Misc Topic in SFM

SARVAGYA INSTITUTE OF COMMERCE

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RIGHT ISSUE 

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A right issue is an offer to existing shareholders enabling them to buy more shares, usually at a price lower than the current market price and in proportion to their existing shareholding. Under right issue a company offers the rights to its existing shareholders. The rights are given to shareholders ‘Free of cost’. The shareholders may use these rights to buy new shares or sell these rights in the market. Suppose a company has 5,00,000 issue of equity shares then it will given 5,00,000 rights (coupon) to existing shareholders. If the subscription per share is 15 and right offer is 1:5 then the shareholders will `

sent 5 coupons to company and 15, then he is allowed one new share. `

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Offer price in a right issue will be lower than current market price of existing shares. A company making right issue must set a price which is low enough to secure the acceptance of shareholders shareholders but not too low that it dilute the earnings per share. Market price of shares after a right issue / Theoretical ex – right right price / Post right price per share – When When a right issue is announced, all existing shareholders have the right to subscribe for new shares and so there are rights attached to the existing shares. The shares are therefore described as ‘Cum right’ (w ith right attached) and are traded cum rights. On the first day of dealings in the newly issued shares, the rights no longer exist and the old shares are now ‘Ex - right’. After the announcement of right issue, share prices normally fall. After the issue has actually been made, the market price per share will normally fall because there are more shares in issue and the new shares are issued at a discounted price. How to calculate theoretical ex – right right price per share:

(No.of existing shares∗Current price per share )+(No.of right shares∗issue price per share) No.of existing shares+No.of right shares

How to calculate value of a right (one coupon): Value of one coupon = Current price per share (Before right offer) – Theoretical Theoretical ex – right right price per share 

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How to calculate value of rights / Value of number of coupons for one new share: Value of a right * Number of rights / coupons for one new share OR Theoretical ex – right right price per share – Subscription Subscription for right shares

How to calculate effect on shareholder’s wealth due to right offer: Case A: If shareholder exercises the rights in full: Wealth before right Wealth after right issue (A) No. of shares before right issue Xxx (A) No. of shares after right issue (Original + Right shares) s hares) (B) Market price per share before Xxx (B) Theoretical ex – right price per share right (A * B) Net wealth Xxx (A * B) Total wealth Less: Cash paid for purchasing right shares Net wealth 

Case B: If shareholder sells the right: Wealth before right (A) No. of shares before right issue (B) Market price per share before right (A * B) Net wealth

Xxx Xxx Xxx

xxx xxx xxx (xxx) xxx

Wealth after right issue (A) No. of original shares (B) Theoretical ex – right price per share

xxx xxx

(A * B) Value of original holding Add: Cash received from sale of rights

xxx (xxx)

COMPILED BY ADHISH BHANSALI (M.COM, ACA) (MO.NO.-9829279730) CLASSES-12th, B.COM, M.COM. CPT, IPCC, FINAL, CS, ICWA, BBA, MBA, ACCA, CIMA


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Net wealth Case: C If shareholder exercise rights in part and remaining rights are sold: Wealth before right Wealth after right issue (A) No. of shares before right issue Xxx (A) No. of shares after right issue (Original + Right shares) (B) Market price per share before Xxx (B) Theoretical ex – right price per share right (A * B) Net wealth Xxx (A * B) Total wealth Less: Cash paid for purchasing right shares Add: Cash received from sale of rights Net wealth

xxx

xxx xxx xxx (xxx) xxx xxx

Case D: If shareholder ignores the right offer / No action taken by the shareholders Wealth before right Wealth after right issue (A) No. of shares before right issue Xxx (A) No. of shares after right issue (Original shares) (B) Market price per share before Xxx (B) Theoretical ex – right price per share right (A * B) Net wealth Xxx (A * B) Net wealth 

xxx xxx xxx

The actual market price of a share after a right issue may differ from the theoretical ex – right price. This will occur when: Expected yield from new funds raised ≠ Earnings yield from existing funds

QUESTIONS RELATE TO RIGHT ISSUE Q.1 100 share of SBC Ltd. were being quoted at 180 the company launched an experience program worth `

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25 Crore and decided to make a public issue. Part of the issue was to be rights. Members were offered one

right share for every six ordinary shares held by them, at a premium of 50 per share. Determine the minimum price that can be expected of the shares after the issue. [ICWA Final Dec. 1995] `

Q.2 Axles Limited has issued 10,000 Equity shares of 10 each. The current market price per share is 30. `

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The company has a plan to make a rights issue of one new Equity share at a price of 20 for every four shares held. You are required to: (i) Calculate of Theoretical post-Rights price per share (ii) Calculate the theoretical value of the rights alone (iii) Show the effect of the rights issue on the wealth of a shareholders who has 1,000 Share assuming he sells the entire rights, and (iv) Show the effect if the same shareholders does not take any action and ignores the issue. [CA Final Nov. 1994] `

Q.3 Pragya limited has issued 75,000 equity shares of 10 each. The market price per share is 24. The `

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company has a make a right issue of one new equity share at a price of 16 for every four shares held. You are required to: (i) Calculate the theoretical post – rights price per shares (ii) Calculate the theoretical value of the rights alone (iii) Show the effect of the rights issue on the wealth of a shareholders who has 1,000 Share assuming he sells the entire rights, and (iv) Show the effect if the same shareholders does not take any action and ignores the issue. [CA Final May 2003] `



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Q.4 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 Lakhs to finance a new project. Required: What is the Ex-right price of shares and the value of a right, if (i) The firm offers one right share for every two share held. (ii) The firm offers one right share for every four shares held. (iii) How does the shareholders’ wealth change from (i) to (ii)? How does right issue increases shareholders’ wealth? [C.A. Final, Nov. 2004] `

