MINI CASE

The balance sheet and profit and loss account of GNL Limited for the year 20X5 are
given below:
Balance Sheet, GNL Limited
(Rs. In million)
20 X4
20
x5
Liabilities and Equity
6.5
Share capital
9.3
Reserves and surplus
8.8
Long-term dept
Short-term blank borrowing
6.7
Current liabilities
38.0
Assets
Net fixed assets
Current assets
Cash and bank
Receivables
2.0
Inventories
9.3
Other assets
2.4

6.5
7.4
5.2
8.3

6.7
6.6
34.0

19.6

23.2

0.6

1.1
2.9
8.2
2.7

34.0

38.0

Profit and Loss Account, GNL Limited

(Rs. In million)
20X4
20X5
Net sales
57.4
Cost of goods sold
45.8
Gross profit
11.6

39.0
30.5
8.5

Operating expenses
7.0
Operating profit
4.6
Non-operating surplus/deficit
0.5
0.4
Profit before interest and tax
4.1
5.0
Interest
2.0
Profit before tax
3.0
Tax

Profit after tax

3.0
Dividends
1.1
Retained earnings
1.9

4.9
3.6

1.5
2.6

2.6
0.9
1.7

Required
a. Compute the key ratios for GNL Limited for the year 20X5.
b. Prepare the Du Pont Chart for the year 20X5.
c. Prepare the common size and common base financial statements for GNL.
d. Identify the financial strengths and weaknesses of GNL Limited.
e. What are the problems in analyzing financial statements?
f. Discuss the qualitative factors relevant for evaluating the performance and
prospects of a company.

MINI CASE
As an investment advisor, you have been approached by a client called Ramesh,
who wants some help in investment related matters.
Ramesh is currently 45 years old and has Rs. 600,000 in the bank. He plans to
work for 15 more years and retire at the age of 60. Rameshs present salary is Rs.
400,000 per year. He expects his salary to increase at the rate of 12 percent per
year until his retirement.
Ramesh has decided to invest his bank balance and future savings in a portfolio in
which stocks and bonds would be equally weighted. For the sake of simplicity,
assume that these proportions will be maintained by him throughout. He also
believes that bonds would provide a return of 7 percent and stocks a return of 13
percent. You concur with his assessment.
Once Ramesh retires at the age of 60 he would like to withdraw Rs. 500,000 per
year from his investments for the following 15 years as he expects to live upto the
age of 75 years. He also wants to bequeath Rs. 1,000,000 to his children at the end
of his life. How much money would he need 15 years from now?
How much should Ramesh save each year for the next 15 years to be able to
meet his investments objectives spelt out above? Assume that the savings will
occur at the end of each year.
Suppose Ramesh wants to donate Rs. 200,000 each year in the last three years of
his life to a charitable cause. Each donation would he made at the beginning of the
year. How much money would he need when he reaches the age of 60 to meet this
specific need?

Ramesh recently attended a seminar on human capital where the speaker talked
about a persons human capital as the present value of his life time earnings.
Ramesh is curious to find out the present value of his life time salary. For the sake of
simplicity assume that his present salary of Rs. 400,000 will be exactly one year
from now, and his salary will be paid annual installments. What is the present value
of his life time salary, if the discount rate is 8n percent? Remember that Ramesh
expects his salary to increase at the rate of 12 percent per year until his retirement.
In answering the above questions, ignore the tax factor.

MINI CASE
You have recently graduated from a business school and joined SMART INVEST as a
financial analyst. Your job is to help clients in choosing a portfolio of bonds and
stocks. Dinshaw Mistry, a prospective client, seeks your help in understanding how
bonds and stocks are valued and what rates of return they offer. In particular, you
have to answer the following questions.
a. How is the value of a bond calculated?
b. What is the value of a 5-year, Rs. 1,000 par value bond with a 10 percent
annual coupon, if the required rate of return is 8 percent?
c. What is the approximate yield to maturity of an 8-year, Rs. 1,000par value
bond with a 10 percent annual coupon, if it sells for Rs. 1,060.
d. What is the yield to call of the bond described in part (c), if the bond can be
called after 2-years at the premium of Rs. 1.050.
e. What is the general formula for valuing any stock, irrespective of its dividend
pattern?
f. How is a constant growth stock valued?
g. Magnum chemicals is a constant growth company which paid a dividend of
Rs. 6.00 per share yesterday (D = Rs. 6.00) and the dividend is expected to
grow at a rate of 12 percent per year forever. If investors require a rate of

return of 15 percent (i) what is the expected value of the stock a year from
now? (ii) What is the expected dividend yield and capital gains yield in the
first year?
h. Zenith Electronics paid a dividend of Rs. 10.00 per share yesterday (D = Rs.
10.00). Zenith Electronics is expected to grow at a supernormal growth rate
of 25 percent for the next 4 years, before returning to a constant growth rate
of 10 percent thereafter. What will be present value of the stock, if investors
require a return of 16b percent?
i. The earnings and dividends of Ravi Pharma are expected to grow at a rate of
20 percent for the next 3 years. Thereafter, the growth rate is expected to
decline linearly for the following 5 years before settling down at 10 percent
per year forever. Ravi Pharma paid a dividend of Rs. 800 per share yesterday
(D = Rs. 800). If investors require a return of 14 percent from the equity of
Ravi Pharma, what is the intrinsic value per share?

