SOUTHERN INDIA REGIONAL COUNCIL OF

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

CA FINAL: ADVANCED FINANCIAL MANAGEMENT
BUSINESS VALUATION

CA. Santhi Ganapathy

Model I: CAPITALISATION OF EARNINGS

Question 1

X Ltd. reported a profit of ₹65 lakhs after 35% tax for the financial year
2007-08. An analysis of the accounts revealed that the income included
extraordinary items ₹10 lakhs and an extraordinary loss ₹3 lakhs. The
existing operations, except for the extraordinary items, are expected to
continue in the future.

In addition, the results of the launch of a new product are expected to be

as follows:

Particulars ₹ lakhs
Sales 60
Material costs 15
Labour Costs 10
Fixed costs 8

Required:
i. Compute the value of the business, given that the capitalization rate
is 15%.
ii. Determine the market price per equity share, with X Ltd.’s share
capital being comprised of 1,00,000 11% preference shares of ₹100
each and 40,00,000 equity shares of ₹10 each and the P/E ratio
being 8 times.

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Model II: GORDON’S MODEL - FREE CASH FLOW

Question 2

The valuation of Hansel Limited has been done by an investment analyst.

Based on an expected free cash flow of ₹54 lakhs for the following year
and an expected growth rate of 9%, the analyst has estimated the value
of Hansel Limited to be ₹1,800 lakhs.

However, he committed the mistake of using the book values of debt and
equity. The book value weights employed by the analyst are not known,
but you know that Hansel Limited has cost of equity of 20 percent and
post-tax cost of debt of 10 percent. The market value of equity is thrice its
book value, whereas the market value of its debt is nine-tenths of its book
value.

What is the correct value of Hansel Limited?

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Question 3

Helium Ltd has developed a new sales strategy for the next 4 years. The
following information has been extracted:

Income Statement (₹’000)

Sales 40,000
Gross Margin at 30% 12,000
Administration & distribution expense at 15% 6,000
Profit before tax 6,000
Tax at 30% 1,800
Profit after tax 4,200

Balance sheet
Fixed Assets 10,000
Current Assets 6,000
Equity 15,000

As per the new strategy, sales will grow at 30% per year for the next four
years. The gross margin ratio will increase to 35%.

The Assets turnover ratio and income tax rate will remain unchanged.
Depreciation is to be at 15% of the value of the net fixed assets at the
beginning of the year.

The company’s target rate of return is 14%.

Determine the incremental value due to adoption of the strategy.

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Question 4

The following information is given in respect of WXY Ltd., which is

expected to grow at a rate of 20% p.a. for the next three years, after which
the growth rate will stabilize at 8% p.a. normal level, to perpetuity.

Particulars Year ended

31st March, 2023
Revenues ₹7,500 Crores
Cost of Goods Sold (COGS) ₹3,000 Crores
Operating Expenses ₹2,250 Crores
Capital Expenditure ₹750 Crores
Depreciation ₹600 Crores
(Included in COGS & Operating Expenses)

During high growth period, revenues, and Earnings before Interest & Tax
(EBIT) will grow at 20% p.a. and capital expenditure net of 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 incremental capital expenditure will be offset by the
depreciation. During both high growth period & normal growth period, net
working capital requirement will be 25% of revenues.

The Weighted Average Cost of Capital (WACC) of WXY Limited is 15%.

Corporate Income Tax rate will be 30%.

Estimate the value of WXY Limited using Free Cash Flows to Firm.

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Model III: EVA / MVA

Question 5

RST Limited’s current Income statement reported its net income as

₹25,00,000. The applicable corporate income tax rate is 30%. Following
is the capital structure of RST Limited at the end of the current financial
year:
Debt (Coupon Rate 11%) ₹40 lakhs
Equity (Share Capital + Reserves & Surplus) ₹125 lakhs
Invested Capital ₹165 lakhs

Additional Information:
Beta of RST Limited 1.36
Risk free rate 8.50%
Average market risk premium 9.00%

Required:
i. Estimate Weighted Average Cost of Capital (WACC) of RST
Limited; and
ii. Estimate Economic Value Added (EVA) of RST Limited.