Q.5 Ray gold Ltd. (RL) has a paid-up ordinary share capital of 200 Lakhs represented by 4 lakh shares of `

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50 each. Earnings after tax in the most recent year (2009-10) were 80,00,000 of which 26,50,000 was distributed as dividend. The current price/earnings ratio of these shares as reported in the financial press is 8. `

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The company (RL) is planning a major investment that will cost 240 Lakhs and is expected to produce additional after-tax earnings over the foreseeable future at a rate of 15 per cent on the amount invested. The necessary finance is to be raised by a rights issue to the existing shareholders at a price 25 per cent below the current market price of the company’s shares. You are require to calculate: (i) The current Market price of the shares already in issue (ii) The Price at which the rights issue will be made (iii) The Number of new shares that will be issued (iv) The price at which the shares of the company should theoretically be quoted on completion of the rights issue (i.e. the ex-rights price) ignoring incidental and transaction costs. Assuming that the rate of return on existing funds is 12.5% and the market accepts the company’s forecast of incremen tal earnings. [I.C.W.A. Final Dec. 2005/ RTP Nov. 2010] `

Q.6 Amol Ltd. makes a right issue at 5 a share of one of the new share for every 4 shares held. Before the `

issue, there were 10 million shares outstanding and the share price was 6. Based on the above information, you are require to compute: (i) The total amount of new money raised. (ii) How many rights are required to buy one new share? (iii) What is the value one right? (iv) What is the prospective ex-right price? (v) How far could the total value of the company fall before shareholders would be unwilling to take up their rights? `

(vi) Whether the company’s shareholders are just as well as off, if right shares are issued at 5? [CWA – Final – Dec. 2007] `

Q.7 The stock of the Soni Plc is selling for £ 50 per common stock. The company then issues rights to subscribe to one new share at £ 40 for each five shares held. (i) What is the theoretical value of a right when the stock is selling rights – on? (ii) What is the theoretical value of one share of stock when it goes ex – rights? (iii) What is the theoretical value of a right when the stocks sells ex – rights at £ 50? (iv) John Speculator has £ 1000 at the time Soni Plc. goes ex – right at £50 per common stock. He feels that the price of the stock will rise to £ 60 by the time the rights expire. Compute his return on his £ 1000 if he (a) Buys Soni Plc. stock at £ 50, or (b) buys rights as the price computed in part (iii) , assuming his price expectations are valid. [RTP – May, 2010] Q.8 The shares of Galaxy Ltd. of a face value of 10 is being quoted at 24. The company has a plan to make a right issue of one equity share for every four shares currently held at a premium of 40 % per share. You are required to: (i) Determine the minimum price that can be expected of share after the issue. (ii) Calculate the theoretical value of rights alone. `

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(iii) Show the effect of the right issue on the wealth of a shareholder who has 1,500 shares, if (a) He sells the entire rights and (b) He ignores the rights. [CA – Nov. 2010] Q.9 Monopoly Ltd. has a paid up ordinary share capital of 2,00,00,0000 represented by 4,00,000 shares of `

50 each. Earnings after tax in the most recent year were 75,00,000 of which 25,00,000 were distributed as dividend. The current price / earnings ratio of these shares as normally reported in the financial press is `

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8. The company is planning a major investment that will cost 2,02,50,000 and is expected to produce additional after tax earnings over the foreseeable future at the rate of 15 % on the amount invested. It was proposed by CFO of company to raise necessary finance by a right issue to the existing shareholders at a price 25 % below the current market price of the company’s shares. (a) Your have been appointed as financial consultant of the company and are required to calculate: (i) The current market price of the shares already in issue; (ii) The price at which the rights issue will be made; (iii) The number of new shares that will be issued; (iv) The price at which the shares of the entity should theoretically be quoted on completion of the right issue (i.e. the ex – right price), assuming no incidental costs and that the market accepts the entity’s forecast of incremental earnings. `

(b) It has been said that, provided the required amount of money is raised and that the market is made aware of the earning power of the new investment, the financial position of existing shareholders should be the same whether or not they decide to subscribe for the rights they are offered. You are required to illustrate that there will be no change in the existing shareholder’s wealth. [CA – RTP – Nov. 2010] ECONOMIC VALUE ADDED / MARKET VALUE ADDED EVA (ECONOMIC VALUE ADDED) - Economic value added is primarily a benchmark to measure earnings efficiency. Stern Stewart & Co. of USA has got a registered trademark for this concept. EVA as a residual income measure of financial performance, is simply the operating profit after tax less a charge for the capital, equity as well as debt, used in the business.

Calculation of EVA: EVA = [ROOC – WACC] OC ROOC = Return on operating capital WACC = Weighted average cost of capital OC = Operating capital ROOC = Net operating profit after tax (NOPAT)/ OC * 100 Calculation of NOPAT: EBIT (earnings before interest and tax) Less: Non – operating income Operating EBIT Less: Economic taxes NOPAT Calculation of operating capital: Equity share capital Add: reserves and surplus Less: Losses Add: Preference share capital Add: Long term debts Total capital Less: Non – operating assets Operating capital

xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx



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Calculation of WACC: Kd + Kp + Ke Kd = Rate of interest (1 - T) * Debt / Total capital Kp = Rate of dividend * Preference capital / Total capital Ke = [R f + β (R m - R f) ]* equity shareholder fund / Total capital R m - R f = Market premium MVA (Market value added) – This is value recorded as wealth due to increment in market prices of equity, preference and debt. This shows premium over book value that securities of equity / preference and debt have. MVA = Market value of equity / preference / debt – Book value of equity / preference / debt (including reserve) If market value of any security is not available then book value of that security should be considered. MVA can be calculated only for entities having listed securities. 

