIAL MANAGEMENT

(vi) Calculation of NPV 15 0.15 Additional reduction 0.2

0 1 2 3 4 The plant at the current rate of exchange will have a depreciation of

Initial - --- --- --- --- USD 1 million annually. Assume local Tax rate as 30%.
investment 18.80
You are required to find out:
Working --- -0.3796 - 0.3832 - 0.3868 - 0.3905
capital (i) Annual Cash Flow After Tax (CFAT) under all the different
WC --- --- --- --- +
scenarios of exchange rate.
recovered 1.5401
Salvage --- --- --- --- + (ii) Expected value of CFAT assuming no repatriation of profits.
0.8000
CFAT --- 2.808 2.9655 4.0315 4.2383 (iii) Viability of the investment proposal assuming an initial
Total (₹) -18.80 2.4284 2.5823 3.6447 6.1879 investment of USD 25 million on plant and working capital
Exchange 1.88 1.8979 1.9160 1.9342 1.9526 with a required rate of return of 11% on investment and on
rate
the basis of CFAT arrived under option (ii). The CFAT will grow
Total CF -100 12.7952 13.4776 18.8434 31.6906
(MUR) @ 3% per annum in perpetuity.
PVT @ 11.2% 1 0.8993 0.8087 0.7273 0.6540
(Exam January – 2021) (8 Marks)
NPV = - 43.1635 Reject
Solution:
Question – 14
(i) Calculation of CFAT
A proposed foreign investment involves creation of a plant with an
annual output of 1 million units. The entire production will be I II III
exported at a selling price of USD 10 per unit. Sales 1,00,00,000 1,00,00,000 1,00,00,000
(10,00,000 × 60,00,000 57,00,000 55,50,000
At the current rate of exchange dollar cost of local production equals 10) 40,00,000 43,00,000 44,50,000
to USD 6 per unit. Dollar is expected to decline by 10% or 15%. The (-) Cost of 10,00,000 9,00,000 8,50,000
change in local cost of production and probability from the expected Production
current level will be as follows: CFBT (i)
- Depreciation
Reduction in local cost PBT 30,00,000 34,00,000 36,00,000
Decline in value of Tax @ 30%(ii) 9,00,000 10,20,000 10,80,000
of production Probability
USD (%) CFAT (i – ii) 31,00,000 32,80,000 33,70,000
(USD/unit)
0 - 0.4
10 0.30 0.4

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 INTERNATIONAL FINANCIAL MANAGEMENT

(ii) Expected CFAT (iv) Expected exchange rate is ₹ 60/$

= (31,00,000 × 0.4) + ( 32,80,000 × 0.4) + (33,70,000 × 0.2) You are required to compute the number of GDR's to be issued and
cost of GDR to Odessa Limited, if 20% dividend is expected to be paid
= $ 32,26,000 with a growth rate of 20%.
(iii) Calculation of NPV (Exam Nov – 2014) (8 Marks)
CFAT 1
PVCI = Solution:
Ke − g
Net Issue Size = $15 million
$ 32,26,000 (1.03)
=
0.11− 0.03 $15 million
Gross Issue = = $15.306 million
0.98
= $ 4,15,34,750
Issue Price per GDR in ₹ (300 × 3 × 90%) ₹ 810
NPV = 4,15,34,750 – $ 25,00,000
Issue Price per GDR in $ (₹ 810/ ₹ 60) $13.50
= $ 1,65,34,750
Dividend Per GDR (D1) = ₹ 2* × 3 = ₹6
Since NPV is positive hence Project should be accepted.
* Assumed to be on based on Face Value of ₹ 10 each share.
PART II: ADR & GDR
Net Proceeds Per GDR = ₹ 810 × 0.98 = ₹ 793.80
Question – 15 (a) Number of GDR to be issued
Odessa Limited has proposed to expand its operations for which it
requires funds of $ 15 million, net of issue expenses which amount $15.306 million
= 1.1338 million
to 2% of the issue size. It proposed to raise the funds though a GDR $13.50
issue. It considers the following factors in pricing the issue:
(b) Cost of GDR to Odessa Ltd
(i) The expected domestic market price of the share is ₹ 300
6.00
Ke = + 0.20 = 20.76%
(ii) 3 shares underly each GDR 793.80

(iii) Underlying shares are priced at 10% discount to the market Question – 16
price M/s. Raghu Ltd. is interested in expanding its operation and
planning to install manufacturing plant at US. It requires 8.82

13.19
 INTERNATIONAL FINANCIAL MANAGEMENT

million USD (net of issue expenses/ floatation cost) to fund the = 9 Million
proposed project. GDRs are proposed to be issued to finance this
project. The estimated floatation cost of GDRs is 2%. Price of GDR = 360 × 20 × 90%

Additional information: = ₹ 648

648
(i) Expected market price of share at the time of issue of GDR is = =$9
72
₹ 360 (Face Value ₹ 100)
$9 million
(ii) Each GDR will represent two underlying Shares. No. of GDR = = 1 million
$9
(iii) The issue shall be priced at 10% discount to the market price. ₹ 100 × 20% × 2
Cost of GDR = + 0.12
(iv) Expected exchange rate is INR/USD 72. 648 × 98%

= 18.30%
(v) Dividend is expected to be paid at the rate of 20% with growth
rate of 12%. (2) Since equivalent loan Interest is 12% i.e. less than Cost of
GDR (18.30%) then it is better to accept US Bank Offer
Requirement:
(3) Savings
(1) You, as a financial consultant, are required to compute the
number of GDRs to be issued and cost of the GDR. = 18.30% – 12%
(2) What is your suggestion if the company receives an offer from = 6.30%
a US Bank willing to provide an equivalent loan with an
interest rate of 12%? Question – 17
MITU Ltd. wants to expand business outside India. For the project
(3) How much company can save by choosing the option as
installation US funds $ 14.775 Million are required. Company wants
recommended by you? to raise money by issue of GDRs.
(RTP May–2022, MTP April–2022 & Exam July - 2021) (8 Marks) Following information is available:
Solution: (1) 7 shares shall underly each GDR.
(1) No. of GDR & Cost of GDR (2) GDR shall be priced at 7% discount to market price.
$ 8.82 m
Gross Issues = (3) Market price of share is ₹ 500 (Face Value ₹ 100) per share.
0.98

13.20
 INTERNATIONAL FINANCIAL MANAGEMENT

(4) Expected exchange rate is $1 = ₹ 81.3750.

PART III: ADJUSTED PRESENT VALUE
(5) Dividend expected to be paid is 15% with growth rate 10%.

(6) Flotation Cost of GDR is 1.5%. Question – 18

XYZ Ltd. is presently all equity financed. The directors of the
Required:
company have been evaluating investment is a project which will
Compute the number of GDRs to be issued and cost of the GDR to require ₹ 270 lakhs capital expenditure on new machinery. They
the company. expect the capital investment to provide annual cash flows of ₹ 42
lakhs indefinitely which is net of all tax adjustments. The discount
(Note: Calculate in lacs with four decimals.) rate which it applies to such investment decisions is 14% net.

(Exam Jan. – 2026) The directors of the company believe that the current capital
structure fails to take advantage of tax benefits of debt, and propose
Solution: to finance the new project with undated perpetual debt secured on
the company’s assets. The company intends to issue sufficient debt
Net Issue Size = $ 14.775 million
to cover the cost of capital expenditure and the after tax cost issue.
$ 14.775 million
Gross Issue = = $ 15 million The current annual gross rate of interest required by the market on
0.985
corporate undated debt of similar risk is 10%. The after tax costs of
Issue Price per GDR in ₹ (500 × 7 × 93%) ₹ 3,255 issue are expected to be ₹ 10 lakh. Company’s tax rate is 30%.

Your are required to calculate The adjusted present value of the

Issue Price per GDR in $ (₹ 3255/ ₹ 81.3750) $ 40
investment.
Dividend Per GDR (D1) (₹ 15 × 7) ₹ 105
Solution:
Net Proceeds Per GDR (₹ 3255 × 0.985) ₹ 3,206.18 Calculation of Adjusted Present Value of Investment (APV)

$ 15 million Adjusted PV
(a) Number of GDR to be issued =
$ 40
= Base Case PV + PV of financing decisions associated with the
= 0.375 million/3.75 Lakhs/3,75,000 project

105.00 Base Case NPV for the project:

(b) Cost of GDR to X Ltd. Ke = + 0.10 = 13.27%
3206.18

13.21
 INTERNATIONAL FINANCIAL MANAGEMENT

(-) ₹ 270 lakhs + (₹ 42 lakhs/0.14) = (-) ₹ 270 lakhs + ₹ 300 lakhs

❖ EBIDTA to be collected from the Toll Road is projected to be
= ₹ 30 USD 33 lakhs per annum for a period of 20 years.
Issue costs = ₹ 10 lakhs
❖ To encourage investment Nepalese government is offering a
Thus, the amount to be raised = ₹ 270 lakhs + ₹ 10 lakhs 15-year term loan of USD 150 lakhs at an interest rate of 6
per cent per annum. The interest is to be paid annually. The
= ₹ 280 lakhs loan will be repaid at the end of 15 year in one tranche.

Annual tax relief on interest payment = ₹ 280 × 0.1 × 0.3

❖ The required rate of return for the project under all equity
= ₹ 8.4 lakhs in perpetuity financing is 12 per cent per annum.

The value of tax relief in perpetuity = ₹ 8.4 lakhs/0.1 ❖ Post tax cost of debt is 5.6 per cent per annum.

= ₹ 84 lakhs ❖ Corporate Tax Rate is 30 per cent.

Therefore, APV
❖ All cash Flows will be in USD.
= Base case PV – Issue Costs + PV of Tax Relief on debt interest
You are required to advise the management of TL Ltd. on the viability
= ₹ 30 lakhs – ₹ 10 lakhs + 84 lakhs of the proposal by using Adjusted Net Present Value method. Ignore
inflation.
= ₹ 104 lakhs
Given
Question – 19
The Management of a multinational company TL Ltd. is engaged in PVIFA (12%, 10) = 5.650, PVIFA (12%, 20) = 7.469, PVIFA (8%,15) =
construction of Infrastructure Project. A proposal to construct a Toll 8.559, PVIF (8%, 15) = 0.315.
Road in Nepal is under consideration of the Management. Note: Make calculations in USD Lakhs and round off them upto 3
The following information is available: decimal points.

❖ The initial investment will be in purchase of equipment costing (RTP November – 2024)
USD 250 lakhs. The economic life of the equipment is 10
years. The depreciation on the equipment will be charged on
straight line method.

13.22
 INTERNATIONAL FINANCIAL MANAGEMENT

Solution:

(i) Net Present Value (All Equity Financed) – Base NPV

Particulars Period USD PVF @ PV (USD

Lakhs 12% Lakhs)
Initial Investment 0 (250.00) 1.000 (250.000)
EBIDTA 1 to 20 33.00 7.469 246.477
Tax 1 to 20 (9.90) 7.469 (73.943)
Depreciation 1 to 10 (25.00)
Tax Saving on 1 to 10 7.50 5.650 42.375
Dep.
NPV (35.091)

(ii) Present Value of Impact of Financing by Debt

Particulars Period USD PVF @ PV (USD

Lakhs 8% Lakhs)
Tax Saving on 1 to 15 2.70 8.559 23.109
Interest

Adjusted Present Value of the Project

Base NPV + PV of Tax Shield on Interest

= - US$ 35.091 + US $ 23.109 lakh

= - US$ 11.982 lakh

Advise: Since APV is negative, TL Ltd. should not accept the project.

13.23
 BUSINESS VALUATION

14 BUSINESS VALUATION
4 With the above information and following assumption you are
PART I: ECONOMIC VALUE ADDED (EVA) & MARKET required to compute
VALUE ADDED
(a) Economic Value Added
Question – 01 (b) Market Value Added.
The following data pertains to XYZ Inc. engaged in software
consultancy business as on 31 December 2010. Assuming that:

($ Million) (i) WACC is 12%.

Income from consultancy 935.00 (ii) The share of company currently quoted at $ 50 each
EBIT 180.00
Less: Interest on Loan 18.00 (SM TYK – 14)
EBT 162.00
Tax @ 35% Solution:
56.70
105.30 (a) Determination of Economic Value Added (EVA)

Balance Sheet ($ Million) $ Million

Liabilities Amount Assets Amount EBIT 180.00
Equity Stock (10 100 Land and Building 200 Less: Taxes @ 35% 63.00
million share @ $ 10 Computers 295 Net Operation Profit after Tax 117.00
each) &Software’s Less: Cost of Capital Employed [[Link].1] 72.60
Reserves & Surplus 325 Economic value added 44.40
Loans 180 Current Assets:
Current Liabilities 180 Debtors 150 (b) Determination of Market Value Added (MVA)
Bank 100 290
Cash 40 785 $ Million
785 Market value of Equity Stock [[Link].2] 500
Equity Fund [[Link].3] 425

14.1
 BUSINESS VALUATION

Market Value Added 75 Following is the capital structure of RST Ltd. at the end of current
financial year:
Working Notes:
₹
(1) Total Capital Employed Debt (Coupon rate = 11%) 40 lakhs
Equity (Share Capital + Reserves & Surplus) 125 lakhs
Equity Stock $ 100 Million
Invested Capital 165 lakhs
Reserve and Surplus $ 325 Million
Following data is given to estimate cost of equity capital:
Loan $ 180 Million
Equity Beta of RST Ltd. 1.36
$ 605 Million Risk –free rate i.e. current yield on Govt. bonds 8.5%
Average market risk premium (i.e. Excess of 9%
WACC 12%
return on market portfolio over risk-free rate)
Cost of Capital employed $ 605 Million × 12% $72.60 Million
Required:
(2) Market Price per equity share (A) $ 50
(i) Estimate Weighted Average Cost of Capital (WACC) of RST
No. of equity share outstanding (B) 10 Million Ltd.; and

Market value of equity stock (A) × (B) $ 500 (ii) Estimate Economic Value Added (EVA) of RST Ltd.
Million
(SM TYK – 10)
(3) Equity Fund
Solution:
Equity Stock $ 100 Million
Cost of Equity as per CAPM
Reserves & Surplus $ 325 Million
ke = R f + β × Market Risk Premium
$ 425 Million
= 8.5% + 1.36 × 9%
Question – 02
= 8.5% + 12.24%
RST Ltd.’s current financial year's income statement reported its net
income after tax as ₹ 25,00,000. The applicable corporate income tax = 20.74%
rate is 30%.

14.2
 BUSINESS VALUATION

Cost of Debt Particulars

Sales ₹ 1000 Lakh
kd = 11%(1 – 0.30) = 7.70% Operating Expenses Including Interest ₹ 620 Lakh
8% Debentures ₹ 250 Lakh
WACC
Equity Share Capital (Face Value of ₹ 10 each) ₹ 250 Lakh
E D Reserves and Surplus ₹ 250 Lakh
(k0) = ke × + kd ×
E+D E+D Market Value of DY Ltd. ₹ 900 Lakh
125 40
Corporate Tax Rate 30%
= 20.74 × + 7.70 × Risk Free Rate of Return 7%
165 165
Market Rate of Return 12%
= 15.71 + 1.87 Equity Beta 1.4

= 17.58% You are required to

Taxable Income = ₹ 25,00,000/(1 − 0.30) i. Calculate Weighted Average Cost of Capital of DY Ltd.

= ₹ 35,71,429 or ₹ 35.71 lakhs ii. Calculate Economic Value Added

Operating Income = Taxable Income + Interest iii. Calculate Market Value Added

= ₹ 35,71,429 + ₹ 4,40,000 (Exam December – 2021) (8 Marks)

= ₹ 40,11,429 or ₹ 40.11 lacs Solution:

EVA = EBIT (1-Tax Rate) – WACC × Invested Capital (i) Calculation of Weighted Average Cost of Capital

= ₹ 40,11,429 (1 – 0.30) – 17.58% × ₹ Equity (250 + 250) = 500

1,65,00,000
Debt = 250
= ₹ 28,08,000 – ₹ 29,00,700
Ke = Rf + (Rm – Rf) β
= - ₹ 92,700
= 7 + (12 – 7) 1.4
Question – 03 = 14%
Following is the information of M/s. DY Ltd. for the year ending
31/03/2021: Kd = I (1 – t)

14.3
 BUSINESS VALUATION

= 8 (1 – 0.30) Question – 04
Delta Ltd.’s current financial year’s income statement reports its net
= 5.6% income as ₹ 15,00,000. Delta’s marginal tax rate is 40% and its
(500 × 14) + (250 × 5.6) interest expense for the year was ₹ 15,00,000. The company has ₹
WACC =
750 1,00,00,000 of invested capital, of which 60% is debt. In addition,
Delta Ltd. tries to maintain a Weighted Average Cost of Capital
= 11.2%
(WACC) of 12.6%.
(ii) Calculation of Economic Value Added
(i) Compute the operating income or EBIT earned by Delta Ltd.
NOPAT in the current year.

Sales = ₹ 1,000 lacs (ii) What is Delta Ltd.’s Economic Value Added (EVA) for the
current year?
(-) Operating Cost [620 – 20] = ₹ 600 lacs
(iii) Delta Ltd. has 2,50,000 equity shares outstanding. According
EBIT = ₹ 400 lacs to the EVA you computed in (ii), how much can Delta pay in
dividend per share before the value of the company would
(-) Tax @ 30% = 120 start to decrease? If Delta does not pay any dividends, what
NOPAT = 280 would you expect to happen to the value of the company?

EVA = NOPAT – C/E × WACC (SM TYK – 13)

= 280 – 750 × 11.2% Solution:

= 196 (i) Taxable income = Net Income/(1 – 0.40)

(iii) Calculation of Market Value Aadded or, Taxable income = ₹ 15,00,000/(1 – 0.40) = ₹ 25,00,000

MVA = Market Value of Firm – Book Value of Firm Again, taxable income = EBIT – Interest

= 900 – 750 or, EBIT = Taxable Income + Interest

= 150 lacs = ₹ 25,00,000 + ₹ 15,00,000

= ₹ 40,00,000

(ii) EVA = EBIT (1 – T) – (WACC × Invested capital)

14.4
 BUSINESS VALUATION

= ₹ 40,00,000 (1 – 0.40) – (0.126 × ₹ 1,00,00,000) 1.5 = PBIT / (PBIT – 40)

= ₹ 24,00,000 – ₹ 12,60,000 1.5 (PBIT – 40) = PBIT

= ₹ 11,40,000 1.5 PBIT – 60 = PBIT

(iii) EVA Dividend = ₹ 11,40,000/2,50,000 1.5 PBIT – PBIT = 60

= ₹ 4.56 0.5 PBIT = 60

60
If Delta Ltd. does not pay a dividend, we would expect the value of or PBIT 0.5 = = ₹ 120 lakhs
0.5
the firm to increase because it will achieve higher growth, hence a
higher level of EBIT. If EBIT is higher, then all else equal, the value NOPAT = PBIT – Tax = ₹ 120 lakhs (1 – 0.30) = ₹ 84 lakhs.
of the firm will increase.
Weighted Average Cost of Capital (WACC)
Question – 05
With the help of the following information of Jatayu Limited compute = 14% × (300/700) + (1 – 0.30) × (10%) × (400/700) = 10%
the Economic Value Added:
EVA = NOPAT – (WACC × Total Capital)
Capital Structure Equity capital ₹ 160 Lakhs
EVA = ₹ 84 lakhs – 0.10 × ₹ 700 lakhs
Reserves and Surplus ₹140lakhs
10% Debentures ₹ 400 lakhs EVA = ₹ 14 lakhs

Cost of equity 14% Question – 06

The following information is given for 3 companies that are identical
Financial Leverage 1.5 times
except for their capital structure:
Income Tax Rate 30%
Orange Grape Apple
(SM TYK – 09) Total invested capital 1,00,000 1,00,000 1,00,000
Debt/assets ratio 0.8 0.5 0.2
Solution: Shares outstanding 6,100 8,300 10,000
Pre tax cost of debt 16% 13% 15%
Financial Leverage = PBIT/PBT
Cost of equity 26% 22% 20%
1.5 = PBIT / (PBIT – Interest) Operating Income (EBIT) 25,000 25,000 25,000

14.5
 BUSINESS VALUATION

The tax rate is uniform 35% in all cases. (ii)

Orange Grape Apple
(i) Compute the Weighted average cost of capital for each company.
WACC 13.52 15.225 17.95
(ii) Compute the Economic Valued Added (EVA) for each company. EVA = [EBIT (1−T) (WACC × 2,730 1,025 -1,700
Invested Capital)]
(iii) Based on the EVA, which company would be considered for best
investment? Give reasons. (iii) Orange would be considered as the best investment since the
EVA of the company is highest and its weighted average cost
(iv) If the industry PE ratio is 11x, estimate the price for the share of capital is the lowest
of each company.
(iv) Estimated Price of each company shares
(v) Calculate the estimated market capitalization for each of the
Companies. Orange Grape Apple
EBIT (₹) 25,000 25,000 25,000
(SM TYK – 12 & MTP April – 2022)
Interest (₹) 12,800 6,500 3,000
Solution: Taxable Income (₹) 12,200 18,500 22,000
Tax 35% (₹) 4,270 6,475 7,700
(i) Working for calculation of WACC Net Income (₹) 7,930 12,025 14,300
(÷)Shares 6,100 8,300 10,000
Orange Grape Apple
EPS (₹) 1.30 1.45 1.43
Total debt 80,000 50,000 20,000
Stock price (EPS × PE Ratio) 14.30 15.95 15.73
Post tax Cost of debt 10.40% 8.45% 9.75%
Equity fund 20,000 50,000 80,000
Since the three entities have different capital structures they
WACC would be exposed to different degrees of financial risk. The PE
ratio should therefore be adjusted for the risk factor.
Orange: (10.4 × 0.8) + (26 × 0.2) = 13.52%
(v) Market Capitalization
Grape: (8.45 × 0.5) + (22 × 0.5) = 15.225%
Estimated Stock Price (₹) 14.30 15.95 15.73
Apple: (9.75 × 0.2) + (20 × 0.8) = 17.95%
No. of shares 6,100 8,300 10,000

Estimated Market Cap (₹) 87,230 1,32,385 1,57,300

14.6
 BUSINESS VALUATION

Question – 07 Question – 08
Herbal Gyan is a small but profitable producer of beauty cosmetics Constant Engineering Ltd. has developed a high tech product which
using the plant Aloe Vera. This is not a high-tech business, but has reduced the Carbon emission from the burning of the fossil fuel.
Herbal’s earnings have averaged around ₹ 12 lakh after tax, largely The product is in high demand. The product has been patented and
on the strength of its patented beauty cream for removing the has a market value of ₹ 100 Crore, which is not recorded in the books.
pimples. The Net Worth (NW) of Constant Engineering Ltd. is ₹ 200 Crore. Long
term debt is ₹ 400 Crore. The product generates a revenue of ₹ 84
The patent has eight years to run, and Herbal has been offered ₹ 40
Crore. The rate on 365 days Government bond is 10 percent per
lakhs for the patent rights. Herbal’s assets include ₹ 20 lakhs of annum. Market portfolio generates a return of 12 percent per annum.
working capital and ₹ 80 lakhs of property, plant, and equipment. The stock of the company moves in tandem with the market.
The patent is not shown on Herbal’s books. Suppose Herbal’s cost of Calculate Economic Value added of the company.
capital is 15 percent. What is its Economic Value Added (EVA)?
(SM TYK – 15) (SM TYK – 16 & Exam May – 2018) (5 Marks)

Solution: Solution:

EVA = Income earned – (Cost of capital × Total Investment) EVA = Income Earned – (Cost of Capital × Total Investment)

Total Investments Total Investments

Particulars Amount Amount ( ₹ Crore)

Working Capital ₹ 20 lakhs Net Worth 200.00
Property, Plant, and equipment ₹ 80 lakhs Long Term Debts 400.00
Patent rights ₹ 40 lakhs Patent Rights 100.00
Total ₹ 140 lakhs Total 700.00

E D
Cost of Capital 15% WACC (k 0 ) = ke × + kd ×
E+D E+D
EVA = ₹ 12 lakh – (0.15 × ₹ 140 lakhs) 300 400
= 12 × + 10 ×
700 700
= ₹ 12 lakh – ₹ 21 lakh
= 5.14% + 5.71%
= -₹ 9 lakh
= 10.85%
Thus, Herbal Gyan has a negative EVA of ₹ 9 lakhs.
EVA = Profit Earned – WACC × Invested Capital

14.7
 BUSINESS VALUATION

= ₹ 84 crore – 10.85% × ₹ 700 crore Kd = 12 (1 – 0.30)

= ₹ 8.05 crore = 8.40%

Question – 09 (800 × 8.45) + (100 × 8.40)

WACC =
Compute EVA of A Ltd. with the following information: 900

All Figure are in ₹ lac = 8.44%

Profit & Loss Statement Balance Sheet (2) NOPAT

Revenue 1,000 PPE 1,000
EBIT 410
Direct Costs -390 Current Assets 300
Selling, General &
(-)Tax @ 30% 123
Admin. Exp. (SGA) -200 1,300
EBIT 410 Equity 700 NOPAT 287
Interest -10 Reserves 100
EBT 400 Non-Current 100 (+) Provision 20
Tax Expense -120 Borrowings 400
EAT Current Liabilities & Adjusted NOPAT 307
280 Provisions 1,300
(3) Adjusted Capital Invested
Assume Bad Debts provision of ₹ 20 lac is included in the SGA, and
same amount is reduced from the trade receivables in current assets. Equity = 800

Also assume that the pre-tax Cost of Debt is 12%, Tax Rate is 30% Debt = 100
and Cost of Equity (i.e. shareholder’s expected return) is 8.45%. = 900
Solution: (+) Provision = 20
(1) WACC = 920
Equity (700 + 100) = 800 EVA = 307 – 920 × 8.44%
Debt = 100
= ₹ 229.35 lacs
= 900

Ke = 8.45%

14.8
 BUSINESS VALUATION

Solution:

PART II: VALUATION OF BUSINESS Working Note 1: WACC

Question – 10 High Growth Period

Following information are available in respect of XYZ Ltd. which is
expected to grow at a higher rate for 4 years after which growth rate Ke = 10 + 6 × 1.15 = 16.9%
will stabilize at a lower level: Kd = 13 (1 – 0.30) = 9.1%
Base year information: K0 = (16.9 × 0.5) + (9.1 × 0.5) = 13%
Revenue - ₹ 2,000 crores
EBIT - ₹ 300 crores Stable Growth Period
Capital expenditure - ₹ 280 crores
Ke =9+5×1 = 14%
Depreciation - ₹ 200 crores
Kd = 12.86 (1 – 0.30) = 9%
Information for high growth and stable growth period are as follows:
K0 = (14 × 3/5) + (8 × 2/5) = 12%
High Stable Growth
Growth Working Note 2: FCFF
Growth in Revenue & EBIT 20% 10%
1 2 3 4 5
Growth in Capital 20% Capital expenditure are
NOPAT = EBIT 252 302.40 362.88 435.456 479.00
Expenditure and Depreciation offset by depreciation (1 – t)
Risk Free Rate 10% 9% = 300
Equity Beta 1.15 1 (1 – 0.30)
Market Risk Premium 6% 5% = 210
Pre Tax Cost of Debt 13% 12.86% (-) [C.E – 96 115.20 138.24 165.89 -
Debt Equity Ratio 1:1 2:3 Depreciation] = 80
(-) ∆ in Working 100 120 144 172.80 103.68
For all time, working capital is 25% of revenue and corporate tax Capital (W.N. 3)
FCFF 56 67.20 80.64 96.766 375.32
rate is 30%. What is the value of the firm?
FCFF4
(SM TYK – 06 & MTP March – 2022) TV3 =
Ko – g

14.9
 BUSINESS VALUATION

375.32 incremental capital expenditure will be offset by the depreciation.

