Professional Documents
Culture Documents
10/31/2010
Backwaters v2.10
IIM Kozhikode
Time: 1 hr. To be Submitted by: 23:00 hrs. IST, 31st October
2) Targets for LBOs in the 1980s tended to be profitable companies in mature industries
with limited investment opportunities. True or False?
3) A low P/E ratio can only imply that a company is undervalued or its earnings are
flat/growing slowly and nothing else. True or False? (along with the explanation)
4) When purchase price exceeds the book net worth of target, accounting net income of
the combined firm will be lower under purchase accounting than under pooling. True or
False?
5) “It” is a highly negotiated provision in the definitive agreement, which may permit a
buyer to avoid closing the transaction in the event that a substantial adverse situation is
discovered after signing or a detrimental post-signing event occurs that affects the
target. What is it called?
7) Purav Petroleum produces and markets crude oil. The following are selected numbers
from the financial statements for 1992 and 1993 (in millions).
1992 1993
Revenues 8,494.0 9,000.0
(Less) Operating Expenses (6,424.0) (6,970.0)
(Less) Depreciation (872.0) (860.0)
= EBIT 1,198.0 1,170.0
(Less) Interest Expenses (510.0) (515.0)
(Less) Taxes (362.0) (420.0)
= Net Income 326.0 235.0
Working Capital (45.0) (50.0)
Total Debt 5.4 billion 5.0 billion
The firm had capital expenditures of 950 million in 1992 and 1 billion in 1993. The working
capital in 1991 was 190 million, and the total debt outstanding in 1991 was 5.75 billion.
There were 305 million shares outstanding, trading at 21 per share.
8) The following are the details on two potential merger candidates, Virmani Inc. and
Sharmaji & Sons , in 1993:
Both firms are in steady state and are expected to grow 5% a year in the long term.
Capital spending is expected to be offset by depreciation. The beta for both firms is 1,
and both firms are rated BBB, with an interest rate on their debt of 8.5%. (The treasury
bond rate is 7%.)
As a result of the merger, the combined firm is expected to have a cost of goods sold of
only 86% of total revenues. The combined firm does not plan to borrow additional debt.
9) Today is 31st March, 2009. This morning FT Ltd. Opened trading at a price of Rs. 40 per
share. This afternoon PQ Ltd. decided that it would take over FT Ltd. by paying FT’s
shareholders Rs. 50 per share when the deal is finalized. Due to legal problems, the firm
cannot announce the deal to the public (it is “insider information” only at this point)
until June 30th, 2009. The deal will be finalized on July 31st, 2009 and the Rs. 50 will be
paid on that date. The expected return for FT Ltd. is 1% per month. For each of the dates
given below, what price do you expect FT Ltd. would be trading at, on that day’s close?
Show your working.
10) Firm A is considering a takeover of Firm B. Acquiring has 10 million shares outstanding,
which sell for $40 each. Takeover Target has 5 million shares outstanding, which sell for
$20 each. The merger gains are estimated at $20 million. If Firm A has a price-earnings
ratio of 12, and Firm B has a P/E ratio of 8, what should be the P/E ratio of the merged
firm? Assume in this case that the merger is financed by an issue of new Firm B shares.
Firm B will get one Firm A share for every two Firm B shares held.
11) You have been asked to value Sendhil Steel, a mid-size steel company. The firm reported
Rs. 80 million in net income, Rs. 50 million in capital expenditure and Rs. 20 million in
depreciation in the just completed financial year. The firm reported that total debt
outstanding increased by Rs. 10 million during that year. The book value of equity at
Sendhil Steel at the beginning of the last financial year was Rs. 400 million. The cost of
equity is 10%.
a) Estimate the equity reinvestment rate, return on equity, and expected growth rate
for Sendhil Steel. (You can assume that the company will continue to maintain the
same debt ratio that it used last year to finance its re-investment needs)
b) If this growth rate is expected to last 5 years and then drop to a 4% stable growth
rate after that and the return on equity after Year 5 is expected to be 12%, estimate
the value of the company to equity holders today.
12) Neha Textiles was registered in 1983 in Calcutta. Its total current sales of Rs.
50,00,00,000 per year are to a leading public sector unit, KLYZ. This year Neha has a
similar 10 year contract of Rs. 15,00,00,000 per year from KLYZ. The company has
accepted the new contract. The current balance sheet for the company shows Rs.
10,00,00,000 of 12% bonds and Rs. 8,00,00,000 of Rs. 10 per value equity shares. The
company must now raise Rs. 7,50,00,000 from external sources in order to expand their
production facilities so that the contract can be fulfilled. For the expansion plan, the
company has to decide that whether the financing should be accomplished through a
debt issues carrying a 15% coupon rate, or by issuing equity shares at Rs. 15 per share.
EBIT is 10% of sales and tax-rate is 50%.
a) Calculate the level of EBIT at which Neha is indifferent using debt or equity.
b) Assuming that a Rs. 75,00,000 per year sinking fund (to meet the principal
repayment) is required on the debt issue, recalculate the level of EBIT at which Neha
is indifferent using debt or equity.
c) Calculate the interest coverage ratio for Neha Textiles under each of the 2 financing
alternatives.
13) You are considering a takeover of Patki Corporation, a firm that has significantly
underperformed its peer group over the last five years, and wish to estimate the value
of control. The data on Patki Corporation, the peer group, and the best managed firm in
the group are given below:
Patki Corporation reported earnings per share of $2.50 in the most recent time period
and is expected to reach stable growth in five years, after which the growth rate is
expected to be 6% for all firms in this group. The beta during the stable growth period is
expected to be 1 for all firms. There are 100 million shares outstanding and the treasury
bond rate is 7% (the tax rate is 40% for all firms).
a) Value the equity in Patki Corporation, assuming that the current management
continues in place.
b) Value the equity in Patki Corporation, assuming that it improves its performance to
peer group levels.
c) Value the equity in Patki Corporation, assuming that it improves its performance to
the level of the best managed firm in the group.