PAPER CODE: MB 204 NAME OF SUBJECT TEACHER: DR.

VISHAL SAGAR

COURSE & SEMESTER: MBA (II) ASSIGNMENT SET: C

ONLINE ASSIGNMENT FOR PARTIAL FULLFILMENT OF MID SEM (EVEN SEM) 2020
ASSESMENT

SUBJECT: CORPORATE FINANCE

NOTE: MAX MARKS: 15

1. The online assignment is part of the Mid Semester (Even) 2020 Assessment.

2. Each Student is required to submit the assignment through designated online platform.

3. Student is required to submit their respective assignment given by Subject Teacher.

Question 1. Electro Koreo, a Korean electric giant, was forced into bankruptcy post-South
East Asian currency crisis in 1997. Mr. Gupta, the President of Electronica India Limited, an
Indian MNC with an eye on expanding his company to global level visited Seoul to explore
the possibility of taking over Electro Koreo. Mr. Gupta called upon Mr. Chin-Hwa, erstwhile
CFO of the Korean company, now working as a consultant, to figure out the problems that
caused the firm’s closure.

The following conversations took place between Mr. Gupta and Mr. Chin-Hwa:

Mr. Gupta: Tell me Mr. Chin what financial problems did Electro Koreo encounter that
caused the demise of the firm?

Mr. Chin: Sir! The problem was not one or two, but three-dimensional. The company
faltered on three basic financial management tenents, i.e. investment selection, finance
sourcing, and fund utilization.

Mr. Gupta: Please go ahead.

Mr. Chin: The problem started with a strong urge to meet the demand and capitalize on
the booming market conditions. In view of the overwhelming demand for electronic products
not only locally but in the global markets too in post 1990s, the company added a wide range
of products to its existing product line. We became over-enthusiastic and to tap the growing
market, expanded production capacity by 500%. Between 1990 and 1992, five new
manufacturing units were set up.

Mr. Gupta: Oh! That is a phenomenal growth in a short period of time.

Mr. Chin: Yeah, true but most of this expansion was debt financed using either short-
term loans from Korean banks or long-term foreign currency loans. With the ongoing phase
of expansion the banks were very open-hearted in lending to the firm. By 1995, the debt-
equity ratio reached a catastrophic level of 5:1. To make hay while the sun shines was the
common phrase that was used by all from top, middle, and lower rungs of people. A wide
array of products and brands emerged by 1995, causing a glut.

Mr. Gupta: I can visualize some of the problems now.

Mr. Chin: Recessionary conditions started setting in early 1996 and the company began
to witness idle capacity that started dragging down its ROI. Theorists say that investment
decisions are irreversible, we witnessed precisely that. Due to recessionary conditions there
were no buyers for the three idle manufacturing units that we wanted to sell off. There was a
huge pile up of raw material, semi-finished and finished goods inventory, which could be
disposed off with a great difficulty at a value that was significantly below the book value.

Mr. Gupta: That would have caused lenders to panic.

Mr. Chin: Exactly. The banks that were hitherto pumping in money on demand were
unwilling to roll over short term loans. To complicate matters further due to devaluation, the
local value of foreign currency loan of the company skyrocketed.

Another major problem was that in the first half of 1990 when the company’s growth
rate was in double digits, the company followed a very liberal dividend policy, which became
unsustainable by 1995 with nose-diving revenues, profits, and cash flows. A sharp cut in
dividends conveyed an adverse signal and the stock price of the company crashed in 1997.

Mr. Gupta: We also witnessed a similar situation in 1990s but could avert the crisis a we
stuck to fundamental principles of finance. Our expansion was need based, market driven and
came in a phased manner. We tried to finance the additional investments as much as
retentions. We maintained a stable dividend payout of 40% even amidst the very high growth
period of 1990s and never allowed the debt-equity ratio to go beyond 2.5:1. Through better
supply chain management and successful implementation of Just-In-Time inventory
management, we ensured that even during this high-growth phase we were carrying close to
zero level of inventories.

Mr. Chin: I appreciate what you did. I presume that only because of sound financial
management policies you are here on a buying spree.

After reading the above case, discuss the following:

(i) Identify the basic financial decisions where Korean company Electro Koreo has gone
wrong & Why?

(ii) If you would have been the finance manager of the company, what decisions should have
been taken according to you?

(iii) What are the long term & short term remedial measures to bring back the company on
right track in such situation?

(iv) Comment whether Mr. Gupta should take over Electro Koreo or not? Justify your
statement with suitable analysis.
Question 2: ABC Ltd. is a manufacturing company engaged in the manufacturing of valves.
They have been in the business for last 3 years and have been manufacturing only one type of
valves. They started their business initially with sales of 10,000 valves per month and now
they have grown the volume to about 50,000 valves per month. They have been buying all the
raw material for the valve and were doing all the manufacturing in house.
Now they have established themselves in the market and are planning to expand and produce
different varieties of valves. They have their plant in the main city and the total area of the
plant is 50,000 sq. ft. Now if they want to expand and continue doing all the activities of
manufacturing of all the varieties in house, they would need another 50,000 [Link]. of the area.
In the recent times, the land prices in the area have more than doubled in the last 3 years and
still land is available with great difficulty. Mr. Mohan is the production head of ABC Ltd.
and has been successful with the production and the level is continuously increasing. But in
recent times, he is facing the problem of quality complaints which have gone up from average
0.2 % in previous 2 years to 0.5 % this year. Also, he is finding that there is a high level of
dissatisfaction among the workers regarding workload as well as salary levels. The workers
are regularly complaining about the over work.