MINI CASE
You have recently graduated as a major in finance and have been hired as a
financial planner by Radiant Securities, a financial services company. Your boss has
assigned you the task of investing Rs. 1,000,000 for a client who has a 1-year
investment horizon. You have been asked to consider only the following investment
alternatives: T-bills, stock A, Stock B, Stock C, and market index.
The economics cell of Radiant Securities has developed the probability distribution
for the state of the economy and the equity researchers of radiant securities have
estimated the rates of return under each state of the economy. You have gathered
the following information from them:
Returns on Alternative Investments
State of the
Stock C
Economy
Portfolio

Probability
Market

T-Bills

Stock A

Stock B

Recession
(10.0%)
Normal
0.5
Boom
0.3

0.2

6.0%
6.0
6.0

20.0
40.0

(15.0%)

30.0%

5.0
(15.0)

15.0
25.0

(5.0%)
16.0
30.0

Your client is a very curious investor who has heard a lot relating to portfolio theory
and asset pricing theory. He requests you to answer the following question:
a. What is the expected return and the standard deviation of return for stocks
A,B,C, and the market portfolio?
b. What is the covariance between the returns on A and B? returns on A and C?
c. What is the coefficient of correlation between the returns on A and B? returns on
A and C?
d. What is the expected return and standard deviation on a portfolio in which
stocks A and B are equally weighted? In which the weights assigned to stocks
A,B and C are 0.4, 0.4, and 0.2 respectively?
e. The beta coefficients for the various alternatives, based on historical analysis,
are as follows:
Security
Beta
T-bills
0.00
A
1.20
B
(0.70)
C
0.90
i.
What is the SML relationship?
ii.
What is the alpha for stocks A, B, and C?
f. Suppose the following historical returns have been earned for the stock market
and the stock of company D.

Period
1
2
3
4
5

Market
(5%)
4
8
15
9

D
(12%)
6
12
20
6

What is the beta for stock D? How would you interpret it?
g. What is Capital Market Line (CML)? Security Market Line (SML)?
h. What is the basic difference between the CAPM and the APT?

MINI CASE
Delphi Capital Management (DCM) is an investment management firm which, inter
alia, offers portfolio management service to high net worth individuals. Avinash
Joshi, managing director of DCM, realized that many clients have interest inn using
options, but often do not understand the risks and rewards associated with these
instruments.
You have joined DCM about six months ago. After majoring in finance you worked
for a well known securities firm where you received good exposure to derivative
instruments, before joining DCM. Appreciating your expertise, Avinash Joshi has
asked you to educate and guide clients interested in using options.
You have been approached by Pradeep Sharma, an eminent surgeon and longtime client of DCM, who wants to understand about options and the strategies
based on options. You have decided to use the following data of Newage Hospitals
Limited, a company in which Pradeep Sharma has equity shares, to guide him.
Newage Hospitals Option Quotes

Stock Price: 325

Strike Price

Calls
Feb

Jan
March

280

Puts
March

Jan

Feb

48

53

_*

34

38

41

15

18

20

14

17

19

40

_
300
6
320
_
340
21
360

_
*A blank means that no quotation is available.
To educate your client you have to develop answers for the following questions:
a) What do the following terms mean: call option, put option, strike price (exercise
price), and expiration date?
b) Which options are in-the-money and which options are out-of-the-money?
c) Assume that Pradeep Sharma owns 1000 shares of Newage Hospitals. What are
the relative pros and cons of selling a call against the position using (i)
January/340 versus (ii) March/300.
d) What is the maximum profit, maximum loss, and break-even price associated
with the strategy of simultaneously buying March/340 call while selling
March/360 call?
e) What are the implications for Pradeep Sharma if he simultaneously writes
March/340 all and buys March/300 put?
f) What impact do the following have on the value of a call option?
(i)Current price, (ii) Exercise price, (iii) Option term to maturity, (iv) Risk-free
rate, and (v) V variability of the stock price.
g) What should be value of the March/320 call as per the Black-Scholes model?
Assume that t =
3 months, rf= 6 percent, and = 0.30.
MINI CASE
Aman Limited is a leading manufacturer of automotive components. It supplies to
the original equipment manufacturers as well as the replacement market. Its
projects typically have a short life as it introduces new models periodically.
You have recently joined Aman Limited as a financial analyst reporting to Ravi
Sharma, the CFO of the company. He has provided you the following information
about three projects, A, B, and C, that are bring considered by the Executive
Committee of Sona Limited:

Project A is an extension of an existing line. Its cash flow will decrease over
time.
Project B involves a new product. Building its market will take some time and
hence its cash flow will increase over time.
Project C is concerned with sponsoring a pavilion at a Trade Fair. It will entail a
cost initially which will be followed by a huge benefit for one year. However,
in the year following that a substantial cost will be incurred to raze the
pavilior
The expected net cash flows of the three projects are as follows.
Year
0
1
2
3

Project A
(15,000)
11,000
7,000
4,800

Project B
(15,000)
3,500
8,000
13,000

Project C
(15,000)
42,000
(4,000)
_

Ravi Sharma believes that all the three projects have risk characteristics similar to
the average risk of the firm and hence the firms cost of capital, viz. 12 percent, will
apply to them.
You are asked to evaluate the projects.
a) What is payback period and discounted payback period? Find the payback
periods and the discounted payback periods of Projects A and B.
b) What is the net present value (NPV)? What are the properties of NPV? Calculate
the NPVs of projects A, B and C.
c) What is internal rate of return (IR)? What are the problems with IRR? Calculate
the IRRs for projects A, B and C.
d) What is modified internal rate of return (MIRR)? What are the pros and cons of
MIRR vis--vis IRR and NPV? Calculate the MIRRs for projects A, B, and C
assuming that the intermediate cash flows can be reinvested at 12 percent
rate of return.

MINI CASE
After seeing Snapples success with fruit drinks, the board of directors of modern
Foods is seriously considering a proposal for a lemon juice project.
You have been recently hired as a financial analyst by Modern Foods and you
report to Mahajan, the CEO of the company. You have been entrusted with the task
of evaluating the project.

The lemon juice would be produced in an unused building adjacent to the main
plant of Modern Foods. The building, owned by Modern Foods, is fully depreciated.
However, it can be rented out for an annual rental of Rs. 1 million. The outlay on the
project is expected to be Rs. 25 million Rs. 15 million toward plant and machinery
and Rs. 10 million toward gross working capital. You can assume that the outlay will
occur right in the beginning. This means that there is no interest during the
construction period.
The proposed scheme of financing is as follows: Rs. 10 million of equity, Rs. 8
million of term loan, Rs. 5 million of working capital advance, and Rs. 2 million of
trade credit.
The term loan is repayable in 8 equal semi-annual installments of Rs. 1 million
each. The first installment will be due after 18 months. The interest on the term loan
will be 15 percent.
The levels of working capital advance and trade credit will remain of Rs. 5 million
and Rs. 2 million respectively, till they are paid back or retired at the end of 5 years
, which is the expected life of the project. Working capital advance will carry an
interest rate of 14 percent.
The lemon juice project is expected to generate a revenue of Rs. 30 million a year.
The operating costs (excluding depreciation and interest) are expected to be Rs. 20
million a year.
For tax purposes, the depreciation rate on fixed assets will be 25 percent as per
the written down value method. Assume that there is no other tax benefit.
The net salvage value of plant and machinery is expected to be Rs. 5 million at
the end of the year 5. Recovery of working capital, at the end of year 5, is expected
to be at book balue.
The income tax rate is expected to be 30 percent.
Mahajan wants you to estimate the cash flows from two different points of view:
a. Cash flows from the point of all investors (which is also called the explicit cost
funds point of view)
b. Cash flows from the point of equity investors.

MINI CASE

Suman Joshi, Managing Director of Omega Textiles, was reviewing two very different
investment proposals. The first one is for expanding the capacity in the main line of
business and the second one is for diversifying into a new line of business.
Suman Joshi asks for ypur help in estimating Omegas weighted average cost of
capital which he believes is relevant for evaluating the expansion proposal. He also
wants you to estimate the hurdle rate for the new line of business.
To enable you to carry out your task, he has provided the following data.
The latest balance sheet of Omega is given below.
(Rs. In million)
Liabilities
Assets
Equity capital
350
Fixed Assets
700
Preference capital
100
Investments
100
Reserves and surplus
200
Current Assets,
Loans and advances
400
Debenture
450
Current liabilities and
100
provisions
1200
1200