= = 18,766 Cr.
0.12 – 0.10 During both high growth & normal growth period, net working capital
requirement will be 25% of revenues.
VB (13%) = (56 × 0.885) + (67.20 × 0.783) + (80.64 × 0.693) +
(96.766 × 0.613) + (18,766 × 0.613) The Weighted Average Cost of Capital (WACC) of WXY Ltd. is 15%.
Corporate Income Tax rate will be 30%.
= 11,720.937 Cr.
Required:
Working Note 3: Change in Working Capital
Estimate the value of WXY Ltd. using Free Cash Flows to Firm (FCFF)
0 1 2 3 4 5 &WACC methodology.
Revenue 2,000 2,400 2,880 3,456 4,147.20 4,561.92
Working 500 600 720 864 1036.80 1140.48 The PVIF @ 15 % for the three years are as below:
Capital @
25% Year t1 t2 t3
∆ WC - 100 120 144 172.80 103.68 PVIF 0.8696 0.7561 0.6575

Question – 11 (SM TYK – 08)

Following information is given in respect of WXY Ltd., which is Solution:
expected to grow at a rate of 20% p.a. for the next three years, after Determination of forecasted Free Cash Flow of the Firm (FCFF)
which the growth rate will stabilize at 8% p.a. normal level, in (₹ in crores)
perpetuity. Yr. 1 Yr.2 Yr.3 Terminal
Year
For the year ended
Revenue 9000.00 10800.00 12960.00 13996.80
March 31, 2014
COGS 3600.00 4320.00 5184.00 5598.72
Revenues ₹ 7,500 Crores
Operating Expenses 1980.00 2376.00 2851.20 3079.30
Cost of Goods Sold (COGS) ₹ 3,000 Crores Depreciation 720.00 864.00 1036.80 1119.74
Operating Expenses ₹ 2,250 Crores EBIT 2700.00 3240.00 3888.00 4199.04
Capital Expenditure ₹ 750 Crores Tax @ 30% 810.00 972.00 1166.40 1259.71
Depreciation (included in Operating ₹ 600 Crores EAT 1890.00 2268.00 2721.60 2939.33
Expenses)
Capital Exp. – Dep. 172.50 198.38 228.60 -
∆ Working Capital 375.00 450.00 540.00 259.20
During high growth period, revenues & Earnings before Interest &
Free Cash Flow 1342.50 1619.62 1953.47 2680.13
Tax (EBIT) will grow at 20% p.a. and capital expenditure net of
(FCF)
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

14.10
 BUSINESS VALUATION

* Excluding Depreciation. Present Value (PV) of FCFF during the Solution:

explicit forecast period is:
Calculation of K0 [Book Value]
FCFF(₹ in crores) PVF @ 13% PV (₹ in crores)
Let assumed existing Ko be x
1342.50 0.8696 1167.44
1619.62 0.7561 1224.59 FCFF1
1953.47 0.6575 1284.41 VF =
Ko – g
3676.44
54
1,800 =
PV of the terminal, value is: x – 0.09

2,680.13 1 1,800 x – 162 = 54

× = ₹ 38,287.57 Crore × 0.6575 = ₹ 25,174.08 Crore
0.15 – 0.08 (1.15)3
54 + 162
x =
The value of the firm is : 1,800

₹ 3,676.44 Crores + ₹ 25,174.08 Crores = ₹ 28,850.52 Crores = 0.12 or 12%

Book Value Weights of Equity & Debt

Question – 12
The valuation of Hansel Limited has been done by an investment (Ke × WE ) + Kd × (1 – WE ) = 12
analyst. Based on an expected free cash flow of ₹ 54 lakhs for the
following year and an expected growth rate of 9 percent, the analyst 20 WE + 10 – 10 WE = 12
has estimated the value of Hansel Limited to be ₹ 1800 lakhs.
10 WE =2
However, he committed a mistake of using the book values of debt
and equity. WE = 2/10
The book value weights employed by the analyst are not known, but WE = 0.20
you know that Hansel Limited has a cost of equity of 20 percent and
post tax cost of debt of 10 percent. The value of equity is thrice its Wd = 0.8
book value, whereas the market value of its debt is nine-tenths of its
Market Value Weights of Equity & Debt
book value. What is the correct value of Hansel Ltd ?
(SM TYK – 06) Market value of equity = 0.2 × 3 = 0.6
9
Debt = 0.8 × = 0.72
10

14.11
 BUSINESS VALUATION

= 1.32 Depreciation 234.4 lakh

(20 × 0.6) + (10 × 0.72) Working capital 44 lakh

Ko =
1.32
Growth rate 8% (from 2010 to 2014)
= 14.545%
Growth rate 6% (beyond 2014)
Correct Value of Firm

54 Free cash flow 240.336 lakh (year 2014 onwards)

VF = = 973.83 lacs
0.14545 – 0.09
The capital expenditure is expected to be equally offset by
Question – 13 depreciation in future and the debt is expected to decline by 30% in
ABC (India) Ltd., a market leader in printing industry, is planning to 2014.
diversify into defense equipment businesses that have recently been
partially opened up by the GOI for private sector. In the meanwhile, Required:
the CEO of the company wants to get his company valued by a
Estimate the value of the company and ascertain whether the ruling
leading consultants, as he is not satisfied with the current market
market price is undervalued as felt by the CEO based on the
price of his scrip.
foregoing data. Assume that the cost of equity is 16%, and 30% of
He approached consultant with a request to take up valuation of his debt repayment is made in the year 2014.
company with the following data for the year ended 2009:
Solution:
Share Price ₹ 66 per share
As per Firm Cash Flow Approach
Outstanding debt 1934 lakh
(i) Computation of Tax Rate
Number of outstanding shares 75 lakh
EBIT = ₹ 245 lakh
Net income (PAT) 17.2 lakh
Interest = ₹ 218.125 lakh
EBIT 245 lakh
PBT = ₹ 26.875 lakh
Interest expenses 218.125 lakh
PAT = ₹ 17.2 lakh
Capital expenditure 234.4 lakh
Tax paid = ₹ 9.675 lakh

14.12
 BUSINESS VALUATION

Tax rate = ₹ 9.675 /26.875 Year 2010 2011 2012 2013 2014
₹ lakh ₹ ₹ lakh ₹ lakh ₹ lakh
= 0.36 =36% lakh
EBIT (1-t) 169.344 182.89 197.52 213.22 230.39
Increase 3.52 3.80 4.10 4.43 4.78
(ii) Computation for Increase in Working Capital working capital
Debt repayment - - - - 1934 ×
Working capital (2009) = ₹ 44 lakh 0.30 =
Free cash flows 165.824 179.09 193.41 208.89 580.2
Increase in 2010 = ₹ 44 × 0.08 PVF @ 13.54% 0.8807 0.7757 0.6832 0.6017 -354.59
PV of free cash 146.04 138.92 132.14 125.69 0.53
flow @ 13.54% -187.93
= ₹ 3.52 lakh
(vi) Cost of Capital (2014 Onwards)
It will continue to increase @ 8% per annum.
Debt = 0.7 × ₹ 1934 = ₹ 1,353.80 lakh
(iii) Weighted Average Cost of Capital
Equity = ₹ 4950 lakh
Present Debt = ₹ 1934 lakh
4,950 1,353.80
Interest Cost = ₹ 218.125 lakh/₹ 1934 Kc = × 16% + × 11.28(1−0.36)
4,950 + 1,353.80 4,950 + 1,353.80

= 11.28 % = 12.56 + 1.55%

Equity Capital = 75 lakh × ₹ 66 = 14.11%

= ₹ 4950 lakh (vii) Continuing Value

4,950 1,934 240.336

Kc = × 16% + × 11.28(1−0.36) × (1/1.1354)5
1,934 + 4,950 1,934 + 4,950 0.1411 – 0.06

= 11.51 + 2.028 = 13.54 = ₹ 1,570.556 lakh

(iv) As capital expenditure and depreciation are equal, they will (a) Value of the firm
not influence the free cash flows of the company.
= PV of free cash flows upto 2014 + continuing value
(v) Computation of Free Cash Flows upto 2012
= ₹ 354.86 lakh + ₹ 1,570.556 lakh

14.13
 BUSINESS VALUATION

= ₹ 1,925.416 lakh Solution:

(b) Value per share (i) Computation of Business Value

= (Value of Firm – Value of Debt)/Number of Shares (₹ Lakhs)

77
Profit before tax
= (₹ 1,925.416 lakh – ₹ 1,353.80 lakh)/75 lakh 1 – 0.30 110
Less: Extraordinary income (8)
= ₹ 7.622 < ₹ 66 (present market price) Add: Extraordinary losses 10
112
Question – 14
Profit from new product (₹ Lakhs)
Eagle Ltd. reported a profit of ₹ 77 lakhs after 30% tax for the Sales 70
financial year 2011-12. An analysis of the accounts revealed that the Less: Material costs 20
income included extraordinary items of ₹ 8 lakhs and an Labour costs 12
extraordinary loss of ₹10 lakhs. The existing operations, except for Fixed costs 10 (42) 28
the extraordinary items, are expected to continue in the future. In 140.00
addition, the results of the launch of a new product are expected to Less: Taxes @ 30% 42.00
be as follows: Future Maintainable Profit after taxes 98.00
Relevant Capitalization Factor 0.14
₹ In Laksh
Value of Business (₹ 98/0.14) 700
Sales 70
Material Cost 20 (ii) Determination of Market Price of Equity Share
Labour Cost 12
Fixed Cost 10
Future maintainable profits (After Tax) ₹ 98,00,000
Less: Preference share dividends 1,00,000 ₹ 13,00,000
You are required to:
shares of ₹ 100 @ 13%
(i) Calculate the value of the business, given that the
Earnings available for Equity Shareholders ₹ 85,00,000
capitalization rate is 14%.
No. of Equity Shares 50,00,000
₹ 85,00,000
(ii) Determine the market price per equity share, with Eagle Ltd.‘s Earning per share = = ₹ 1.70
50,00,000
share capital being comprised of 1,00,000 13% preference
PE Ratio
shares of ₹ 100 each and 50,00,000 equity shares of ₹ 10 each 10
Market price per share
and the P/E ratio being 10 times. ₹ 17

(SM TYK – 02)

14.14
 BUSINESS VALUATION

Question – 15 (d) ₹ 450 crore + ₹ 200 crore − ₹ 50 crore = ₹ 600 crore

Sun Ltd. recently made a profit of ₹ 200 crore and paid out ₹ 80 crore
(slightly higher than the average paid in the industry to which it
pertains). The average PE ratio of this industry is 9. The estimated Question – 16
beta of Sun Ltd. is 1.2. As per Balance Sheet of Sun Ltd., the ABC Co. is considering a new sales strategy that will be valid for the
shareholder’s fund is ₹ 450 crore and number of shares is 10 crore. next 4 years. They want to know the value of the new strategy.
In case the company is liquidated, building would fetch ₹ 200 crore Following information relating to the year which has just ended, is
available:
more than book value and stock would realize ₹ 50 crore less.
The other data for the industry is as follows: Income Statement ₹
Projected Dividend Growth 4% Sales 20,000
Gross margin (20%) 4,000
Risk Free Rate of Return 6% Administration, Selling & distribution expense (10%) 2,000
PBT 2,000
Market Rate of Return 11% Tax (30%) 600
Calculate the valuation of Sun Ltd. using PAT 1,400
Balance Sheet Information
(a) P/E Ratio Fixed Assets 8,000
Current Assets 4,000
(b) Dividend Growth Model Equity 12,000
(c) Book Value
If it adopts the new strategy, sales will grow at the rate of 20% per
(d) Net Realizable Value
year for three years. From 4th year onward Cash Flow will be
(RTP May – 2021) stabilized. The gross margin ratio, Assets turnover ratio, the Capital
structure and the income tax rate will remain unchanged.
Solution:
Depreciation would be at 10% of net fixed assets at the beginning of
(a) ₹ 200 crore × 9 = ₹ 1800 crore the year.

(b) Ke = 6% + 1.2 (11% − 6%) = 12% The Company’s target rate of return is 15%.
80 Crore × 1.04
= = ₹ 1,040 crore Determine the incremental value due to adoption of the strategy.
0.12 − 0.04

(c) ₹ 450 crore (SM TYK – 03 & RTP May – 2020)

14.15
 BUSINESS VALUATION

(-) Capital 2,400 2,880 3,456 1,382

Expenditure
Solution: (-) ∆ Working 800 960 1,152 0
Capital
Pre-Strategy Value FCFF - 720 - 864 -1,037 2,419
1,400 Cr. 2,419
Pre-Strategic Value = = ₹ 9,333 Cr. TV3 = = 16,127
15% 15%

Post-Strategic Value VB = (-720 × 0.870) + (-864 × 0.756) + (-1,037 × 0.658) + (-

16,127 × 0.658)
Projected B/s
= ₹ 8,650
1 2 3 4
FA (8,000) 9,600 11,520 13,824 13,824
Value of Strategy
CA (4,000) 4,800 5,760 6,912 6,912
Total Asset 14,400 17,280 20,736 20,736 = 8,650 – 9,333
Equity 14,400 17,280 20,736 20,736
= - 683
Working Note 1:
Not financed viable.
Calculation of Depreciation
Question – 17
1 2 3 4 Following details are available for X Ltd.
Opening WDV 8,000 9,600 11,520 13,824
(-) Depreciation 800 960 1,152 1,382 Income Statement for the year ended 31st March, 2018
Balance 7,200 8,640 10,368 12,442
(-) Closing WDV 9,600 11,520 13,824 13,824 Particulars Amount
Capital 2,400 1,880 3,456 1,382 Sales 40,000
Expenditure Gross Profit 12,000
Administrative Expenses 6,000
FCFF
Profit Before tax 6,000
1 2 3 4 Tax @ 30% 1,800
PAT (1,400) 1,680 2,016 2,419 2,419 Profit After Tax 4,200
(+) Depreciation 800 960 1,152 1,382
CFAT 2,480 2,976 3,571 3,801 Balance sheet as on 31st March, 2018

14.16
 BUSINESS VALUATION

Particulars Amount Equity (37.5% of 19,500 25,350 32,955 42,841.50 42,841.50

Fixed Assets 10,000 sales)
Current Assets 6,000 Sundry 1,300 1,690 2,197 2,856.10 2,856.10
Total Assets 16,000 Creditors (2.5%
Equity Share Capital 15,000 of Sales)
Sundry Creditors 1,000 Total Liabilities 20,800 27,040 35,152 45,697.60 45,697.60
Total Liabilities 16,000
Projected Cash Flows:-
The Company is contemplating for new sales strategy as follows :
Year Year 2 Year 3 Year 4 Year 5
1
(i) Sales to grow at 30% per year for next four years.
Sales 52,000 67,600 87,880.00 1,14,244.00 1,14,244.00
(ii) Assets turnover ratio, net profit ratio and tax rate will remain PBT (15% of sales) 7,800 10,140 13,182.00 17,136.60 17,136.60
PAT (10.5% of sales) 5,460 7,098 9,227.40 11,995.62 11,995.62
the same.
Depreciation 1,500 1,950 2,535.00 3,295.50 4,284.15
(iii) Depreciation will be 15% of value of net fixed assets at the Addition to Fixed 4,500 5,850 7,605.00 9,886.50 4,284.15
beginning of the year. Assets
increase in Net 1,500 1,950 2,535.00 3,295.50 --
(iv) Required rate of return for the company is 15% Current Assets
Operating cash flow 960 1,248 1,622.40 2,109.12 11,995.62
Evaluate the viability of new strategy

(Exam November – 2018) (12 Marks) Projected Cash Flows:-

Solution: Present value of Projected Cash Flows:-

Projected Cash Flows PVF at 15% PV

Balance Sheet 960 0.870 835.20
Year 1 Year 2 Year 3 Year 4 Year 5 1248 0.756 943.49
Fixed Assets 13,000 16,900 21,970 28,561.00 28,561.00 1622.40 0.658 1067.54
(25% of Sales) 2109.12 0.572 1206.42
Current Assets 7,800 10,140 13,182 17,136.00 17,136.00 4,052.65
(15% of Sales)
Residual Value = 11,995.62/0.15
Total Assets 20,800 27,040 35,152 45,697.60 45,679.60
= 79,970.80

14.17
 BUSINESS VALUATION

Present value of Residual value = 79,970.80 × PVF (15%, 4) (iv) Market to Net Income

= 79,970.80 × 0.572 The following data are available for your analysis:

= 45,743.30 (Amount in ₹)

Total shareholders’ value = 45743.30 + 4052.65 SK Ltd AS Ltd. XY Ltd.

Market Value 450 400
= 49795.95
Book Value 400 300 250
Pre-strategy value = 4200/0.15 Replacement Cost 600 550 500
Sales 550 450 500
= 28,000 Net Income 18 16 14

 Value of strategy = 49795.95 – 28,000 (Exam November – 2019) (5 Marks)

= 21795.95 Solution:
Conclusion: The strategy is financially viable. Estimation of Reties

Sl. Particulars SK Ltd AS Ltd. Average

COMPARABLE METHOD No.
(i) Market to Book Value 450 400 1.2290
( ) = 1.125 ( ) = 1.333
400 300
Question – 18 450 450
(ii) Market to (600) = 0.750 (550) = 0.727 0.7385
XY Ltd., a Cement manufacturing Company has hired you as a
Replacement Cost
financial consultant of the company. The Cement Industry has been 450 400
(iii) Market to Sales (550) = 0.818 (450) = 0.889 0.8535
very stable for some time and the cement companies SK Ltd. & AS
Ltd. are similar in size and have similar product market mix (iv) Market to Net Income 450 400 25
( 18 ) = 25 ( 16 ) = 25
characteristic. Use comparable method to value the equity of XY Ltd.
In performing analysis, use the following ratios: Application of Ratios to XY Ltd.
(i) Market to book value Sl. Particulars XY Ltd. Average Indicative Value of
No (₹) XY Ltd. (₹)
(ii) Market to replacement cost

(iii) Market to sales (i) Book Value 250 1.2290 250 × 1.2290 = 307.25
(ii) 500 0.7385 500 × 0.7385= 369.25

14.18
 BUSINESS VALUATION

(iii) Replacement 500 0.8535 500 × 0.8535= 426.75 Wholesale 0.85 0.7 9
(iv) Cost 14 25 14 × 25 = 350.00 Retail 1.2 0.7 8
Sales General 0.8 0.7 4
Net Income
Average ₹ 363.31 Solution:

Business Capital-to- Segment Theoretical

Value of XY Ltd. according to the comparable method is ₹ 363.31 Segment Sales Sales Values
Wholesale 0.85 €2,25,000 € 1,91,250
CHOP SHOP APPROACH OR BREAKUP VALUE Retail 1.2 €7,20,000 € 8,64,000
General 0.8 € 25,00,000 € 20,00,000
APPROACH
Total Value € 30,55,250
Question – 19
Using the chop-shop approach (or Break-up value approach), assign Business Capital-to- Segment Theoretical
a value for Cranberry Ltd. whose stock is currently trading at a total Segment Assets Assets Values
market price of €4 million. For Cranberry Ltd, the accounting data Wholesale 0.7 € 6,00,000 € 4,20,000
set forth three business segments: consumer wholesale, retail and Retail 0.7 € 5,00,000 € 3,50,000
general centers. Data for the firm’s three segments are as follows: General 0.7 € 40,00,000 € 28,00,000
Total Value € 35,70,000
Business Segment Segment Segment
Segment Sales Assets Operating
Income
Business Capital-to Operating Theoretical
Wholesale €225,000 €600,000 €75,000
Segment Operating Income Values
Retail €720,000 €500,000 €150,000
Income
General € 2,500,000 €4,000,000 €700,000
Wholesale 9 € 75,000 € 6,75,000
Industry data for “pure-play” firms have been compiled and are Retail 8 € 1,50,000 € 12,00,000
summarized as follows: General 4 € 7,00,000 € 28,00,000
Total Value € 46,75,000
Business Capitalizati Capitalizati Capitalization/
Segment on/Sales on/Assets Operating 30,55,250 + 35,70,000 + 4,67,500
Average theoretical value = = 37,66,750
3
Income
Average theoretical value of Cranberry Ltd. = €37,66,750

14.19
 BUSINESS VALUATION
290
EPS = = ₹ 8.923
FCFE APPROACH 32.50

Calculation of FCFE per shares

Question – 20
EPS = 8.923
Calculate the value of share from the following information:
(-) Capital expenditure per share (Net of Depreciation)
Profit after tax of the company ₹ 290 crores
Only equity contribution
Equity capital of company ₹ 1,300 crores (47 – 39) (1 – 0.27) = ₹ 5.84

Par value of share ₹ 40 each (-) ∆ WC = 3.45 (1 – 0.27) = ₹ 2.5185

Debt ratio of company (Debt/ Debt + Equity) 27% FCFE per share = 0.5645
FCFE1
Long run growth rate of the company 8% Value of equity per share =
Ke – g

Beta 0.1; risk free interest rate 8.7%

Ke = 8.7 + (10.3 – 8.7) 0.1
Market returns 10.3% = 8.86%
Capital expenditure per share ₹ 47 0.5645 (1.08)
Value per share =
0.0886 – 0.08
Depreciation per share ₹ 39
= ₹ 70.89
Change in Working capital ₹ 3.45 per share
Question – 21
(RTP May – 2020) Calculate the value of one equity share of X Ltd. from the following
Solution: information:

(FCFE Approach) Profit of the company (Before Tax) ₹ 8,000 crores

Equity share capital of the company ₹ 19,000 crores
PAT = 290 No. of equity shares 380 crores
Long run growth rate of the company 7%
1,300 Risk free rate of return 9.50%
No. of shares = = 32.50 Cr.
40 Beta of the company 0.1
Market risk premium 3.10%

14.20
 BUSINESS VALUATION

Total capital expenditure ₹ 20,140 crores = 9.50% + 0.1 × 3.10%

Chargeable depreciation ₹ 17,100 crores
Total increase in working capital ₹ 1,755.60 crores = 9.81%
New debt to be issued for funding ₹ 2,062.108
FCFE (1 + g)
crores Value of Equity =
Ke − g
Tax rate 30%
2,866.508 crore (1.07)
Note: All calculation to rounded off upto 4 decimal points and final =
0.0981 − 0.07
value of equity share to be rounded off upto 2 decimal points.
3,067.1636 crore
(MTP October – 2024) =
0.0281

Solution: = ₹ 1,09,151.7295 crore

Profit After Tax (PAT) or Net Income 1,09,151.7295 crore

Value of One Equity Share =
380 crore
= ₹ 8,000 crores (1 – 0.30)
= ₹ 287.24
= ₹ 5,600 crores
Alternatively, it can also be calculated by using per share basis as
Free Cash Flow to Equity (FCFE) follows:

= Net Income – Capital Expenditures + Depreciation -/+ Change in FCFE

FCFE per share =
Net Working Capital + New Debt Issued - Debt Repayments + Net No. of Equity Shares
issue of Preference Shares – Preference Share Dividends
2,866.508 crore
Free Cash Flow to Equity (FCFE)
= = ₹ 7.5434
380 crore

= ₹ 5,600 crores − ₹ 20,140 crore + ₹ 17,100 crore − ₹ 1,755.60 FCFE (1 + g)

Value of per Equity Share =
crore + ₹ 2,062.108 crore Ke − g

= ₹ 2,866.508 crore 7.5434(1.07)

=
0.0981 – 0.07
Cost of Equity
8.0714
=
= Rf + β (Rm – Rf) or Rf + β Market Risk Premium 0.0281

= ₹ 287.24

14.21
 BUSINESS VALUATION

Question − 22 Calculation up to 2 decimal points.

ABC Ltd’s share is currently traded at the price of ₹ 192.50 per share.
Mr. Roni is planning to purchase the shares of the company. For this (Exam September – 2025)
purpose, he has taken the services of a financial analyst to know Solution:
whether the price of ABC Ltd. is fairly priced. The analyst has
assembled the following information: Working Notes:

● The before-tax required rates of return on ABC Ltd. debt, (I) Calculation of WACC
preferred stock, and common stock are 8.60%, 11%, and 13%,
respectively. = 8.60% (1 – 0.30) × 20% + 11% × 30% + 13% × 50%

● The company’s target capital structure is 20% debt, 30% = 1.20% + 3.30% + 6.50% = 11%
preferred stock and 50% Common stock. (II) Value of Firm Based on FCFF
● The market value of the company’s debt is ₹ 275 million and ₹ 125 Millions (1.08) ₹ 135 Million
its preferred stock are valued at 120 million. = = = ₹ 4500 Million
0.11 − 0.08 0.03

● ABC Ltd’s free cash flow to the firm (FCFF) for the year just (i) To decide whether the value of share is justified let us
ended is ₹ 125 million. FCFF is expected to grow at a constant compute the value per share based on FCFF as follows:
rate of 8% for the foreseeable future.
Value of Firm ₹ 4500
● The tax rate is 30%. Less: Value of Company’s Debt Million
Less: Value of Company’s ₹ 275 Million
● ABC Ltd. has 20 million outstanding common shares. Preferred Stock ₹ 120 Million
Value of Equity Shares ₹ 4105
You are required to — No. of Equity Shares Million
Value of Per Equity Share 20 Million
(i) As a financial analyst, on the basis of value per share, advise ₹ 205.25
Mr. Roni whether he should purchase the shares of the
company at market price or not. Advise: Mr. Roni should purchase share at this price
as it is underpriced.
(ii) Assume, we are to get same value of equity as calculated in (i)
for using FCFE approach, calculate free cash flow to the equity (ii) Computation of Free Cash Flow to Equity
(FCFE) for the year just ended, if FCFE is expected to grow at
a constant rate of 8.50% for the foreseeable future. Value of one Equity Share as per FCFF ₹ 205.25

14.22
 BUSINESS VALUATION

Accordingly, by using Growth Model formula we can You are required to work out the value of the Company's, shares on
find the FCFE per share as follows: the basis of Net Assets method and Profit-earning capacity
(capitalization) method and arrive at the fair price of the shares, by
FCFF (1.085)
205.25 = considering the following information:
0.13 − 0.085
(i) Profit for the current year ₹ 64 lakhs includes ₹4 lakhs
FCFE per share = ₹ 8.51
extraordinary income and ₹ 1 lakh income from investments
No. of Equity Shares outstanding = 20 million of surplus funds; such surplus funds are unlikely to recur.

FCFE of the ABC Ltd. shall be (ii) In subsequent years, additional advertisement expenses of ₹
₹ 8.51 × 20 million = ₹ 170.20 million 5 lakhs are expected to be incurred each year.

Alternatively, this calculation can be made on the total (iii) Market value of Land and Building and Plant and Machinery
capital instead of per share basis as follows: have been ascertained at ₹ 96 lakhs and ₹ 100 lakhs
respectively. This will entail additional depreciation of ₹ 6
FCFF (1.085)
4,105 = lakhs each year.
0.13 − 0.085
(iv) Effective Income-tax rate is 30%.
FCFE = ₹ 170.25 million
(v) The capitalization rate applicable to similar businesses is
MISCELLANEOUS 15%.

