ICWAI Exam Paper Business Valuation Management

ICWAI Exam Paper Business Valuation Management

CWA ICWA Final – Group IV : Business Valuation Management – December 2011
This Paper has 34 answerable questions with 0 answered.
F—P18(BVM)
Syllabus 2008
Time Allowed : 3 Hours Full Marks : 100
The figures in the margin on the right side indicate full marks.
Answer Question No. 1 which is compulsory carrying 25 marks and any five from the rest.
1. (a) State whether the following statements are true or false: 1×5
(i) The CAPM assumes perfect market competition. (0)
(ii) If expected rate of return is more than required rate, stock should be sold. (0)
(iii) For trading investments, the valuation is at market value. (0)
(iv) Intrinsic value of a share decreases after a bonus issue. (0)
(v) In a synergistic merger, the post–merger value exceeds the sum of the separate companies’ pre–merger values. (0)
(b) Fill in the blanks by using the words/phrases given in the brackets: 1×10
(i) EVA is__________________ related to shareholders’ value. (directly/inversely) (0)
(ii) Under DCF valuation technique, higher rates of discount will be used for ___________ project. (Safe/ Risky) (0)
(iii) One way to increase EVA is to maintain the same operating income with ————— capital, (more/less) (0)
(iv) A type of merger,___________, takes place when two companies in unrelated lines of business with nothing in common join hands. (Vertical Integration/Horizontal Integration/Conglomerate) (0)
(v) _______________ is the present value of expected future cash flows that will result from the combined operations and additional benefits expected to accrue. (Discount Cash Flow Value/Synergy Value/ Value Gap/Purchase Price) (0)
(vi) LIFO as a method of inventory valuation_____________ allowed as per Indian Accounting Standard. (Is/Is not) (0)
(vii) The commonly used basis for revaluation of freehold land would be_______________. (current replacement price/present value of future earnings) (0)
(viii) If EPS of a company is Rs. 15 and the PE ratio is 10, then market value of the share of this company will be Rs. _______________. (150/1.5/25) (0)
(ix) If a firm defers taxes, the taxes paid in the current period will be at a rate ____________ than the marginal tax rate. (lower/higher) (0)
(x) Key to income based approach of valuation is ______________.(capitalization rate/internal rate of return) (0)
(c) In each of the questions given below one out of the four options is correct. Indicate the correct answer: 2×5
i. An investment is risk free when actual returns are always the ____________ expected returns.
(a) equal to
(b) less than
(c) more than
(d) depends upon circumstances
(0)
ii. In valuing a firm, the _________________tax rate should be applied to earnings of every period.
(a) marginal
(b) effective
(c) average
(d) maximum
(0)
iii. X Ltd. currently pays a dividend of Re. 1 per share and has a share price of Rs. 20. If the dividend is expected to grow @12% pa forever, what is firm’s required return on equity using dividend discount model?
(a) 17.6%
(b) 16.17%
(c) 11.67%
(d) 20%
(0)
iv. If the expected rate of return on a stock exceeds the required rate
(a) The stock is experiencing super normal growth
(b) The stock should be sold
(c) The company is not probably trying to maximize price per share
(d) The stock is a good buy
(0)
v. Mr. Bhupati deposits Rs.2,00,000 in a bank account which pays 10 percent interest. How much can he withdraw annually for a period of 15 years? [PVIF A (10%,15 yrs) =7.606]
(a) Rs.26,295
(b) RS.29,625
(c) Rs. 22,569
(d) None of the above.
(0)
2. (a) What do you understand by free cash flows? 5 (0)
(b) Give the steps of calculating economic value added. 5 (0)
(c) What is ‘Asset–based approach’ towards business valuation? 5 (0)
3. (a) Dominating Limited is planning to acquire Weak Limited and it is expected that the deal would be finalized after one year. The management of Dominating Limited is trying to get an estimate of share prices of Weak Limited after one year.
Assume that the company contacts you and provides the following necessary information:




