Financial Management

2011
Assignment
Sharanyan Sampath, John Deere India Private limited Ex-PGDBM
 Financial Management Assignment 2011

ASSSIGNMENT 1

Alpha Ltd has currently equity share capital of Rs 60 lakhs, consisting of 60,000 shares of Rs 100 each. The
management is planning to raise another Rs 50 lakhs to finance a major programme of expansion through
one of the three possible financing plans. The options are as follows:
a) Entirely through equity shares of Rs 100 each.
b) Rs 20 lakhs through equity shares of Rs 100 each and Rs 30 lakhs through 14 % long term debt.
c) Rs. 10 lakhs through equity shares of Rs. 100 each and Rs. 40 lakhs through 15% debt.
d) Rs 30 lakhs through equity shares of Rs 100 each and Rs 20 lakhs by issuing 15% preference shares
The company’s expected EBIT is Rs 23,60,000. Assuming a tax rate of 35 %, which plan would you advise?
Comment on the implications of financial leverage.

Solution

Statement Showing EPS

Plan A Plan B Plan C Plan D

100% Equity Rs20 Lakh Quantity Rs10 Lakh Quantity Rs30 Lakh Quantity
Share@Rs100 Share @Rs100 each Share @Rs100 each Share @Rs100 each
each Rs30 Lakh Long term Rs40 Lakh Long term Rs20 Lakh by issuing
Debt @14% Debt @15% 15% preference
shares
EBIT 2360000 2360000 2360000 2360000
Less Debt@14% 0 420000 0 0
Less Debt@15% 0 0 600000 0
EBT 2360000 1940000 1760000 2360000
Less Tax@35% 826000 679000 616000 826000
PAT 1534000 1261000 1144000 1534000
Preference
Share@15% 0 0 0 300000
EAT
(A) 1534000 1261000 1144000 1234000

Number of Share
Old 60000 60000 60000 60000
New 50000 20000 10000 30000
Total (B) 110000 80000 70000 90000

Earnings Per Share

=(A/B) 13.94545455 15.7625 16.34285714 13.71111111

Sharanyan Sampath
 Financial Management Assignment 2011

As Earning per Share (EPS) for Plan “C” is highest i.e. 16.342 as compared to all other plans, company
should raise fund for financial expansion as per Plan “C”.

Use of debt will have favorable impact on EPS which would enhance market values of company shares.
Since interest on debt is deductible item of expense, in arriving at taxable income more over there is no
dilution of control with use of debt hence from all point of view financial Leverage appear to be favorable.

ASSIGNMENT 2

Beta Ltd is considering two mutually exclusive projects, Project A and Project B which will cost Rs 35 lakhs
and Rs 40 lakhs respectively. Company follows straight line method of depreciation. Expected salvage
value from project A Rs. 5 lakhs and project B Rs 6 lakhs

The expected cash inflows before depreciation and tax from these projects are as follows:

Year A (Rs.) B (Rs.)

1 6,50,000 7,50,000

2 8,20,000 8,30,000

3 9,60,000 9,00,000

4 8,00,000 10,15,000

5 7,40,000 6,20,000

a) What is the payback period for each of the projects?

b) If cost of capital is 12 %, determine NPV of both the projects? Which project should the company
select?

c) Determine IRR of both the projects.

Sharanyan Sampath
 Financial Management Assignment 2011

Solution:

Project A:

Cost of Project A = 3500000

Scrap Value Project A = 500000
Estimated Life =5 Year
Depreciation for Project A = (Cost-Scrap Value)/Estimated Life
= (3500000-500000)/5
Depreciation for Project A = 600000

Statement Showing NPV for Project A:

CFAT+
Year CFBDT Depreciation CFBT Tax@35% CFAT Depreciation DF@12% DCF
1 650000 600000 50000 17500 32500 632500 0.893 564822.5
2 820000 600000 220000 77000 143000 743000 0.797 592171
3 960000 600000 360000 126000 234000 834000 0.712 593808
4 800000 600000 200000 70000 130000 730000 0.636 464280
5 740000 600000 140000 49000 91000 1191000 0.567 675297
Total DCF 2890379
Amount Invested 3500000
NPV 609621.5

Payback Period for Project A:

= 4 Year+ {(560500/1191000)*12 = 4 Year+5.647 Month

Statement Showing NPV for Project A DF@5%:

Year CFBDT Depreciation CFBT Tax@35% CFAT CFAT+ Depreciation DF@5% DCF
1 650000 600000 50000 17500 32500 632500 0.952 602140
2 820000 600000 220000 77000 143000 743000 0.907 673901
3 960000 600000 360000 126000 234000 834000 0.864 720576
4 800000 600000 200000 70000 130000 730000 0.823 600790
5 740000 600000 140000 49000 91000 1191000 0.784 933744
Total DCF 3531151
Amount Invested 3500000
NPV 31151

Sharanyan Sampath
 Financial Management Assignment 2011

IRR for Project A:

Start Rate+ [{NPV at Start Rate/ (Total DCF at Start Rate - Total DCF at End Rate)}*(End Rate-Start Rate)]
= 12+ [{-609622/ (2890379-3531151)}*(5-12)]
= 12-6.659707
= 5.34%

Project B:

Cost of Project B = 4000000

Scrap Value Project B = 600000
Estimated Life =5 Year
Depreciation for Project B = (Cost-Scrap Value)/Estimated Life
= (4000000-600000)/5
Depreciation for Project B = 680000

CFAT+
Year CFBDT Depreciation CFBT Tax@35% CFAT DF@12% DCF
Depreciation
1 750000 680000 70000 24500 45500 725500 0.893 647871.5
2 830000 680000 150000 52500 97500 777500 0.797 619667.5
3 900000 680000 220000 77000 143000 823000 0.712 585976
4 1015000 680000 335000 117250 217750 897750 0.636 570969
5 620000 680000 -60000 -21000 -39000 1241000 0.567 703647
Total DCF 3128131
Amount Invested 4000000
NPV -871869

Payback Period for Project B:

= 4 Year+ {(776250/1241000)*12}
= 4 Year+7.506 Month

Statement Showing NPV for Project B DF@3%:

CFAT+
Year CFBDT Depreciation CFBT Tax@35% CFAT DF@3% DCF
Depreciation
1 750000 680000 70000 24500 45500 725500 0.971 704460.5
2 830000 680000 150000 52500 97500 777500 0.943 733182.5
3 900000 680000 220000 77000 143000 823000 0.915 753045
4 1015000 680000 335000 117250 217750 897750 0.889 798099.8
5 620000 680000 -60000 -21000 -39000 1241000 0.863 1070983
Total DCF 4059771
Amount Invested 4000000
NPV 59770.75

Sharanyan Sampath
 Financial Management Assignment 2011

IRR for Project B:

Start Rate+ [{NPV at Start Rate/ (Total DCF at Start Rate - Total DCF at End Rate)}*(End Rate-Start Rate)]
= 12+ [{-871869/ (3128131-4059771)}*(3-12)]
= 12-8.422589
= 3.577411%

Both the Project A & B have negative NPV as calculated above at cost of capital of 12%, so company
should reject both projects A & B.

If it is mandatory to invest in any one project A or B, then company should select Project A as it lesser
negative NPV (-609622) and lesser payback period of 4 Year, 5.647 Month when compared to Project B
which has negative NPV of (-871869) and payback period of 4 Year, 7.506 Month.

Sharanyan Sampath