Solution:
Question – 23
Given below is the Balance Sheet of S Ltd. as on 31.3.2008: ₹ lakh
Net Assets Method
Liabilities ₹ (in lakh) Assets ₹ (in lakh)
Assets: Land & Buildings 96
Share capital Land and building 40
Plant & Machinery 100
(share of ₹ 10) 100 Plant and 80
Investments 10
Reserves and 40 machinery 10
Stocks 20
surplus 30 Investments 20
Debtors 15
Long Term Debts Stock 15
Cash & Bank 5
170 Debtors 5
Total Assets 246
Cash at bank 170
Less: Long Term Debts 30
Net Assets 216

14.23
 BUSINESS VALUATION

Value per share 21.60 + 19.40 41.00 ₹ 20.50

Fair Price = =
1,00,00,000 2 2
(a) Number of shares 10
= 10,00,000
2,16,00,000
(b) Net Assets = ₹ 21.6 Question – 24
10,00,000
You are interested in buying some equity stocks of RK Ltd. The
company has 3 divisions operating in different industries. Division A
Profit-earning Capacity Method ₹ lakh captures 10% of its industries sales which is forecasted to be ₹ 50
Profit before tax 64.00 crore for the industry. Division B and C captures 30% and 2% of their
Less: Extraordinary income 4.00 respective industry's sales, which are expected to be ₹ 20 crore and
Investment income (not likely to recur) 1.00 5.00 ₹ 8.5 crore respectively. Division A traditionally had a 5% net income
59.00 margin, whereas divisions B and C had 8% and 10% net income
Less: Additional expenses in forthcoming margin respectively. RK Ltd. has 3,00,000 shares of equity stock
years outstanding, which sell at ₹ 250.
Advertisement 5.00
Depreciation 6.00 11.00 The company has not paid dividend since it started its business 10
Expected earnings before taxes 48.00 years ago. However from the market sources you come to know that
Less: Income-tax @ 30% 14.40 RK Ltd. will start paying dividend in 3 years time and the pay-out
Future maintainable profits (after taxes) 33.60 ratio is 30%. Expecting this dividend, you would like to hold the stock
for 5 year. By analyzing the past financial statements, you have
Value of business determined that RK Ltd.'s required rate of return is 18% and that
P/E ratio of 10 for the next year and on ending P/E ratio of 20 at the
33.60
Capitalization factor = 224 end of the fifth year are appropriate.
0.15

Less: Long term Debts 30 194 Required:

1,94,00,000 (i) Would you purchase RK Ltd. equity at this time based on your
Value per share ₹ 19.40
10,00,000 one year forecast?

Fair Price of Share ₹ (ii) If you expect earnings to grow @ 15% continuously, how much
Value as per Net Assets Method 21.60 are you willing to pay for the stock of RK Ltd ?

Value as per Profit earning capacity (Capitalization) 19.40 Ignore taxation.

method PV factors are given below :

14.24
 BUSINESS VALUATION

Years 1 2 3 4 5 Year EPS (₹) Dividend PVF@18% PV (₹)

PVIF@ 18% 0.847 0.718 0.609 0.516 0.437 (₹)
1 28.64 --- 0.847 ---
(Exam November – 2019 & MTP March – 2021) 2 32.93 --- 0.718 ---
3 37.87 11.36 0.609 6.92
Solution:
4 43.55 13.07 0.516 6.74
Working Notes: 5 50.08 15.02 0.437 6.56
20.22
Computation of Earnings per Share (EPS)
15.02 (1.15)
Share Price after 5 years = = ₹ 575.77
Particulars Amount (₹) 0.18 – 0.15
Margin of Division A (₹ 50 crore × 10% × 5%) 25,00,000
PV of the Market Price after 5 years = ₹ 575.77 × 0.437 = ₹
Margin of Division B (₹ 20 crore × 30% × 8%) 48,00,000
251.61
Margin of Division C (₹ 8.5 crore × 2% × 10%) 1,70,000
74,70,000 Total PV of Inflows = ₹ 20.22 + ₹ 251.61 = ₹ 271.83
No. of Equity Shares 3,00,000
EPS ₹ 24.90 Thus, the maximum price I would be willing to pay for the
share shall be ₹ 271.83.
(i) Market Price based on One Year Forecast
Question – 25
Expected Market Price at the end of the year = ₹ 24.90 × 10 There is a privately held company X Pvt. Ltd. that is operating into
= ₹ 249 the detail space, and is now scouting for angel investors. The
unleveraged beta based on the industry in which it operates is 1.8,
PV of the Expected Price = ₹ 249 × 0.847 = ₹ 210.90 and the average debt to equity ratio of X Pvt. Ltd. is hovering at 40:60.
I would NOT like to purchase the share as the expected The rate of return provided by risk free GOI Bonds is 5%. The rate of
market return for the industry is 11%. The FCFs for the next 3 years
market price of shares is less than its current price of ₹ 250.
are as follows:
(ii) If Earning is expected to grow @ 15%
Year 1 Year 2 Year 3
Free Cash Flows (₹ Crores) 10 12 15

The pre-tax cost of debt is 12%. Assume a tax regime of 30%.

14.25
 BUSINESS VALUATION

Determine the potential value to be placed for X Pvt. Ltd. based on Year 1 Year 2 Year 3
above-mentioned FCFs. Free Cash Flows 10 12 15
Discount Factor 0.863 0.745 0.643
Note: Use PVF and round off calculations upto 3 decimal points. PVs of Cash Flows 8.63 8.94 9.645
Value of X Pvt. Ltd. (₹ 27.215
(MTP September – 2024) Crores)

Solution:

To compute the value of A Ltd. first, we shall calculate WACC of the

PART III: GEARING OF BETA
company. Since its share is not trading in the market, we shall use
proxy beta to calculate the cost of equity. Since the unlevered beta of
the industry is 1.8 the levered beta of the company will be:
Question – 26
= 1.8[1 + (1 – 0.3)*40/60)] The total market value of the equity share of O.R.E. company is ₹
60,00,000 and the total value of the debts is ₹ 40,00,000. The
= 2.64 treasure estimate that the beta of the stock is currently 1.5 and that
the expected risk premium on the market is 10%. The treasury bill
The Cost of equity in accordance with CAPM rate is 8%.

= r (f) + β (Rm – Rf) Required:

= 5% + 2.64 (11% – 5%) (1) What is the beta of the company’s existing portfolio of assets?

= 20.84% (2) Estimate the company’s cost of capital and the discount rate
for an expansion of the company’s business.
The WACC = Cost of Equity + Cost of Debt
Solution:
= 20.84 (60/100) + 12.0 (1 – 0.3) (40/100)
(1) Asset Beta
= 15.864 E
BA = BE ×
E+D
Finally, the free cash flows can be discounted at the WACC obtained
above as under – 60,00,000
= 1.5 ×
1,00,00,000

14.26
 BUSINESS VALUATION

= 0.9
Solution:
(2) Cost of Capital
KGF Ltd. [E 410 + D 170] = ₹ 580 Cr.
Ke = Rf + MRP × BE
BD = 0.24
= 8 + 10 × 1.5 = 23%
Printer (74%) SCD (26%)
Kd = Rf = 8%
BP = 1.45 BP = 1.20
(60,00,000 × 23) + (40,00,000 × 8)
WACC =
1,00,00,000 BA of KGF Ltd.

= 17% BA = (1.45 × 74%) + ( 1.20 × 26%)

If company expand same business with same risk then = 1.385

discount rate 17% should be used.
(i) Equity Beta of KGFL
Question – 27
E D
Equity of KGF Ltd. (KGFL) is ₹ 410 Crores, its debt, is worth ₹ 170 BA = (BE × ) + (BD × )
E+D E+D
Crores. Printer Division segments value is attributable to 74%, which
410 170
has an Asset Beta (βp) of 1.45, balance value is applied on Spares 1.385 = (BE × 580) + (0.24 × 580)
and Consumables Division, which has an Asset Beta (βsc) of 1.20
KGFL Debt beta (βD) is 0.24. 1.385 = 0.7069 BE + 0.0703
1.385 – 0.0703
You are required to calculate: BE = 0.7069

(i) Equity Beta (βE), = 1.86

(ii) Ascertain Equity Beta (βE), if KGF Ltd. decides to change its (ii) BE of KGF Ltd.
Debt Equity position by raising further debt and buying back
of equity to have its Debt Equity Ratio at 1.90. Assume that 1
Equity = 580 Cr. × 2.9
the present Debt Beta (βD1) is 0.35 and any further funds
raised by way of Debt will have a Beta (βD2) of 0.40. = 200 Cr.

(iii) Whether the new Equity Beta (βE) justifies increase in the 1.9
Debt = 580 Cr. × 2.9
value of equity on account of leverage?

14.27
 BUSINESS VALUATION

= 380 Cr. * Capital Structure: Debt-to-Equity Ratio of 30:70

Present Debt = 170 * Risk-Free Rate: 6% (based on liquid bonds).

BD = 0.35 * Market Rate of Return: 12% (internal industry assement).

Further Debt = 210
* Equity Value (EV): The EV is to be taken at a multiple of 8 on
BD = 0.40 EBITDA.

200 170 210

1.385 = (BE × 580) + (0.35 × 580) + (0.40 × 580) * The pre-tax cost of debt is 12.45% and assume a tax regime
of 30%
1.385 = 0.3448 BE + 0.1026 + 0.1448
The Future Cash Flows (FCFs) for the next three years are as follows
1.385 – 0.1026 – 0.1448
BE = Year 1 Year 2 Year 3
0.3448
Future cash flows (₹ in 150 200 220
= 3.299 Lakh)
(iii) Since BE increased due to increase in debt, hence risk of equity Future cash flows are discounted at Weighted Average Cost of
also increase. Capital (WACC)
Question – 28
PV Factor at 15% & 14% are as under-
ZIO is a small-to-medium-sized privately held company specializing
in electrical equipment manufacturing and is seeking additional
1 2 3
investors. Below are key financial indicators to assist in evaluating
PV Factor at 15% 0.870 0.756 0.658
the investment potential:
PV Factor at 14% 0.877 0.769 0.675
* Break-even Achieved: The Company has reached its break-
Calculation upto 2 decimal places.
even point this year.

* EBITA: ₹ 110 Lakh, including an extraordinary gain of ₹ 16 Y1 Y2 Y3

Lakh. Future Cash Flows 100 120 150

You are required to calculate potential value to be placed on

* Pending Adjustments: ₹ 38 Lakh in preliminary sales
ZIO Company.
promotion costs are yet to be written off.
(Exam May – 2025) (7 Marks)
* Unlevered Beta: 1.5 (based on the industry benchmark).

14.28
 BUSINESS VALUATION

Solution: The company has achieved break even this year and has an EBITDA
of ₹ 90 crore. The unleveraged beta based on the industry in which
The levered beta of the company will be it operates is 1.8, and the average debt to equity ratio is hovering at
1.5[1 + (1 – 0.3) × 30/70)] = 1.95 40:60. The rate of return provided by risk free liquid bonds is 5%.
The EV is to be taken at a multiple of 5 on EBITDA. The accountant
The adjusted EBITDA would be has informed that the EBITDA of ₹ 90 crore includes an extraordinary
gain of ₹ 10 crore for the year, and a potential write off of preliminary
₹ 110 Lakh – ₹ 16 Lakh – ₹ 38 Lakh = ₹ 56 Lakh
sales promotion costs of ₹ 20 crore are still pending. The internal
The EV will be multiple of 8 on the ₹ 56 Lakh obtained above = ₹ 448 assessment of rate of market return for the industry is 11%. The
Lakh FCFs for the next 3 years are as follows:

The Cost of equity in accordance with CAPM = Rf + β (Rm – Rf) (₹ crore)

= 6% + 1.95 (12% - 6%) = 17.70% The post-tax cost of debt is 8.40%. Assume a tax regime of 30%.

The WACC = Cost of Equity + Cost of Debt What is the potential value to be placed on X Pvt. Ltd?
= 17.70 (70/100) + 12.45 (1-0.3) (30/100) Note: While PV Factors values to be rounded off to 3 decimal points
the other calculations to be rounded off to 2 decimal points.
= 15.00%

Finally, the future cash flows can be discounted at the WACC

(MTP March – 2025)
obtained above as under –
Solution:
Y1 Y2 Y3
Future Cash Flows 150 200 220 The levered beta of the company will be 1.8 [1 + (1 − 0.3) × 40/60)]
Discount Factor 0.870 0.756 0.658
= 2.64
PVs of Cash Flows 130.50 151.20 144.76
Value of the Firm 426.46 The adjusted EBITDA would be ₹ 90 crore – ₹ 10 crore – ₹ 20 crore =
₹ 60 crore
Question – 29
There is a privately held company X Pvt. Ltd that is operating into The EV will be multiple of 5 on the 60 obtained above = ₹ 300 crore
the retail space, and is now scouting for angel investors. The details
pertinent to valuing X Pvt. Ltd are as follows – The Cost of equity in accordance with CAPM

= Rf + β (Rm – Rf)

14.29
 BUSINESS VALUATION

= 5% + 2.64 (11% − 5%) = 20.84% XYZ ABC Proxy entity

for KLM in
The WACC = Cost of Equity + Cost of Debt the same
line of
= 20.84 (60/100) + 8.40 (40/100) = 15.864 business
No. of shares 100 80 ---
Finally, the future cash flows can be discounted at the WACC Current share price lakhs lakhs ---
obtained above as under – Dividend pay out ₹ 287 ₹ 375 50%
Debt: Equity at 40% 50% 1:4
Y1 Y2 Y3 market values 1:2 1:3 12
Future Cash flows (₹ crore) 100 120 150 P/E ratio 10 13 1:1
Discount factor (₹ crore) 0.863 0.745 0.643 Equity beta 1 1:1
PVs of cash flows (₹ crore) 86.30 89.40 96.45
Value of Firm (₹ crore) 272.15 Assume that gearing level of KLM to be the same as for ABC
and a debt beta is zero.
Question – 30
ABC, a large business house is planning to sell its wholly owned You are required :
subsidiary KLM. Another large business entity XYZ has expressed its
(a) To calculate appropriate cost of equity for KLM based
interest in making a bid for KLM. XYZ expects that after acquisition
on the data available for the proxy entity.
the annual earning of KLM will increase by 10%.
(b) A range of values for KLM both before and after any
Following information, ignoring any potential synergistic benefits
potential synergistic benefits to XYZ of the acquisition.
arising out of possible acquisitions, are available:
(c) Compute the market value of KLM as a part of ABC.
(i) Profit after tax for KLM for the financial year which has just
ended is estimated to be ₹ 10 crore. Note: Round off calculation up to 2 decimal and compute
figure in ₹ crores.
(ii) KLM's after-tax profit has an increasing trend of 7% each year
and the same is expected to continue. (RTP May – 2025)
(iii) Estimated post tax market return is 10% and risk-free rate is Solution:
4%. These rates are expected to continue.
(a) To calculate cost of equity for KLM first we shall calculate β of
(iv) Corporate tax rate is 30%. KLM as follows:

β (equity un-geared for the proxy company)

14.30
 BUSINESS VALUATION

= 1.1 × 4/[4 + (1 – 0.3)] = 0.94 P/E Based Dividend Based

Pre synergistic ₹ 100 Crore ₹ 135.10
0.94 = β equity geared × 3/ [3 + (1 − 0.3)] Post synergistic ₹ 110 Crore ₹ 148.61
β equity geared = 1.16 (c) Market Price
Cost of equity = 0.04 + 1.16 × (0.10 – 0.04) Although no information is available about the value of KLM,
it may be possible to calculate a market value based on
= 10.96%
proportion of earnings of ABC that is generated by KLM.
(b) Based on the data available range of valuation can be
Market value of ABC = 80 Lakh Shares × ₹ 375 = ₹ 300 Crore
computed using P/E and dividend-based valuation approach.

(i) P/E valuation (Based on earning of ₹ 10 Crore) Post−tax earnings of ABC = ₹ 300 crore/13 = ₹ 23.08 Crore

If market value of ABC is allocated to KLM in the proportion

Using proxy Using XYZ’s P/E
entity’s P/E of relative earning of KLM to that of ABC, KLM would have a
Pre synergistic = 12 ×₹ 10 Crore = 10 ×₹ 10 Crore market value of ₹ 300 crore × [ 10/23.08] = ₹ 129.98 Crore.
value = ₹ 120 Crore = ₹ 100 Crore
Post synergistic = 12 ×₹ 10 Crore = 10 ×₹ 10 Crore KLM’s Post Tax earning = ₹ 10 Crore.
value × 1.1 × 1.1
If ABC’s P/E ratio is applied to it, the market value of KLM
= ₹ 132 Crore = ₹ 110 Crore
becomes ₹ 10 Crore × 13 = ₹ 130 Crore.
(ii) Divided valuation model
Question – 31
Based on 50% Based on 40% STR Ltd.’s current financial year's income statement reported its net
pay-out pay-out income after tax as ₹ 50 Crore.
Pre synergistic 0.5 ×10×1.07 0.4 ×10 ×1.07
= 0.1096 − 0.07
= 0.1096 −0.07
Following is the capital structure of STR Ltd. at the end of current
value
financial year:
= ₹ 135.10 Crore = ₹ 108.08 Crore
Pro synergistic 0.5 ×10 ×1.1×1.07 0.4 × 10 × 1.1 × 1.07 ₹
= 0.1096 − 0.07 0.1096 - 0.07
value Debt (Coupon rate = 11%) 80 Crore
Equity (Share Capital + Reserves & Surplus) 250 Crore
= ₹ 148.61 Crore = ₹ 118.89 Crore
Invested Capital 330 Crore
(iii) Range of valuation
Following data is given to estimate cost of equity capital:

14.31
 BUSINESS VALUATION

EVA = NOPAT – C/E × WACC

Asset Beta of STR Ltd. 1.11
Risk free rate of return 8.5% = 56.1600 – 330 × 17.57%
Average market risk premium 9%
= 1.821 Cr.
The applicable corporate income tax rate is 30%. Question − 32
Estimate Economic Value added (EVA) of STR Ltd. in ₹ lakh. PN Limited submits the following details for the financial year ended
on 31st March 2025:
(RTP November – 2021 & MTP October – 2020)
Number of Equity Shares 1,50,000
Solution:
Current market price per share 12
BE
10% Debts ₹ 2,00,000
250
1.11 = BE × 250 + 80 (1 – 0.30) Cash and Cash Equivalents ₹ 5,00,000
250
1.11 = BE × Gross Profit ₹ 12,00,000
306

BE = 1.359 Indirect Expenses ₹ 5,00,000

(Excluding Depreciation & Interest)
Ke = 8.5 + 9 × 1.359 = 20.73%
Depreciation ₹ 30,000
Kd = 11 (1 – 0.30) = 7.7%
Risk-free rate of return 7%
250 80
K0 = (20.73 × ) + (7.7 × ) Market rate of return 16%
330 330

= 17.57% Beta of the Company 0.8

NOPAT Applicable Tax Rate 20%

50 On the basis of above details, you are required to calculate the
EBIT = [(1 + 8.80] = 80.2286 Cr.
– 0.30)
following :
(-) Tax @ 30%
(i) Cost of Equity of the company using CAPM.
NOPAT = 56.1600 Cr.

14.32
 BUSINESS VALUATION

(ii) Earnings Per Share (EPS) of the company. (iv) Enterprise Value of Company

(iii) Equity Value of the company if applicable EBIDTA multiple is Number of Equity Shares 1,50,000
4. Current Market Price (CMP) 12
Market Capitalization ₹ 18,00,000
(iv) Enterprise Value of the company. Add: Outstanding Debts ₹ 2,00,000
Less: Cash and Cash Equivalent ₹ 5,00,000
Calculation up to 2 decimal points. Enterprise Value 15,00,000

(Exam September – 2025)

Solution:

(i) Cost of Equity using CAPM

7% + 0.8(16% − 7%) = 14.20%

(ii) Earnings per Share (EPS) (₹)

Gross Profit 12,00,000

less: Indirect Expenses 5,00,000
EBIDTA 7,00,000
Less: Depreciation 30,000
6,70,000
Less: Interest on Debt (10% on ₹ 2,00,000) 20,000
6,50,000
Less: Tax @ 20% 1,30,000
Profit After Tax (PAT) 5,20,000
Number of Equity Shares 1,50,000
Earnings Per Share (EPS) 3.47

(iii) Equity Value of the Company

EBITDA ₹ 7,00,000
EBITDA multiple 4
Capitalized Value ₹ 28,00,000
Less: Outstanding Debts ₹ 2,00,000
Equity Value ₹ 26,00,000

14.33
 BUSINESS VALUATION

(a) ₹ 54600 Thousand

MULTIPLE CHOICE QUESTIONS (b) ₹ 20500 Thousand
(c) (-)₹ 34000 Thousand
Case Scenario – 01
(d) ₹ 21500 Thousand
During one business meeting at XYZ Ltd., one of the member pointed
out that while evaluating the performance of any company one
III. The price per share of Gama Ltd. shall be ……………..
should not only see its Operating Income but should also analyze its
(a) ₹ 28.60 (b) ₹ 31.90
Capital structure as well. Weighted Average Cost of Capital changes
(c) ₹ 31.46 (d) ₹ 29.45
on the basis of capital structure keeping all other factors unchanged.

He presented data relating to 3 companies Alpha Ltd., Beta Ltd. and IV. The estimated market capitalization for Alpha Ltd.
Gama Ltd. whose operating Income are equal, but their capital is…………….
structure is different. (a) ₹ 26,47,700 Thousand
(b) ₹ 31,46,000 Thousand
The following information relating to these 3 companies is as follows: (c) ₹ 17,44,600 Thousand
(in ₹ ‘000) (d) ₹ 23,73,800 Thousand
Alpha Ltd. Beta Ltd. Gama Ltd.
Total invested capital 20,00,000 20,00,000 20,00,000 V. Earning per share of Beta Ltd. is……………..
Debt/Assets ratio 0.8 0.5 0.2 (a) ₹ 2.60 (b) ₹ 2.90
Shares outstanding 61,000 83,000 1,00,000 (c) ₹ 2.86 (d) ₹ 2.15
Pre tax Cost of Debt 16% 13% 15% (MTP April – 2024 & August – 2025)
Cost of Equity 26% 22% 20%
Operating Income 5,00,000 5,00,000 5,00,000 Answer: Case Scenario – 01
(EBIT)
The Tax rate is uniform 35% in all cases. The industry PE ratio is I. (a) 13.520%
11X.
II. (b) ₹ 20500 Thousand
Based on above case scenario, choose the most appropriate answer
of the following: III. (c) ₹ 31.46

I. The weighted average cost of capital of Alpha Ltd. shall IV. (c) ₹ 17,44,600 Thousand
approximately be ………………..
V. (d) ₹ 2.15
(a) 13.520% (b) 15.225%
(c) 17.950% (d) 18.000%
II. The Economic Valued Added (EVA) for Beta Ltd. is……………. Case Scenario – 02

14.34
 BUSINESS VALUATION

During one business meeting at ABC Ltd., one of the members (a) ₹ 28.60
presented data relating to 3 companies X Ltd., Y Ltd. and Z Ltd. (b) ₹ 31.90
whose operating Income are equal, but their capital structure is (c) ₹ 31.46
different. (d) ₹ 29.45

(In ₹ ‘000)
IV. The estimated market capitalisation of Y Ltd. is…………….
X Ltd. Y Ltd. Z Ltd. (a) ₹ 80,29,900 Thousand
Total invested capital 40,00,000 40,00,000 40,00,000 (b) ₹ 48,10,000 Thousand
Debt/Assets ratio 0.8 0.5 0.2 (c) ₹ 52,91,000 Thousand
Shares outstanding 1,22,000 1,66,000 2,00,000 (d) ₹ 59,41,650 Thousand
Post tax cost of debt 10.40% 8.45% 9.75%
Cost of equity 26% 22% 20% V. Earning per share of X Ltd. approximately is……………..
Operating income 10,00,000 10,00,000 10,00,000 (a) ₹ 2.60
(EBIT) (b) ₹ 2.90
The Tax rate is uniform 35% in all cases. The industry PE ratio is (c) ₹ 2.86
10X. (d) ₹ 2.15
From the information given above, choose the correct answer to the
following questions:
I. The weighted average cost of capital of Y Ltd. shall be
approximately …………….
(a) 13.52% Answer Case Scenario – 02
(b) 15.23%
(c) 17.95% I. (b) 15.23%
(d) 18.00% II. (a) ₹ 1,09,200 Thousand
III. (a) ₹ 28.60
II. The Economic Valued Added (EVA) of X Ltd. is……………. IV. (b) ₹ 48,10,000 Thousand
(a) ₹ 1,09,200 Thousand V. (a) ₹ 2.60
(b) ₹ 1,71,600 Thousand
(c) ₹ 2,82,000 Thousand
(d) ₹ 3,91,000 Thousand

III. The price per share of Z Ltd. shall be ……………..

14.35
 BUSINESS VALUATION

14.36
 MERGER
+0……..

15 MERGER
4
PART I: MERGER Solution:

STOCK DEAL (i) Before Merger

Question – 01 A Ltd. B Ltd.

A Ltd., a listed company, is considering merger of B Ltd. which is also Earning after tax (₹) 10,00,000 2,50,000
a listed company, with itself by means of a stock swap (exchange). B No. of shares outstanding 4,00,000 2,00,000
Ltd. has agreed to a plan under which A Ltd. will offer the current EPS ₹ 2.50 ₹ 1.25
market value of B Ltd.'s shares. Current Market Price/Share ₹ 50 ₹ 20
P/E Ratio 20 16
Additional Information:
Particulars A Ltd. B Ltd. (ii) If B Ltd.’s P/E Ratio is 10
Earnings after tax (₹) 10,00,000 2,50,000
Number of shares outstanding 4,00,000 2,00,000 Then, it’s Current Market Price = 10 × ₹ 1.25 = ₹ 12.50
Current market price (₹) per share 50 20
Exchange Ratio = 12.50 : 50 i.e. 1 share of A Ltd. for every 4
shares of B Ltd.
On the basis of above information, you are required to calculate the
following: No. of shares to be issued = 50,000
(i) What is the pre-merger Earnings per Share (EPS) and P/E
ratio of both the companies? A Ltd. Post-Merger EPS
(ii) If B Ltd.'s P/E is 10, what is its current market price per
Post-Merger Earning (10,00,000 + 2,50,000) ₹ 12,50,000
share? What is the exchange ratio? What will A Ltd.'s post-
merger EPS be? No. of Equity Shares after Merger (4,00,000 + 50,000)
(iii) What must the exchange ratio be for A Ltd.'s Pre-merger and 4,50,000
Post-merger EPS to be the same?
EPS ₹ 2.78

(Exam November – 2019) (8 Marks) (iii) Calculation of Exchange Ratio for A Ltd.’s pre-merger and
post-merger EPS to be the same

15.1
 MERGER

= Total earnings/Pre-merger EPS of A Ltd. Solution:

= ₹ 12,50,000/₹ 2.50 (i) Earning per share of company MK Ltd after merger:-

= 5,00,000 shares Exchange ratio 160 : 200 = 4 : 5.

Now, number of shares to be issue to B Ltd. that is 4 shares of MK Ltd. for every 5 shares of NN Ltd.

= 5,00,000 – 4,00,000 ∴ Total number of shares to be issued = 4/5 × 3,00,000

= 1,00,000 shares = 2,40,000 Shares.

Therefore, the share exchange ratio is 1,00,000 : 2,00,000 or ∴ Total number of shares of MK Ltd. and NN Ltd.
1:2. It means for every two shares in B Ltd., one share should
be issued from A Ltd. =12,00,000 (MK Ltd.) + 2,40,000 (NN Ltd.)

