IMT-61: Corporate Finance

IMT - 61: CORPORATE FINANCE

PART - A

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Q1. 'Profit maximization is not an operationally feasible criterion'. Do you agree? Illustrate your views.

Q2. Discuss the fundamental principle behind the concept of 'value of time'.

Q3. There is a direct relationship between risk and return in every area of financial management. Explain.

Q4. A firm is considering the following project:

CASH FLOWS (Rs) FOR FIVE YEARS

0	1	2	3	4	5
-50000	+11300	+12769	+14429	+16305	+18421

(a) Calculate the NPV for the project if the cost of capital is 10%. What is the project's IRR?

(b) Recompute the project's NPV assuming a cost of capital of 10% for years 1 and 2, 12% for years 3 and 4 and 13% for year 5. Can the IRR method be used for accepting or rejecting the project under these conditions of changing cost of capital over time? Why or why not?

Q5. Define cost of capital. Explain its significance in financial decision-making.

PART - B

Q1. A company requires Rs 500,000 to construct a new plant. The feasible financial plans are as follows: (i) The Company may issue 25,000 common shares at Rs 10 per share and 2,500 debentures of Rs 100 denomination bearing an 8 per cent rate of interest. (ii) The Company may issue 50,000 common shares at Rs 10 per share. (iii) The Company may issue 25,000 common shares at Rs 10 per share and 2,500 preference shares at Rs 100 per share bearing an 8 per cent rate of dividend.

If the company's earnings before interest and taxes are Rs 10,000, Rs 20,000, Rs 40,000, Rs 60,000 and Rs 1,00,000, what are the earnings per share under each of the three financial plans? Which alternative would you recommend and why?

Q2. Explain the NI and NOI approaches of financing the capital structure with hypothetical examples.

Q3. Discuss the Modigliani and Miller approach, and critically analyse the hypothesis.

Q4. The following is the summarized balance sheet of Philips India Ltd as on 31 March 2002 and 2003.

Prepare the cash flow statement for the year ended 2003.

Liabilities	2002	2003	Assets	2002	2003
Share Capital	1350000	1350000	Fixed Assets	1200000	960000
General Reserve	900000	930000	Investments	150000	180000
Profit & Loss a/c	168000	204000	Stock	720000	630000
Creditors	504000	402000	Debtors	630000	1365000
Provision for Taxation	225000	30000	Bank	447000	591000
Mortgage Loan	-	810000
Total	3147000	3726000	Total	3147000	3726000

Additional Information:

(a) Investments costing Rs 24,000 were sold during the year for Rs 25,500.

(b) Provision for tax made during the year was Rs 27,000.

(c) During the year, a part of the fixed assets costing Rs 30,000 were sold for Rs 36,000. The profit was included in the profit and loss account.

(d) Interim dividend paid during the year amounted to Rs 1,20,000.

Q5. What are the important ratios used to assess the financial position of a company?

PART - C

Q1. What is the difference between hire purchase and lease finance?

Q2. A firm has applied for working capital finance from a commercial bank. You are requested by the bank to prepare an estimate of the working capital requirements of the firm. You may add 10% to your estimated figure to account for exigencies. The following is the firm's projected profit and loss account:

Particulars	Rupees
Sales	2247000
Cost of Goods Sold	1637100
Gross Profit	609900
Administrative expenses	149800
Selling expenses	139100
Profit before tax	321000
Tax Provision	107000
Profit after Tax	214000

The cost of goods sold is calculated as follows:

Particulars	Rupees
Material Used	898800
Wages & other mfg. expenses	668750
Depreciation	251450
	1819000
Less: Stock of finished goods (10% product not yet sold)	181900
Cost of Goods Sold	1637100

The figures given above relate only to the goods that have been finished, and not to work in progress; goods equal to 15% of the year's production (in terms of physical units) are in progress, on an average requiring full material but only 40% of other expenses. The firm has a policy of keeping two months' consumption of materials in stock. All expenses are paid one month in arrear. Suppliers of material grant one and a half month's credit; 20% sales are made in cash while the remaining is sold on two months' credit. 70% of income tax has to be paid in advance in quarterly instalments.

Q3. What synergies exist in a (a) horizontal merger, (b) vertical merger and (c) conglomerate merger?

Q4. What are the different forms of public-sector enterprises? Explain with the help of a chart.

Q5. Explain overcapitalization. What are the advantages & evils of overcapitalization?

CASE STUDY-1

The following is the capital structure of Simon co.as on 31st March 2008

Equity Shares : 10000 shares ( of Rs 100 each) 10,00,000

12% Preference Shares ( of Rs 100 each) 4,00,000

10% Debentures 6,00,000

20,00,000

The market price of the company's share is Rs 110 & it is expected that a dividend of Rs 10 per share would be declared at the end of current year . The dividend growth rate is 6%.