• Beta of Weak Limited = 1.25
Expected Return on the Market Index = 16.50%
Risk Free Rate = 8%
Expected Dividend Payment by the end of the year by Weak Limited = Rs. 5 per share on a face value of Rs. 10 each.
Share price of Weak Limited at present = Rs. 70
You are required to determine the expected price of Weak Limited after one year. 6 (0)
(b) Suggest any three adjustments you will like to make in financial statements before calculating EVA. 3 (0)
(c) Solid Limited is in the Pharmaceutical Industry and has a business strategy of growing inorganically. For this purpose, it is contemplating to acquire Fluid Limited which has a strong hold in cardiac segment. Solid Limited has 30 crores shares outstanding which are trading on an average price of Rs. 300 while Fluid Limited has outstanding shares 20 crores and are selling at an average price of Rs. 195 per share. The EPS are Rs. 12 and Rs. 6 for Solid Limited and Fluid Limited respectively. Recently, the management of both the companies had a meeting wherein number of alternative proposals were considered for exchange of shares. They are —
i. Exchange Ratio should be in proportion to the relative EPS of two companies.
ii. Exchange Ratio should be in proportion to the relative Prices of two companies.
iii. Exchange Ratio should be 3 shares of Solid Limited for every 5 shares of Fluid Limited.
You are required to estimate EPS and Market Price assuming the PIE of Solid Limited after merger will remain unchanged, under each of the three options.

6 (0)
4. (a) The following is the data regarding two Companies ‘x’ and ‘Y’ belonging to the same risk class.
Company X Company Y
No. of ordinary shares
Face value of share
Market price per share
6% Debentures
Profit before interest 90,000
Rs. 10
Rs. 1.20
Rs. 60,000
Rs. 18,000 1,50,000
Rs. 10
Rs. 1.00

Rs. 18,000
All profits after debentures interest are distributed as dividends.
Examine how under Modigliani and Miller approach an investor holding 10 per cent of shares in company X will be better off in switching his holdings to company Y. 10 (0)
(b) S.K. Lab a pharmaceutical company in Western India was expected to have revenues of Rs. 50 lakhs in 2003 and report net income of Rs. 9 lakhs in that year.
The firm had a book value of assets of Rs. 110 lakhs and a book value of equity of Rs. 58 lakhs at the end of 2002. Its market capitalization was Rs. 85 lakhs.

The firm was expected to maintain sales in its niche product, a multivitamin tablet and grow at 5% a year in the long term, primarily by expanding into the generic drug market. The beta of S.K. Lab traded in Mumbai Stock Exchange was 1.25.

The return on 10 year GOI bond in India in 2002 was 7% and the risk premium for stocks over bond is assumed to be 3.5%

Do you consider the market price as the fair value of the shares of S.K. Lab?

5 (0)
5. (a) What is partial Selloff? 4 (0)
(b) A Ltd. Plans to acquire B Ltd. The following information is available:
Particulars A Ltd. (Rs.) B Ltd. (Rs.)
Total current earnings, (E)
Number of Outstanding shares, (S)
Market price per share, (P) Rs. 50 million
20 Million
RS.30 Rs.20 million
10 million
Rs.20
i. What is the maximum exchange ratio acceptable to the shareholders of A Ltd. if the PE ratio of the combined entity is 12 and there is no synergy gain?
ii. What is the exchange ratio acceptable to the shareholders of B Ltd. if the PE ratio is 11 and there is synergy benefit of 5%?
iii. Assuming that there is no synergy gain, at what level of PE multiple will the lines indicating earnings ratio I and earnings ratio 2 intersect?
4+4+3=11 (0)
6. The Balance Sheet of PQR Ltd. as on 31st March, 2011 is as under:
Liabilities Rs. (lacs) Assets Rs. (lacs)
Equity Shares of Rs. 10 each
Reserves (including provision
for taxation of Rs. 300 lacs)
5% Debentures

Secured Loans
Sundry Creditors
Profit & Loss A/c
Balance from previous B/S32
Profit for the year after
(Taxation)1,100 3,000

1,000
2,000

200
300

1,132 Good will
Premises and Land at
cost
Plant and Machinery
Motor Vehicles (purchased on
01.10.2010)
Raw materials at cost
Work–in–progress at cost
Finished goods at cost

Book Debts
Investment (meant for
replacement of Plant and
Machinery)
Cash at Bank and Cash in hand
Discount on Debentures
Underwriting Commission 744