= 14,40,000 Shares
Question – 02
MK Ltd. is considering acquiring NN Ltd. The following information Total profit after tax = ₹ 60,00,000 MK Ltd.
is available:
= ₹ 18,00,000 NN Ltd.
Company Earning after No. of Equity Market Value
Tax (₹) Shares Per Share (₹) = ₹ 78,00,000
MK Ltd. 60,00,000 12,00,000 200.00
∴ EPS. (Earning Per Share) of MK Ltd. after merger
NN Ltd. 18,00,000 3,00,000 160.00
₹ 78,00,000/14,40,000 = ₹ 5.42 per share
Exchange of equity shares for acquisition is based on current market
value as above. There is no synergy advantage available. (ii) To find the exchange ratio so that shareholders of NN Ltd.
would not be at a Loss:
(i) Find the earning per share for company MK Ltd. after merger,
and Present earning per share for company MK Ltd.

(ii) Find the exchange ratio so that shareholders of NN Ltd. would = ₹ 60,00,000/12,00,000 = ₹ 5.00
not be at a loss.
Present earning per share for company NN Ltd.
(SM TYK – 03 & MTP October – 2020)
= ₹ 18,00,000/3,00,000 = ₹ 6.00

15.2
 MERGER

∴ Exchange ratio should be 6 shares of MK Ltd. for every 5 (ii) 1 share of Cauliflower Limited for two shares of Cabbage
shares of NN Ltd. Limited.

∴ Shares to be issued to NN Ltd. Required:

= 3,00,000 × 6/5 = 3,60,000 shares (a) Calculate the EPS after merger under both the alternatives.

Now, total No. of shares of MK Ltd. and NN Ltd. (b) Show the impact on EPS for the shareholders of the two
companies under both the alternatives.
=12,00,000 (MK Ltd.) + 3,60,000 (NN Ltd.)
(RTP November – 2021)
= 15,60,000 shares
Solution:
∴ EPS after merger = ₹ 78,00,000/15,60,000 = ₹ 5.00 per
share (i) Exchange ratio in proportion to relative EPS

Total earnings available to shareholders of NN [Link] merger Company Existing No. EPS Total
of shares earnings
= 3,60,000 shares × ₹ 5.00 = ₹ 18,00,000. Cauliflower Ltd. 5,00,000 5.00 25,00,000
Cabbage Ltd. 3,00,000 3.00 9,00,000
This is equal to earnings prior merger for NN Ltd.
Total earnings 34,00,000
∴ Exchange ratio on the basis of earnings per share is
recommended. No. of shares after merger 5,00,000 + 1,80,000 = 6,80,000

3.00
Question – 03 Note: 1,80,000 may be calculated as = (3,00,000 × )
5.00
Cauliflower Limited is contemplating acquisition of Cabbage Limited.
Cauliflower Limited has 5 lakh shares having market value of ₹ 40 34,00,000
EPS for Cauliflower Ltd. after merger = = 5.00
per share while Cabbage Limited has 3 lakh shares having market 6,80,000
value of ₹ 25 per share. The EPS for Cabbage Limited and Cauliflower
Impact on EPS
Limited are ₹ 3 per share and ₹ 5 per share respectively. The
managements of both the companies are discussing two alternatives ₹
for exchange of shares as follows: Cauliflower Ltd. ‘s shareholders
(i) In proportion to relative earnings per share of the two companies. EPS before merger 5.00
EPS after merger 5.00
Increase/ Decrease in EPS 0.00

15.3
 MERGER

Cabbage Ltd. ‘s shareholders ABC Ltd. is planning to offer a premium of 25% over the market price
EPS before merger 3.00 of XYZ Ltd. Required:
EPS after the merger 5.00 × 3/5 3.00
Increase/ Decrease in EPS 0.00 (i) What is the swap ratio based on current market price?

(ii) Find the number of shares to be issued by ABC Ltd. to the

(ii) Merger effect on EPS with share exchange ratio of 1:2
shareholders of XYZ Ltd.
Total earnings after merger ₹ 34,00,000
(iii) Compute the new EPS of ABC Ltd. after merger and comment
No. of shares post merger
on the impact of merger.
5,00,000 +1,50,000 (0.5 × 3,00,000) 6,50,000
EPS (34,00,000 ÷ 6,50,000) ₹ 5.23 (iv) Determine the market price of the share when P/E ratio
remains unchanged.
Impact on EPS
(v) Compute the market price when P/E declines to 12 and
₹ comment on the results. Figures are to be rounded off to 2
Cauliflower Ltd. ‘s shareholders decimals.
EPS before merger 5.00
EPS after merger 5.23 (Exam November – 2019) (8 Marks)
Increase/ Decrease in EPS 0.23
Solution:
Cabbage Ltd. ‘s shareholders
EPS before merger 3.000 Computation of Market Price of the Shares
EPS after the merger 5.23 × 0.5 2.615
Decrease in EPS 0.385 Particulars ABC Ltd. XYZ Ltd.
EAT ₹ 9,00,000 ₹ 2,40,000
Question – 04 No. of Equity Shares 1,50,000 60,000
ABC Ltd. is a company operating in the software industry. It is EPS ₹ 6.00 ₹ 4.00
considering the acquisition of XYZ Ltd. which is also into software P/E Ratio 14.00 10.00
industry. The following information are available for the companies: Market Price Per Share ₹ 84.00 ₹ 40.00

ABC Ltd. XYZ Ltd. (i) Exchange Ratio based on Current Market Price
Earnings after tax (₹) 9,00,000 2,40,000
Number of equity shares 1,50,000 60,000 Exchange ratio 40 × 1.25:84 = 50:84
P/E ratio (no. of times) 14 10

15.4
 MERGER

that is 50 shares of ABC Ltd. for every 84 shares of XYZ Ltd. PE Ratio 14
or New Price of the Share (₹ 6.13 × 14) ₹ 85.82

25 shares of ABC Ltd. for every 42 shares of XYZ Ltd. (v) New Market Price of share if PE Ratio falls to 12
(ii) No. of Shares to be issued New EPS ₹ 6.13
50 PE Ratio 12
= 0.596 i.e. 0.60 share for 1 share of XYZ Ltd.
84 New Price of the Share (₹ 6.13 × 12) ₹ 73.56
60,000 × 0.60 = 36,000
Gain/ loss from the Merger to the shareholders of ABC Ltd.
(iii) Computation of EPS and Impact after Merger
Market Price of Share ₹ 73.56
Total earnings after merger ₹ 11,40,000 Market Price of Share before Merger ₹ 84.00
No. of shares post merger (1,50,000 + 36,000) 1,86,000 Loss from the merger (per share) ₹ 10.44
EPS 6.13
Gain/ loss from the Merger to the shareholders of XYZ Ltd.
Impact on EPS
Equivalent Market Price of Share (73.56 × 0.6) ₹ 44.14
For ABC Ltd.’s shareholders ₹ Market Price of Share before Merger ₹ 40.00
EPS before merger 6.00 Gain from the merger (per share) ₹ 4.14
EPS after merger 6.13
Increase in EPS 0.13 Comments: With the merger there is a decrease in the
For XYZ Ltd.’s Shareholders market price of shares for the shareholders of ABC Ltd and a
EPS before merger 4.00 gain for shareholders of XYZ Ltd.
Equivalent EPS after the merger (6.13×0.6) 3.68
Question – 05
Decrease in EPS 0.32
B Ltd. Wants to acquire S Ltd. and has offered a swap ratio of 2:3 (2
Thus, with the proposed merger while the EPS for shares for every 3 share of S Ltd.). Following information is available:
shareholders of ABC Ltd. will improve and EPS for
Particulars B Ltd. S Ltd.
shareholders of XYZ Ltd. will be decreased. Profit after tax (in ₹) 21,00,000 4,50,000
Equity shares outstanding (Nos.) 6,00,000 1,80,000
(iv) Market Price of Share after Merger
EPS (₹) 3.5 2.5
PE Ratio 10 times 7 times
New EPS ₹ 6.13

15.5
 MERGER

Price quoting per share on BSE before 35.00 17.50 (ii) EPS of B Ltd. after acquisition:
the merger announcement (₹)
Total Earnings (₹ 21,00,000 + ₹ 4,50,000) ₹ 25,50,000
Required:
No. of Shares (6,00,000 + 1,20,000) 7,20,000
(i) The number of equity shares to be issued by B Ltd. for
acquisition of S Ltd. EPS (₹ 25,50,000/7,20,000) ₹ 3.5416 or 3.54

(ii) What is the EPS of B Ltd. after the acquisition?

(iii) Determine the equivalent earnings per share of S Ltd. and (iii) Equivalent EPS of S Ltd. and gain/loss to shareholders:
calculate per share gain or loss to shareholders of S Ltd. 2
Equivalent EPS of S Ltd. (₹ 3.54 × ) ₹ 2.36
3
(iv) What is the expected market price per share of B Ltd. after the Less: EPS before merger
2.50
acquisition, assuming its PE Multiple remains unchanged? Loss
(0.14)
(v) Determine the market value of the merged firm.
(iv) New market price of B Ltd. (P/E remaining unchanged):
(vi) After the announcement of merger, price of shares of S Ltd.
Present P/E Ratio of B Ltd. 10 times
rose by 10% on BSE. Mr. X, an investor, having 10,000 shares
Expected EPS after merger ₹ 3.54
of S Ltd. is having another investment opportunity, which Expected Market Price (₹3.54 × 10) ₹ 35.40
yields annual return of 14% is seeking your advice whether he
needs to offload the shares in the market or accept the shares (v) Market value of merged firm:
from B Ltd.
Total number of shares 7,20,000
(RTP May – 2022) Expected market price ₹ 35.40
Total value (7,20,000 × 35.40) ₹ 2,54,88,000
Solution:
(vi)
(i) The number of shares to be issued by B Ltd.:
a) Equivalent EPS of S Ltd. ₹ 2.36
The exchange ratio is 2:3 b) BSE price per share before merger announcement ₹ 17.50
c) After the merger announcement 10% increase in price ₹ 1.75
2
So, new shares = 1,80,000 × = 1,20,000 shares. of shares.
3
d) Present market price of share (b + c) ₹ 19.25
e) Return on market price per share (a/d) 12.26

15.6
 MERGER

As Mr. X is having another opportunity to earn 14% and expected The Exchange ratio is 0.5
return on S Ltd.’s share is 12.26%, it is advisable to offload in market. So, new Shares = 1,80,000 × 0.5 = 90,000 shares.

Question – 06 (b) EPS of Alfa Ltd. after acquisition:

Alfa Ltd. wants to acquire Beta Ltd. and has offered a swap ratio of
1:2 (0.5 shares for every one share of Beta Ltd.) Following information Total Earnings (₹ 18,00,000 + ₹ 3,60,000) ₹ 21,60,000
is provided:
No. of Shares (6,00,000 + 90,000) 6,90,000
Alfa Ltd. Beta Ltd.
Profit after tax (₹) 18,00,000 3,60,000 EPS (₹ 21,60,000)/6,90,000) ₹ 3.13
Equity shares outstanding (Nos.) 6,00,000 1,80,000
EPS (₹) 3 2 (c) Equivalent EPS of Beta Ltd.:
PE Ratio 10 times 7 times
Market price per share (₹) 30 14 No. of new Shares 0.5

(i) You are required to determine: EPS ₹ 3.13

(a) The number of equity shares to be issued by Alfa Ltd. Equivalent EPS (₹ 3.13 × 0.5) ₹ 1.57 or ₹ 1.56
for acquisition of Beta Ltd.
(d) New Market Price of Alfa Ltd. (P/E = 12):
(b) The EPS of Alfa Ltd. after the acquisition.
Revised P/E Ratio of Alfa Ltd. 12 times
(c) The equivalent earnings per share of Beta Ltd.
Expected EPS after merger ₹ 3.13
(d) The expected market price per share of Alfa Ltd. * after
the acquisition, if PE increases to 12 times. Expected Market Price (₹ 3.13 × 12) ₹ 37.56

(e) The market value of the merged firm. (e) Market Value of merged firm:

(ii) If you are the shareholder of Beta Ltd. and holding 100 shares, Total number of Shares 6,90,000
will you be interested to sell your stake? Why?
(Exam November – 2022) (8 Marks) Expected Market Price ₹ 37.56
Solution:
Total value (6,90,000 × 37.56) ₹ 2,59,16,400
(i) (a) The number of shares to be issued by Alfa Ltd.:
(ii) Present market Value of share of Beta Ltd. (100 × ₹ 14) ₹ 1,400

15.7
 MERGER

Revised market price of each share of Alfa Ltd. after Merger Income Statement

₹ 37.56 Particulars R. Ltd. (₹) S. Ltd. (₹)

A. Net Sales 69,00,000 34,00,000
Equivalent No. of Alfa Ltd. share in exchange of B. Cost of Goods sold 55,20,000 27,20,000
Beta Ltd. (0.50 × 100) 50 C. Gross Profit (A-B) 13,80,000 6,80,00
D. Operating Expenses 4,00,000 2,00,000
Equivalent Value of Alfa Ltd. share in exchange of E. Interest 1,60,000 96,000
Beta Ltd. (100 × 0.50 × ₹ 37.56) ₹ 1,878 F. Earnings before taxes [C-(D + E)] 8,20,000 3,84,000
G. Taxes @ 35% 2,87,000 1,34,400
Increase in Market Value (₹ 1,878 − ₹ 1,400) ₹ 478
H. Earnings After Tax (EAT) 5,33,000 2,49,600
No, I am not agreed to sell the stake as there is increase in
market value. Additional Information:

Question – 07 No. of equity shares 2,00,000 1,60,000

R Ltd. and S Ltd. are companies that operate in the same industry. Dividend payment Ratio (D/P) 20% 30%
The financial statements of both the companies for the current
financial year are as follows: Market price per share ₹ 50 ₹ 20
Balance Sheet
Particulars R. Ltd. (₹) S. Ltd (₹) Assume that both companies are in the process of negotiating a
merger through exchange of Equity shares:
Equity & Liabilities
Shareholders Fund You are required to:
Equity Capital (₹ 10 each) 20,00,000 16,00,000
Retained earnings 4,00,000 (i) Decompose the share price of both the companies into EPS &
Non-current Liabilities P/E components. Also segregate their EPS figures into Return
16% Long term Debt 10,00,000 6,00,000 On Equity (ROE) and Book Value/Intrinsic Value per share
Current Liabilities 14,00,000 8,00,000 components.
Total 48,00,000 30,00,000
(ii) Estimate future EPS growth rates for both the companies.
Assets
Non-current Assets 20,00,000 10,00,000 (iii) Based on expected operating synergies, R Ltd. estimated that
Current Assets 28,00,000 20,00,000 the intrinsic value of S Ltd. Equity share would be ₹ 25 per
Total 48,00,000 30,00,000 share on its acquisition. You are required to develop a range
of justifiable Equity Share Exchange ratios that can be offered

15.8
 MERGER

by R Ltd. to the shareholders of S Ltd. Based on your analysis = 0.40:1 (lower limit)
on parts (i) and (ii), would you expect the negotiated terms to
be closer to the upper or the lower exchange ratio limits and (b) Intrinsic Value Based = ₹ 25/ ₹ 50
why?
= 0.50:1 (max. limit)
(SM TYK – 27)
Since R Ltd. has higher EPS, PE, ROE and higher growth
Solution: expectations the negotiated term would be expected to be
(i) Determination of EPS, P/E Ratio, ROE and BVPS of R Ltd. closer to the lower limit, based on existing share price.
& S Ltd.
Question – 08
R Ltd. S Ltd. X Ltd. is studying the possible acquisition of Y Ltd. by way of merger.
EAT (₹) 5,33,000 2,49,600 The following data are available in respect of both the companies.
N 2,00,000 1,60,000
Particulars X Ltd. Y Ltd.
EPS (EAT ÷ N) 2.665 1.56
Market Capitalization (₹) 75,00,000 90,00,000
Market Price Per Share 50 20 Gross Profit Ratio 20% 20%
PE Ratio (MPS/EPS) 18.76 12.82 Inventory Turnover Ratio 5 times 4 times
Equity Fund (Equity Value) 24,00,000 16,00,000 Debtor Turnover Ratio 3 times 5 times
BVPS (Equity Value ÷ N) 12 10 12% Debenture (₹) 10,00,000 -
ROE (EAT ÷ EF) or 0.2221 0.156 10% Debenture (₹) - 14,40,000
No. of Equity Shares 1,00,000 60,000
ROE (EAT ÷ EF) × 100 22.21% 15.60%
Operating Expenses 86% 78%
Corporate Tax Rate 30% 30%
(ii) Determination of Growth Rate of EPS of R Ltd.& S Ltd. 15,00,000 5,00,0000
Closing Stock (₹)
Debtors (₹) 10,00,000 8,00,000
R Ltd. S Ltd.
Retention Ratio (1-D/P Ratio) 0.80 0.70 You are required to calculate:
Growth Rate (ROE × Retention Ratio) or 0.1777 0.1092
Growth Rate (ROE × Retention Ratio) × 17.77% 10.92% (i) Swap ratio based on EPS & MPS respectively as weightage of
100 40% and 60%.

(iii) Justifiable equity share exchange ratio (ii) Post Merger EPS

(a) Market Price Based = MPSS/MPSR (iii) Post Merger market price assuming same PE Ratio of X Ltd.
= ₹ 20/₹ 50 (iv) Post Merger gain or loss in EPS.

15.9
 MERGER

(MTP May – 2020) (2)

X Ltd. Y Ltd.
Solution: No. of Shares 1,00,000 60,000
EPS 8,34,750/1,00,000 2,84,200/60,000
Working Notes: (EAT/ No. of = ₹ 8.34 = ₹ 4.74
Shares)
COGS Market Price 75,00,000/ 90,00,000/
(1) Inventory Turnover Ratio =
Closing Stock Share 1,00,000 60,000
(Market = ₹ 75 = ₹ 150
X Ltd. Y Ltd. Capitalization/
No. Shares)
COGS COGS PE Ratio (MPS/ 75/ 8.34 150/ 4.74
5= 4=
15,00,000 5,00,000 EPS) = 8..99 = 31.65

Target Co.
COGS = ₹ 75,00,000 COGS = ₹ 20,00,000 (i) Swap Ratio = Acquirer Co.

Gross Profit Ratio = 20% means COGS is 80% of Sales, then Acquirer Co. Target Co. Weight
X Ltd. Y Ltd.
75,00,000 × 100 20,00,000 × 100 EPS 8.34 4.74 0.40
Sales = Sales =
80 80 MPS 75 150 0.60

= ₹ 93,75,000 = ₹ 25,00,000 4.74

EPS 0.227
× 0.40 =
8.34
Statement of Profit MPS 150 1.200
× 0.60 =
75
X Ltd. Y Ltd. 1.427
Sales 93,75,000 25,00,000
Less: Operating 80,62,500 19,50,000 (ii) Post Merger EPS
Exp. 13,12,500 5,50,000
EBIT 1,20,000 1,44,000 EATX + EATY
Less: Interest 11,92,500 4,06,000 =
[Link] Shares of Both Cos.
EBT 3,57,750 1,21,800
Less: Tax @ 30% 8,34,750 2,84,200 8,34,750 + 2,84,200
EAT =
1,00,000 + (60,000×1.427)

15.10
 MERGER

11,18,950 Earning before interest, depreciation and 400.86 115.71

=
1,85,620 tax (EBIDAT) (₹ Lakhs)
Market Price/share (₹) 220.00 110.00
= 6.03
T Ltd. plans to offer a price for E Ltd., business as a whole which will
(iii) Post Merger market price assuming same PE of X Ltd.
be 7 times EBIDAT reduced by outstanding debt, to be discharged by
own shares at market price.
MPS = PE × EPS
E Ltd. is planning to seek one share in T Ltd. for every 2 shares in E
= 8.99 × 6.03
Ltd. based on the market price. Tax rate for the two companies may
= ₹ 54.21 be assumed as 30%.

Calculate and show the following under both alternatives - T Ltd.'s

(iv) Gain or Loss to the share holders
offer and E Ltd.'s plan:
Pre-Merger EPS Post Merger EPS
(i) Net consideration payable.
X Ltd. ₹ 8.34 ₹ 6.03
Y Ltd. ₹ 4.74 ₹ 6.03 × 1.427 = ₹ (ii) No. of shares to be issued by T Ltd.
8.60
(iii) EPS of T Ltd. after acquisition.
While Shareholders of X Ltd. will lose EPS of ₹ 2.31 (₹
8.34 − ₹ 6.03) per share the shareholders of Y Ltd. (iv) Expected market price per share of T Ltd. after acquisition.
stands to gain EPS of ₹ 3.86 (₹ 8.60 − ₹ 4.74) per share.
(v) State briefly the advantages to T Ltd. from the acquisition.
Question – 09
Note: Calculations (except EPS) may be rounded off to 2 decimals in
T Ltd. and E Ltd. are in the same industry. The former is in
lakhs.
negotiation for acquisition of the latter. Important information about
the two companies as per their latest financial statements is given (SM TYK – 21 & Exam November – 2018) (12 Marks)
below:
Solution:
T Ltd. E Ltd.
₹ 10 Equity shares outstanding 12 Lakhs 6 Lakhs As per T Ltd.’s Offer
Debt:
₹ In lakhs
10% Debentures (₹ Lakhs) 580 --
(i) Net Consideration Payable 809.97
12.5% Institutional Loan (₹ Lakhs) -- 240
7 times EBIDAT, i.e. 7 × ₹ 115.71 lakh 240.00

15.11
 MERGER

Less: Debt 569.97 As per E Ltd’s Plan

(ii) No. of shares to be issued by T Ltd
₹ 569.97 lakh/₹ 220 (rounded off) (Nos.) 2,59,000 ₹ In lakhs
(i) Net consideration payable
(iii) EPS of T Ltd after acquisition
6 lakhs shares × ₹ 110 660
Total EBIDT (₹ 400.86 lakh + ₹ 115.71 lakh) 516.57
Less: Interest (₹ 58 lakh + ₹ 30 lakh) 88.00 (ii) No. of shares to be issued by T Ltd
428.57 ₹ 660 lakhs ÷ ₹ 220 3 lakh
Less: 30% Tax 128.57
(iii) EPS of T Ltd after Acquisition
Total earnings (NPAT) 300.00
14.59 lakh NOPAT (as per earlier calculations) 300.00
Total no. of shares outstanding (12 lakh +
2.59 lakh) Total no. of shares outstanding (12 lakhs + 3 15 lakh
EPS (₹ 300 lakh/ 14.59 lakh) 20.56
lakhs)
(iv) Expected Market Price:
Earning Per Share (EPS) ₹ 300 lakh/15 lakh ₹ 20.00
Pre-acquisition P/E multiple: 400.86
EBIDAT (₹ in lakhs) 58.00 (iv) Expected Market Price (₹ 20 × 11) 220.00
Less: Interest (580 × 10/100)( ₹ in lakhs) 342.86
EBT 102.86 (v) Advantages of Acquisition to T Ltd.
Less: 30% Tax (₹ in lakhs) 240.00
EAT (₹ in lakhs) 12.00 Since the two companies are in the same industry, the
(÷) No. of shares (lakhs) ₹ 20.00 following advantages could accrue:
EPS
11 — Synergy, cost reduction and operating efficiency.
220
Hence, PE multiple
20 — Better market share.
Expected market price after acquisition (₹
20.56 ×11) ₹ 226.16
— Avoidance of competition

Question – 10
C Ltd. and P Ltd. both companies operating in the same industry
decided to merge and form a new entity S Ltd. The relevant financial
details of the two companies prior to merger announcement are as
follows:

15.12
 MERGER

C Ltd. P Ltd. Post Merger MPS = 2.438 × 9

Annual Earnings after Tax (₹ lakh) 10,000 5,800
No. Shares Outstanding (lakh) 4,000 1,000 = ₹ 21.94
PE Ratio (No. of Times) 8 10
8 + 10
Avg P/E Ratio = =9
The merger will be affected by means of stock swap (exchange) of 3 2
shares of C Ltd. for 1 share of P Ltd.
Gain or Loss to the Shareholders of P Ltd.
After the merger it is expected that due to synergy effects, Annual
MPS before Merger ₹ 58
Earnings (Post Tax) are expected to be 8% higher than sum of the
earnings of the two companies individually. Further, it is expected MPS after Merger (21.94 × 3) ₹ 65.82
that P/E Ratio of S Ltd. shall be average of P/E Ratios of two
companies before the merger. Gain = ₹ 7.82

Evaluate the extent to which shareholders of P Ltd. will be benefitted Question – 11

per share from the proposed merger. Reliable Industries Ltd. (RIL) is considering a takeover of Sunflower
Industries Ltd. (SIL). The particulars of 2 companies are given below:
(MTP April – 2021)
Particulars Reliable Sunflower
Solution: Industries Ltd Industries Ltd.
Earnings After Tax (EAT) ₹ 20,00,000 ₹ 10,00,000
C Ltd. P Ltd. Equity shares O/s 10,00,000 10,00,000
EAT 10,000 lacs 5,800 lacs Earnings per share (EPS) 2 1
÷ No. 4000 1000
PE Ratio (Times) 10 5
EPS 2.50 5.80
(×) P/E Ration 8 10
MPS ₹ 20 ₹ 58 Required:

(i) What is the market value of each Company before merger?

No. of shares to be issued = 1,000 shares × 3/1
(ii) Assume that the management of RIL estimates that the
= 3000 shares
shareholders of SIL will accept an offer of one share of RIL for
(10,000 + 5,800) (1.08) four shares of SIL. If there are no synergic effects, what is the
Post Merger EPS = market value of the Post-merger RIL? What is the new price
4,000 + 3,000
per share? Are the shareholders of RIL better or worse off than
= 2.438 they were before the merger?

