EVALUATION TEST

Q1 (Q1 – Summer 2005)

Victory Ltd. manufactures engineering equipment. The company has received an order
from a new customer for five machines at Rs.50,000 each. Victory Ltd.’s terms of sale
are 10% of the sales value payable with order and the balance is payable six months after
delivery. The delivery is to be made at the end of six months from acceptance of order.

Victory Ltd.’s past experience has been that only 60% of similar customers pay within
time. Customers who do not pay within six months of delivery are referred to a debt
agency to pursue the debt. The agency has in the past had 50% success rate obtaining
immediate payment once they became involved. When they are unsuccessful the debt is
written off by Victory Ltd. The agency’s fee is 2% of the recoverable amount payable
with the request for service. This fee is not refundable.

You are an accountant in Victory Ltd.’s credit control department, and based on the
company’s past experience and on discussions with the sales and credit managers, you do
not expect the pattern of payment and collection to change.

Incremental costs associated with the new customer’s order are expected to be Rs.36,000
per machine. 70% of these are for materials and are incurred shortly after the order has
been accepted. The remaining 30% includes all other costs which you can assume is paid
six months after delivery. Victory Ltd.’s opportunity cost of capital is 16%. Ignore
taxation.

Required:

Write a report to the Credit Control Manager evaluating purely from a financial point of
view, whether Victory Ltd. should accept the order or not. (10)

Q2 (Q-3 Summer 2006)

Following information has been extracted by you regarding some companies listed on the
Karachi Stock Exchange:

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Market return has been estimated to be on average around 14.5% per annum (adjusted for
the dividend exclusion thereof) with a variance of 25%, whereas the risk free rate is
around 6% per annum.

Required:

Estimate and interpret the ‘Alpha Values’ for each of the given companies. (10)

Q3 (Q-6 December 2005)

Bayleaf Pharmacy is a private limited company operating a chain of natural herbal

products stores located in major cities of Pakistan.

The directors of Bayleaf have come to know that Naturale (Pvt.) Ltd., a company
engaged in similar business is for sale. The Naturale is owned by Dr. Naushad who now
wants to go back into clinical practice instead of managing the day to day hassles of
running a business, provided he gets a good price.

Naturale has eleven stores operating throughout the country. Seven of them are owned by
the company, whereas the rest are on annual lease. The total assets are approximately
30% of the total assets of Bayleaf Ltd.

The directors of Bayleaf are considering to acquire Naturale, as this will give rise to
economies of scale as well as greater geographical expansion (Naturale stores are located
in diverse locations which are of great interest to Bayleaf). However, the directors have
no experience of such deals and they ask you for help.

The Senior Director is sharing the above information with you as he has written
the following e-mail:

“I have absolutely no experience of buying companies. Mr. Naushad initially sent me

audited financial statements showing the following gross figures:

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 Looking at the above figures we thought that Mr. Naushad may be willing to take
around Rs.42 million as price of his business. But recently, after meeting with his
financial advisor he sent me following information, though relevant, but very
confusing to me.

I feel that if we start a similar business from the scratch with assets of similar age and
conditions then, in addition to the cost of assets our startup cost would not be less than
Rs.12 million. Further, Bayleaf’s return on the combined equity is around 20%. Our idea
for incremental future net of tax cash flows from acquisition of Naturale is Rs. 15 million
for a maximum period of 10 years.

I am going to meet him next week for the said purpose I request you to please prepare
something meaningful for me to assess the valuation of business. Regards, Arthur”

Required:
Draft a reply suggesting any five business valuation methods that Bayleaf could use
showing necessary calculations along with brief comments on each of the method
proposed. (15 marks)

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Q4 (Q-5 Summer 2006)

PoliteOne Limited, presently engaged in manufacturing of fancy tents, is considering

investing in a manufacturing facility for long life tents to be used as shelter for victims of
natural disasters all over the world. The project will change the company’s balance sheet
footing significantly. Other relevant details of the project are as under:

(i) Total investment is expected to be Rs. 35 million.

(ii) Directors have decided to meet funding requirements through a debt of Rs.15 million
and remainder by a fresh equity issue.
(iii) Debt is available at a subsidized rate of 12% per annum for this particular project.
(iv) Operations will start from year one. Project’s life is expected to be infinite.
(v) Corporate tax is chargeable at the rate of 30%.
(vi) Debt equity ratio of the industry is around 35:65 with 15% cost of debt before tax
adjustment and 18% cost of equity. Company’s existing WACC is 21%.
(vii) The new project is expected to give revenue of Rs. 17.5 million in Year- 1with a
growth of 50% per annum till Year - 3. Revenue is expected to stabilize at Rs. 60
million from Year – 4.
(viii) Margin in the industry is around 35%. Fixed costs of the company are Rs. 1.5
million per annum for the first year rising by 5% annually and stabilizing from
year-4.
(ix) It is assumed that costs are paid at the end of year. Revenue collection follows a
pattern of 15% in the year earned and remaining in the next year.
(x) Life of assets is taken as 4 years for tax purposes.

Required:

From financial perspective, should the company invest in this project? Support your
answer with relevant workings. (20 marks)

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Q5 (Q-1 Winter 2005)

Saleem & Company Limited (SCL) is a UK based importer of clock mechanisms from
Switzerland. The Company has contracted to purchase 3,000 mechanisms at a unit price
of eighteen (18) Swiss francs. Three months credit is allowed before payment is due.

SCL currently has no surplus cash, but can borrow on short term basis @ 2% above the
bank’s base rate or invest on short term basis @ 2% below bank’s base rate in either the
United Kingdom or Switzerland.

The prevailing foreign exchange rates are as follows:

Required:

(a) Suggest whether SCL should opt for forward contract or money market hedge in the
above case. Assume that interest rates will not change during the next three months.
(6)
(b) Compare Forward Contracts with Futures Contracts (5)