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CONCEPT OF ECONOMIC VALUE ADDED AND MARKET VALUE ADDED Q.10 DISA and Co. has provided the following information: `

in lakhs

400

Equity share capital ( 10 each) `

15 % Preference share capital ( 10 each)

200

Reserves and surplus 15 % Debentures

220 1,600 140

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10 % non – trade investments (Nominal value 100 lakhs) `

Land and building held as investment Advance given for purchase of plant Capital work in progress Underwriting commission (not written off) Earnings per share Tax rate Beta factor Market rate of return Risk free rate of return Calculate Economic value added by the company.

20 10 30 20 16 30 % 1.65 16.25 % 9.85 % [CA – Nov. 2014]

Q.11 The following data pertains to XYZ Inc. engaged in software consultancy business as on 31st December 2010: $ million Income from consultancy 935.00 EBIT 180.00 Less: Interest on loan 18.00 EBT 162.00 Tax @ 35 % 56.70 105.30 Liabilities Equity stock (10 million shares @ $ 10 each)

Balance sheet $ million Assets 100 Land and building

$ million 200


SARVAGYA INSTITUTE OF COMMERCE Reserves and surplus Loans Current liabilities

325 180 180

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Computer and software Current assets: Debtors Bank Cash

295 150 100 40 785

785 With the above information and following assumption you are required to compute – (a) Economic value added (b) Market value added Assuming that: (i) WACC is 12 %. (ii) The share of company currently quoted at $ 50 each. [RTP (SFM)- May, 2012] Q.12 ABC Limited has divisions A, B and C. The division C has recently reported on annual operating profit of 20,20,00,000. This figure arrived at after charging 3 crores full cost of advertisement expenditure for launching a new product. The benefits of this expenditure is expected to be lasted for 3 years. The overall cost of capital of division C is 11 % and cost of debt is 8 %. The Net assets (Invested `

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capital) of division C as per latest Balance – sheet is 60 crore, but replacement cost of these assets is `

estimated at 84 crores. You are required to compute EVA of the Division C. [RTP (SFM)- Nov., 2012] `

Q. 13 Nappp.com Plc is a closely held company based Lincolnshire in B2B business offering logistic services mainly to small and medium sized companies through internet, who cannot afford sophisticated logistics practices. Company is planning to go for public issue in the coming year and is interested to know what the company’s share will be worth. The company engaged a consultant based in Leicestershire. The consultant evaluated company’s future prospects and made following estimates of future free cash flows. Year 1 Year 2 Year 3 Year 4 Sales £1,00,000 £1,15,000 £1,32,250 £1,32,250 Operating income £16,000 £18,400 £21,160 £21,160 (earnings before interest and taxes) Less: Cash tax payments (£4,800) (£5,520) (£6,348) (£6,348) Net operating profit after £11,200 £12,880 £14,812 £14,812 tax Less: investment in (£1,695.65) (£1950) (£2,242.50) working capital Capital expenditure (£2,347.83) (£2,700) (£3,105) Free cash flows £7,156.52 £8,230 £9,464.50 £14,812 Further, the company’s investment banker had done a study of the company’s cost of capital and estimated WACC to be 12 %. You are required to determine. (i) Value of Napp.com plc based on these estimates. (ii) Market value added by company supposing that invested capital in the year 0 was £31,304.05. (iii) Value per share, if company has 2,000 common equity share outstanding and debt amounting to £4,000. [RTP (SFM) - Nov. 2010] Q. 14 Herbal Gyan is a small but profitable producer of beauty cosmetics using the plant Aloevera. This is not a high – tech business, but herbal’s earnings have averaged around 12 lakhs after tax, largely on the strength of its patented beauty cream for removing the pimples. The patent has eight year to run and Herbal `

has been offered 40 lakhs for the patent rights. Herbal’s assets include 20 lakhs of working capital and `

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80 lakhs of property, plant and equipment. The patent is not shown on herbal’s books. Suppose Herbal’s cost of capital is 15 %. What is the Economic value added? [RTP – May 2010] `



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Q. 15 Consider the following operating information gathered from 3 companies that are identical except for their capital structures: P Limited Q Limited R Limited €1,00,000 €1,00,000 €1,00,000 Total capital invested Debt / asset ratio 0.80 0.50 0.20 Shares outstanding 6,100 8,300 10,000 Before – tax cost of debt 14 % 12 % 10 % Cost of equity 26% 22 % 20 % €25,000 €25,000 €25,000 Operating income €8,970 €12,350 €14,950 Net income Tax rate 35 % 35 % 35 % (a) Compute the weighted average cost of capital, WACC for each firm. (b) Compute EVA for each firm. (c) Based on the results of your computations in part b, which firm would be considered the best investment and why? (d) Assume the industry P/E ratio generally 15. Using the industry norms, estimate the price for each share. [RTP – Nov. 2009] Q.16 Calculate EVA with the help of following information of a company: Financial leverage 1.6 Capital structure: Equity capital 270 lakhs `

Reserves and surplus

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10 % Debentures

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Cost of equity Income tax rate

130 lakhs 600 lakhs

16 % 30 % [RTP – June, 2009] SUSTAINABLE GROWTH RATE

Meaning – Sustainable growth rate of a firm is the maximum rate of growth in sales that can be achieved, given the firm’s profitability, asset utilization, desired dividend payout ratio and debt

(financial leverage) ratios. Assumptions of the model:

(i) Assets of the firm will increase proportionally to sales. (ii) Net profit is a constant proportion of sales. (iii) Business wants to maintain a target capital structure without issuing new equity. (iv) Dividend pay – out ratio and debt – equity ratio of the firm are given. (v) Business wants to maintain a target dividend payment ratio. (vi) Increase sales as rapidly as market conditions allow. Computation of SGR:

SGR (g) = ROE (1 – Dividend payout ratio)

Where ROE =

SGR =  

  

