STRATEGIC FINANCIAL MANAGEMENT
1. ABC Limited is looking at expanding its business and wants to invest in a new plant to boost its production capacity. The plant has a life of three years. The details are as follows.
- The plant would depreciate in three years from the acquiring cost of Rs. 4,20,000 to zero in three years. There would be no salvage value at the end of three years. The depreciation would be on a straight line basis.
- The additional revenue from the plant would be ~ Rs. 6,00,000 in year 1, Rs. 7,00,000 in year 2 and 3.
- The input cost (raw material) is expected to be ~ Rs. 3,00,000 for year 1 and 2 and Rs. 4,00,000 in year 3.
Assuming a tax rate of 30% and a discount rate of 20%, you are required to
1. Arrive at the expected annual cash flows (after-tax)
2. Compute the net present value of the investment and determine if the investment is financially viable?
2. As an investor in the equity market you become aware of investment opportunity in 3 corporates. Assuming that the cost of equity is 8%, compute the fair value of X Limited, Y Limited and Z Limited using the Dividend discount model.
a. Given the history of the company, X Limited is expected to pay a uniform dividend of Rs. 5.00 per share.
b. Being in the IT Industry, Y Limited is expected to pay a dividend of Rs. 4.00 per share and an increase of 5% year on year thereafter.
c. A pharmaceutical company, Z Limited has been paying a dividend of Rs. 2.00 over for the last 3 years. The company is expected to do extremely well and increase the dividend pay-out by 7% year on year. This year the dividend expected is Rs. 8.00.
Additionally, what is the biggest lacuna in the Dividend Discount Model in valuing stocks? Give an example to explain.
3. As an Investment Banker your client, LMN Limited is looking at a restructuring its business. You extract the following data from the financials of the company.
|Equity capital (Face value Rs. 10)||1,000.00|
|Debentures (@ 12%)||400.00|
|Long Term unsecured loan (@15%)||200.00|
The company has been paying a dividend of 20% per annum (historically). The stock of LMN Limited is listed at Rs. 20 on the NSE.
You are required to
a. Compute the cost of Equity capital.
b. Weighted Average cost of capital of LMN Limited.