Indian School of Business

Capital Raising Strategies for Corporations, 2015

FINAL EXAM
Due on December 30, 2015. Submit via LMS
Instructions: There are several questions as part of the final exam. The first question relates
to the HBS case MOFS. The remaining questions are based on material covered in class.
To maximize learning, treat the final exam as part of the learning experience for the course
rather than as "just one more thing" to do. I do not recommend bullet point format answers,
but if you nevertheless insist on them, write in complete sentences. Answers that reference
appropriate material discussed in class will get more credit. Use normal font (12 points or
more) and spacing (1.5 or more). Page limits for each question are specified below.
Calculations can be presented separately as exhibits but their justifications should be in the
text. Any exhibits you include should be referenced in the text. The text itself should be selfcontained so readers do not need to reference it for answers.
Question 1: MOFS (Case) [2 Pages]
This question refers to the case, Motilal Oswal Financial Services Ltd.: An IPO in India.
(MOFSL). MOFSL is planning an IPO. In tandem with its investment banker, MOFS has to
decide the amount of money to be raised and the IPO price.
a. MOFSL has raised capital through VCs. The case mentions that the VCs had the
option of putting back their shares to the company at a pre-specified IRR. Explain
this feature and explain the role of the assumed IRR. How should the acceptable IRR
be set? [10 points]
b. Carefully explain the value drivers for MOFSL. State and defend your assumptions
about the future of brokerage in India and the value implications for MOFSL. [10
points]
c. Should MOFSL go public? Do not give a laundry list of pros and cons. Rather,
prioritize. Discuss the top 4 reasons and explain your reasoning. [10 points]
d. At what price should MOFSL go public? Include a discussion of the baseline
valuation and the level of expected underpricing for MOFSL with justification. [10
points]

Question 2: [1 Page]
Assume that 10-year zero coupon Indian rupee debt is sold by the Indian government to
domestic investors at a yield APY of 10% per annum. Suppose that World Bank, a AAA rated
entity world-wide with no default risk, wishes to issue rupee debt of the same maturity on the
same date. World Bank can sell matching maturity dollar debt at yield of 4% per annum. The
rupee trades on the issue date at INR 60 = 1$. An investor wishing to buy or sell rupees 10year forward will pay INR 107.45 = $1, which is equivalent to an annual currency
depreciation rate of 6% per annum.
Assume that investors are rational and that taxation is symmetric in the sense that all
investors in debt are subject to a single tax rate that cannot be avoided or evaded (That is, this
question is not about taxes). Use analytic frameworks of the sort taught to you in the course
to answer this question.
1.

Assuming perfect markets of the sort in the MM theorems, discuss why World Bank
rupee debt should be priced to yield 10% per annum. [5 points]

2.

Assume that investors abroad are willing to buy World Bank rupee debt at a yield of 8%
per annum. Discuss, based on the paradigms taught to you, what imperfections can let
World Bank issue cheap debt. [10 points]

3.

(Bonus question) Indian politicians argue that Let World Bank borrow at 8% and onlend the money to the Indian government at 8.25%. This lowers the countrys cost of
capital. Evaluate this argument, again based on the paradigms taught to you. [5 points,
awarded only if, in our sole judgment, the entire answer is correct]

Question 3: [1 Page]
You have studied the case US Bank of Washington and understood the value of banks. Using
the analytic paradigms taught to you in the course, evaluate the statement Banks are
irrelevant in the 21st century. [15 points]
Question 4: [1 Page]
Adverses is an all equity firm. The value of the assets of the firm, equal to the value of its
equity, is currently $500. There are two future states possible for Adverse, a good state when
its value will be $700 and a bad state when its value will be $300. In the absence of precise
information, the market assesses equal probabilities for the two states.
Adverse Inc. is looking to raise $210 to invest in a new project. The market assess the new
project to have an incremental NPV (that is, above the amount invested) of $45 in the good
state of the firm and $35 in the bad state. Assume that investors are risk-neutral and the riskfree rate is about zero (so this question is not about risk premiums or discount rates).
1.
2.

What us the current market value of Adverse Inc. and the market value in the good and
bad states if the firm announces the new project? [5 points]
Adverse is considering using a secondary equity issue to raise the $210 capital needed.
If information is symmetric and the market and Adverses insiders asses equal

3.

probabilities to the good state and the bad state, what percentage equity stake in the
firm must Adverse Inc. sell in order to raise capital of $210? [10 points]
Assume that information is asymmetric, i.e. Adverses insiders know for sure whether
the good state or bad state will prevail and whether the true return on the project is $45
or $35 while the market continues to assess each state as having probabilities of 0.5. If
Adverse announces an equity issue.
a. What will be the market reaction to the announcement? What fraction of the
company equity will Adverse need to sell to raise $210? [7.5 points]
b. If Adverses management knows that the firm will be in the good state and the
true NPV of the new project is $45, but it cannot communicate this
information credibly to outside shareholders. What is the loss to Adverses
current shareholders from the equity issue in part (a)? [7.5 points]