15.13
 MERGER

(iii) Due to synergic effects, the management of RIL estimates that Gains From Merger: ₹
the earnings will increase by 20%. What are the new post- Post-Merger Market Value of the Firm 3,00,00,000
merger EPS and Price per share? Will the shareholders be Less: Pre-Merger Market Value
better off or worse off than before the merger? RIL 2,00,00,000
SIL 50,00,000 2,50,00,000
(SM TYK – 24) Total gains from Merger 50,00,000
Solution:
Apportionment of Gains between the Shareholders:
(i) Market value of Companies before Merger
Particulars RIL (₹) SIL (₹)
Particulars RIL SIL Post-Merger Market Value:
EPS ₹2 Re.1 10,00,000 × 24 2,40,00,000 --
P/E Ratio 10 5 2,50,000 × 24 - 60,00,000
Market Price Per Share ₹ 20 ₹5 Less: Pre-Merger Market Value 2,00,00,000 50,00,000
Equity Shares 10,00,000 10,00,000 Gains from Merger: 40,00,000 10,00,000
Total Market Value 2,00,00,000 50,00,000
Thus, the shareholders of both the companies (RIL + SIL) are
(ii) Post Merger Effects on RIL better off than before

₹ (iii) Post-Merger Earnings:

Post-merger earnings 30,00,000
Increase in Earnings by 20%
Exchange Ratio (1:4)
No. of equity shares o/s (10,00,000 + 12.50,000 New Earnings: ₹ 30,00,000 × (1 + 0.20) ₹ 36,00,000
2,50,000)
EPS: 30,00,000/12,50,000 2.4 No. of equity shares outstanding: 12,50,000
PE Ratio 10
EPS (₹ 36,00,000/12,50,000) ₹ 2.88
Market Value 10 × 2.4 24
Total Value (12,50,000 × 24) 3,00,00,000 PE Ratio 10

Market Price Per Share: = ₹ 2.88 × 10 ₹ 28.80

15.14
 MERGER

∴ Shareholders will be better-off than before the merger (d) H Ltd. to issue shares of ₹ 100 each to the shareholders of B
situation. 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
Question – 12 shares arrived on Net Asset basis and Earnings capitalization
H Ltd. agrees to buy over the business of B Ltd. effective 1 st April, method respectively for both H Ltd. and B Ltd.)
[Link] summarized Balance Sheets of H Ltd. and B Ltd. as on 31st
March 2012 are as follows: You are required to arrive at the value of the shares of both H Ltd.
and
Balance sheet as at 31st March, 2012 (In Crores of Rupees)
B Ltd. under:
Liabilities: H. Ltd B. Ltd.
(i) Net Asset Value Method
Paid up Share Capital
-Equity Shares of ₹100 each 350.00 (ii) Earnings Capitalization Method
-Equity Shares of ₹10 each 6.50
Reserve & Surplus 950.00 25.00 (iii) Exchange ratio of shares of H Ltd. to be issued to the
Total 1,300.00 31.50 shareholders of B Ltd. on a Fair value basis (taking into
Assets: consideration the assumption mentioned in point 4 above.)
Net Fixed Assets 220.00 0.50
(SM TYK – 17)
Net Current Assets 1,020.00 29.00
Deferred Tax Assets 60.00 2.00 Solution:
Total 1,300.00 31.50
(i) Net Asset Value
H Ltd. proposes to buy out B Ltd. and the following information is
H Ltd. ₹ 1300 Crores − ₹ 300 Crores
provided to you as part of the scheme of buying: = ₹ 285.71
₹ 3.50 Crores
B Ltd. ₹ 31.50 Crores
(a) The weighted average post tax maintainable profits of H Ltd. = ₹ 48.46
0.65 Crores
and B Ltd. for the last 4 years are ₹ 300 crores and ₹ 10 crores
respectively. (ii) Earning Capitalization Value
(b) Both the companies envisage a capitalization rate of 8%. H Ltd. ₹ 300 Crores/0.08
= ₹ 1,071.43*
₹ 3.50 Crores
(c) H Ltd. has a contingent liability of ₹ 300 crores as on 31st B Ltd. ₹ 10 Crores /0.08
March, 2012. = ₹ 192.31
0.65 Crores

15.15
 MERGER

*Alternatively, Contingent Liability can also be deducted from ₹ lakhs

this Valuation. Sources
Share Capital
(iii) Fair Value 20 lakhs equity shares of ₹10 each fully paid 200
₹285.71 × 1 + ₹1,071.43 × 3 10 lakhs equity shares of ₹10 each, ₹5 paid 50
H Ltd.
= ₹ 875 Loans 100
4
B Ltd. ₹48.46 × 1 + ₹192.31× 3 Total 350
= ₹ 156.3475
4 Uses
Fixed Assets (Net) 150
Exchange ratio ₹ 156.3475/₹ 875 = 0.1787 Net Current Assets 200
350
H Ltd should issue its 0.1787 share for each share of B Ltd.
An independent firm of merchant bankers engaged for the
Note: In above solution it has been assumed that the negotiation, have produced the following estimates of cash flows from
contingent liability will materialize at its full amount. the business of XY Ltd.:

Question – 13 Year ended By way of ₹ lakhs

AB Ltd., is planning to acquire and absorb the running business of 31.3.07 after tax earnings for equity 105
XY Ltd. The valuation is to be based on the recommendation of 31.3.08 Do 120
merchant bankers and the consideration is to be discharged in the 31.3.09 Do 125
form of equity shares to be issued by AB Ltd. As on 31.3.2006, the 31.3.10 Do 120
paid up capital of AB Ltd. consists of 80 lakhs shares of ₹ 10 each. 31.3.11 Do 100
The highest and the lowest market quotation during the last 6 Terminal Value estimate 200
months were ₹ 570 and ₹ 430. For the purpose of the exchange, the
price per share is to be reckoned as the average of the highest and It is the recommendation of the merchant banker that the business
lowest market price during the last 6 months ended on 31.3.06. of XY Ltd. may be valued on the basis of the average of (i) Aggregate
of discounted cash flows at 8% and (ii) Net assets value. Present value
XY Ltd.’s Balance Sheet as at 31.3.2006 is summarized below: factors at 8% for years

1-5: 0.93 0.86 0.79 0.74 0.68

You are required to:

(a) Calculate the total value of the business of XY Ltd.

15.16
 MERGER

(b) The number of shares to be issued by AB Ltd.; and Question – 14

Snake Ltd. is taking over Lizard Ltd, both are listed companies. The
(c) The basis of allocation of the shares among the shareholders PE Ratio of Lizard Ltd. has been low as 4 and high as 7 and is
of XY Ltd. currently 5. Lizard Ltd.’s previous year EPS was ₹ 3.40 and current
(SM TYK – 26) expected EPS this year to be ₹ 4.00.
Determine the different range of values of shares using P/E Model.
Solution:
(MTP Nov – 2021)
Price/share of AB Ltd. for determination of number of shares to be Solution:
issued
The range of values using P/E Ratio and EPS either historic or
= (₹ 570 + ₹ 430)/2 = ₹ 500 projected are as follows.

EPS Value (₹) P/E Ratio Value Value of

Value of XY Ltd based on future cash flow Shares
capitalization (105 × 0.93) + (120 × 0.86) + Historic 3.40 Lowest 4 13.60
(125 × 0.79) + (120 × 0.74) × (300 × 0.68) Historic 3.40 Current 5 17.00
Historic 3.40 Highest 7 23.80
Value of XY Ltd based on net assets ₹ lakhs 592.40 Expected 4.00 Lowest 4 16.00
Expected 4.00 Current 5 20.00
Average value (592.40 + 250)/2 ₹ lakhs 250.00 Expected 4.00 Highest 7 28.00

No. of shares in AB Ltd to be issued ₹ 421.20 Question – 15

B Ltd. is a highly successful company and wishes to expand by
4,21,20,000/500
acquiring other firms. Its expected high growth in earnings and
Basis of allocation of shares Nos. 84,240 dividends is reflected in its PE ratio of 17. The Board of Directors of
B Ltd. has been advised that if it were to take over firms with a lower
Fully paid equivalent shares in XY Ltd. (20 PE ratio than it own, using a share-for-share exchange, then it could
+ 5) lakhs 25,00,000 increase its reported earnings per share. C Ltd. has been suggested
as a possible target for a takeover, which has a PE ratio of 10 and
Distribution to fully paid shareholders 67,392
1,00,000 shares in issue with a share price of ₹ 15. B Ltd. has
84,240 × 20/25 5,00,000 shares in issue with a share price of ₹ 12.

Distribution to partly paid shareholders 16,848

(84,240 − 67,392)

15.17
 MERGER

Calculate the change in earnings per share of B Ltd. if it acquires the = ₹ 0.71
whole of C Ltd. by issuing shares at its market price of ₹12. Assume
the price of B Ltd. shares remains constant. So the EPS affirm B will increase from Re. 0.71 to ₹ 0.80 as a result
of merger
(SM TYK – 01 & RTP November – 2018)
Question – 16
Solution: The following information is provided related to the acquiring Firm
Mark Limited and the target Firm Mask Limited:
Total market value of C Ltd is = 1,00,000 × 15 = ₹ 15,00,000
Firm Mark Firm Mask
PE ratio (given) = 10
Limited Limited
Therefore, earnings = ₹ 15,00,000 /10 Earning after tax (₹) 2,000 lakhs 400 lakhs
Number of shares outstanding 200 lakhs 100 lakhs
= ₹ 1,50,000 P/E ratio (times) 10 5

Total market value of B Ltd. is = 5,00,000 × ₹ 12 = ₹ 60,00,000 Required:

PE ratio (given) = 17 (i) What is the Swap Ratio based on current market prices?
Therefore, earnings = ₹ 60,00,000/17 (ii) What is the EPS of Mark Limited after acquisition?

= ₹ 3,52,941 (iii) What is the expected market price per share of Mark Limited
after acquisition, assuming P/E ratio of Mark Limited remains
The number of shares to be issued by B Ltd.
unchanged?
₹ 15,00,000 ÷ 12 = 1,25,000
(iv) Determine the market value of the merged firm.
Total number of shares of B Ltd = 5,00,000 + 1,25,000
(v) Calculate gain/loss for shareholders of the two independent
= 6,25,000 companies after acquisition

The EPS of the new firm is = (₹ 3,52,941 + ₹ 1,50,000)/6,25,000 (SM TYK – 07)

= ₹ 0.80 Solution:

The present EPS of B Ltd is = ₹3,52,941/5,00,000 Particulars Mark Ltd. Mask Ltd.

EPS ₹ 2,000 Lakhs/ 200 lakhs ₹ 400 lakhs / 100 lakhs

15.18
 MERGER

= ₹ 10 ₹4 Mask Ltd. 100 Lakhs × ₹ 20 = 20 crores ₹ 220.00 crores

Market Price ₹ 10 × 10 = ₹ 100 ₹ 4 × 5 = ₹ 20 Gain from merger ₹ 20.02 crores

(i) The Swap ratio based on current market price is Appropriation of gains from the merger among shareholders:

₹ 20/₹ 100 = 0.2 Mark Ltd. Mask Ltd.

Post merger value 218.20 crores 21.82 crores
or 1 share of Mark Ltd. for 5 shares of Mask Ltd. Less: Pre-merger market value 200.00 crores 20.00 crores
No. of shares to be issued = 100 lakh × 0.2 Gain to Shareholders 18.20 crores 1.82 crores

= 20 lakhs. Question – 17
You have been provided the following Financial data of two
2,000 lakhs + 400 lakhs
(ii) EPS after merger = companies:
200 lakhs + 20 lakhs
Krishna Ltd. Rama Ltd.
= ₹ 10.91
Earnings after taxes ₹ 7,00,000 ₹ 10,00,000
(iii) Expected market price after merger assuming P/E 10 times. No. of Equity shares(outstanding) 2,00,000 4,00,000
EPS 3.5 2.5
= ₹ 10.91 × 10 P/E ratio 10 times 14 times
Market price per share ₹ 35 ₹ 35
= ₹ 109.10

(iv) Market value of merged firm Company Rama Ltd. is acquiring the company Krishna Ltd.,
exchanging its shares on a one-to-one basis for company Krishna
= ₹ 109.10 market price × 220 lakhs shares Ltd. The exchange ratio is based on the market prices of the shares
of the two companies.
= 240.02 crores
Required:
(v) Gain from the merger
(i) What will be the EPS subsequent to merger?
Post merger market value of the merged firm ₹ 240.02 crores
(ii) What is the change in EPS for the shareholders of companies
Less: Pre-merger market value Rama Ltd. and Krishna Ltd.?
Mark Ltd. 200 Lakhs × ₹ 100 = 200 crores (iii) Determine the market value of the post-merger firm. PE ratio
is likely to remain the same.

15.19
 MERGER

(iv) Ascertain the profits accruing to shareholders of both the (iv)

companies.
Rama Ltd. Krishna Total
(SM TYK – 11) Ltd
No. of shares after merger 4,00,000 2,00,000 6,00,000
Solution: Market price ₹ 39.62 ₹ 39.62 ₹ 39.62
Total Mkt. Values ₹ 1,58,48,000 ₹ 79,24,000₹ 2,37,72,000
(i) Exchange Ratio 1:1 Existing Mkt. values ₹ 1,40,00,000 ₹ 70,00,000₹ 2,10,00,000
Gain to share holders ₹ 18,48,000 ₹ 9,24,000 ₹ 27,72,000
New Shares to be issued 2,00,000

Total shares of Rama Ltd. (4,00,000 + 2,00,000) 6,00,000 or ₹ 27,72,000 ÷ 3 = ₹ 9,24,000 to Krishna Ltd. and ₹
18,48,000 to Rama Ltd. (in 2 : 1 ratio)
Total earnings (₹ 10,00,000 + ₹ 7,00,000) ₹ 17,00,000

New EPS (₹ 17,00,000/6,00,000) ₹ 2.83

CASH DEAL
(ii) Existing EPS of Rama Ltd. ₹ 2.50
Question – 18
Increase in EPS of Rama Ltd (₹ 2.83 – ₹ 2.50) ₹ 0.33 The CEO of a company thinks that shareholders always look for EPS.
Therefore, he considers maximization of EPS as his company's
Existing EPS of Krishna Ltd. ₹ 3.50
objective. His company's current Net Profits are ₹ 80.00 lakhs and
Decrease in EPS of Krishna Ltd. (₹ 3.50 – ₹ 2.83) ₹ 0.67 P/E multiple is 10.5. He wants to buy another firm which has current
income of ₹ 15.75 lakhs & P/E multiple of 10.
(iii) P/E ratio of new firm (expected to remain same) 14 times
What is the maximum exchange ratio which the CEO should offer so
New market price (14 ×₹ 2.83) ₹ 39.62 that he could keep EPS at the current level, given that the current
market price of both the acquirer and the target company are ₹ 42
Total No. of Shares 6,00,000
and ₹ 105 respectively?
Total market Capitalization (6,00,000 ×₹ 39.62)₹ 2,37,72,000
If the CEO borrows funds at 15% and buys out Target Company by
Existing market capitalization paying cash, how much cash should he offer to maintain his EPS?
(₹ 70,00,000 +₹ 1,40,00,000) ₹ 2,10,00,000 Assume tax rate of 30%.

Total gain ₹ 27,72,000 (SM TYK – 05 & MTP – 2020)

15.20
 MERGER

Solution: outstanding in number; and promoters' equity holding in the

(i) company is 40%.

Acquirer Target PQR Ltd. wishes to acquire XYZ Ltd. because of likely synergies. The
Company Company estimated present value of these synergies is ₹ 80,00,000.
Net Profit ₹ 80 lakhs ₹ 15.75 lakhs
PE Multiple 10.50 10.00 Further PQR feels that management of XYZ Ltd. has been over paid.
Market Capitalization ₹ 840 lakhs ₹ 157.50 lakhs With better motivation, lower salaries and fewer perks for the top
Market Price management, will lead to savings of ₹ 4,00,000 p.a. Top management
₹ 42 ₹ 105
No. of Shares with their families are promoters of XYZ Ltd. Present value of these
20 lakhs 1.50 lakhs
EPS savings would add ₹ 30,00,000 in value to the acquisition.
₹4 ₹ 10.50
Following additional information is available regarding PQR Ltd.:
10.50
Maximum Exchange Ratio = = 2.625:1
4 Earnings per share : ₹4
Thus, for every one share of Target Company 2.625 shares of Total number of equity shares outstanding : 15,00,000
Acquirer Company.
Market price of equity share : ₹ 40
(ii) Let X lakhs be the amount paid by Acquirer company to Target
Company. Then to maintain same EPS i.e. ₹ 4 the number of Required:
shares to be issued will be:
(i) What is the maximum price per equity share which PQR Ltd.
(80 lakhs + 15.75 lakhs)- 0.70 × 15% × X can offer to pay for XYZ Ltd.?
=4
20 lakhs
(ii) What is the minimum price per equity share at which the
95.75 – 0.105 X management of XYZ Ltd. will be willing to offer their
=4
20 controlling interest?
X = ₹ 150 lakhs (SM TYK – 31)
Thus, ₹ 150 lakhs shall be offered in cash to Target Company Solution:
to maintain same EPS.
(i) Calculation of maximum price per share at which PQR Ltd.
Question – 19 can offer to pay for XYZ Ltd.’s share
The equity shares of XYZ Ltd. are currently being traded at ₹ 24 per
share in the market. XYZ Ltd. has total 10,00,000 equity shares

15.21
 MERGER

Market Value (10,00,000 ×₹ 24) ₹ 2,40,00,000 Abhiman Ltd. Abhishek Ltd.

Synergy Gain ₹ 80,00,000 Share Capital (₹) 200 lakh 100 lakh
Saving of Overpayment ₹ 30,00,000 Free Reserve and Surplus (₹) 800 lakh 500 lakh
₹ 3,50,00,000 Paid up Value per share (₹) 100 10
Free float Market Capitalization (₹) 400 lakh 128 lakh
Maximum Price (₹ 3,50,00,000/10,00,000) ₹ 35 P/E Ratio (times) 10 4

(ii) Calculation of minimum price per share at which the Trident Ltd. is interested to do justice to the shareholders of both the
management of XYZ Ltd.’s will be willing to offer their Companies. For the swap ratio weights are assigned to different
controlling interest parameters by the Board of Directors as follows:

Value of XYZ Ltd.’s Management Holding Book Value 25%

(40% of 10,00,000 × ₹ 24) ₹ 96,00,000
EPS (Earning per share) 50%
Add: PV of loss of remuneration to top ₹ 30,00,000
management ₹ 1,26,00,000 Market Price 25%
4,00,000
No. of Shares (a) What is the swap ratio based on above weights?
Minimum Price (₹ 1,26,00,000/4,00,000) (b) What is the Book Value, EPS and expected Market price of
₹ 31.50
Abhiman Ltd. after acquisition of Abhishek Ltd. (assuming
P.E. ratio of Abhiman Ltd. remains unchanged and all assets
and liabilities of Abhishek Ltd. are taken over at book value).
FREE FLOAT MARKET CAPITALIZATION
(c) Calculate:
Question – 20
The following information relating to the acquiring Company (i) Promoter’s revised holding in the Abhiman Ltd.
Abhiman Ltd. and the target Company Abhishek Ltd. are available.
(ii) Free float market capitalization.
Both the Companies are promoted by Multinational Company,
Trident Ltd. The promoter’s holding is 50% and 60% respectively in (iii) Also calculate No. of Shares, Earning per Share (EPS)
Abhiman Ltd. and Abhishek Ltd.: and Book Value (B.V.), if after acquisition of Abhishek
Ltd., Abhiman Ltd. decided to :

(1) Issue Bonus shares in the ratio of 1 : 2; and

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 MERGER

(2) Split the stock (share) as ₹ 5 each fully paid. Swap ratio is for every one share of Abhishek Ltd., to issue
0.15 shares of Abhiman Ltd. Hence total no. of shares to be
(SM TYK – 20) issued.
Solution: 10 Lakh × 0.15 = 1.50 lakh shares
(a) Swap Ratio (b) Book Value, EPS & Market Price
Abhiman Ltd. Abhishek Ltd. Total No of Shares = 2 Lakh + 1.5 Lakh
Share Capital 200 lakh 100 lakh
Free Reserve 800 lakh 500 lakh = 3.5 Lakh
Total 1000 lakh 600 lakh
Total Capital = ₹ 200 Lakh + ₹ 150 Lakh
No. of Shares 2 lakh 10 lakh
Book Value per share ₹500 ₹ 60 = ₹ 350 Lakh
Promoter’s holding 50% 60 %
Non promoter’s holding 50% 40 % Reserves = ₹ 800 Lakh + ₹ 450 Lakh
Free Float Market Cap. 400 lakh 128 lakh
Total market Cap. 800 lakh 320 lakh = ₹ 1,250 Lakh
No. of Shares 2 lakh 10 lakh ₹ 350 Lakh + ₹ 1,250 Lakh
Market Price ₹ 400 ₹ 32 BVPS =
3.5 Lakh
P/E Ratio 10 4
EPS = ₹ 457.14 per share
40 8
Profits (₹ 2 × 40 lakh) 80 lakh - Total Profit
(₹ 8 × 10 lakh) Post Merger EPS =
- ₹ 80 lakh [Link] Share

₹ 80 Lakh + ₹ 80 Lakh
Calculation of Swap Ratio = 3.5 Lakh
60 ₹ 160 Lakh
Book Value = 0.12 × 25% 0.03 =
500 3.5
8
EPS = 0.20 × 50% 0.10 = ₹ 45.17
40

32 Expected Market Price EPS(₹ 45.71) × P/E Ratio (10) = ₹

Market Price = 0.08 × 25% 0.02
400 457.10
Total 0.15 (c) (i) Promoter’s holding

15.23
 MERGER

Promoter’s Revised Abhiman 50% i.e. 1.00 Lakh shares The capitalization rate is 20 percent.

Holding Abhishek 60% i.e. 0.90 Lakh shares The promoters holding is to be restricted to 75 per cent as per the
norms of listing requirement. The Board of Directors have decided to
Total 1.90 Lakh shares fall in line to restrict the Promoters’ holding to 75 percent by issuing
Promoter’s % = 1.90/3.50 × 100 = 54.29% Bonus Shares to minority shareholders while maintaining the same
Price Earnings Ratio (P/E).
(ii) Free Float Market Capitalization
You are required to calculate:
Free Float Market = (3.5 Lakh – 1.9 Lakh) × ₹ 457.10
(i) Bonus Ratio;
Capitalization = ₹ 731.36 Lakh
(ii) MPS after issue of Bonus Shares; and
(iii) (a) & (b)
(iii) Free float Market capitalization after issue of Bonus Shares
Revised Capital ₹ 350 Lakh + ₹ 175 Lakh = ₹ 525 Lakh
(Exam May – 2018) (8 Marks)
No. of shares before
Solution:
Split (F.V ₹ 100) 5.25 Lakh
1. No. of Bonus Shares to be Issued:
No. of Shares after
Split (F.V. ₹ 5 ) 5.25 × 20 = 105 Lakh Free Float Capitalization = ₹ 45 crore

EPS 160 Lakh / 105 Lakh = 1.523 Market Price Per Share = ₹ 150

Book Value Cap. ₹ 525 Lakh + ₹ 1075 Lakh ₹ 4,500 lacs

Shares of Minority = = 30 lacs
₹ 150
No. of Shares =105 Lakh
Minority Share Holding (100% − 80%*) = 20%
= ₹ 15.238 per share
30 lacs
Hence Total shares = = 150 lacs
0.20
Question – 21
Intel Ltd., promoted by a Trans National Company, is listed on the Promoters holding 80%, = 120 lacs shares
stock exchange.
Shares remains the same, but holding % to be taken as 75%
The value of the floating stock is ₹ 45 crores. The Market Price per
Share (MPS) is ₹ 150.

15.24
 MERGER

Hence Total shares =

120 lacs
= 160 lacs MERGER OF BANKS
0.75
Question – 22
Shares of Minority = 160 lacs – 120 lacs = 40 lacs
Bank 'R' was established in 2005 and doing banking in India. The
Bonus 10 lacs for 30 lacs i.e. 1 shares for 3 shares held. bank is facing DO OR DIE situation. There are problems of Gross
NPA (Non Performing Assets) at 40% & CAR/CRAR (Capital Adequacy
2. Market Price after Bonus Issue: Ratio/ Capital Risk Weight Asset Ratio) at 4%. The net worth of the
bank is not good. Shares are not traded regularly. Last week, it was
Let us compute PE with given ke as follows:
traded @ ₹ 8 per share. RBI Audit suggested that bank has either to
PE =
1
=
1
=5 liquidate or to merge with other bank.
ke 0.20
Bank 'P' is professionally managed bank with low gross NPA of 5%.It
Market Price Given = ₹ 150 has Net NPA as 0% and CAR at 16%. Its share is quoted in the market
@ ₹ 128 per share. The board of directors of bank 'P' has submitted
Hence EPS will be (₹ 150/5) = ₹ 30
a proposal to RBI for take over of bank 'R' on the basis of share
Total No. of shares before bonus issue = 150 lacs exchange ratio.

Accordingly, Total PAT shall be (₹ 30 × 150 lacs) = ₹ 4,500 lacs The Balance Sheet details of both the banks are as follows:

Total No. of shares after bonus issue = 150 lacs + 10 lacs = Bank ‘R’ Bank ‘P’
160 lacs Amt. in ₹ Amt. In ₹
lacs lacs
EPS after Bonus Issue = ₹ 4,500 lacs/160 lacs = ₹ 28.125 Paid up share capital (F.V. ₹ 10 each) 140 500
Reserves & Surplus 70 5,500
Market Price After Bonus Issue = ₹ 28.125 × 5 = ₹ 140.63 Deposits 4,000 40,000
Other liabilities 890 2,500
3. Free Float Capitalization after Bonus Issue Total Liabilities 5,100 48,500
Cash in hand & with RBI 400 2,500
₹ 140.63 × 40 lacs = ₹ 5,625.20 lacs i.e. ₹ 56.252 crore Balance with other banks - 2,000
Investments 1,100 15,000
Note: Since the information regarding the promoters’ holding is Advances 3,500 27,000
missing in the question, above solution is based on assumption of Other Assets 100 2,000
promoter’s holding as 80%. However, student can assume any % Total Assets 5,100 48,500
other than 80% and solve the question accordingly.

15.25
 MERGER

It was decided to issue shares at Book Value of Bank 'P' to the Calculation of Capital Reserve
shareholders of Bank 'R'. All assets and liabilities are to be taken over
at Book Value. Book Value of Shares ₹ 210.00 lac

For the swap ratio, weights assigned to different parameters are as Less: Value of Shares issued ₹ 17.50 lac
follows:
Capital Reserve ₹ 192.50 lac
Gross NPA 30%
Balance Sheet
CAR 20%
Market price 40% ₹ lac ₹ lac
Book value 10% Paid up Share Capital 517.50 Cash in Hand & RBI 2,900.00
Reserves & Surplus 5,500.00 Balance with other 2,000.00
(a) What is the swap ratio based on above weights? Capital Reserve 192.50 banks 16,100.00
Deposits 44,000.00 Investment 30,500.00
(b) How many shares are to be issued? Other Liabilities 3,390.00 Advances 2,100.00
53,600.00 Other Assets 53,600.00
(c) Prepare Balance Sheet after merger.
(d) Calculation CAR & Gross NPA % of Bank ‘P’ after Merger
(d) Calculate CAR & Gross NPA % of Bank 'P' after merger.
Total Capital
CAR/CRWAR =
Solution: Risky Weighted Assets

(a) Swap Ratio Bank ‘R’ Bank ‘P’ Merged

CAR (Given) 4% 16%
Gross NPA 5 : 40 i.e 5/40 × 30% = 0.0375 Total Capital ₹ 210 lacs ₹ 6000 lacs ₹ 6210 lacs
CAR 4 : 16 i.e 4/16 × 20% = 0.0500 Risky Weighted ₹ 5250 lacs ₹ 37500 lacs ₹ 42750 lacs
Market Price 8 : 128 i.e 8/128 × 40% = 0.025 Assets
Book Value Per Share 15 : 120 i.e 15/120 × 10% = 0.0125
₹ 6,210 lacs
Car = = 14.53%
Thus, for every 1 share of Bank ‘R’ 0.125 share of Bank ‘P’ ₹ 42,750 lacs
shall be issued. Gross NPA
GNPA Ratio = × 100
Gross Deposits
(b) No. of Equity Shares to be Issued:

₹ 140 lac Bank ‘R’ Bank ‘P’ Merged

× 0.125 = 1.75 lac shares GNPA 0.40 0.5
₹ 10
(Given) GNPAR GNPAS
0.40 = 0.05=
(c) Balance Sheet after Merger ₹ 3,500 lacs ₹ 27,000 lacs

15.26
 MERGER

₹ 1400lac ₹ 1350 lac (×) P/E ratio 8 7

Gross NPA ₹ 2750 lacs MPS ₹ 24 ₹ 14

(a) Maximum Exchange Ratio

MINIMUM & MAXIMUM EXCHANGE RATIO (Conn & Let assume maximum Exchange Ratio be x at which post
Nielson Model) merger MPS be ₹ 24

1,200 + 400
(400 + 200 x) × 8 = ₹ 24
Question – 23
ABC Ltd. is intending to acquire XYZ Ltd. by way of merger and the
12,800 = 9,600 + 4,800 x
following information is available in respect of these companies:
12,800 − 9,600
ABC Ltd. XYZ Ltd. x= = 0.6667:1
4,800
Total Earnings (E) (in lakh) ₹ 1,200 ₹400
Number of outstanding shares (S) 400 200 (b) Minimum Exchange Ratio
(in lakh) 8 7
Price earnings ratio (P/E) Let assume maximum Exchange Ratio be x at which post
merger Equivalent MPS should be ₹ 14
(a) Determine the maximum exchange ratio acceptable to the
shareholders of ABC Ltd., if the P/E ratio of the combined firm 1,200 + 400
is expected to be 8? (400 + 200 x ) × 10 × x = ₹ 14
(b) Determine the minimum exchange ratio acceptable to the 16,000 x = 5,600 + 2,800 x
shareholders XYZ Ltd., if the P/E ratio of the combined firm is
expected to be 10? 13,200 x = 5,600

Note: Make calculation in lakh multiples and compute ratio upto 4 5,600
x= = 0.4242:1
decimal points. 13,200

(RTP May – 2021) Question – 24

Solution: Longitude Limited is in the process of acquiring Latitude Limited on
ABC XYZ a share exchange basis. Following relevant data are available:
EAT 1,200 lacs 400 lacs
(÷) No. 400 200
EPS ₹3 ₹2

15.27
 MERGER

Longitude Latitude 5
Swap Ratio =
8
Limited Limited
Profit after Tax (PAT) ₹ in 120 80 = 0.625:1
Number of Shares Lakhs 15 16
Earning per Share (EPS) Lakhs 8 5 (2) Maximum exchange ratio without dilution of
Price Earnings Ratio (P/E ₹ 15 10 market price per share
Ratio)
(Ignore Synergy) 50
Swap Ratio =
120

You are required to determine:

= 0.4169:1
(i) Pre-merger Market Value per Share, and
Question – 25
(ii) The maximum exchange ratio Longitude Limited can offer XYZ Ltd. wants to purchase ABC Ltd. by exchanging 0.7 of its share
without the dilution of for each share of ABC Ltd. Relevant financial data are as follows:

(1) EPS and Equity shares outstanding 10,00,000 4,00,000

EPS (₹) 40 28
(2) Market Value per Share Calculate Ratio/s up to four Market price per share (₹) 250 160
decimal points and amounts and number of shares up
to two decimal points. (i) Illustrate the impact of merger on EPS of both the companies.
(SM TYK – 13) (ii) The management of ABC Ltd. has quoted a share exchange
ratio of 1:1 for the merger. Assuming that P/E ratio of XYZ
Solution:
Ltd. will remain unchanged after the merger, what will be the
(i) Pre Merger Market Value of per Share gain from merger for ABC Ltd.?