(i) If the tax rate is 35% compute the WACC by book value & market value weights

(ii) For expansion the company intends to borrow a fund of Rs 10 lakh bearing 12% rate of interest, what will be revised WACC ? The financing decision is expected to increase dividend from Rs 10 to Rs 12 per share & the market price of share will reduce to Rs 105 per share

CASE STUDY-2

While corporate finance is concerned with treasury operations; working capital management; and project evaluation and investor relations, cash management refers to the collection, concentration and disbursement of cash. It encompasses a company's level of liquidity, its management of cash balance and its short-term investment strategies. The need for effective cash flow management is felt due to uncertainty in cash flows and the lack of synchronization of inflows and outflows. Although companies want to hold as little cash as possible, they would also keep enough reserves to face contingencies that may occur.

At CPL Ltd, a study was conducted on the measures used for collections management.

The Company was aware of the benefits of a cash management system. They realized that a CMS would help optimize working capital management, speed up the realization of receivables, allow the Company to stress on core competency and make use of their bankers' sophisticated technology and expertise. CPL realized that as banks have centres at many locations, CMS would be an additional revenue generator and they would not charge high amounts from companies for their service.

The Company had very recently started working on Real Time Gross Settlement (RTGS) for collections and 1.5 per cent of their business, i.e., about Rs 2 crore, was being handled through RTGS. There were two ways of implementing RTGS, one was through taking mandate from dealers and triggering a file for billing and debiting their account. This was in tandem with the dealer's stock management system which was maintained by the Company. There was always a chance of legal issues as the dealer could later accuse the Company of making numerous debit entries. Therefore, this option was avoided and the Company opted for the method wherein the money was first transferred by the stockist as and when required by crediting the Company's account; subsequently a mail was sent by the company's bankers along with a PDF file attachment which was password protected. After processing this file, the order was sent to the warehouse and shipments were effected.

On an average, there were forty to fifty RTGS transactions per month. None of the dealers were forced to shift to RTGS. It was totally voluntary.

The Company had been using both cheques and demand drafts as collection instruments; the discretion being made based on the credit history of the stocklist. The Company accepted only DDs from new stockists for a period of three to six months and only after that, depending on their payment record, could they use either of the two instruments. They used RTGS only for stockists paying through the DD mode and not through cheques.

The turnaround time for RTGS was two to three hours but in order to avail the facility, the transaction had to be made before a fixed time every day, that is, 10 a.m., the Mumbai account would be credited between 10 a.m. and 12 noon. However, in remote areas, the transfer would take place between 1 and 3 p.m. In case of clogging of transactions, the RBI would use the priority assigned by sending the banks to their transactions as per their value.

CPL planned to run both the cheque-based system and RTGS parallely because it did not want to compel the dealers to travel from remote areas just for remitting through RTGS.

It would be advantageous for stockists to shift to RTGS because a commitment was made to them that their orders would be shipped the same day in case of payments through RTGS, which otherwise was not made. The Company wished to encourage their bankers to provide RTGS free of cost to itself as well as its dealers or offer it at a very low price.

The legal issues related to RTGS were solved by taking cheques from dealers. If the dealers failed to pay post dispatch, the Company had the right to deposit the cheques. If the cheques were dishonoured, the Company could sue that dealer.

The percentage of collection under RTGS was 1.5 per cent, but which was estimated to increase to at least 10 per cent in the short run and 40 per cent in the long run as soon as viewing rights were given. The mapping of dealer information was in bad shape and at times CP Ltd had to just respond on the basis of guesswork.

CPL soon began to benefit from the use of RTGS. Not only did costs come down by Rs 1.25 (to Rs 2) per 1000 but DD making charges were also eliminated. The administration charges for RTGS were prohibitive. The Company felt that RTGS was the way ahead but for that they would first have to map RTGS entries manually which was not a bright proposition. So automatic mapping of data was required. In addition, it was discovered that since charges for T+1 transactions were very high, they had arrangements with two banks, one handling T+1 and the other handling T+6. They were receiving customized MIS from their two bankers. The time lag of two to three days for making DDs was done away with. The Company was facing the following problems:

(i) Often, important information related to the sender's identification was missing.

(ii) In the absence of an automatic update system, they had to manually update the system into ERP.

(iii) No mapping was being done during reconciliation.

(iv) Dealers were unwilling to share the expenditure on RTGS. So they were unaffected by the charges by the bank for the RTGS.

(v) There were many sender banks and they all followed different formats. Therefore, to match them manually was difficult.

(vi) The file sent by the bankers did not contain sufficient information and could not be directly linked to ERP which necessitated manual intervention which was laborious and expensive.

It was found that although the transition of the Company to RTGS seemed a little troublesome due to the collection network, on the whole, it was better to be a part of the system at the formation stage so that it could be customized according to the needs instead of allowing others to get the system organized or designed.

Questions

1. What is the role of a CMS in corporate finance?

2. What drawbacks in the existing collection system did the RTGS system seek to improve on?

3. In your opinion, was the RTGS system able to improve the Company's collection management?

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