 ∗∗

 

  −[ ∗∗

 ] 



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OR SGR =

      −  

OR

SGR =

 (−)/  − (−) / 

Where, m = Net profit margin ratio d = Dividend payout ratio A = Total assets E = Equity / Net worth S0 = Current sales HOW TO PREPARE INCOME STATEMENT Particulars `

Sales Less: Operating costs Operating profit / EBIT Less: Interest Earnings before tax / PBT Less: Tax @ …. % Profit after tax Less: Dividend Retained earnings

xxx (xxx) xxx (xxx) xxx (xxx) xxx (xxx) xxx

SOME OTHER RATIOS: (1) Return on Investment (ROI) / Return on capital employed (ROCE) ROI / ROCE =

   

OR ROI / ROCE =

 (−)   

Note: Bothe equations are correct. Students can use any equation in exam. Decision: Higher the better. (2) Asset turnover ratio (ATR) =

   

Note: Total asset does not include fictitious assets. Decision: Higher the better.


SARVAGYA INSTITUTE OF COMMERCE (3) Capital gearing ratio (CGR) =

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+  +      ′  

Decision: Lower the better. (4) Fixed interest and fixed dividend coverage ratio =

  + + 

Decision: Higher the better. Q.17 Following financial data are available for PQR Ltd. for the year 2011 (Rs. In lakhs) 8 % debentures 125 10 % bonds (2010) 50 Equity shares (Rs. 10 each) 100 Reserves and surplus 300 Total assets 600 Assets turnover ratio 1.1 Effective interest rate 8% Effective tax rate 40 % Operating margin 10 % Dividend payout ratio 16.67 % Current market price of shares 14 Required rate of return of investors 15 % You are required to: (i) Draw income statement for the year. (ii) Calculate its sustainable growth rate (iii) Calculate the fair price of the company’s share using dividend discount model, and (iv) What is your opinion on investment in the company’s share at current price? [CA – Nov. 09] Q. 18 Following are the financial data of Platinum Limited for a year: Particulars in lakhs `

100

Equity shares ( 100 each) 8 % Debentures 10 % bonds Reserves and surplus Total assets Assets turnover ratio Effective tax rate Operating margin Required rate of return of investors Dividend payout ratio Current market price of share `

150 50 200 500 1.1 30 % 10 % 15 % 20 % 13

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You are required to – (i) Draw income statement for the year. (ii) Calculate the sustainable growth rate. (iii) Calculate the fair price of the company’s share using dividend discount model. [CA – Nov. 2012] (iv) Draw your opinion in the company’s share at current price. Q.19 MM Ltd. had sales during last year of 10 crores. For the current year projections of the company Growth in sales by 25 % Profit margin of 5 % `

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SARVAGYA INSTITUTE OF COMMERCE 

Dividend pay – out ratio of 50 %.

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Equity share capital of 200 lakhs

10

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Total assets and current liabilities worth 650 lakhs and 150 lakhs respectively. Calculate sustainable growth rate. 

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Q. 20 From the following information, calculate sustainable growth rate of the BOC India Ltd. Profit and loss account 61,409 Income 24,01,484 `

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Dividend pay – out Total assets

Nil 50,24,716

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Net worth

26,28,869

`

Current sales

24,01,484

`

Sales

23,65,596

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Depreciation

1,27,552

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INTEREST COVERAGE RATIO The interest coverage ratio is a financial ratio used to measure a company's ability to pay the interest on its debt. The interest coverage ratio is also known as the times interest earned ratio. How to compute Interest coverage ratio =

 (    ) 

A large interest coverage ratio indicates that a corporation will be able to pay the interest on its debt even if its earnings were to decrease. A small interest coverage ratio sends a caution signal. The lower the ratio, the more the company is burdened by debt expense. When a company's interest coverage ratio is 1.5 or lower, its ability to meet interest expenses may be questionable. An interest coverage ratio below 1 indicates the company is not generating sufficient revenues to satisfy interest expenses. Things to Remember: (i) A ratio under 1 means that the company is having problems generating enough cash flow to pay its interest expenses. (ii) Ideally you want the ratio to be over 1.5.

Q. 21 Tiger Ltd. is presently working with Earnings before Interest and Taxes (EBIT) of 90 lakhs. Its present borrowings are as follows: `

in lakhs 300

`

12 % term loan Working capital borrowings: From bank at 15 % Public deposit at 11 %

200 100

The sales of the company are growing and to support this, the company proposes to obtain additional borrowing of 100 lakhs expected to cost 16%.The increase in EBIT is expected to be 15%. Calculate the change in interest coverage ratio after the additional borrowing is effected and comment on the arrangement made. [CA – Nov. 2012] `



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Q.22 A company is presently working with earnings before interest and tax (EBIT) if 15 lakhs. Its present borrowings are: `

in lakhs 15 % Term loan 50 Borrowing from bank @ 20 % 33 Public deposit @ 14 % 15 The sales of the company are growing and to support this, the company proposes to obtain additional `

borrowings of 25 lakhs. The increase in EBIT is expected to be 20 %. Calculate the change in interest `

coverage ratio after the additional borrowing is effected and comment on the arrangement made. MONEY MARKET INSTRUMENTS (1) Call money – Call money is an amount borrowed or lent on demand for a very short period. The call money is a part of the money market where day to day surplus funds, mostly of banks are traded. Moreover, the call money market is most liquid of all short – term money market instruments. Call money or inter bank money market is a segment of the money market where scheduled commercial banks lend on call or at short notice to manage the day – to – day surplus and deficits in their cash flows. (2) Treasury bills (T - Bill) – Issuer – Central bank or RBI Nature – Negotiable instrument Issue mechanism – Issued at discount and redeemable at par on maturity. Credit risk – Nil. Considered safest and most marketable instrument in the money market as bills are issued by the RBI. Price risk – Low risk, as the tenure is short.    

