1) Re=RF+β×MRP
=0.08+0.708×0.03
=0.08+0.02124
=0.10124
=10.124%
Since the debt-equity ratio is 50:50, we have E/V = 0.5 and D/V = 0.5.
WACC=(0.5)×0.10124+(0.5)×0.095×(1−0.35)
=0.05062+0.030875
=0.081495
=8.1495%
2) There are several agency costs involved that could potentially affect the interests of various
stakeholders:
a. Conflict of Interest: Rahul Bhatia's ability to appoint key positions like Managing Director and
Chairman of the Board, coupled with his involvement in related party transactions without
proper approval, creates a conflict of interest. This could lead to decisions that prioritize his
interests over those of other shareholders.
b. Biased Clauses in Shareholding Agreement: Allegations of biased clauses in the shareholding
agreement, favoring one promoter over the other, suggest a lack of fairness and transparency in
corporate governance practices. This could erode trust among shareholders and potentially
impact the company's reputation.
c. Regulatory Scrutiny and Legal Costs: The involvement of regulatory bodies like SEBI and the
Ministry of Corporate Affairs can result in significant legal costs and potential penalties for
non-compliance. This not only affects the company's financial health but also damages its
reputation in the market.
d. Stakeholder Distrust: Internal conflicts and regulatory interventions can lead to distrust among
stakeholders, including investors, employees, and customers. This can result in a loss of
confidence in the company's leadership and affect its long-term sustainability.
To mitigate such agency problems in the future, the following measures could be proposed:
a. Enhanced Corporate Governance Practices: Implementing robust corporate governance
mechanisms, including independent board oversight, transparent decision-making processes,
and regular audits, can help ensure fairness and accountability in the company's operations.
b. Clear Policies and Procedures: Establishing clear policies and procedures for related party
transactions, including mandatory approvals from the audit committee and board of directors,
can prevent conflicts of interest and ensure compliance with regulatory requirements.
c. Shareholder Activism and Engagement: Encouraging shareholder activism and engagement
can help hold management accountable and prevent abuse of power by promoters or
executives. Regular shareholder meetings and open communication channels can facilitate
transparency and trust-building.
d. Legal and Regulatory Compliance: Ensuring strict adherence to legal and regulatory
requirements, including timely disclosures and compliance with corporate laws, can mitigate
the risk of regulatory scrutiny and legal costs.
e. Conflict Resolution Mechanisms: Implementing effective conflict resolution mechanisms,
such as mediation or arbitration, can help resolve internal disputes amicably and prevent
escalation to regulatory authorities or litigation.
Impact of Failure to Disclose Related-Party Transactions:
a. Lack of Transparency: Failure to disclose related-party transactions undermines transparency
and accountability, eroding investor trust in the company's management and governance
practices.
b. Potential Conflicts of Interest: Non-disclosure of related-party transactions raises concerns
about potential conflicts of interest and insider dealings, further damaging the company's
reputation and investor confidence.
c. Legal and Regulatory Risks: The failure to disclose related-party transactions to the audit
committee and shareholders may result in regulatory sanctions and legal liabilities, leading to
financial losses and reputational damage for the company.
d. Market Perception: Investors may perceive the company as being less reliable and trustworthy,
leading to a decline in its market value and investor interest.