Although, Mr. Mohan has found that the workers have been spending lot of time on tea
breaks, lunch breaks and even in between the production spending lot of time talking to each
other. But, due to insufficient workers and staff, he is unable to take strict action and the
workers are taking advantage of this situation. For completing the work and delivering the
products timely, he has to employ workers on overtime and his overtime cost has also
increased 3 times. Mr. Mohan is worried about the new expansion plan of the management
and is worried where the new workers would come from as he is already finding shortage of
workers for the existing job. He has requested the management not to go for expansion
immediately and look at improving and consolidating the existing set up. He has sent his
request to Mr. S. Kumar Director – Operations.

Mr. Kumar has gone through the request of Mr. Mohan and called a meeting of all the
department heads and explained the situation to all concerned. The marketing manager has
expressed very bullish prospect about the company’s growth and said that the company
should take advantage of growing economy and established brand image of the company and
definitely go for expansion. The finance manger also expressed that this will result in
economy of scale for the products and will further increase the profitability of the products.
Mr. Mohan again expressed his problems regarding availability of manpower as well as
production control and effect on quality and productivity. The Marketing manager asked the
Production manager about the option of outsourcing. Mr. Mohan is skeptical about the
outsourcing option as he felt that the outside agency will always charge more as he will try to
make his profit as well and also is worried about the possible problems of deliveries. Mr.
Kumar asked the Mr. Naresh who is the Purchase manager about his views. He said that since
the suppliers would also be interested in doing the business, they would not like to delay as
with delay they also incur loss. The Finance manager said that we can look at cost
comparison for buying against in house manufacturing.
After listening to all the views, Mr. Kumar told Mr. Mohan to work out the cost of production
for future sales as per the forecast given by the Marketing department. He also told Mr.
Naresh to collect the details of the future requirements to get the purchase cost details for few
components of the valve.

Mr. Mohan and Mr. Naresh have collected their data and they have presented the data in the
meeting called by Mr. Kumar to review the plan. First the marketing head Mr. Suresh
presented his market forecast and then Mr. Mohan presented his report and explained the
details as follows:

 One supervisor with monthly salary of Rs. 5000 with expected increase of 10 % per
year.
 Direct wages of worker as Rs. 4 per unit.
 With 10 % reduction in second year, no change in 3rd year and increase of 10 % every
subsequent year.
 Material cost of Rs. 14 per unit with an increase of 10 % every year. Power and fuel
cost of Rs. 2 per unit with increase of 10 % every year.
 Indirect labor as 50 % of direct labor.
 They will have to buy a new machine with a cost of Rs. 50 lac. With usable life of 5
years

Mr. Naresh explained his details as follows:

 Component price from supplier at Rs. 20 for the first 2 years with an increase of 10 %
every subsequent year.
 Transportation cost of Rs. 2 per unit for the first year with increase of Rs. 0.20 every
subsequent year.
 Inventory cost (storage cost) as 5 % per year of the basic material cost.

The Marketing manager has given the sales forecast for next 5 years as follows:

Year 1 2 3 4 5
Sales 300000 500000 700000 900000 1000000
quantity

Discuss:

(i). Based on this data, is it economical for ABC Ltd. to go for buying the product from
market or manufacturing in house.

(ii). What other factors should ABC Ltd. look at for making this decision?

Question 3: Suppose you recently completed a degree in finance and have now reported to
work as an investment advisor in the Share Khan & Co. as financial planner. Your first task
is to explain the nature of Indian financial markets to Michelle Verga, a professional tennis
player who recently arrived in the United States from Mexico. Varga is a highly rated tennis
player who expects to invest significant sums of money through Smith Barry. She is very
bright; So she wants to understand in general what will happen to her money. Your boss has
developed the following questions to use to explain the Indian financial system to Varga.

A. What are the three main ways capital is transferred between savers and borrowers?
Describe each one.
B. What is a Market? Distinguish between the following types of markets: Physical Asset
Markets vs. Financial Asset Markets, Spot Markets vs. Future Markets, Money Markets vs.
Capital Markets, Primary Markets vs. Secondary Markets, and Public Markets vs. Private
Markets third. Why are financial markets essential to a healthy economy and economic
growth?
D. Briefly describe each of the following financial institutions: commercial banks, investment
banks, mutual funds, hedge funds and private equity firms.
and. What are the top two stock markets? Describe the two basic types of stock markets.
G. If Apple Computers had decided to issue additional common stock and Erga had
purchased 100 shares of this stock from Smith Barry, the signer, would this deal be a primary
deal or a secondary market deal? Will it make a difference if Verga acquires outstanding
Apple shares in the merchant market? explain.
H. What is an initial public offering (IPO)?
I am. After consulting with Michelle, she would like to discuss these two scenarios with you:

 While in the waiting room of your office, she heard an analyst on a financial
television network said that a particular medical research company had just received
FDA approval for one of its products. On the basis of this "hot" information, Michelle
wants to buy many shares of company stock. Assuming the stock market is highly
efficient, what advice would you give her?

 (2) She has read a number of newspaper articles about a huge flotation by a leading
technology company. She wants to get as many shares in the offering and she will
even be willing to buy the shares in the open market immediately after the IPO. What
advice do you have for her?