P/E Ratio × EPS (iii) What will be the gain/loss to shareholders of XYZ Ltd.?

Longitude Ltd. ₹ 8 × 15 = ₹ 120.00 (iv) Determine the maximum exchange ratio acceptable to
shareholders of XYZ Ltd.
Latitude Ltd. ₹ 5 × 10 = ₹ 50.00
(SM TYK – 08, Exam November – 2019 & December – 2021) (8
(ii) (1) Maximum exchange ratio without dilution of EPS Marks)

15.28
 MERGER

Solution: Working Notes Total Profit (₹ 400,00,000 + ₹112,00,000) ₹ 512,00,000

(a) EPS ₹ 36.57

Market Price of Share (₹ 36.57 × 6.25) ₹ 228.56
XYZ Ltd. ABC Ltd.
Equity shares outstanding 10,00,000 4,00,000 Market Price of Share before Merger ₹ 160.00
(Nos.) Impact (Increase/ Gain) ₹ 68.56
EPS ₹ 40 ₹ 28
Profit ₹ 400,00,000 ₹ 112,00,000 (iii) Gain/ loss from the Merger to the shareholders of
PE Ratio 6.25 5.71 XYZ Ltd.
Market price per share ₹ 250 ₹ 160
Market Price of Share ₹ 228.56
(b) EPS after merger Market Price of Share before Merger ₹ 250.00
Loss from the merger (per share) ₹ 21.44
No. of shares to be issued (4,00,000 × 0.70) 2,80,000
Exiting Equity shares outstanding 10,00,000 (iv) Maximum Exchange Ratio acceptable to XYZ Ltd.
Equity shares outstanding after merger 12,80,000 shareholders
Total Profit (₹ 400,00,000 + ₹ 112,00,000) ₹ 512,00,000
EPS (₹ 512,00,000/12,80,000) ₹ 40 28
Swap Ratio =
40
(i) Impact of merger on EPS of both the companies
= 0.70:1
XYZ Ltd. ABC Ltd.
EPS after Merger ₹ 40 ₹ 28 PART II: DEMERGER
EPS before Merger ₹ 40 ₹ 28*
Nil Nil Question – 26
The following information is relating to Fortune India Ltd. having two
* ₹ 40 × 0.70 division, viz. Pharma Division and Fast Moving Consumer Goods
Division (FMCG Division). Paid up share capital of Fortune India Ltd.
(ii) Gain from the Merger if exchange ratio is 1: 1 is consisting of 3,000 Lakhs equity shares of Re. 1 each. Fortune
India Ltd. decided to de-merge Pharma Division as Fortune Pharma
No. of shares to be issued 4,00,000
Ltd. w.e.f. 1.4.2009. Details of Fortune India Ltd. as on 31.3.2009
Exiting Equity shares outstanding 10,00,000 and of Fortune Pharma Ltd. as on 1.4.2009 are given below:
Equity shares outstanding after merger 14,00,000

15.29
 MERGER

Particulars Fortune Fortune 3. Book Value per share of both the Companies immediately after
Pharma Ltd. (₹) India Ltd. (₹) Demerger.
Outside Liabilities
(SM TYK – 22)
Secured Loans 400 lakh 3,000 lakh
Unsecured Loans 2,400 lakh 800 lakh Solution:
Current Liabilities & Provisions 1,300 lakh 21,200 lakh
Assets Share holders’ funds
Fixed Assets 7,740 lakh 20,400 lakh
Investments 7,600 lakh 12,300 lakh Particulars Fortune Fortune Fortune India
Current Assets 8,800 lakh 30,200 lakh India Ltd. Pharma Ltd. (FMCG) Ltd.
Loans & Advances 900 lakh 7,300 lakh Assets 70,000 25,100 44,900
Deferred tax/Misc. Expenses 60 lakh (200) lakh Outside Liabilities 25,000 4,100 20,900
Net worth 45,000 21,000 24,000
Board of Directors of the Company have decided to issue necessary 1. Calculation of Shares of Fortune Pharma Ltd. to be issued
equity shares of Fortune Pharma Ltd. of Re. 1 each, without any to shareholders of Fortune India Ltd.
consideration to the shareholders of Fortune India Ltd. For that
Fortune Pharma Ltd.
purpose following points are to be considered:
Estimated Profit (₹ in lakhs) 1,470
(a) Transfer of Liabilities & Assets at Book value. Estimated market price (₹) 24.5
Estimated P/E 25
(b) Estimated Profit for the year 2009-10 is ₹ 11,400 Lakh for Estimated EPS (₹) 0.98
Fortune India Ltd. &₹ 1,470 lakhs for Fortune Pharma Ltd. No. of shares lakhs 1,500

(c) Estimated Market Price of Fortune Pharma Ltd. is ₹ 24.50 per

Hence, Ratio is 1 share of Fortune Pharma Ltd. for 2 shares of
share. Fortune India Ltd.
(d) Average P/E Ratio of FMCG sector is 42 & Pharma sector is or for 0.50 share of Fortune Pharma Ltd. for 1 share of Fortune
25, which is to be expected for both the companies. India Ltd.
Calculate: 2. Expected market price of Fortune India (FMCG) Ltd.
1. The Ratio in which shares of Fortune Pharma are to be issued
Fortune India (FMCG) Ltd.
to the shareholders of Fortune India Ltd.
Estimated Profit (₹ in lakhs) 11,400
2. Expected Market price of Fortune India (FMCG) Ltd. No. of equity shares(₹ in lakhs) 3,000

15.30
 MERGER

Estimated EPS (₹) 3.8 Solution:

Estimated P/S 42
159.60 VALUATION BASED ON MARKET PRICE
Estimated Market price (₹)
Market Price per share ₹ 400
3. Book value per share
Thus value of total business is (₹ 400 × 1.5 Cr.) ₹ 600 Cr.
Fortune Fortune India
Pharma Ltd. (FMCG) Ltd. VALUATION BASED ON DISCOUNTED CASH FLOW
Net worth (₹ in lakhs) 21,000 24,000
No. of shares (₹ in lakhs) 1,500 3,000 Present Value of cash flows
Book value of shares ₹ 14 ₹8
(₹ 250 cr × 0.893) + (₹ 300 cr. × 0.797) + (₹ 400 cr. × 0.712 ) =

₹ 747.15 Cr.
TRUE COST OF AEQUISITION
Value of per share (₹ 747.15 Cr. / 1.5 Cr) ₹ 498.10 per share
Question – 27
ABC Company is considering acquisition of XYZ Ltd. which has 1.5 RANGE OF VALUATION

crores shares outstanding and issued. The market price per share is Per Share ₹ Total ₹ Cr.
₹ 400 at present. ABC's average cost of capital is 12%. Available Minimum 400.00 600.00
Maximum 498.10 747.15
information from XYZ indicates its expected cash accruals for the
next 3 years as follows:

Question – 28
Year ₹ Crore Elrond Limited plans to acquire Doom Limited. The relevant financial
1 250 details of the two firms prior to the merger announcement are:
2 300 Elrond Limited Doom Limited
3 400 Market price per share ₹ 50 ₹ 25
Calculate the range of valuation that ABC has to consider. (PV factors Number of outstanding shares 20 lakhs 10 Lakhs

at 12% for years 1 to 3 respectively: 0.893, 0.797 and 0.712). The merger is expected to generate gains, which have a present value
of ₹ 200 lakhs. The exchange ratio agreed to is 0.5.
(SM TYK – 01 & MTP April – 2021)

15.31
 MERGER

What is the true cost of the merger from the point of view of Elrond (ii) On the basis of aforesaid conditions calculate the gain or loss
Limited? to shareholders of both the companies, if AFC Ltd. were to offer
one of its shares for every four shares of BCD Ltd.
(SM TYK – 02)
(iii) Calculate the gain to the shareholders of both the Companies,
Solution: if AFC Ltd. pays ₹ 22 for each share of BCD Ltd., assuming
Market Value of Firm after Merger the P/E Ratio of AFC Ltd. does not change after the merger.
EPS of AFC Ltd. is ₹ 8 and that of BCD is ₹ 2.50. It is assumed
Vf = (20 × 50) + (10 × 25) + 200 = ₹ 1,450 that AFC Ltd. invests its cash to earn 10%.

Value of Doom Ltd. (SM TYK – 25)

1,450 Solution:
After Merger ( × 5) = 290 Lakh
25
(i) Increase in Total Value of BCD
Pre merger Market Value = 250 Lakh
D1 ₹ 0.60
True cost of acquisition = 40 Lakh Ke = +g= + 0.07 = 0.10 or 10%
P0 20

Question – 29 ₹ 0.60
P0 = = ₹ 30
0.10 – 0.08
AFC Ltd. wishes to acquire BCD Ltd. The shares issued by the two
companies are 10,00,000 and 5,00,000 respectively: Value of synergy = (30 – 20) × 5,00,000 = ₹ 50,00,000

(i) Calculate the increase in the total value of BCD Ltd. resulting (ii) Gain or Loss due to Merger
from the acquisition on the basis of the following conditions:
1
No. of shares to be issued = (5,00,000 × 4) = 1,25,000 shares
Current expected growth rate of BCD Ltd. 7%

Expected growth rate under control of AFC Ltd., (without any MPS after merger
additional capital investment and without any change in risk Value of AFC Ltd before Merger (10,00,000 × 100) = ₹ 1,000 L.
of operations) 8%
Value of BCD before Merger (5,00,000 × ₹ 20) = ₹ 100 Lacs
Current Market price per share of AFC Ltd. ₹ 100
Value of synergy = ₹ 50 Lacs
Current Market price per share of BCD Ltd. ₹ 20
VB after Merger = ₹ 1,150 Lacs
Expected Dividend per share of BCD Ltd. ₹ 0.60

15.32
 MERGER

÷ No. of shares after merger = 11.25 Lacs Long Ltd., is planning to acquire Tall Ltd., with the following data
available for both the companies:
MPS after Merger = ₹ 102.22 Long Ltd. Tall Ltd.
Gain or Loss Expected EPS ₹ 12 ₹5
AFC BCD Expected DPS ₹ 10 ₹3
MPS before merger ₹ 100 ₹ 20
MPS after merger ₹ 102.22 25.55 (102.22 × No. of Shares 30,00,000 18,00,000
0.25)
Gain 2.22 5.55 Current Market Price of Share ₹ 180 ₹ 50

(iii) Gain/Loss As per an estimate Tall Ltd., is expected to have steady growth of
earnings and dividends to the tune of 6% per annum. However, under
EAT of BCD (5,00,000 × 2.50) = ₹ 12,50,000
the new management the growth rate is likely to be enhanced to 8%
(-) Opportunity Cost = ₹ 11,00,000 per annum without additional investment.

EAT = ₹ 1,50,000 You are required to:

EAT (AFC) (10,00,000 × 8) = ₹ 80,00,000 (i) Calculate the net cost of acquisition by Long Ltd., if ₹ 60 is
paid for each share of Tall Ltd.
80,00,000 + 1,50,000
Post Merger EPS = = ₹ 8.15 (ii) If the agreed exchange ratio is one share of Long Ltd., for every
10,00,000
three shares of Tall Ltd., in lieu of the cash acquisition as per
Post Merger MPS = 8.15 × 12.5 = 101.875 (i) above, what will be the net cost of acquisition?

Gain to AFC [101.875 - 100] = ₹ 1.1875 (iii) Calculate Gain from acquisition.

Gain to BCD [₹ 22 – ₹20] =₹2 (Exam July – 2021 & RTP May – 2026) (8 Marks)

Pre merger P/E Ratio Solution:

₹ 100 (1) Net Cost of Acquisition
P/E = = 12.5
8
Cash paid [18,00,000 × 60] = ₹ 1,08,00,000
Question – 30
(-) Market value of Tall Ltd. [18,00,000 × 50]= ₹ 9,00,00,000

15.33
 MERGER

Net Cost of Acquisition = ₹ 18,00,000 details of the two companies prior to merger announcement are as
follows:
(ii) Net Cost of Acquisition (Stock Deal)
P Ltd R Ltd
Value of synergy
Profit before Tax (₹ Crore) 15 13.50
3
Ke = + 0.06 = 0.12
50
No. of Shares (Crore) 25 15
3
P0 = = ₹ 75 P/E Ratio 12 9
0.12-0.08

Value of synergy = (75 – 50) × 18,00,000 Corporate Tax Rate 30%

= ₹ 4,50,00,000 You are required to determine:

(iii) Post Merger MPS (i) Market value of both the company.

VA (30 lacs × 180) = ₹ 5,400 lacs (ii) Value of original shareholders.

VB (18 lacs × 50) = ₹ 900 lacs (iii) Price per share after merger.

VS = ₹ 450 lacs (iv) Effect on share price of both the company if the Directors of P
Ltd. expect their own pre-merger P/E ratio to be applied to the
Market Value = ₹ 6,750 lacs combined earnings.
6,750
Value of Tall after Merger ( × 6) = 1,125 (SM TYK – 14)
36

Value of Tall before Berger = 900

Cost of Acquisition = 225 lacs

1 Solution:
No. = 18,00,000 × = 6,00,000
3
P Ltd. R Ltd.
Question – 31 Profit before Tax (₹ in crore) 15 13.50
P Ltd. is considering take-over of R Ltd. by the exchange of four new Tax 30% (₹ in crore) 4.50 4.05
shares in P Ltd. for every five shares in R Ltd. The relevant financial Profit after Tax (₹ in crore) 10.50 9.45

15.34
 MERGER

Earning per Share (₹) 10.50 9.45 Combined Value of Entity 211.05 crore
= ₹ 0.42 = ₹ 0.63
25 15
No. of shares after Merger 37 crore
Price of Share before ₹ 0.42 × 12 = ₹ ₹ 0.63 × 9 = ₹
Value of Per Share ₹ 5.70405
Merger (EPS × P/E Ratio) 5.04 5.67
Value of P Ltd. Shareholders (25 crores
× ₹ 5.70405) ₹ 142.60 crore
(i) ∴ Market Value of company Value of R Ltd. Shareholders (12 crores
P Ltd. = ₹ 5.04 × 25 Crore = ₹ 126 crore × ₹ 5.70405) ₹ 68.45 crore

R Ltd. = ₹ 5.67 × 15 Crore = ₹ 85.05 crore (iii) ∴ Price per Share after Merger

19.95 Crore
Combined = ₹ 126 +₹ 85.05 = ₹ 211.05 Crores EPS = = ₹ 0.539 per share
37 Crore

After Merger P/E Ratio = 12

P Ltd. R Ltd. Market Value Per Share = ₹ 0.539 × 12 = ₹ 6.47
4
No. of Shares 25 crores 15 × = 12 Crores Total Market Value = ₹ 6.47 × 37 crore = ₹ 239.39 crore
5

Market Value 239.39 crore

Combined Shares = 37 Crores Price of Share = = = ₹ 6.47
Number of Shares 37 Crore
25 12
% of Combined Equity Owned ×100 = 67.57% ×100 = 32.43% (iv) Effect on Share Price
37 37

(ii) ∴ Value of Original Shareholders P Ltd.

P Ltd. R Ltd. Gain/loss (-) per share = ₹ 6.47 – ₹ 5.04 = ₹ 1.43

₹ 211.05 crore × 67.57% ₹ 211.05 crore × 32.43% i.e.

6.47 – 5.04
× 100 = 0.284 or 28.4%
5.04
= ₹ 142.61 = ₹ 68.44
∴ Share price would rise by 28.4%
Alternatively, it can also be computed as follows:
R Ltd.
4
6.47 × = ₹ 5.18
5

Gain/loss (-) per share = ₹ 5.18 – ₹ 5.67 = (- ₹ 0.49)

15.35
 MERGER
5.18 – 5.67 Profit after Tax (₹ in crore) 12.60 14.56
i.e. × 100 (-) = 0.0864 or (-) 8.64% = ₹ 0.63 = ₹ 0.81
5.67 Earnings per Share 20 18

∴ Share Price would decrease by 8.64%. ₹ 0.63 × 11 = ₹ ₹ 0.81 × 8 = ₹

Price per Share before
Merger 6.93 6.48
Question – 32 (EPS × P/E Ratio)
M/s. Vasavi Ltd. is considering the takeover of M/s. SKPD Ltd. by
the exchange of five new shares in M/s. Vasavi Ltd. for every eight a. Market Value of company
shares in M/s. SKPD Ltd. The relevant financial details of the two
companies prior to merger announcement are as follows: M/s Vasavi Ltd. = ₹ 6.93 × 20 Crore = ₹ 138.60 crore

Particulars M/s. Vasavi Ltd. M/s. SKPD Ltd. M/s SKPD Ltd. = ₹ 6.48 ×18 Crore = ₹ 116.64 crore
Profit before tax (₹ crore) 18 20.8
No. of shares (in crore) 20 18 b. Value of Original Shareholders
P/E ratio 11 8
After Merger
Corporate tax rate 30%.
M/s Vasavi Ltd. M/s SKPD Ltd.
You are required to determine: No. of Shares 20 crores 18 ×
5
= 11.25
8
a. Market value of both the companies crores
Combined 31.25 crores
% of Combined 20 11.25
b. Value of original share holders × 100 = × 100 =
Equity Owned 31.25 31.25
c. Price per share after merger 64.00% 36.00%
Value of Original ₹ 255.24 crore × ₹ 255.24 crore ×
d. Effect on share price of both the companies. If the directors of Shareholders 64.00% 36%
Vasavi Ltd. expect their own pre-merger P/E ratio to be = ₹ 163.35 crores = ₹ 91.89 crores
applied to the combined earnings. c. Price per Share after Merger
(Exam May – 2022) (8 Marks)
₹ 27.16 Crore
Solution: EPS = = ₹ 0.87 per share
31.25 Crore

M/s Vasavi Ltd. M/s SKPD Ltd. P/E Ratio = 11

Profit before Tax (₹ in crore) 18.00 20.80
Tax 30% (₹ in crore) 5.40 6.24 Market value per share = ₹ 0.87 × 11 = ₹ 9.57
12.60 14.56

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 MERGER

d. Effect on Share Price The number of shares outstanding in both the companies before the
merger is the same and the companies agree to an exchange ratio of
M/s Vasavi Ltd. 0.5 shares of Yes Ltd. for each share of No Ltd.

Gain/loss (-) per share = ₹ 9.57 − ₹ 6.93 = ₹ 2.64 PV factor at 15% for years 1-5 are 0.870, 0.756; 0.658, 0.572, 0.497
respectively.
9.57 – 6.93
i.e. × 100 = 0.381 or 38.10%
6.93 You are required to:
∴ Share price would increase by 38.10% (i) Compute the Value of Yes Ltd. before and after merger.

M/s SKPD Ltd. (ii) Value of Acquisition and

9.57 ×
5
= ₹ 5.98 (iii) Gain to shareholders of Yes Ltd.
8 (SM TYK – 16)
Gain/loss (-) per share = ₹ 5.97 − ₹ 6.48 = (₹ 0.51) Solution:
5.97 – 6.48 (i) Working Notes:
i.e. × 100 = (0.0787) or (-7.87%)
6.48
Present Value of Cash Flows (CF) upto 5 years
∴ Share Price would decrease by 7.87%.
Year CF of Yes PVF PV of CF of PV of CF
Question – 33 End Ltd. (₹ @15% CF (₹ Merged of Merged
Yes Ltd. wants to acquire No Ltd. and the cash flows of Yes Ltd. and lakhs) lakhs) Entity Entity
the merged entity are given below: (₹ (₹ lakhs)
lakhs)
Year 1 2 3 4 5
1 175 0.870 152.25 400 348.00
Yes Ltd. 175 200 320 340 350
2 200 0.756 151.20 450 340.20
Merged Entity 400 450 525 590 620
3 320 0.658 210.56 525 345.45
Earnings would have witnessed 5% constant growth rate without 4 340 0.572 194.48 590 337.48
merger and 6% with merger on account of economies of operations 5 350 0.497 173.95 620 308.14
after 5 years in each case. The cost of capital is 15%. 882.44 1679.27

PV of cash flows of Yes Ltd. after the forecast period

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 MERGER

CF5 (1 + g) 350 (1 + 0.05) 367.50 = Share of Yes Ltd. in merged entity – Value of Yes Ltd. before
TV5 = = = = ₹ 3,675 lakhs
Ke − g 0.15-0.05 0.10 merger

PV of TV5 = ₹ 3675 lakhs × 0.497 = ₹ 1,826.475 lakhs = ₹ 3,538.98 lakhs − ₹ 2,708.915 = ₹ 830.065 lakhs

PV of Cash Flows of Merged Entity after the forecast period

CAPITAL RESTRUCTURING
CF5 (1 + g) 620 (1 + 0.06) 657.20
TV5 = = = = ₹ 7,302.22 lakhs
Ke − g 0.15 − 0.06 0.09 Question – 34
The following is the Balance-sheet of Grape Fruit Company Ltd as at
PV of TV5 = ₹ 7302.22 lakhs × 0.497 = ₹ 3,629.20 lakhs
March 31st, 2019.
Value of Yes Ltd. (₹ in (₹ in
Liabilities Assets
lakhs) lakhs)
Before merger After merger Equity shares of ₹ 100 600 Land and Building 200
(₹ lakhs) (₹ lakhs) each
PV of CF (1-5 years) 882.440 1679.27 14% preference shares 200 Plant and Machinery 300
Add: PV of TV5 1826.475 3629.20 of ₹ 100/- each
2708.915 5308.47 13% Debentures 200 Furniture and Fixtures 50
Debenture interest 26 Inventory 150
(ii) Value of Acquisition accrued and payable
= Value of Merged Entity – Value of Yes Ltd. Loan from bank 74 Sundry debtors 70
Trade creditors 340 Cash at bank 130
= ₹ 5,308.47 lakhs – ₹ 2,708.915 lakhs Preliminary expenses 10
Cost of issue of 5
= ₹ 2,599.555 lakhs debentures
Profit and Loss 525
(iii) Gain to Shareholders of Yes Ltd.
account
1 1440 1440
Share of Yes Ltd. in merged entity = ₹ 5,308.47 lakhs ×
1.5
The Company did not perform well and has suffered sizable losses
= 3,538.98 lakhs
during the last few years. However, it is felt that the company could
Gain to shareholder be nursed back to health by proper financial restructuring.
Consequently the following scheme of reconstruction has been drawn
up:

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 MERGER

(i) Equity shares are to be reduced to ₹ 25/- per share, fully paid (a) Reduction of Liabilities payable
up;
₹ in lakhs
Reduction in equity share capital (6 lakh shares 450
(ii) Preference shares are to be reduced (with coupon rate of 10%) × ₹ 75 per share)
to equal number of shares of ₹ 50 each, fully paid up. Reduction in preference share capital (2 lakh 100
shares × ₹ 50 per share)
Waiver of outstanding debenture Interest 26
(iii) Debenture holders have agreed to forgo the accrued interest due 85
Waiver from trade creditors (₹ 340 lakhs × 0.25)
to them. In the future, the rate of interest on debentures is to 661
be reduced to 9 percent.
(b) Revaluation of Assets
Appreciation of Land and Building (₹ 450 lakhs 250
(iv) Trade creditors will forego 25 percent of the amount due to
− ₹ 200 lakhs)
them. Total (A) 911
(v) The company issues 6 lakh of equity shares at ₹ 25 each and
the entire sum was to be paid on application. The entire amount (ii) Amount of ₹ 911 lakhs utilized to write off losses, fictious
was fully subscribed by promoters. assets and over – valued assets.

Writing off profit and loss account 525

(vi) Land and Building was to be devalued at ₹ 450 lakhs, Plant and
Cost of issue of debentures 5
Machinery was to be written down by ₹ 120 lakhs and a Preliminary expenses 10
provision of ₹15 lakhs had to be made for bad and doubtful Provision for bad and doubtful debts 15
debts. Revaluation of Plant and Machinery 120
(₹ 300 lakhs – ₹ 180 lakhs) _____
Required: Total (B) 675
Capital Reserve (A) – (B) 236
(a) Show the impact of financial restructuring on the company’s
activities. (iii) Balance sheet of Grape Fruit Ltd. as 31st March 2011 (after re-
construction)
(b) Prepare the fresh balance sheet after the reconstructions is
completed on the basis of the above proposals. Liabilities Amt. Assets Amt.
12 lakhs equity shares 300 Land & Building 450
Solution: of ₹ 25/- each Plant & Machinery 180
10% Preference shares 100 Furniture & 50
Impact of Financial Restructuring of ₹ 50/- each Fixtures 150
Capital Reserve 236 Inventory 7
200 Sundry debtors 55
(i) Benefits to Grape Fruit Ltd.