400
3,000

40
920
130
180

400

1,600
192
10
16
7,632 7,632
The resale value of Premises and Land is Rs. 1.200 lacs and that of Plant and Machinery is 2,400 lacs. Depreciation @ 20% is applicable to Motor Vehicles. Applicable depreciation on Premises and Land is 2%, and that on Plant and Machinery is 10%. Market value of the Investments is Rs. 1.500 lacs. 10% of book debts is bad. In a similar company the market value of the equity shares of the same denomination is Rs. 25 per share and in such company dividend is consistently paid during last 5 years @ 20%. Contrary to this. PQR Ltd. though currently paying same dividend as the comparable company. it is having a marked upward or downward trend in case of dividend payment in the past.
Past 5 years’ profits of the company were as under:

Year(s) Rs. (in lacs)
2005–06
2006–07
2007–08
2008–09
2009–10 67
(−) 1.305 (loss)
469
546
405
The unusual negative profitability of the company during 2005–2006 and 2006–2007 was due to the lock out in the major manufacturing unit of the company which happened in the beginning of the second quarter of the year 2005–2006 and continued till last quarter of 2006–2007.

Value the Goodwill of the company on the basis of 4 years’ purchase of the Super Profit. (Necessary assumption for adjustment of the Company’s inconsistency in regard to the dividend payment may be made by the examinee).

15 (0)
7. Crystal (India) Limited has changed its focus from “Profit Maximization” to “Value Maximization” and accordingly, it is changing its whole strategic road–map for future. In this exercise, they have to see what divisions are creating value and what are destroying value so that it should divest from value destroying divisions.
Assume that you have been assigned to estimate the value of one of their divisions – Engineering Division. For that you have been provided the following necessary information:

Rs. in lacs
Actual Projected
2010–11 2011–12 2012–13 2013–14 2014–15 2015–16 2016–17
A. Partial Profit and
Loss Account
Net Sales
Less Operating Cost
except Depreciation
Operating Profit
(without depreciation)
Less Depreciation
Earnings Before
Interest and Taxes
B. Partial Balance Sheet
Assets:
Inventories
Debtors
Cash and Bank Balance
Total Current Assets
Net Fixed Assets
Liabilities:
Creditors
Outstanding Expenses

1000.0
810.5

189.5

59.0

130.5

300.0
80.0
10.0
390.0
590.0

50.0
60.0

1050.0
850.5

199.5

62.0

137.5

315.0
84.0
10.5
409.5
619.5

52.5
63.0

1102.5
893.0

209.5

65.0

144.5

330.8
88.2
11.0
430.0
650.5

55.1
66.2

1157.6
937.7

219.9

68.3

151.6

347.3
92.6
11.6
451.5
683.0

57.9
69.5

1215.5
984.6

230.9

71.7

159.2

364.7
97.2
12.2
474.1
717.1

60.8
72.9

1276.5
1033.8

242.7

75.3

167.4

382.9
102.1
12.8
497.8
753.0

63.8
76.6

1300.0
1046.8

253.2

78.5

174.7

400.0
118.5
13.1
531.6
777.5

66.7
78.5
Total Current Liabilities 110.0 115.5 121.3 127.4 133.7 140.4 145.2
After 2016–17, it is expected that the cash flows will grow at a growth rate of 8%. The Company pays tax at the rate of 40% and it has cost of funds of 14%.

Using the Free Cash Flow Valuation Method, you are required to determine the value of the Division

Years 1 2 3 4 5 6
Discount
@ 14% Factor 0.8772 0.7695 0.6750 0.5921 0.5194 0.4556
15 (0)
8. (a) What are the defensive strategies available to a company in case of hostile takeover? 5 (0)
(b) Fair Ltd. is considering takeover of White Ltd. and Black Ltd. The financial data for the three companies are as follows:-
Particulars Fair Ltd. White Ltd. Black Ltd.
Equity Share Capital of Rs. 10 each
(Rs. Million)
Earnings (Rs. Million)
Market price of each share (Rs.)
900
180
120
360
36
74
180
36
92
You are required to calculate:¬

(i) Price Earning Ratios
(ii) Earning per share of Fair Ltd. after acquisition of White Ltd. and Black Ltd. separately.
(iii) Will you recommend the merger of either/both of the companies? Justify your answer.

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