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Yield rate =

− 

x 100 x

365 

F = Face value P = Issue price m = Maturity period (3) Certificate of deposits (CD) – Issuer – Banks and financial institution Maturity – Minimum 15 days and Maximum 12 months Amount – Minimum 1 lakh, beyond which in multiple of 1 lakh. Lock in period = Nil Nature - Negotiable instrument Issue mechanism – Issued at discount and redeemable at par on maturity       

Yield =

− 

x 100 x

365 

(4) Commercial paper – Issuer – Corporates, primary dealers and financial institution Maturity – Minimum 7 days and maximum 1 years Lock – in – period – Nil Nature – Negotiable instrument Issue mechanism – Issued at discount and redeemable at par Credit rating – Mandatory Buy – back – Issuer can buy back its own CP        

Yield =

− 

x 100 x

365 

Q.23 AXY Ltd. is able to issue commercial paper of 50,00,000 every 4 months at a rate of 12.50 % p.a. `

The cost of placement of commercial paper issue is 2,500 per issue. AXY Ltd. is required to maintain line `



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of credit 1,50,000 in bank balance. The applicable income tax rate for AXY Ltd. is 30 %. What is the cost of funds (after tax) to AXY Ltd. for commercial paper issue? The maturity of commercial paper is four months. [CA – May, 2014] `

Q. 24 K Limited issued commercial paper as per following details: Date of issue Date of maturity Interest rate Face value of commercial paper

19th October, 2010 17th January, 2011 7.25 % per annum

10 crores What was the net amount received by the company on issue of commercial paper? [CS – June, 2007] Q.25 From the following particulars, calculate the effective interest p.a. as well as the total cost of funds to ABC Ltd., which is planning a CP issue: Issue price of commercial paper 97,350 `

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Maturity period Issue expenses: Brokerage Rating charges Stamp duty

3 months 0.125 % for 3 months 0.50 % p.a. 0.125 % for 3 months [CA Final May 2006]

Q.26 X Co. Ltd. issued commercial paper as per following detail: Date of issue 17th January 1998 Date of maturity 17th April 1998 No. of days 90 Interest rate 11.25% What was the net amount received by the company on issue of commercial paper? [CA Final May 1998, CA Final June 2009 adapted] Q.27 M Ltd has to make a payment on 30the January, 2004 of 80 lakhs. It has surplus cash today, i.e. 31st October, 2003; and has decided to invest sufficient cash in a bank’s certificate of Deposit scheme offering on yield of 8% p.a. on simple interest basis. What is the amount to be invested now? [CA Final Nov. 2003, CA Final Nov. 1998 adapted] `

Q.28 RBI sold a 91 day T-bill of face value of 100 at a yield of 6%. What was the issue price? [C.A. Final May, 2005] `

Q.29 M Limited has to make a payment on 30th January,2011 of 80 lakhs. It has surplus cash today i.e. 31st October, 2010 and has decided to invest sufficient cash in a bank’s certificate of deposit scheme offering a yield of 8 % p.a. on simple interest basis. What is the amount to be invested now? [CA – Nov. 2003] `

Q.30 (a) Suppose Mr. X purchase Treasury bill for 9,940 maturing in 91 days for 10,000. Then what would be annualized investment rate for Mr. X and annualized discount rate for the Government investment. `

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(b) Suppose government pays 5,000 at maturity for 91 days Treasury bill. If Mr. Y is desirous to earn an annualized discount rate of 3.50 %, then how he can pay for it. [RTP – Nov. 2011] `

Q.31 XYZ & Co plans to issue Commercial paper of 1,00,000 at a price of 97,000. Maturity period – 3 months Issue expenses are: (i) Brokerage is 0.12 % (ii) Rating charges is 0.50 % and stamp duty is 0.12 %. What is the effective interest rate per annum and the cost of fund? [RTP – June 2009] `

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REPURCHASE / BUY – BACK OF SHARES Q. 32 Rahul Ltd. has surplus cash of 100 lakhs and wants to distribute 27 % of it to the shareholders. The company decides to buy back shares. The finance manager of the company estimates that its share price after buy – back is likely to be 10 % above the buy – back price if the buy – back route is taken. The `

number of shares outstanding at present is 10 lakhs and the current EPS is 3. You are required to determine: (i) The price at which the shares can be re – purchased, if the market capitalization of the company should `

be 210 lakhs after buy – back. (ii) The number of shares that can be re – purchased, and (iii) The impact of share re – purchase on the EPS, assuming that net income is the same. [RTP – May, 2012] `

Q.33 trust Ltd. is deciding whether to payout 4,80,000 in excess cash in the form of an extra dividend or `

go for a share repurchase. Current earnings are 2.40 per share and the stock sells for 24. The market value balance sheet currently is as follows: `

Balance sheet Equity Debt

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( 000) Assets other than cash Cash `

2,400 2,560 640 480 3,040 3,040 Evaluate the two alternatives in term of the effect of the price per share of the stock, the EPS and the P/E ratio. Which alternative do you recommend? Give reasons. [I.C.W.A. Final June 2003] Q. 34 ABC Company has a surplus of 100 lakhs to distribute 30 % of it to the shareholders. The company decides to buyback shares. The finance manager of the company estimates that its share price after buy – back is likely to be 10 % above the buy – back price if the buy – back route is taken. The number of shares `

outstanding at present is 10 lakhs and the current EPS is 4. You are required to determine: (i) The price at which the shares can be re – purchased, if the market capitalization of the company should `

be 200 lakhs after buy – back. (ii) The number of shares that can be re – purchased, and (iii) The impact of share re – purchase on the EPS, assuming that net income is the same. [RTP – June, 2009] `

