VALUATION OF SECURITIES
Q.1. A company has issued debenture of Rs. 50 lacs to be repaid after 7 year. How much should the company invest in a sinking fund earning 12% in order to the able to repay debentures.
Ans. Rs. 4,95,589.
Q.2. What is the present worth of opening expenditures of Rs. 1,00,000 per year which are assumed to be incurred continuously throughout in 8 year period if the effective annual rate interest is 12% ?
Q.3. A firm purchases a machinery for Rs. 8,00,000 by making a down payment of Rs. 1,50,000 and remainder in equal installments of Rs. 1,50,000 for six years. What is the rate of interest to the firm ?
Q.4. Mr. X borrows Rs. 1,00,000 at 8% compounded annually. Equal annual payment are to be made for 6 year. However, at the time of the fourth payment, the individual elects to pay off the loan. How much should be paid ?
Q.5. Ten year from now Mr. X will start receiving a pension of Rs. 3,000 a year. The payment will continue for sixteen year. How much is the pension worth now, if his interest rate is 10% ?
Ans. Rs. 9,952.
Q.6. ABC instruments Ltd. is considering the purchases of a machine to replace to an existing machine that has a book value of Rs. 24,000 and can be sold for Rs. 12,000. the salvage value of the old machine in four year is zero, and it is depreciated on a straight-line basis. The proposed machine will perform the same function the old machine is performing : however improvements in technology will enable the firm to reap cash benefits ( before depreciation and taxes ) of Rs. 56,000 per year in materials, labor, and overhead. The new machine has a four year. Assuming straight-line depacement .
Ans. Initial outlay: Rs. 95,200; Yearly incremental inflows are Rs. 40,800 per annum ; the terminal cost inflow is Rs. 16,000.
Q.7. A company is faced with the problem of choosing between two mutually exclusive projects. Project A requires a cash outlay of Rs. 1,00,000 and cash running expenses of Rs. 35,000 per year. On the other hand, Project B has will cost Rs. 1,50,000 and requires cash running expenses of Rs. 20,000 per year. Both the machines have a eight-year life. Project A has a Rs. 4,000 salvage value and Project B has Rs. 14,000 salvage value. The company’s tax rate is 50% and has a 10% required rate of return. Assume depreciation on straight line basis and no tax on salvage values of assets. Find out the Initial, Annual and Terminal cash flows on incremental basis.
Ans. Initial outflow Rs. 50,000; Annual inflows Rs. 10,000 per annum: and Terminal cash inflow is Rs. 10,000.
Q.8. PQR Ltd. is attempting to find out the cost of equity shares it is proposing to issue. The current price of the equity share is Rs.64 per share and the flotation cost of new share is Rs. 2.50 per share. The dividend of Rs. 3 is expected at the end of current year and the dividends paid for the last 6 year are Rs. 2.34, 2.43, 2.54, 2.65, 2.75 and Rs. 2.86 respectively. Find out the growth rate, cost of retained earnings and cost of equity capital.
Ans. g =4%, k=8.7% , and k1=8.88%.
Q.9. XYZ Ltd. has an annual profit of Rs. 50,000 and the required rate of rerun of the shareholders is 10%. It is further expected that the shareholders will have to incur 3% brokerage cost of the dividend received and invested by them for making new investments. Find out the cost of retained earnings to the firm given that the tax rate applicable to shareholders is 30%
Ans. k= 6.79.
Q.10. The following information is available in respect of XYZ Ltd. :
|Number of shares issued||10,000|
|Market price per share||Rs. 20|
|Expected EBIT||Rs. 15,000|
The firm needs Rs. 50,000 for investment next year. Should the firm issue debt or equity to produce higher EPS. Also find out the indifference level of EBIT for the two alternatives? What is the EBS for that EBIT ?
Ans. EPS is Rs. 0.49, and 0.65; the indifference level of EBIT is Rs. 30,000 and the EPS at that level is Rs. 1.30.
Q.11. X Ltd. Y Ltd. are identical except that the former uses debt while the latter does not . the levered firm has issued 10% Debenture of Rs. 9,00,000. Both the firms earn EBIT of 20% on total assets of Rs. 15,00,000. assuming tax rate of 50% and capitalization rate of 15% for an all-equity firm ;
(i) Compute the value of the two firms using NI approach.
(ii) Compute the value of the two firms using NOI approach.
(iii) Calculate the overall cost of capital , k. for both the firms using NOI approach.
Ans. (i) Rs.16,00,000 and Rs. 10,00,000 (ii) Rs. 14,50,000 and Rs. 10,00,000 , (iii) 10.34% and 15% respectively.
Q.16. Companies U and L are identical in every respect, except that U is unlevered while L is levered. Company L has Rs. 20,00,000 of 8% Debentures outstanding. Assume (I) that all the MM assumptions are met, (2) that the tax rate is 50%, (3) that EBIT is Rs. 6,00,000 and that equity –capitalization rate for company U is 10% .
(a) What would be the value for each firm according to MM’s approach ?
(b) Suppose V=Rs. 25,00,000 and V= 45,00,000. according to MM, do they represent equilibrium value ? if not, explain the process by which equilibrium will be restored.
Ans. Values are Rs. 30,00,000 and Rs. 40,00,000.