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 MERGER

9% debentures 74 Prov. for Doubtful - 280 [Given: PVIF at 20% for year 1 to Year 5: 0.833, 0.694, 0.579, 0.482,
Loan from Bank 255 Debts 1 0.402]
Trade Creditors Cash-at-Bank 5
1165 (Balancing figure)* 1165 (Exam November – 2019) (8 Marks)

*Opening Balance of ₹ 130/- lakhs + Sale proceeds from issue of new Solution:
equity shares ₹ 150/- lakhs.
(i) Value of Firm

Year Cash Flow PVF PV (₹ in lakhs)

RESIDUAL (₹ in lakhs)
1 1760 0.833 1466.08
Question – 35 2 480 0.694 333.12
Mr. X, a financial analyst, intends to value the business of PQR Ltd. 3 640 0.579 370.56
in terms of the future cash generating capacity. He has projected the 4 860 0.482 414.52
following after tax cash flows : 5 1170 0.402 470.34
PV of Cash flows upto year 5 3054.62
Year : 1 2 3 4 5
Cash flows (₹ in lakh) 1,760 480 640 860 1,170 If PV of Terminal Value is considered with the growth rate (at
the end of 5th year)
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 10,260 (1 + 0.08) 11,080,80
= = = ₹ 92,340 lakh
0.20 – 0.08 0.12
inflation. The perpetual cash flow is estimated to be ₹ 10,260 lakh at
the end of the 5th year. Now, PV (at the beginning of the year)
Required: = ₹ 92,340 × 0.402 = ₹ 37,120.68 Lakhs
(i) What is the value of the firm in terms of expected future cash So, Present Value of the firm
flows, if the cost of capital of the firm is 20%.
= ₹ 3,054.62 + ₹ 37,120.68 = ₹ 40,175.30 Lakhs
(ii) The firm has outstanding debts of ₹ 3,620 lakh and cash/bank
balance of ₹ 2,710 lakh. Calculate the shareholder value per (ii) Value per Share
share if the number of outs tending shares is 151.50 lakh.
= Value of Firm – Value of Debt / No of shares
(iii) The firm has received a takeover bid from XYZ ltd. of ₹ 225 per
= (40,175.30 – 3,620)/151.50 = ₹ 241.29
share. Is it a good offer?

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 MERGER

(iii) Takeover bid of ₹ 225 per share seems to be not a good offer Borrowing 1,955 890
as it is lesser than the intrinsic value i.e. value per share of ₹ Capital Employed
241.29.
Market price share (₹) 52 75
Question – 36
ICL is proposing to take over SVL with an objective to diversify. ICL’s ICL’s Land & Buildings are stated at current prices. SVL’s Land &
profit after tax (PAT) has grown @ 18 per cent per annum and SVL’s Buildings are revalued three years ago. There has been an increase
PAT is grown @ 15 per cent per annum. Both the companies pay of 30 per cent per year in the value of Land & Buildings.
dividend regularly. The summarized Profit & Loss Account of both
SVL is expected to grow @ 18 per cent each year, after merger.
the companies are as follows:
ICL’s Management wants to determine the premium on the shares
₹ in Crores
over the current market price which can be paid on the acquisition
Particulars ICL SVL of SVL.
Net Sales 4,545 1,500
PBIT 2,980 720 You are required to determine the premium using:
Interest 750 25
(i) Net Worth adjusted for the current value of Land & Buildings
Provisions for Tax 1,440 445
PAT 790 250 plus the estimated average profit after tax (PAT) for the next
Dividends 235 125 five years.

(ii) The dividend growth formula.

ICL SVL
Fixed Assets
(iii) ICL will push forward which method during the course of
Land & Building (Net) 720 190
Plant & Machinery (Net) 900 350 negotiations?
Furniture & Fixtures (Net) 30 1,650 10 550
Period (t) 1 2 3 4 5
Current Assets 775 580
FVIF 1.300 1.690 2.197 2.856 3.713
Less: Current Liabilities
(30%, t)
Creditors 230 130
Overdrafts 35 10 FVIF 1.15 2.4725 3.9938 5.7424 7.7537
(15%,t)
Provision for Tax 145 50
Provision for dividends 60 470 50 240
(Exam November – 2020) (8 Marks)
Net Assets 1,955 890
Paid up share capital (₹ 10 250 125
per share) 1,050 1,300 660 785
Reserve and Surplus 655 105

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 MERGER

Solution: 97.70 – 75
Premium = × 100 = 27.60%
75
(i) Value per Share
(iii) ICL will push forward dividend growth model, due to lower
Net worth = 785 premium.

(+) Revaluation in L & B Question – 37

M/s. Roly Ltd. wants to acquire M/s. Poly Ltd. The following is the
[190 (1.30)3 − 190] Balance Sheet of Poly Ltd. as on 31st March, 2020:
[190 × 2.197 – 190] 227.43 Liabilities ₹ Assets ₹
Equity Capital (₹ 10 10,00,000 Cash 20,000
Net Worth ₹ 1,012.43 Cr.
per share) Debtors 50,000
250 × 7.7535 Retained Earnings 3,00,000 Inventories 2,00,000
(+) ( ) ₹ 387.685 Cr. 12% Debentures 3,00,000 Plant & 16,50,000
5
Creditors and other 3,20,000 Machinery
Value of SVL ₹ 1,400.115 Cr. liability
Total 19,20,000 Total 19,20,000
÷ No. of shares 12.50 Cr.
Shareholders of Poly Ltd. will get one share of Roly Ltd. at current
Value per share ₹ 112 Market price of ₹ 20 for every two shares. External liabilities are
112 – 75
expected to be settled at a discount of ₹ 20,000. Sundry debtors and
Premium = × 100 = 49.33% Inventories are expected to realize ₹ 2,00,000.
75

(ii) Dividend Growth Model Poly Ltd. will run as an independent unit. Cash Flow After Tax is
D1
expected to be ₹ 4,00,000 per annum for next 6 years. Assume the
Ke = +g disposal value of the plant after 6 years will be ₹ 1,50,000.
P0

125 Poly Ltd. requires a return of 14%

D0 = = ₹ 10
12.5

10 (1.15) n 1 2 3 4 5 6
Ke = + 0.15
75
PVIF (14%, n) 0.877 0.769 0.675 0.592 0.519 0.456
= 0.3033 or 30.33%
Advise the Board of Directors on the financial feasibility of the
10 (1.18)
P0 = = ₹ 95.70 Proposal.
0.3033 – 0.18

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 MERGER

(Exam Jan – 2021) (8 Marks) Business Probability Simple Ltd. ₹ Dimple Ltd. ₹
Condition Lacs Lacs
Solution:
High Growth 0.20 820 1050
Medium Growth 0.60 550 825
Calculation of Purchase Consideration
Slow Growth 0.20 410 590
₹
Issue of Share 50,000 × ₹ 20 10,00,000 The current debt of Dimple Ltd. is ₹ 65 lacs and of Simple Ltd. is ₹
External Liabilities settled 3,00,000 460 lacs.
12% Debentures 3,00,000
16,00,000 Calculate the expected value of debt and equity separately for the
Less: Realization of Debtors and Inventories 2,00,000
Cash 20,000 merged entity.
13,80,000
(SM TYK – 15)
Net Present Value
Solution:
= PV of Cash Inflow + PV of Demerger of Roly Ltd. – Cash Outflow
Compute Value of Equity
Simple Ltd.
= ₹ 4,00,000 PVAF(14%,6) + ₹ 1,50,000 PVF(14%, 6) – ₹ 13,80,000
( ₹ in Lacs)
= ₹ 4,00,000 × 3.888 + ₹ 1,50,000 × 0.456 – ₹ 13,80,000 High Medium Slow
Growth Growth Growth
= ₹ 15,55,200 + ₹ 68,400 – ₹ 13,80,000 Debit + Equity 820 550 410
Less: Debt 460 460 460
= ₹ 2,43,600 Equity 360 90 -50

Since NPV of the decision is positive it is advantageous to acquire Since the Company has limited liability the value of equity cannot be
Poly Ltd. negative therefore the value of equity under slow growth will be taken
as zero because of insolvency risk and the value of debt is taken at
Question – 38
410 lacs. The expected value of debt and equity can then be
Simple Ltd. and Dimple Ltd. are planning to merge. The total value
calculated as:
of the companies are dependent on the fluctuating business
conditions. The following information is given for the total value (debt
+ equity) structure of each of the two companies.

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 MERGER

Simple Ltd. Balance Sheet of S Ltd

(₹ in Lacs)
Liabilities Amount (₹) Assets Amount (₹)
High Growth Medium Slow Growth Expecte
Current Liabilities 1,59,80,000 Current 2,48,75,000
Growth d Value
Long Term Liabilities 1,28,00,000 Assets
Prob. Value Prob. Value Prob. Value Reserve & Surplus 2,79,95,000 Other Assets 94,00,000
Debt 0.20 460 0.60 460 0.20 410 450 Share Capital Property
Equity 0.20 360 0.60 90 0.20 0 126 (80 Lakhs shares of ₹ 1,20,00,000 Plants & 3,45,00,000
820 550 410 576 1.5 each) Equipment
Total 6,87,75,000 Total 6,87,75,000
Dimple Ltd.
(₹ in Lacs)
High Growth Medium Slow Growth Expecte Particulars R Ltd. (₹) S Ltd. (₹) Combined
Entity (₹)
Growth d Value
Profit after Tax 86,50,000 49,72,000 1,21,85,000
Prob. Value Prob. Value Prob. Value
Residual Net Cash Flows per year 90,10,000 54,87,000 1,85,00,000
Equity 0.20 985 0.60 760 0.20 525 758
Required return on equity 13.75% 13.05% 12.5%
Debt 0.20 65 0.60 65 0.20 65 65
1050 825 590 823 You are required to compute the following:

Expected Values (i) Minimum price per share S Ltd. should accept from R Ltd.
(₹ in Lacs)
Equity Debt (ii) Maximum price per share R Ltd. shall be willing to offer to S
Ltd.
Simple Ltd. 126 Simple Ltd. 450
Dimple Ltd. 758 Dimple Ltd. 65 (iii) Floor Value of per share of S Ltd., whether it shall play any
884 515 role in decision for its acquisition by R Ltd.

Question – 39 (Exam May – 2019) (8 Marks)

R Ltd. and S Ltd. operating in same industry are not experiencing
any rapid growth but providing a steady stream of earnings. R Ltd.'s Solution:
management is interested in acquisition of S. Ltd. due to its excess
(i) Calculation of Minimum price per share S Ltd. should
plant capacity. Share of S Ltd. is trading in market at ₹ 3.20 each.
accept from R Ltd.
Other data relating to S Ltd. is as follows:
Residual Cash Flow 54,87,000
Value of S Ltd. = = = ₹ 4,20,45,977
Ke − g 0.1305 − 0

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 MERGER
4,20,45,977
Value per share of S Ltd. = = ₹ 5.26
80,00,000 MULTIPLE CHOICE QUESTIONS
3,99,95,000
Book Value of per share of S Ltd. = = ₹ 4.99 or ₹ 5 Case Scenario – 01
80,00,000
SM Limited has a market capitalization of ₹ 3,000 crore and the
Therefore, the minimum price per share S ltd. should accept current earnings per share (EPS) is ₹ 200 with a price earnings ratio
from R Ltd. is ₹ 5 (current book value) (PER) of 15. The Board of directors is considering a proposal to buy
back 20% of the shares at a premium which can be supported by the
(ii) Calculation of Maximum price per share R Ltd. shall be
financials of the company. The Boards expects post buy back market
willing to offer to S Ltd.
price per share (MPS) of ₹ 3057. Post buy back PER will remain same.
Residual Cash Flow 90,10,000 The company proposes to fund the buy back by availing 8% bank
Value of R Ltd. = = = ₹ 6,55,27,273
Ke − g 0.1375 − 0 loan since available resources are committed for expansion plans.
1,85,00,000 Applicable income tax rate is 30%.
Value of Combined entity = = ₹ 14,80,00,000
0.125-0
Based on above Case Scenario, select the most appropriate
Value of synergy
alternative.
= Value of Combined entity – Individual values of R Ltd. and S
I. The number of shares proposed to be bought back
Ltd.
is……………..
= ₹ 14,80,00,000 – (₹ 4,20,45,977 + ₹ 6,55,27,273)
(a) 12 lakhs (b) 15 lakhs
= ₹ 4,04,26,750
(c) 20 lakhs (d) 22 lakhs
Maximum price per share R Ltd. shall be willing to offer to S
Ltd. shall be computed as follows:

Value of SLtd. as per Residual cash flows + Synergy benefits

II. The interest amount which can be paid for availing the bank
= loan
No. of Shares

=
4,20,45,977 + 4,04,26,750
= ₹ 10.31 (a) ₹ 5,280.00 Lakhs (b) ₹ 5,575.00 Lakhs
80,00,000
(c) ₹ 4,865.00 Lakhs (d) ₹ 6,485.00 Lakhs
(iii) Floor value of per share of S Ltd shall be ₹ 3.20 (current
market price) and it shall not play any role in decision for the
acquisition of S Ltd. as it is lower than its current book value.

15.45
 MERGER

III. The loan amount to be raised and ASE Ltd. DNF Ltd.
Profit after tax ₹ 36,00,000 ₹ 7,20,000
(a) ₹ 55,650 Lakhs (b) ₹ 62,300 Lakhs Equity shares outstanding (Nos.) 12,00,000 3,60,000
(c) ₹ 66,000 Lakhs (d) ₹ 72,450 Lakhs PE Ratio 10 times 7 times
Market price per share ₹ 30 ₹ 14

On the basis of above information, choose the most appropriate

IV. The premium per share paid over the current MPS answer to the following questions:

(a) ₹ 200 (b) ₹ 250 I. The number of equity shares to be issued by AES Ltd. for
acquisition of DNF Ltd. would be………………
(c) ₹ 300 (d) ₹ 350
(a) 1,68,000 (b) 1,80,000

(c) 2,40,000 (d) 3,00,000

V. % premium over CMP shall be …………..

(a) 12% (b) 14%

II. The EPS of AES Ltd. after the acquisition would be………………
(c) 10% (d) 15%
(a) ₹2 (b) ₹3
Answer: Case Scenario – 01
(c) ₹ 3.13 (d) ₹ 4.00
I. (c) 20 lakhs

II. (a) ₹ 5,280.00 Lakhs

III. The equivalent earnings per share of DNF Ltd. would
III. (c) ₹ 66,000 Lakhs
be………..
IV. (c) ₹ 300
(a) ₹1 (b) ₹ 1.50
V. (c) 10%
(c) ₹ 1.57 (d) ₹ 2.00
Case Scenario – 02
AES Ltd. wants to acquire DNF Ltd. and has offered a swap ratio of
1:2 (0.5 shares for every one share of DNF Ltd.). Following
information is provided:

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 MERGER

IV. If AES Ltd. PE multiple remains unchanged then its expected EPS 50%
market price per share after the acquisition would
be……………… Market price 25%

(a) ₹ 14 (b) ₹ 30 Book value 25%

(c) ₹ 31.30 (d) ₹ 40.00 I. The swap ratio based on assigned weight shall be_______

Answer-1 : 0.825 Answer-2 : 0.925

(MTP March – 2024)
Answer-3: 0.952 Answer-4: 0.752
Answer: Case Scenario – 02

I. (b) 1,80,000
II. Based on swap ratio as per weights the total number of share
II. (c) ₹ 3.13
issue by P Ltd to Q Ltd. shall be_______
III. (c) ₹ 1.57
Answer-1 : 46250 Answer-2 : 41250
IV. (c) ₹ 31.30
Answer-3: 47600 Answer-4: 37600

Case Scenario – 03 III. Post merger the EPS of the P Ltd shall be ___________
P Ltd is studying the possible acquisition Q Ltd. by way of merger
.the following are available: Answer-1 : 5.39 Answer-2 : 5.25

Firm After-Tax No. of Market Book Answer-3: 5.28 Answer-4: 5.47

Earnings Equity Price Per Value Per
Shares Share Share
P Ltd. ₹ 10,00,000 2,00,000 ₹ 75 ₹ 210 IV. In case Q Ltd. wants to be sure that its EPS is not diminished
Q Ltd. ₹ 3,00,000 50,000 ₹ 60 ₹ 105 by the merger, the relevant exchange ratio to achieve the same
objective should be________
The merger shall be gone through by exchange of equity share and
the exchange ratio is set according to different weights assigned to Answer-1 : 0.83 Answer-2 : 1.20
different basis as mentioned below :-
Answer-3: 1.30 Answer-4: 1.10

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 MERGER

(MTP November – 2025) (a) 1:0.952 (b) 1:2.125

Answer: Case Scenario – 03 (c) 1:2.023 (d) 1:0.196

I. Answer-2: 0.925
II. Answer-1: 46250
III. Answer-3: 5.28 III. No. of shares to be issued by X Ltd. shall be
IV. Answer-2: 1.20 approximately..........................

Case Scenario – 04 (a) 3.9375 Lakhs (b) 1.7639 Lakhs

The company X Ltd. proposes to take over Y Ltd. The chief executive (c) 3.7485 Lakhs (d) 0.3631 Lakhs
of the company thinks that shareholders always look for the earnings
per share. Therefore, he considers maximization of the earnings per (EXAM NOVEMBER 2024)
share as his company’s objective. The following information is
available in respect of X Ltd. and Y Ltd. Answer: Case Scenario – 04

X Ltd. Y Ltd. I. (c) 150 Lakhs

Net Profit ₹ 80 Lakh ₹ 15.75 Lakh II. (b) 1:2.125
P/E ratio 10.50 10.00
Current market price per share ₹ 42 ₹ 85 III. (a) 3.9375 Lakhs

From the information given above, choose the correct answer to the
following questions: Case Scenario – 05
Mr. Ramesh, a 40-year-old investor, has invested ₹ 10,00,000 in an
I. If the company borrows funds @ 15% rate of interest and buys actively managed Equity Mutual Fund. The fund has an Expense
out Target Company by paying cash, how much it should offer Ratio of 2.50% and follows the Nifty 50 Index as its benchmark. Upon
to maintain its EPS assuming tax rate @30%. analyzing the Fund details, he comes across the concept of Tracking
Error (TE) and finds out that the same Fund has a Tracking Error
(a) 210 Lakhs (b) 315 Lakhs (TE) of 3.20%.
(c) 150 Lakhs (d) 0 Lakhs A few months later, Mr. Ramesh receives a notification that the Fund
has implemented Side Pocketing. The Fund has an exposure of 15%
of his investment in a debt instrument of XYZ Ltd, a company facing
II. Maximum exchange ratio which the company should offer so a severe financial crisis. Since XYZ Ltd has defaulted on its
that the company could keep EPS at current level is............

15.48
 MERGER

payments, the Fund Manager has moved this portion into a side (A) Successful (B) Unsuccessful
pocket.
(C) Can’t say (D) Data is insufficient
Following the decision of Fund Manager, Mr. Ramesh decides to
reconsider any of the following option:

1. Should he stay invested in this Fund and wait for the Side- III. After the decision of Fund Manager for side-pocketing the
Pocketed assets to recover? equivalent portion of Mr. Ramesh’s investment shall_____

2. Should he switch to a Passive Index Fund that has a lower (A) remains illiquid until the Fund Manager decides to sell
Tracking Error and lower Expense Ratio it or the company recovers.

3. Should he redeem his remaining liquid holdings and invest in (B) be immediately written off, and the Mr. Ramesh loses
a better-performing actively Managed Fund? that portion.

Based on the above scenario and given his current situation, choose (C) be returned to Mr. Ramesh in proportion to his
the most appropriate answer for the following multiple-choice holdings.
questions: (D) be moved into a different Mutual Fund Scheme with no
I. Is it necessary for investors to pay close attention to the risk.
Expense Ratio of a Mutual Fund because………………..

(A) a high expense ratio can significantly reduce net returns IV. If Mr. Ramesh switches to a Passive Index Fund with an
over time. expense ratio of 0.8%, then he will save annually compared to
(B) a higher expense ratio always guarantees better fund his current Expense Ratio of 2.50%?
performance. (A) ₹ 8,000 (B) ₹ 10,000
(C) the expense ratio only matters in the first year of
(C) ₹ 17,000 (D) ₹ 18,000
investment.

(D) funds with higher expense ratios are always risk-free.

V. The advantage for Mr. Ramesh to switch over to a Passive
Index Fund shall be____
II. The Fund has been ……………… in replicating return on Nifty
(A) lower expense ratio and lower tracking error.
50.

15.49
 MERGER

(B) guaranteed recovery of side-pocketed assets. Calculation up to 2 decimal places.

(C) higher risk exposure compared to active funds. From the information given above, choose the correct answer to the
following question No. I to 27 :
(D) avoiding capital gains tax on redemption.
(EXAM SEPTEMBER - 2025)
(MTP March: 2025)
I. P/E Ratio of ABC Ltd. after acquisition is
Answer: Case Scenario – 05 (a) 20 times (b) 15.38 times
I. (A) a high expense ratio can significantly reduce net returns (c) 10 times (d) 14.55 times
over time.

II. (B) Unsuccessful II. EPS of ABC Ltd. & XYZ Ltd. before acquisition are respectively
(a) ₹ 0.8 &₹ 2.0 (b) ₹ 2.0 &₹ 0.8
III. (C) be returned to Mr. Ramesh in proportion to his holdings.
(c) ₹ 0.8 &₹ 1.04 (d) ₹ 1.04 &₹ 0.8
IV. (C) ₹ 17,000

V. (A) lower expense ratio and lower tracking error. III. EPS of ABC Ltd. after acquisition is
(a) ₹ 0.84 (b) ₹ 0.96
Case Scenario – 06 (c) ₹ 1.04 (d) ₹ 1.14
ABC Ltd. is planning to acquire XYZ Ltd. The following information Answer: Case Scenario – 06
is available in this respect : I. (b) 15.38 times
Company No. of Shares Market Price P/E Ratio II. (a) ₹ 0.8 &₹ 2.0
Per Share(₹)
ABC Ltd. 12,00,000 16 20 times III. (c) ₹ 1.04

XYZ Ltd. 4,00,000 20 10 times

Case Scenario – 07
ABC Ltd. plans to acquire the whole of XYZ Ltd. by issuing shares Ujwal Bank Ltd. (UBL) and Suraksha Bank Ltd. (SBL) are Scheduled
at its market price of ₹ 16, It is expected that the price of ABC Ltd. Banks to merge.
share will remain constant after this acquisition. Purchase
Consideration is ₹80,00,000 UBL is strong Private Sector Bank with stable capital adequacy, while
SBL has negative CRAR due to heavy NPAs.

15.50
 MERGER

Data of both the Banks is as follows: Answer Case Scenario – 07

Particulars UBL SBL (B) 0.20

Book Value per share (₹) 50 25
Market Price per share (₹) 200 50 (D) 4,000 shares
CRAR % 12 (-) 2
(A) ₹ 11.11
NPA % 2 12
No. of shares in thousands 50,000 20,000
Price Earning Ratio (PE Ratio) 20 10 Case Scenario – 08
A Ltd. wants to acquire D Ltd. and has offered a swap ratio of 1:2
Weights for swap ratio are Book Value per share 20%, Market Price
(0.5 shares for every one share of D Ltd.). Following information is
per share 40%, CRAR (%) 20% and balance for NPA %.
provided:
From the information given above, choose the correct answer to the A Ltd. D Ltd.
Question No. 10 to 12: Profit after tax ₹ 72,00,000 ₹ 14,40,000
I. The swap ratio based on information given shall be for 1 share Equity shares outstanding (Nos.) 24,00,000 7,20,000
PE Ratio 5 times 3.5 times
of UBL _________ shares of SBL.
Market price per share ₹ 15 ₹7
(A) 1.07 (B) 0.20 From the information given above, choose the correct answer to the
(C) 0.86 (D) 1.73 following questions:
I. The number of equity shares to be issued by A Ltd. for
II. Based on swap ratio total number of shares issued by UBL to acquisition of D Ltd. would be………………
SBL shall be ________ (in Thousands). (a) 3,36,000 (b) 3,60,000
(A) 21,400 shares (B) 24,000 shares (c) 4,80,000 (d) 6,00,000
(C) 17,200 shares (D) 4,000 shares
II. The EPS of A Ltd. after the acquisition would be………………
III. Post merger Earning Per Share (EPS) of UBL shall be ₹ ________ (a) ₹2 (b) ₹3
(A) ₹ 11.11 (B) ₹ 12.50 (c) ₹ 3.13 (d) ₹ 4.00
(C) ₹ 8.50 (D) ₹ 10.00
(EXAM JANUARY – 2026)

15.51
 MERGER

III. The equivalent earnings per share of D Ltd. would be……….. The company is planning to borrow funds @ 15% rate of interest and
(a) ₹1 (b) ₹ 1.50 buys out the target company by paying cash.

(c) ₹ 1.57 (d) ₹ 2.00 Assume tax rate @30%.

From the information given above, choose the correct answer to the
IV. If A Ltd. PE multiple remains unchanged then market following questions:
capitalization of A Ltd. after the acquisition would
I. The total market value of equity of XYZ Ltd. is
be………………
approximately……………..
(a) ₹ 50.40 Lakh (b) ₹ 360.00 Lakh
(a) ₹ 3150 lakh (b) ₹ 3400 lakh
(c) ₹ 431.94 Lakh (d) ₹ 400.00 Lakh
(c) ₹ 4200 lakh (d) ₹ 16800 lakh
Answer Case Scenario – 08

I. (b) 3,60,000 II. Suppose if XYZ Ltd. is borrowing funds at a high interest rate

II. (c) ₹ 3.13 to finance acquisition it will affect its EPS mainly due
to…………………
III. (c) ₹ 1.57
(a) increase in operating profit.
IV. (c) ₹ 431.94 Lakh (b) increase in interest burden.
(c) increase in market price of shares.

Case Scenario – 09 (d) increase in tax liability.

The company ABC Ltd. proposes to take over XYZ Ltd. The chief III. Suppose if ABC Ltd. is offering about ₹ 4030 Lakh to XYZ Ltd.
executive of the company thinks that shareholders always look for
for the proposed acquisition it will result in……………….
the earnings per share. Therefore, he considers maximization of the
earnings per share as his company’s objective. The following (a) EPS accretion
information is available in respect of ABC Ltd. and XYZ Ltd. (b) EPS dilution

ABC Ltd. XYZ Ltd. (c) No Change

Net Profit (Post Tax) ₹ 400 Lakh ₹ 315 Lakh (d) Risk free EPS
P/E Ratio 10.50 10.00 Answer Case Scenario – 09
Current market price per share ₹ 840 ₹ 1,700
I. (a) ₹ 3150 lakh

15.52
 MERGER

II. (b) increase in interest burden. IV. NAV as on 31/03/2023 shall be approximately………………
III. (b) EPS dilution (a) 24.65 (b) 24.85
Case Scenario – 10 (c) 25.95 (d) 26.45
Mr. X on 1st July 2021, during the initial offer of some Mutual Fund
invested in 10,000 units having face value of ₹ 10 for each unit. On V. NAV as on 31/03/2024 shall be approximately………………
31st March 2022, the dividend paid by the M.F. was 10% and Mr. X (a) 20.50 (b) 25.95
found that his annualized yield was 153.33%. On 31st December (c) 26.75 (d) 27.20
2023, 20% dividend was given. On 31st March 2024, Mr. X redeemed Answer Case Scenario – 10
all his balance of 11,296.11 units when his annualized yield was I. (b) ₹ 20.50
73.52%. II. (a) 10487.80 units
From the information given above, choose the correct answer to the III. (c) ₹ 20975.60
following questions: IV. (c) 25.95
I. NAV as on 31/03/2022 shall be approximately……………… V. (c) 26.75
(a) ₹ 19.50 (b) ₹ 20.50
(c) ₹ 21.50 (d) ₹ 22.50

II. Total number of units as on 31/03/2022 shall be

approximately………….
(a) 10487.80 units (b) 12585.65 units
(c) 9465.35 units (d) 11575.40 units

III. Dividend as on 31/03/2023 shall be ………………

(a) ₹ 20625.50 (b) ₹ 20870.45
(c) ₹ 20975.60 (d) ₹ 21565.75

15.53
 MERGER

15.54
 EXAM MAY 2026

16 CA FINAL AFM EXAM MAY/2026 ATTEMPT

4 1. An investor Mr. JK purchases 200 grams of SGB at ₹ 5,000
PART – I (MCQ PORTION) per gram. The investor falls in the 30% tax bracket.
Inflation is 4% per annum. What are the post-tax annual
interest income and the approximate real post-tax return
Case Scenario – I (%) on initial investment?
The Government of India issues a 5-year Sovereign Gold Bond (SGB) (A) ₹ 25,000 and 2.25%
at an issue price of ₹ 5,000 per gram. An investor Mr. JK has (B) ₹ 17,500 and –2.25%
purchased 200 grams SGB under this scheme. The bond carries a
(C) ₹ 17,500 and 1.75%
coupon rate of 2.5% per annum, calculated as simple interest on the
(D) ₹ 17,500 and –1.75%
initial investment amount, payable annually. At the end of five years,
the bond will be redeemed at the prevailing market price of gold. The 2. After 5 years, gold price becomes ₹ 6,800 per gram.
annual interest received is taxable at the investor’s applicable Inflation is constant at 4% annually. What is the indexed
marginal income tax rate. Any capital gain arising on redemption is cost of acquisition and taxable capital gain to Mr. JK?
taxable at 20% after considering the benefit of indexation. Inflation
rate during the holding period is assumed to be 4% per annum. (A) Indexed cost ₹ 12,00,000 ; Taxable gain ₹ 1,60,000

From the information given above, choose the correct answer to the (B) Indexed cost ₹ 11,69,860 ; Taxable gain ₹ 1,90,140
Question Nos. 1 to 3:
(C) Indexed cost ₹ 12,16,653 ; Taxable gain ₹ 1,03,343
(Exam May – 2026)
(D) Indexed cost ₹ 12,16,653 ; Taxable gain ₹ 1,43,347

3. Assume SGB redeems at ₹ 6,800 per gram and Mr. JK is in

30% tax bracket. What is the net amount received after
capital gains tax (20% with indexation)?