VENTURE CAPITAL FINANCING Q.35 TMC is a venture capital financier. It received a proposal for financing requiring an investment of 45 `

crore which returns 600 crores after 6 years if succeeds. However, it may be possible that the project may fail at any time during the six years. The following table provide the estimates of probabilities of the failure of the projects. Year 1 2 3 4 5 6 Probability of failure 0.28 0.25 0.22 0.18 0.18 0.10 In the above table the probability that the project fails in the second year is given that it has survived throughout year 1. Similarly for year 2 and so forth. TMC is considering an equity investment in project. The beta of this type of project is 7. The market return and risk free rate of return are 8 % and 6 % respectively. You are required to compute the expected NPV of the venture capital project and advice the TMC. [RTP – May, 2011] `



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FACTORING Meaning of factoring – Factoring is a financial service, which involves managing, financing and collecting receivables. It is both a financial as management support to supplier of goods / services. It is a method of converting non – productive assets (receivables) into productive assets (cash). A factor makes the conversion of receivables into cash possible. Factoring may be defined as a contract between the supplier if goods / services and the factor under which the factor agrees to perform at least two of the following functions: (i) To finance the assigned book debts (receivables). (ii) To maintain accounts relating to receivables. (iii) To collect book debts. (iv) To provide protection against default in payment by debtors. (v) To provide credit administration services to the clients to decide whether or not and how much credit should be extended to the customers. Factoring commission – The commission charged by the factor for providing factoring services is known as factoring commission. It is usually expressed as a percentage of face value of receivables factored. The commission is expected to be lower for recourse factoring since the factor does not assume the risk of bad debts. The commission is expected to be higher for non - recourse factoring since the factor assumes the risk of bad debts.



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Types of factoring – (1) Non – recourse factoring – Under non – recourse factoring factor assumes the risk of bad debts and charges higher commission for and advances up to 80 % - 90 % of book debts immediately.

(2) Recourse factoring – Under recourse factoring, factor does not assume the risk of bad debts and charges lower commission for and advances cash up to 70 % - 80 % of book debts. (3) Advance factoring – Under advance factoring, factor advances cash against the book debts due to client immediately. (4) Maturity factoring – Under maturity factoring, the factor makes payment on maturity. (i.e. in case of non – recourse factoring on collection of book debts or on insolvency of customers, in case of recourse factoring on collection of book debts from customers). (5) Non – notification factoring – Under non – notification factoring, the notice of assignment of receivables is not given to the debtors. But the factor performs all his functions without a disclosure to the customer that he owns the book debts. How to decide whether or not to engage a factor: A firm should engage a factor if the benefits exceed the cost or the rate of effective cost of factoring to the firm is less than the rate of interest on other sources of short – term factoring.

Rate of effective cost of factoring to the firm = Net annual cost of factoring to the firm / Actual advance granted * 100 Statement showing the evaluation of factoring arrangement: (A) Annual benefits of factoring to the firm: Credit administration cost avoided Bad debts avoided Interest saved due to reduction in average collection period [Cost of annual credit sales * rate of interest]*[present collection period – new collection period]/ 365 period Total (B) Annual cost of factoring to the firm: Factoring commission [Annual credit sales * % of commission] Interest charged by factor on advance [Annual credit sales – factoring commission – factoring reserve]* Collection period / 365 * rate of interest Total Calculation of actual advance granted: Average age of receivables [credit sales * collection period / 365 days] Less: Factoring commission Less: Factoring reserve Eligible amount of advance Less: Interest charges [Eligible amount of advance * rate of interest] * [period / 365] Actual advance granted

Xxx Xxx Xxx

Xxx Xxx Xxx

Xxx Xxx Xxx Xxx Xxx Xxx Xxx

QUESTION BANK Q.36 A Ltd has total sales of Rs. 3.2 crores and its average collection period is 90 days. The past experience indicates that the bad debts losses are 1.5 % on sales. Total expenditure incurred by the firm in administering its receivable collection efforts are Rs. 5,00,000. A factor is p repared to buy the firm’s receivables by charging 2 % commission. The factor will pay advance on receivables to the firm at an interest rate of 18 % p.a. after withholding 10 % as reserve. Calculate effective cost of factoring.(Assume 360 days) [May 2002] Q.37 A company is considering to engaged a factor, the following information is available: COMPILED BY ADHISH BHANSALI (M.COM, ACA) (MO.NO.-9829279730) CLASSES-12th, B.COM, M.COM. CPT, IPCC, FINAL, CS, ICWA, BBA, MBA, ACCA, CIMA


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(i) The current average collection period for the company’s debtors is 80 days and ½ % of debtors default. The factor has agree to pay money due after 60 days and will take the responsibility of any loss on account of bad debts. (ii) The annual charge for the factoring is 2 % of turnover payable annually in arrears. Administration cost saving is likely to be Rs. 1,00,000 per annum. (iii) Annual sales all on credit, are Rs. 1,00,00,000. cost is 80 % sales price. The company’s cost of borrowing is 15 % per annum. Assume the year is consisting of 365 days. Should the company enter into a factoring agreement. [May 2006]