Question 6

Delta Ltd’s current financial year’s income statement reports its net
income as ₹15,00,000. Delta’s marginal rate of tax is 40% and its interest
expense for the year was ₹15,00,000.

The company has ₹1,00,00,000 of invested capital, of which 60% is debt.

Delta Ltd tries to maintain a weighted average cost of capital of 12.6%.

Required:
i. Compute the operating income or EBIT earned by Delta Ltd in the
current year.
ii. What is Delta Ltd.’s Economic Value Added for the current year?
iii. Delta Ltd has 2,50,000 equity shares outstanding. According to the
EVA you computed in (ii), how much can Delta pay in dividend per
share before the value of the company starts to decrease?
iv. If delta does not pay any dividends, what would you expect to
happen to the value of the company?
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Question 7

Compute Economic Value Added from of the following information:

Capital Structure Equity Capital ₹160 Lakhs

Reserves & Surplus ₹140 lakhs
10% Debentures ₹400 lakhs
Cost of Equity 14%
Financial Leverage 1.5 times
Income Tax Rate 30%

Question 8

The following information is given for 3 companies that are identical

except for their capital structure:

Particulars Orange Grape Apple

Total Invested Capital 1,00,000 1,00,000 1,00,000
Debt / Assets Ratio 0.8 0.5 0.2
Shares Outstanding 6,100 8,300 10,000
Pre-Tax Cost of Debt 16% 13% 15%
Cost of Equity 26% 22% 20%
Operating Income (EBIT) 25,000 25,000 25,000
The Tax rate is 35% in all cases.

Required:
i. Compute the weighted average cost of capital for each company.
ii. Compute the Economic Value Added (EVA) for each company.
iii. Based on EVA, which company would be considered as the best
investment? Give reasons.
iv. If the Industry PE Ratio is 11X, estimate the price for the share of
each company.
v. Compute the estimated market capitalization for each of the
companies.

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Model IV: Relative Valuation

Question 9

True Value Ltd. is planning to raise funds through issue of common stock
for the first time. However, the management of the company is not sure
about the value of the company and therefore it attempts to study similar
companies in the same line which are comparable to True value in most
of the aspects.

From the following information (₹in crores), you are required to compute
the value of True Value Ltd. using the Comparable Firms Approach.

Particulars True Jewel Real Unique

Value Value Value Value
Sales 250 190 210 270
Profit after tax 40 30 44 50
Book value 100 96 110 128
Market value 230 290 440

The valuer is of the opinion that 50% weightage should be given to

earnings in the valuation process; sales and book value may be given
equal weightage.

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Model V: Enterprise Value / Equity Value

Question 10

The balance sheet of HK Ltd. is as follows:

₹’000
EQUITY & LIABILITIES
Shareholders’ Funds 800
Non-current Liabilities 200
Current Liabilities 1,000
Total 2,000
ASSETS
Non-current Assets 1,000
Current Assets
Trade Receivables 500
Cash and cash equivalents 500
Total 2,000

The shares are actively traded, and the current market price is ₹12 per
share. Shareholders’ funds represent 70,000 shares of ₹10 each and
retained earnings.

Compute Enterprise Value of HK Ltd.

Question 11

A Ltd. made a gross profit of ₹10,00,000 and incurred indirect expenses

of ₹4,00,000. No. of equity shares issued is 1,00,000. It has Reserves &
Surplus to the tune of ₹5,00,000. The company has a debt of ₹3,00,000.

Market related details are as under:

Risk free rate of return 4.50%
Market rate of return 12.00%
Beta of the company 0.90

Required:
i. Per share earning value of the company.
ii. Equity value of the company if applicable EBITDA multiple is 5.
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