(A) ₹ 13,56,331

(B) ₹ 13,16,996

16.1
 EXAM MAY 2026

(C) ₹ 13,31,331 (Exam May – 2026)

(D) ₹ 13,28,000 4. NewChem Ltd. plans to invest ₹ 3.20 crore today in a solar
power plant generating annual electricity savings of ₹ 25
Case Scenario – II lakh in perpetuity. The WACC is 9.5%. After one year,
NewChem Ltd., a leading chemical manufacturing firm based in savings may change to ₹ 40 lakh (high scenario) or ₹ 15
Telangana, is evaluating the installation of a new-generation solar lakh (low scenario) due to tariff revisions.
power plant to meet the energy needs of its primary manufacturing
unit. This initiative is part of NewChem’s long-term sustainability Calculate NPV if invested today and NPV after one year in both
and cost-reduction goals. scenarios (in ₹ crore).

The total cost of installing the solar plant is ₹ 3.20 crore. Based on (A) Today: –0.45; High: 1.01; Low: –1.62
the current state electricity tariffs, the plant is projected to generate
savings in electricity expenses of ₹ 25 lakh per year in perpetuity. (B) Today: –0.57; High: 1.21; Low: –1.42

However, due to regulatory uncertainty, a new state government is (C) Today: –0.57; High: 1.01; Low: –1.62
expected to take office in one year and it is anticipated that electricity
tariffs will be revised. Based on industry analysis, the annual savings (D) Today: –0.63; High: 0.95; Low: –1.58
from the solar plant could change to one of two possibilities:
5. For NewChem’s ₹ 3.20 crore solar plant (WACC 9.5%), after
- Scenario 1 (Low Savings): Savings could decrease to ₹ 15 lakh per one year savings will be ₹ 40 lakh or ₹ 15 lakh perpetuity.
year in perpetuity. Risk-free rate is 6.5%. Using risk-neutral valuation,
compute returns in both scenarios and risk-neutral
- Scenario 2 (High Savings): Savings could increase to ₹ 40 lakh per probability of high scenario (%).
year in perpetuity.
(A) High: 31.56%; Low: –50.63%; Prob: 69.5%
The company’s Weighted Average Cost of Capital (WACC) is 9.5% and
the current risk-free rate based on 10-year government bonds is (B) High: 28.45%; Low: –48.25%; Prob: 65.2%
6.5%.
(C) High: 31.56%; Low: –50.63%; Prob: 73.8%
From the information above, choose the correct answer to Questions
4 to 6: (D) High: 35.20%; Low: –52.15%; Prob: 69.5%

16.2
 EXAM MAY 2026

(A) White Knight

6. NewChem can invest ₹ 3.20 crore in solar plants today or (B) Poison Put
wait one year, when savings will be ₹ 40 lakh or ₹15 lakh (C) Poison Pill
perpetuity (WACC 9.5%, risk-free rate 6.5%). Using risk- (D) White Squire
neutral probabilities, find PV of option to wait one year,
8. Identify the correct meaning from among the following
discounted at risk-free rate and WACC. (₹ lakh).
options when X Ltd., a target company adopts
(A) PV at RF rate: ₹ 70.23 lakh; WACC: ₹ 68.50 lakh “Greenmail” tactics to defend itself from hostile takeover.
(B) PV at RF rate: ₹ 68.50 lakh; WACC: ₹ 70.23 lakh (A) When X Ltd. issues bonds that encourage the holder to
(C) PV at RF rate: ₹ 44.15 lakh; WACC: ₹ 42.30 lakh cash in at higher prices.
(D) PV at RF rate: ₹ 19.53 lakh; WACC: ₹ 18.98 lakh (B) When X Ltd. offers hefty compensations to its managers
if they get ousted due to takeover.
Case Scenario – III
(C) When X Ltd. makes a counter bid for the acquirer
XYZ Ltd. is professionally engaged in providing consultancy services
company.
related to corporate mergers and acquisitions. It is on an expansion
(D) When X Ltd. offers the acquirer a higher price for its
mode and decided to hire freshly qualified Chartered Accountants for
shares than market price.
the post of “M&A Consultant”. For selection of the candidate, each of
the candidates needs to pass a written test. Following are some of 9. R Ltd. is a parent company and J Ltd. is its subsidiary
the questions asked in the test to identify the concepts related to company. J Ltd. is growing at a faster pace than R Ltd.
M&A. and also carries higher valuations than other businesses
owned by R Ltd. To unlock the value of J Ltd., and
You are an examinee in written test paper therefore, you are required generate cash, a strategy which R Ltd. may take is to make
to choose the correct option to the Questions Nos. 7 to 9: J Ltd. go public through an IPO but keep a controlling
stake in the newly traded subsidiary. Such tactic adopted
(Exam May – 2026) by R Ltd. is called ___________.
(A) Split-up
7. AB Ltd., the acquiring company may issue substantial (B) Carve Out
amount of convertible debentures to its existing (C) Sell-Off
shareholders to be converted at a future date when it faces
(D) Spin-Off
takeover threat. The tactic used by AB Ltd. is
called__________. Case Scenario – IV
Mr. X a portfolio manager invests ₹ 25,00,000 in stock Alpha and
Beta in ratio of 60 : 40. The daily standard deviation of stock Alpha

16.3
 EXAM MAY 2026

is 1.20% and stock Beta is 0.90%. The correlation between Alpha and (A) VaR increase by ₹ 48,085
Beta is 0.6. Mr. X wanted to measure VAR for confidence level 99% (B) VaR decrease by ₹ 48,085
and 90% level. (Z score: 99% confidence level = 2.33 and 90% (C) VaR increase by ₹ 3,029
confidence level = 1.28) Assume 252 trading days in a year and mean
(D) VaR decrease by ₹ 3,029
return is zero.
Case Scenario – V
From the information given above, choose the correct answer to Green Agro Exports Ltd. entered a 3-month forward contract on
Questions Nos. 10 to 12: January 1, 2026 to buy USD 2,00,000 (import payment due April 1,
2026).
(Exam May – 2026)
USD-INR Bank Quotes:
10. What is the approximate annual Value at Risk (VaR) of the
portfolio in rupee terms at the given 99% confidence level? Date Spot Spot 1M 1M 2M 2M 3M 3M
Bid Ask Fwd Fwd Fwd Fwd Fwd Fwd
(A) ₹ 57,027 Bid Ask Bid Ask Bid Ask
(B) ₹ 5,43,162 01.01.202 83.2 83.5 - - - - 83.6 84.0
(C) ₹ 9,05,271 6 0 5 0 0
(D) ₹ 7,94,080 01.02.202 83.8 84.1 - - 83.9 84.3 - -
6 0 5 5 5
11. What is the approximate diversification benefit (per day) of 01.03.202 83.4 83.7 83.7 84.0 84.1 84.4 - -
6 0 5 0 5 0 5
the portfolio while you calculate amount of VaR at 90%
01.04.202 84.2 84.5 84.3 84.6 - - - -
confidence level?
6 0 0 0 5

(A) ₹ 11,540
From the information given above, choose the correct answer to the
(B) ₹ 23,060
Questions No. 13 to 15:
(C) ₹ 34,580
(D) ₹ 3,252
(Exam May – 2026)
12. If the correlation between Stock Alpha and Stock Beta
increases from 0.60 to 0.80, what will be the impact on
annual Value at Risk (VaR) at the 99% confidence level?

16.4
 EXAM MAY 2026

13. Green Agro Exports Ltd. entered 3-month USD 2,00,000

forward on Jan 1, 2026. On March 1, 2026, what is PART – II (DESCRIPTIVE PORTION)
maturity settlement cost vs. net extra cost of closing
original and rebooking 1-month forward? Question – 01(a)
(A) Maturity ₹ 1,68,00,000; Extra ₹ 60,000 Bharat Infrastructure Ltd. (BIL), a premier Indian Engineering firm,
(B) Maturity ₹ 1,68,00,000; Extra ₹ 10,000 has been invited to establish and operate a high-speed data center
infrastructure in the Republic of Valoria. The initial investment
(C) Maturity ₹ 1,68,00,000; Extra ₹ 70,000
required for the project is 4,000 million Valors (VL).
(D) Maturity ₹ 1,67,20,000; Extra ₹ 70,000
14. If import obligation is settled early on March 1, 2026, Under the agreement, BIL will sell the project back to the Valorian
what total cash outflow is required that day to close government after 4 years for a guaranteed sale price of 8,000 million
forward contract and make import payment? VL.
(A) ₹ 16,74,000
(B) ₹ 16,81,000 During the four-year operational period, BIL will provide technical
(C) ₹ 16,87,000 maintenance and security protocols and earn annual fee of 80 million
VL payable at the end of each year.
(D) ₹ 16,89,000
15. Green Agro Exports Ltd. cancels the import and closes
To hedge the foreign exchange risk associated with the initial capital
USD 2,00,000 forward contract (Jan 1, 2026; 84.00 Ask).
investment, BIL’s investment bankers have proposed a Currency
What are the mark-to-market gain/(loss) on following
Swap arrangement with the following terms:
dates?
(A) Feb 1: ₹ 10,000; Mar 1: ₹ 60,000; Apr 1: ₹ 40,000 - BIL will swap the principal amount of 4,000 million VL for Indian
(B) Feb 1: ₹ 10,000; Mar 1: ₹ 60,000; Apr 1: ₹ 40,000 Rupees immediately (Year 0) at today’s spot rate.
(C) Feb 1: ₹ 30,000; Mar 1: ₹ 60,000; Apr 1: ₹ 40,000
(D) Feb 1: ₹ 10,000; Mar 1: ₹ 30,000; Apr 1: ₹ 20,000 - The swap will be reversed at Year 4, with both parties re-
exchanging the same principal amounts at the same spot rate
locked in at inception.

- The bank will charge an annual facilitation fee of 0.30%

calculated on the ₹ principal amount, payable at the end of each
year.

16.5
 EXAM MAY 2026

The currency swap covers only the initial investment and terminal - Terminal Data (Year 6+): ROE of 12% and retention ratio of
principal. BIL’s policy is to hedge all other foreign currency cash flows 50%.
using forward contracts at the respective forward rates prevailing in
the market today. - Market Data: Required return of 13% and Market Price of ₹
850.
Period Spot 1 Year 2 Year 3 Year 4 Year
Forward Forward Forward Forward You are required to:
Exchange 50.00 53.00 56.18 59.55 63.12
Rate (VL/₹) (i) Estimate the intrinsic value per share using the H-Model.
PV Factor @ 1.000 0.877 0.769 0.675 0.592
14% (ii) Given the current market price of ₹ 850 per share, assess
whether the stock is undervalued or overvalued and calculate
Cumulative PVFA for 4 years at 14% = 2.913 the percentage deviation from intrinsic value.

Assume a risk-adjusted discount rate of 14% per annum. Ignore (Exam May – 2026)
taxation.
Question – 01(c)
You are required to evaluate the project’s financial viability MT Ltd. has approached you for an additional loan of ₹ 20 crores to
using the Net Present Value (NPV) method, with all cash flows fund its aggressive expansion plans. The company’s current
expressed in Indian Rupees (₹ million). sustainable growth rate is 10%, but it aims to grow at 16% annually.
Its debt-to-equity ratio is already at the maximum permissible limit
(Exam May – 2026) of 2.5:1. Additionally, the industry is experiencing 5% inflation,
which is increasing the company’s asset financing requirements.
Question – 01(b)
XYZ Ltd. recently paid a dividend of ₹ 40. The company is entering a As a credit analyst, you are required to explain the key concerns
5-year transition phase where its current 15% growth rate will regarding this loan request and suggest two alternative courses of
decline linearly to a stable perpetual rate. action available to the company to achieve its growth objectives
sustainably.
Financial Parameters
(Exam May – 2026)
- Transition Period: 5 years, declining linearly from Year 1.

- Current Data: ROE of 20% and retention ratio of 25%.

16.6
 EXAM MAY 2026

Question – 02(a) Question – 02(b)

Mr. RJ owns two securities X and Y priced according to a two-factor On 1 July, ALPS Company shares trade at ₹ 2,000. An investor enters
Arbitrage Pricing Model. The factor sensitivities and expected returns the following option: (3-month maturity):
are as follows:
Option Type Strike (₹) Premium (₹)
Particulars Security X Security Y A Call 1920 130
Beta with Factor 1 (β₁) 1.2 0.8 B Call 2000 85
Beta with Factor 2 (β₂) 0.5 1.4 C Call 2080 45
Expected actual return 14% 16% D Put 1920 40
E Put 2000 95
Additional Information F Put 2080 155

- Risk-free rate = 6% Contract size = 100 shares.

- Risk premium for Factor 1 = 4% Risk-free rate = 6% p.a. Continuous compounding not required and
the stock does not pay dividends.
- Risk premium for Factor 2 = 5%
Ignore transaction costs. Assume that investor chooses any one
Required: option.

(i) Evaluate whether Security X and Security Y are correctly Required:

priced under the two-factor Arbitrage Pricing Model.
(i) Assess the ITM, ATM, OTM of each option A to option F at
(ii) Mr. RJ has ₹ 1,00,000 available and intends to construct a initiation and compute the intrinsic and time value embedded
long-short portfolio by taking a long position in Security A and in the premiums.
a short position in Security B. You are required to analyse and
determine the amount to be invested in Security A and the (ii) In the next 3 months expiry price may increase by 150 or may
amount to be short in Security B if the desired portfolio decrease 150. Under each expiry scenario, examine which
sensitivities are 1.40 with respect to Factor 1 and 0.05 with options will be rationally exercised and appraise the profit or
respect to Factor 2. loss per contract.

(Exam May – 2026) (Exam May – 2026)

16.7
 EXAM MAY 2026

Question – 02(c) Spot rate = ₹ 90/€

The technology start-up, Fincorp Pvt. Ltd., is in its early growth
stage and is evaluating multiple sources of financing including Corporate tax rate (India) = 30%
Angel Investment, Venture Capital (VC), Convertible Notes, SAFE
and IPO. Financing Options: 50% Debt Required

Evaluate the following statements and state whether they are True Option Borrowing Currency Interest Rate (p.a.)
or False, giving brief justification in each case: A India (INR) 9%
B Euro (EUR) 5%
(i) In early-stage start-ups, valuation is primarily based on C USA (USD) 3%
discounted cash flow (DCF) using stable historical earnings.
Additional Data
(ii) Venture capital financing typically involves staged funding to
reduce agency problems and mitigate investment risk. Spot USD/INR = ₹ 75

(iii) Bootstrapping reduces dilution risk but may limit growth Spot EUR/USD = 1.20
due to capital constraints.
Interest rate in USA = 3% p.a.
(iv) Angel investors generally invest at a later stage than venture
capitalists and demand stronger control rights. Interest rate in Europe = 5% p.a.

(Exam May – 2026) Assume: Interest Rate Parity holds and no transaction cost.

Question – 03(a) Required

An Indian company is investing in a 2-year project in Europe (EURO).
(i) Identify which option is the cheapest and why.
Initial Investment = € 4,000,000
(ii) Compute Adjusted Present Value (APV) under cheapest
Annual after-tax operating cash flow = € 2,500,000 option.

Life = 2 years Present Value Factor 1st Year 2nd Year

Unlevered cost of capital = 12% 12% 0.893 0.797

16.8
 EXAM MAY 2026

5% 0.952 0.907 Question – 03(c)

Transfer of NPAs through securitization improves balance sheet
(Exam May – 2026) health but may involve regulatory and valuation challenges.”
Comment on the statement above.
Question – 03(b)
A mutual fund offers two plans: Dividend Plan and Bonus Plan. An (Exam May – 2026)
investor invests ₹ 12,00,000 on 1 April, 2025 in the ratio 60:40
respectively. Initial NAV of both plans is ₹ 48. Question – 04(a)
A portfolio manager is analysing four equity securities to construct
Entry load is 2% and exit load is 1% (on redemption value). an optimal risky portfolio using Sharpe’s Single Index Model. The
securities are traded in an efficient market and follow CAPM
Under the Dividend Plan, a dividend of ₹ 5 per unit is declared on 30 assumptions.
September, 2025 when NAV is ₹ 56. After declaration, NAV becomes
₹ 51. The dividend is reinvested at ₹ 51. Closing NAV on 31 March, The following information is available:
2026 is ₹ 54.
Security Expected Beta (βi) Residual
Under the Bonus Plan, a bonus issue of 1:4 is declared on 30 Return E (Ri) Variance (σei2)
September, 2025 when NAV is ₹ 60. After bonus adjustment, NAV A 17% 1.4 0.0225
becomes ₹ 45. Closing NAV on 31 March, 2026 is ₹ 52. B 15% 1.1 0.0196
C 13% 0.9 0.0144
Ignore taxation. D 11% 0.6 0.01

You are required to: Additional Information

Evaluate the total return and Holding Period Return under each plan Risk-free rate (Rf) = 6%
after considering loads and assess which plan provides higher
effective return. Market expected return (Rm) = 14%

(Exam May – 2026) Market variance (σm2) = 0.040

Cut-off Rate (C*) = 7.95

You are required to:

16.9
 EXAM MAY 2026

(i) Given the cut-off rate, identify the securities to be included in (Exam May – 2026)
the optimal portfolio.
Question – 04(c)
(ii) Compute the proportion of investment in each selected Explain the Elliot Wave Theory of Technical Analysis.
security.
OR
(iii) Using CAPM, compute the expected return and value of each
selected security. ABC Ltd. has a ₹ 100 Crores floating-rate loan, reset annually for 4
years.
(iv) Why is the portfolio constructed using Sharpe’s Model
consistent with CAPM assumptions? It enters into a collar strategy to hedge against interest rate risk.

(Exam May – 2026) Cap Rate = 9.5%

Question – 04(b) Expected Interest rates & Discounting Factors:

Consider the recent performance of the closed ended fund.
Year Expected Rate Discounting Factor
Period NAV (₹) Premium/Discount 1 7.8% 0.96
% 2 8.6% 0.92
0 20 0 3 9.2% 0.88
1 22.5 -5 4 10.6% 0.84
2 19.5 2.3
3 21 -3.2 You are required to identify a Floor Rate that makes the collar a zero
4 22.3 4 cost collar. (Ignore Volatility)
Required:
(Exam May – 2026)
(i) Evaluate the average return per period based on Geometric
Question – 05(a)
Mean for an investor who bought 1000 shares of the closed
A “momentum-driven” investment consultant is pitching Lumina
fund at the invitation and then sold her position at the end of
Cloud Systems (LCS) to your client. The consultant claims LCS is a
period 4.
bargain because its Cash Flow from Operations (CFO), when
capitalized at the prime lending rate of 9%, yields a value of ₹ 425
(ii) Geometric growth rate in NAV over the same period and
per share. LCS currently trades at ₹ 240 per share.
interpret the results.

16.10
 EXAM MAY 2026

You are required to perform a Two-Stage FCFE Valuation to verify (ii) If the current market price of ₹ 240.00 is considered “fair” by
these claims. the market, calculate the implied sustainable growth rate for
the terminal stage (Year 3 onwards).
Financial Data & Assumptions:
(Exam May – 2026)
- Net Income (Base Year): ₹ 180 Crores.
Question – 05(b)
- High-Growth Stage (Years 1-2): Net Income will grow by 25% Zenith Commercial Bank’s ALCO is evaluating the re-pricing risk for
annually. the 0-90 days’ time bucket. The following quarterly data is available:

- Net Investment in Operating Assets: This is projected to be ₹ Financial Data:

240 Crores in Year 1 and ₹ 280 Crores in Year 2. (Note: This
represents capital expenditure less depreciation plus the - Rate Sensitive Assets (RSAs): ₹ 12,500 Crores
increase in working capital).
- Rate Sensitive Liabilities (RSLs): ₹ 15,800 Crores
- Debt Policy: The Company finances 30% of its net investment
in operating assets through new debt. - Quarterly Net Interest Income (NII): ₹ 450 Crores

- Cost of Equity: The risk-free rate is 6%, the company’s Beta is Risk Policy:
1.20 and the Equity Risk Premium (ERP) is 5%.
The bank’s Earnings at Risk (EaR) limit is 8% of quarterly NII.
- Stable Stage (Year 3 onwards): Net investment in operating Hedging is mandatory if the potential NII impact in any scenario
assets will drop to 20% of Net Income each year. exceeds this threshold.

- Outstanding Shares: 60 Crores. You are required to:

- Present Value Factor: 1st Year 2nd Year 3rd Year (i) Identify the Gap Position, (Positive/Negative) and determine
which of the following scenarios is favourable for the bank’s NII,
12% 0.893 0.797 0.7118 providing a brief justification:

Requirements: - Scenario A: Repo rate increase of 50 bps.

(i) Calculate the total Present Value of the FCFE for the high- - Scenario B: Repo rate decrease of 25 bps.
growth period (Stage 1).

16.11
 EXAM MAY 2026

(ii) Calculate the Earnings at Risk (EaR) in ₹ Crores and as a 1. Combined Entity: Post-merger PAT is estimated at ₹ 6,850
percentage of NII for both scenarios. Based on the bank’s risk crore (including synergies). The expected P/E of the combined
policy, advise whether management should activate hedging entity is 34x.
strategies or not.
2. Synergies Value: The total synergy gain (increase in combined
(Exam May – 2026) entity value over the sum of standalone values) is capped at ₹
34,000 crore.
Question – 05(c)
Briefly justify why transaction exposure is generally considered more 3. Settlement Offers (Per 1 share of MedGen):
critical than translation exposure from a financial risk management
perspective. - Offer 1 (Cash): ₹ 4,000 (Premium of 5.82% over the
standalone fair value of MedGen).
(Exam May – 2026)
- Offer 2 (Hybrid Equity): ₹ 1,000 Cash + Arotech shares
Question – 06(a) (X) (Premium of 21.69% over standalone fair value).
Arotech Industries Ltd. (A), a listed engineering major, are evaluating
the acquisition of MedGen Labs Pvt. Ltd. (M), an unlisted - Offer 3 (Hybrid Debt): ₹ 1,150 Cash + 5 Convertible
pharmaceutical laboratory. Financial parameters as of 31 March, Bonds of Arotech (Premium of 25.66% over standalone
2025 are as follows: fair value).

Particulars Arotech MedGen Labs (M) 4. Bond Terms (Arotech): Face Value ₹ 500, 4-year term, 10%
Industries (A) discount rate. Each bond converts into 2 Arotech shares or
Profit After Tax (PAT) ₹ 6,000 crore ₹ 450 crore redeems at ₹ 680.24.
No. of Equity Shares 500 crore 5 crore
P/E Ratio 30x 1.2 × Industry Avg You are required to:
P/E
Market Price/Standalone ₹ 360.00 To be determined (i) Determine the annual post-merger synergies (PAT basis) and
Fair Value MedGen’s standalone P/E ratio.

Additional Information: (ii) Calculate the Industry Average P/E and MedGen’s Standalone
Fair Value per share.

(iii) Solve for the number of Arotech shares (X) offered in Offer 2.

16.12
 EXAM MAY 2026

(iv) Rank all three offers from MedGen’s perspective assuming

Arotech’s share price has fallen to and remains at ₹ 330 at the
time of settlement/conversion.

Question – 06(b)
The current price of F Ltd. is ₹ 120 and a European option with an
exercise price of ₹ 115 will expire in 50 days. The annual
continuously compounded risk free rate of interest is 8%. The
standard deviation of annual returns of F Ltd. is 30%.

Value of (d1) = 0.5375; Year = 365 days and value of e-rt = 0.9891.

Using Black-Scholes Model, you are required to calculate:

(i) The Hedge Ratio

(ii) The probability that price in spot market on expiration would

be higher than the exercise price of the call option.

(iii) Value of call and put options.

Cumulative Area Tables extract.

0.00 0.01 0.02 0.03 0.04 0.05

0.4 0.6554 0.6591 0.6628 0.6664 0.6700 0.6736
0.5 0.6915 0.6950 0.6985 0.7019 0.7054 0.7088
0.6 0.7257 0.7291 0.7324 0.7357 0.7389 0.7422

16.13
 NORMAL PROBABILITY DISTRIBUTION TABLE

NORMAL PROBABILITY DISTRIBUTION TABLE

Normal Probability Distribution Table

Number of Standard Deviations Area to the Left ot Right (One Tail) Number of standard Deviations Area to the lft or Right (One Tail)
from mean (Z) from Mean (Z)
0.00 0.5000 1.55 0.0606
0.05 0.4801 1.60 0.0548
0.10 0.4602 1.65 0.0495
0.15 0.4404 1.70 0.0446
0.20 0.4207 1.75 0.0401
0.25 0.4013 1.80 0.0359
0.30 0.3821 1.85 0.0322
0.35 0.3632 1.90 0.0287
0.40 0.3446 1.95 0.0256
0.45 0.3264 2.00 0.0228
0.50 0.3085 2.05 0.0202
0.55 0.2912 2.10 0.0179
0.60 0.2743 2.15 0.0158
0.65 0.2578 2.20 0.0139
0.70 0.2420 2.25 0.0122
0.75 0.2264 2.30 0.0107
0.80 0.2119 2.35 0.0094
0.85 0.1977 2.40 0.0082
0.90 0.1841 2.45 0.0071
0.95 0.1711 4.50 0.0062
1.00 01557 2.55 0.0054
1.05 0.1469 2.60 0.0047
1.10 0.3570 2.65 0.0040
1.15 0.1251 2.70 0.0035
 NORMAL PROBABILITY DISTRIBUTION TABLE

1.20 0.1151 2.75 0.0030

1.25 0.1056 2.80 0.0026
1.30 0.0986 2.85 0.0022
1.35 0.0885 2.90 0.0019
1.40 0.0808 2.95 0.0016
1.45 0.0735 3.00 0.0013
1.50 0.0668