Q.38 The turnover of PQR Ltd. is Rs. 120 lakhs of which 75 % is on credit. The cost of sales ratio is 80 %. The credit terms are 2/10, net 30. On the current level of sales, the bad debts are 1 % of sales. The company spends Rs. 1,20,000 per annum on administrating its credit sales. The cost includes salaries of staff who handle credit checking, collection etc. these are avoidable costs. The past experience indicates that 60 % of the customers avail of the cash discount, the remaining customers pay on an average 60 days after the date of sale. The book debts (receivable) of the company are presently being financed in the ratio of 1:1 by a mix of bank borrowings and owned funds which cost per annum 15 % and 14 % respectively. A factoring firm has offered to buy the firm’s receivables. The main e lements of such structured by the factor are: (i) Factor reserve, 12 % (ii) Guaranteed payment, 25 days (iii) Commission 4 % of the value of receivables. (iv) Interest charged by factor – 15 % Assume 360 days in a year. Required: What advise would you give to PQR Ltd. – Whether to continue with the in house management to receivables or accept the factoring firm’s offer? [PCE – May 2007] Q.39 The turnover of R Ltd. is Rs. 60 lakhs of which 80 % is on credit. Debtors are allowed one month to clear off the dues. A factor is willing to advance 90 % of the bills raised on credit for a fee of 2 % a month plus a commission of 4 % on the total amount of debts. R Ltd. as a result of this arrangement is likely to save Rs. 21,600 annually in management costs and avoid bad debts at 1 % on the credit sales. A scheduled bank has come forward to make an advance equal to 90 % of the debts at an interest rate of 18 % p.a. However, its processing fee will be at 2% on the debts. Would you accept factoring or the offer from the bank? [CA – May, 97]

Q.40 MSN Ltd. has total sales of Rs. 4.50 crores and its average collection period is 120 days. The past experience indicates that bad debt losses are 2 % on sales. The expenditure incurred by the company in administrating its receivable collection efforts are Rs. 6,00,000. A factor is prepared to buy the company’s receivables by charging 2 % commission. The factor will pay advance on receivables to the company at an interest rate of 18 % per annum after withholding 10 % as reserve. You are required to calculate effective cost of factoring to the company. [CA – Nov. 08] Q.41 A Ltd. is considering to engage a factor and provides you the following informations: (i) Total annual sales: Rs. 450 lakhs of which 80 % on credit. (ii) Existing average collection period: 60 days. (iii) Existing bad debts: 2 %. (iv) Credit administration cost: Rs. 9,00,000 of which one third is avoidable. (v) Factoring commission: 2 %. (vi) Advance against receivable: Factor agrees to grant advance against receivables at an interest rate of 18 % p.a. after withholding 10 % as reserve. Required: should the company engage a factor if the company can borrow at a rate of (a) 12 % p.a. (b) 15 % p.a. (Assume 360 days in a year). Q.42 M/s Atlantic Company Limited with a turnover of 4.80 crores is expecting growth of 25 % for forthcoming year. Average credit period is 90 days. The past experience shows that bad debts losses are `

1.75 % on sales. The company’s administering cost for c ollecting receivables is 6,00,000. It has decided to `



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take factoring service of Pacific factors on terms that factor will buy receivables by charging 2 % commission and 20 % risk with recourse. The factor will pay advance on receivables to the firm at 16 % interest rate per annum after withholding 10 % as reserve. Calculate the effective cost of factoring to the firm. (Assume 360 days in a year). [CA – Nov. 2013] Q.43 ABC Limited is considering appointment of a factor. The Following information is available: (i) Annual sales which are all in credit is 1,20,00,000. (ii) Variable cost is 80 % of selling price. (iii) Cost of borrowing is 15 % per annum. (iv) Current average collection period for debtors is 90 days. (v) Annual bad debts is 1 % of sundry debtors. (vi) Saving administration cost 1,00,000. (vii) Annual charge for factoring is 2.5 % of turnover. (viii) Factor has agreed to pay money due after 60 days and loss on account of bad debts will be the responsibility of the factor. Should the company enter into the agreement? [RTP – June, 2009] `

Q.44 X Ltd. has a credit sales of 3,00,00,000 and its average collection period is 90 days. The past experience indicates that bad – debts losses are 1.10 % on sales, which will be responsibilities of the factor. `

The expenditure incurred by the firm in administering its receivable collection efforts are 6,00,000. A factor is prepared to buy the firm’s receivables by charging 2 % commission. The factor will pay advance on receivables to the firm at an interest rate of 18 % p.a. after withholding 10 % as reserve and 2 % commission. Calculate the effective cost of factoring to the firm, taking one year = 360 days. [RTP – June, 2009] `

Q.45 ABC Co. Ltd. has a turnover of 900 lakhs and 80 % of which is on credit. Average collection period of debtors is one month. A factor is willing to advance against the bills raised after charging a factoring commission of 2 % and interest @ 12 % per annum on the amount of advance. Administrative expenses for collection of credit is 5,00,000 per annum. The bad debts remain to be approximately 1 % which will be the responsibility of the factor. Interest rate of bank on working capital is 18 %. Advise whether the company should accept the offer of the factor (for calculation, assume one year = 360 days). [RTP – June, 2009 (New)] `

Q.46 The credit sales and receivables of M/s M Limited at the end of the year are estimated at 3,74,00,000 `

and 46,00,000 respectively. The average variable overdraft interest rate is 5 %. M Ltd. is considering a proposal for factoring its debts on a non – recourse basis at an annual fee of 3 % on credit sales. As a `

result, M Ltd. will save 1,00,000 per year in administration cost and 3,50,000 as bad debts. The factor will maintain a receivables collection period of 30 days and advance 80 % of the face value thereof at an annual interest rate of 7 %. Evaluate the viability of the proposal. [RTP – May, 2012] `

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Q.47 A firm has a total sales of 12,00,000 and its average collection period is 90 days. The past experience indicates that bad debts losses are 1.50 % on sales. The expenditure incurred by the firm in `

administrating receivable collection effort are 50,000. A factor is prepared to buy the firm’s receivables by charging 2 % commission. The factor will pay advance on receivables to this firm at an interest rate of 16 % p.a. after withholding 10 % as reserve. Calculate effective cost of factoring to the firm. Assume 360 days in a year. [IPCC – May, 2009] `