3)
Debenture interest 15%
Tax 35%
Funds needed(Rs lakh) 400
Share price(Rs) 25
Plan I Equity Debenture
Proportion 100% -
Amount (Rs 400 -
million)
No of shares 16 -
Interest (Rs) - -
EBIT 10(Rs Million) 40(Rs Million) 80(Rs Million)
Interest 0 0 0
PBT 10 40 80
PAT 6.5 26 52
Pref. div. 0 0 0
Equity earnings 6.5 26 52
EPS 0.41 1.63 3.25
Plan II Equity Debenture
Proportion 50% 50%
Amount (Rs 200 200
million)
No of shares 8 -
Interest (Rs) - 30
EBIT 10(Rs Million) 40(Rs Million) 80(Rs Million)
Interest 30 30 30
PBT -20 10 50
PAT -20 6.5 32.5
Pref. div. 0 0 0
Equity earnings -20 6.5 32.5
EPS -- 0.81 4.06
At Indifference point
EBIT (EBIT−30)
16
= 8
EBIT=2 ∗ (EBIT − 30)
EBIT= 2*30
EBIT = 60(Rs Million)
4)
Year 1 2 3 4
Operating Cash Flow
Prices/Unit 1,307 1,320 1,333 1,347
Material Cost/Unit 983 1,003 1,023 1,043
Annual Sales 212,160 216,403 220,731 225,146
Annual Sales Revenue 277,293,120 285,667,372 294,294,527 303,182,222
Operating Expenses
Raw Material 208,553,280 216,978,833 225,744,777 234,864,866
Plant Staff Costs 5,124,000 5,380,200 5,649,210 5,931,671
Other Utilities 2,136,000 2,242,800 2,354,940 2,472,687
Depreciation 3,636,650 3,636,650 3,636,650 3,636,650
General Administrative Staff 2,412,000 2,532,600 2,659,230 2,792,192
Salaries
Miscellaneous Expense 180,000 189,000 198,450 208,373
Selling and Distribution Expense 8,318,794 8,570,021 8,828,836 9,095,467
Total Operating Expenses 230,360,724 239,530,104 249,072,093 259,001,904
EBIT 46,932,396 46,137,269 45,222,434 44,180,317
– Tax 13,610,395 13,379,808 13,114,506 12,812,292
Net Earnings 33,322,001 32,757,461 32,107,928 31,368,025
+ Depreciation 3,636,650 3,636,650 3,636,650 3,636,650
Total Operating Cash Flows 36,958,651 36,394,111 35,744,578 35,004,675
Terminal Cash Flow
Salvage Value
Total Cash Flow 36,958,651 36,394,111 35,744,578 35,004,675
Discount Factor 0.88 0.77 0.67 0.59
Discounted Cash Flow 32,419,870 28,004,086 24,126,572 20,725,578
Year 5 6 7 8 9 10
Operating Cash Flow
Prices/Unit 1,360 1,374 1,387 1,401 1,415 1,429
Material Cost/Unit 1,064 1,085 1,107 1,129 1,152 1,175
Annual Sales 229,649 234,242 238,927 243,705 248,579 253,551
Annual Sales 312,338,325 321,770,942 331,488,425 341,499,375 351,812,656 362,437,398
Revenue
OperatingExpenses
Raw Material 244,353,407 254,225,285 264,495,986 275,181,624 286,298,962 297,865,440
Plant Staff Costs 6,228,254 6,539,667 6,866,650 7,209,983 7,570,482 7,949,006
Other Utilities 2,596,321 2,726,137 2,862,444 3,005,567 3,155,845 3,313,637
Depreciation 3,636,650 3,636,650 3,636,650 3,636,650 3,636,650 3,636,650
General
Administrative Staff 2,931,801 3,078,391 3,232,311 3,393,926 3,563,623 3,741,804
Salaries
Miscellaneous 218,791 229,731 241,217 253,278 265,942 279,239
Expense
Selling and
Distribution
9,370,150 9,653,128 9,944,653 10,244,981 10,554,380 10,873,122
Expense
Total Operating 269,335,374 280,088,989 291,279,911 302,926,009 315,045,882 327,658,897
Expenses
EBIT 43,002,950 41,681,953 40,208,513 38,573,366 36,766,774 34,778,501
– Tax 12,470,856 12,087,766 11,660,469 11,186,276 10,662,364 10,085,765
Net Earnings 30,532,095 29,594,187 28,548,045 27,387,090 26,104,409 24,692,736
+ Depreciation 3,636,650 3,636,650 3,636,650 3,636,650 3,636,650 3,636,650
Total Operating 34,168,745 33,230,837 32,184,695 31,023,740 29,741059 28,329,386
Cash Flows
Terminal Cash Flow
Salvage Value 35,150,000
Total Cash Flow 34,168,745 33,230,837 32,184,695 31,023,740 29,741,059 63,479,386
Discount Factor 0.52 0.46 0.40 0.35 0.31 0.27
Discounted Cash 17,746,175 15,139,522 12,862,205 10,875,653 9,145,612 17,123,171
Flow
Results:
Investment Returns
NPV (Rs) 93,068,445
IRR (%) 36
Profitability Index 1.98
5)
6) A= FV (i /(1+i)n -1)
= 10,00,000(0.1/(1+0.10)5 - 1)
= ₹ 1,63,797
7) According to NI approach both the cost of debt and the cost of equity are independent of the
capital structure; they remain constant regardless of how much debt the firm uses. As a result,
the overall cost of capital declines and the firm value increases with debt. This approach has
no basis in reality; the optimum capital structure would be 100 per cent debt financing under NI
approach.
Assumption- firm operates in a frictionless world that is there are no taxes and transaction costs
and debt is riskfree and shareholders perceive no financial risk arising from the use of debt.