Omegas target capital structure has 50 percent equity, 10 percent preference,

and 40 percent debt.
Omega has Rs. 100 par, 10 percent coupon, annual payment, noncallable
debentures with 8 years to maturity. These debentures are selling currently at
Rs. 112.
Omega has Rs. 100 par, 9 percent annual dividend, preference shares with a
residual maturity of 5 years. The market price of these preference shares is Rs.
106.
Omegas equity stock is currently selling at Rs. 80 per share. Its last dividend
was Rs. 2.80 and the dividend per share is expected to grow at a rate of 10
percent in future.
Omegas equity beta is 1.1, the risk-free rate is 7 percent, and the market risk
premium is estimated to be 7 percent.
Omegas tax rate is 30 percent.
The new business that Omega is considering has different financial
characteristics that omegas existing business. Firms engaged purely in such
business have, on overage, the following characteristics: (i) Their capital
structure has debt and equity in equal proportions. (ii) Their cost of debt is 11
percent. (iii) Their equity beta is 1.5.
a. What sources of capital would you consider relevant for calculating the
weighted average cost of capital?
b. What is Omegas post-tax cost of debt?
c. What is Omegas cost of preference?
d. What is Omegas estimated cost of equity using the dividend discount
model?
e. What is Omegas estimated cost of equity using the capital asset pricing
model?

f.

What is Omegas weighted average cost of capital? Use the capital asset
pricing model to estimate the cost of equity.
g. What would be your estimate for the cost of capital for the new business?
h. What is the difference between company cost of capital and project cost of
capital?

MINI CASE

PTR is a venerable restaurant of Bangalore set up decades ago by Prakash Naik.

Despite its phenomenal success, Prakash Naik was unwilling to set up branches
because he was concerned about the dilution of quality. In the last decade,
however, alluring business opportunities and competitive compulsions persuaded
Prakash Naik to set up a few branches of PTR at select locations in Bangalore and
Chennai. This initiative, financed mainly through internal accruals, turned out to be
quite profitable. Buoyed by this success, the Naik family, which owns 100 percent
equity of PTR Limited, has chalked up an ambitious plan to set up a nation-wide
chain of PTR restaurants and to support this initiative it wants to raise Rs. 100 crore
through an initial public offering.
Prakash Naik has asked you to brief the family members on various issues
associated with the move, by answering the following questions
(a) What the pros of going public?
(b) What are the cons of going public?
(c) What conditions should a company satisfy to make an IPO?
(d) What is book building?
(e) What are the principal steps in an IPO?
(f) What role is played by the lead manager?
(g) What are the costs of a public issue?
(h) Can a company making a public issue freely price its shares?
(i) Why is under-pricing of IPOs a universal phenomenon?
(j) What is a rights issue?
(k) What are the different kinds of dilution?

MINI CASE

Divya Electronics was promoted about twenty years by Dipankar Mitrs, who
continues to be the Executive Chairman of the firm. Initially, the firm employed a
dept-equity ratio of 1.5:1 as the promoter had limited resources. While the firm had
a few bad patches, it has performed fairly well and has been reasonably profitable.
Over time, the proportion of dept in the capital structure diminished. The firm also
issued bonus shares on two occasions once before making its IPO eight years ago
and once subsequently.
The financial statements of the firm for the just concluded financial year are given
below.
The profit and loss account has been cast in the contribution format to facilitate the
calculation of leverages.
Balance Sheet
Profit And Loss Account
Sources of Funds
Rs. In million

1. Shareholders Funds
800
Paid up equity capital
(140 million shares of
4800
Rs. 10 each)
3200
Reserve and surplus
1800
2. Loan Funds
taxes
1400

Rs. In million

Revenues

1400

Contribution margin
2500
2000
6000

200
Application of funds
1200
1. Net Fixed Assets
360
2. Net Current Assets
840

Variable costs

Fixed operating costs

Profit before interest and
Interest
Profit before tax

4000

Tax

2000

Profit after tax

6000
The current market price per share is Rs. 115, giving a retrospective PE ratio of
19.17, the highest in its history.
Dipankar Mitra and his family holds 45 million shares of Divya Electronics. The rest
is held more or less equally by institutional investors and retail investors.
The firm has an expansion project on hand that will require an outlay of Rs. 2000
million which will be supported by external financing. The expansion project is
expected to generate annual revenue of Rs. 2400 million. Its variable costs will be
60 percent of revenues and its fixed operating costs would be Rs. 500 million. The
expansion can be completed quickly.

EMAN Consultants, the merchant bankers of Divya Electronics, believe that Divya
Electronics can make public issues of equity shares at Rs. 106. The issue expenses,
however, will be Rs. 6 per share. The other option is to privately place debentures
carrying an interest rate of 8 percent.
The board of directors of Divya Electronics would be meeting shortly to decide on
the means of financing to be adopted for the proposed expansion plan.
You have been requested to present an analysis of the two options. In particular,
you have been asked to.
a. Compute the EPS-PBIT indifference point for the two financing options.
b. Calculate the EPS for the following year under the two financing options
assuming that the expansion project would be fully operational.
c. Show how the degree of total leverage will change under the two financing
options.
d. Highlight any other issues that you believe are important for taking the
decision.