Q. 48 The credit sales and receivables of DEF Limited at the end of the year are estimated at 561 lakhs `

and 69 lakhs respectively. The average variable overdraft interest rate is 5 % per annum. DEF Limited is considering a factoring proposal for its receivables on a non – recourse basis at an annual fee of 1.25 % of `



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credit sales. As a result, DEF Limited will save 1.50 lakhs p.a. in administrative cost and 5.25 lakhs p.a. as bad debts. The factor will maintain a receivables collection period of 30 days and will provide 80 % of receivables as advance at an interest rate of 7 % p.a. You may take 365 days in a year for the purpose of calculation of receivables. Required: Evaluate the validity of factoring proposal. [CA – May, 2014] `

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Q.49 The turnover of R Limited is 60 lakhs of which 80 % is on credit. Debtors are allowed one month to clear off the dues. A factor is willing to advance 90 % of the bills raised on credit for a fee of 2 % a month plus a commission of 4 % on the total amount of debt. R Limited as a result of this arrangement is likely to `

save 21,600 annually in management costs and avoid bad debts at 1 % on the credit sales. A bank has come forward to make an advance equal to 90 % of the debt at an annual interest rate of 18 %. However, its processing fee will be at 2 % on the debts. Would you accept factoring or offer from the bank? `

Q.50 PQR Limited has credit sales of 165 crores during the financial year 2014 – 15 and its average collection period is 65 days. The past experience suggests that bad debts losses are 4.28 % of credit sales. `

Administration cost incurred in collection of its receivables is 12,35,000 per annum. A factor is prepared to buy the company’s receivable by charging 1.95 % commission. The factor will pay advance on receivables to the company at an interest rate of 16 % per annum after withholding 15 % as reserve. Estimate the effective cost of factoring to the company assuming 360 days in a year. [CA – May, 2015] `

Q.51 A Limited has an export sales of 50 crores of which20 % is paid by importers in advance of dispatch and for balance the average collection period is 60 days. However, it has been obs erved that these payments have been running late by 18 days. The past experience indicates that bad debts losses are 0.60 `

% on sales. The expenditure incurred for efforts in receivable collection are 60,00,000 per annum. So far A Limited had no specific arrangements to deal with export receivables, following two proposals are under consideration: (i) A non – recourse export factoring agency is ready to buy A Limited’s receivables by charging 2 % commission. The factor will pay an advance on receivables to the firm at an interest rate of MIBOR + 1.75 % after withholding 20 % as reserve. `

(ii) Insu Limited an insurance company has offered a comprehensive insurance policy at a premium of 0.45 % of the sum insured covering 85 % of risk of non – payment. A Limited can assign its right to a bank in return of an advance of 75 % of the value insured at MIBOR + 1.50 % Assuming that MIBOR is 6 % and A Limited can borrow from its bank at MIBOR + 2 % by using existing overdraft facility. Determine the which of the two proposal should be accepted by A Limited (1 year = 360 days). [RTP – May, 2015]

STOCK SPLIT AND REVERSE SPLIT Q.52 N Limited has 1,000 shares of 10 each raised at a premium of 15 per share. The company’s retained `

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earnings are 5,52,500. The company’s stock sells for 20 per share. (a) If a 10 % stock dividend is declared how many new shares would be issued? What would be the market price after the stock dividend? How would the equity account change? `

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(b) If the company instead declares a 5:1 stock split, how many shares will be outstanding? What would be new par value? What would be the new market price? (c) Suppose if the company declares a 1: 4 reverse split, how many shares will be outstanding? What would be the new par value? What would be the new market value? COMPILED BY ADHISH BHANSALI (M.COM, ACA) (MO.NO.-9829279730) CLASSES-12th, B.COM, M.COM. CPT, IPCC, FINAL, CS, ICWA, BBA, MBA, ACCA, CIMA


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Q.53 P Limited has 6,000 shares of stock outstanding with a par value of 1 per share. The current market `

value of the firm is 1,45,600. The company just announced a 3 – for – 2 stock split. How many shares will be outstanding? What would be the new market price? `

Q.54 A Corporation has 67,000 shares of stock outstanding at a market price of 48 a share. The company has just announced a 3 – for – 2 stock split. How many shares of stock will be outstanding after the split? What would be the new market price? `

FINANCIAL RESTRUCTURING / INTERNAL RECONSTRUCTION Q.55 The following is the Balance-sheet of Grape Fruit Company Ltd as at March 31st ,2011. Liabilities Assets in lakhs in lakhs 600 Land and building 200 Equity shares of 100 each `

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14 % Preference shares of 100 each 13 % Debentures Debenture interest accrued and payable Lan from bank Trade creditors `

200

Plant and machinery

300

200 26

Furniture and fixtures Inventory

50 150

74 340

Sunder debtors Cash at bank Preliminary expenses Cost of issue of debentures Profit and loss account

70 130 10 5 525 1,440 1,440 The Company did not perform well and has suffered sizable losses during the last few years. However, it is felt that the company could be nursed back to health by proper financial restructuring. Consequently the following scheme of reconstruction has been drawn up : (i) Equity shares are to be reduced to 25/- per share, fully paid up; `

(ii) Preference shares are to be reduced (with coupon rate of 10%) to equal number of shares of 50 each, fully paid up. (iii) Debenture holders have agreed to forgo the accrued interest due to them. In the future, the rate of interest on debentures is to be reduced to 9 percent. (iv) Trade creditors will forego 25 percent of the amount due to them. `

(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 was fully subscribed by promoters. `

(vi) Land and Building was to be revalued at 450 lakhs, Plant and Machinery was to be written down by `

120 lakhs and a provision of 15 lakhs had to be made for bad and doubtful debts. Required: (i) Show the impact of financial restructuring on the company’s activities. (ii) Prepare the fresh balance sheet after the reconstructions is completed on the basis of the above proposals. [CA – Nov. 2011] `


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