A Report

On

Assessing the Impact of Suresh Manufacturing’s Proposed

Risky Investment on Its Stock Value and Stock Valuation of
Assar Corporation

Course Name: Financial Management (F-206)

Group No: 5
Assessing the Impact of Suresh Manufacturing’s Proposed
Risky Investment on Its Stock Value and Stock Valuation
of Assar Corporation

Prepared for:

Nausheen Rahman
Professor
Department of Finance
Faculty of Business Studies
University of Dhaka

Prepared by:

Group No: 5
Section: B
Batch: 23rd
Department of Finance
University of Dhaka

10 October, 2018
Group
Profile
Group No: 5
Section: B
Batch: 23rd
Department of Finance
University of Dhaka

The report is a combined effort of:

Sl. No. Name Section Id No. Remarks

01 Sajeeb Dutta B 23-002
02 Shuvo Roy B 23-036
03 Md. Helal Uddin Chowdhury B 23-039
04 Mithila Nag B 23-051
05 Rakibul Hasan B 23-054
06 Md. Nazir Hossain B 23-102
07 Md. Jonaidul Islam B 23-120
08 Md. Asfakul Islam B 23-126
09 Aklima Akter B 23-136
10 Shaikh Saifullah Khalid B 23-160
 Letter of
Transmittal

October 10, 2018

Nausheen Rahman
Professor
Department of Finance
Faculty of Business Studies
University of Dhaka

Subject: Submission of report

Dear Madam,
Here is the in-depth quantitative study of ‘Suresh Manufacturing’s Proposed Risky
Investment on Its Risky Value and Stock Valuation of Assar Corporation’ that you
assigned on September 23, 2018.
We collected the financial information of Suresh Manufacturing and Assar Corporation
from our textbook case study and used financial techniques to represent our findings.
Thank you for giving this kind of creative task. We look forward to working with you
again.
Sincerely yours,

......................................

Shaikh Saifullah Khalid

Id No: 23-160
Section: B
Batch: 23rd
On behalf of Group 5
Department of Finance
University of Dhaka
 Table of Contents

Executive Summary....................................................................................................................................i
Chapter 1: INTRODUCTION.....................................................................................................................1
Objectives of the Study.............................................................................................1
Research Methods....................................................................................................1
Limitations of the Study............................................................................................1
Chapter 2: CASE OVERVIEW AND SOLUTION...................................................................................2
Case............................................................................................................................2
Case Solution.............................................................................................................4
Chapter 3: SPREADSHEET EXERCISE AND SOLUTION..................................................................8
Case..............................................................................................................................8
Solution.......................................................................................................................9
Chapter 4: CONCLUSION.......................................................................................................................12
Works Cited.............................................................................................................................................13
 Executive Summary
Finance decisions deal with how money is raised and used by business, governments
and individuals. To make rational financial decisions we must understand three general
concepts: Everything else equal, (1) more value is preferred to less; (2) the sooner the
cash is received, the more valuable it is; and (3) less risky assets are more valuable
than riskier assets. However, in this précised report, we presented the rationality of
investment decision of Suresh Manufacturing and the stock valuation of Assar
Corporation. We can classify our report in main two sections.
Case Overview and Solution: Here we solved the case study Suresh Manufacturing
and presented the proper solution.
Spreadsheet Exercise and Solution: We solved stock valuation problems of Assar
Corporation through Excel spreadsheet in this section.

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 Chapter
INTRODUCTION
1
A firm that practices sound financial management can provide better products to its
customers at lower prices, can pay higher salaries to its employees, and still provide
greater returns to investors who put up the funds needed to form and operate the
business. In this report, we solved two case studies. First one is about the investment
rationality of Suresh Manufacturing and the final one is about the stock valuation of
Assar Corporation.

Objectives of the Study

 Completing the obligation of this course
 Solving real life financial cases
 Solving financial cases through Excel
 Applying theoretical knowledge in real life

Research Methods
We have created a group consisting 10 members. Then, we discussed the probable
outcomes of those two cases. We took reference from various financial websites and
textbooks. We solved the second case through excel software.

Limitations of the Study

 Focusing on quantitative aspects rather than theoretical aspects
 Lack of software skill
 Lack of time
 Limitations of proper interpretations
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 Chapter
CASE OVERVIEW AND SOLUTION
2
Case
Early in 2007, Guna, the chief financial officer for Suresh Manufacturing, was given the
task of assessing the impact of a proposed risky investment on the firm’s stock value.
To perform the necessary analysis, Inez gathered the following information on the firm’s
stock.
During the immediate past 5 years (2002–2006), the annual dividends paid on the firm’s
common stock were as follows:

Year Dividend per share

2006 Rs.1.90

2005 1.70

2004 1.55

2003 1.40

2002 1.30

The firm expects that without the proposed investment, the dividend in 2007 will be
Rs.2.09 per share and the historical annual rate of growth (rounded to the nearest
whole percent) will continue in the future. Currently, the required return on the common
stock is 14%. Guna’s research indicates that if the proposed investment is undertaken,
the 2007 dividend will rise to Rs.2.15 per share and the annual rate of dividend growth
will increase to 13%. She feels that in the best case, the dividend would continue to
grow at this rate each year into the future and that in the worst case, the 13% annual
rate of growth in dividends would continue only through 2009, and then, at the
2

beginning of 2010, would return to the rate that was experienced between 2002 and
Page

2006. As a result of the increased risk associated with the proposed risky investment,
the required return on the common stock is expected to increase by 2% to an annual
rate of 16%, regardless of which dividend growth outcome occurs.
Armed with the preceding information, Guna must now assess the impact of the
proposed risky investment on the market value of Suresh’s stock. To simplify her
calculations, she plans to round the historical growth rate in common stock dividends to
the nearest whole percent.

Required:
a. Find the current value per share of Suarez Manufacturing’s common stock.
b. Find the value of Suarez’s common stock in the event that it undertakes the proposed
risky investment and assuming that the dividend growth rate stays at 13% forever.
Compare this value to that found in part a. What effect would the proposed investment
have on the firm’s stockholders? Explain.
c. On the basis of your findings in part b, do the stockholders win or lose as a result of
undertaking the proposed risky investment? Should the firm do it? Why?
d. Rework parts b and c assuming that at the beginning of 2007 the annual dividend
growth rate returns to the rate experienced between 2002 and 2006.

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Case Solution
This case demonstrates how a risky investment can affect a firm's value. First, we must
calculate the current value of Suresh's stock, rework the calculations assuming that the
firm makes the risky investment, and then draw some conclusions about the value of
the firm in this situation. In addition to gaining experience in valuation of stock, students
will see the relationship between risk and valuation.

a) Current per share value of common stock

Growth rate of dividends: ‘g’ can be solved for by using the geometric growth
equation as shown below in (1) or by finding the PVIF for the growth as shown in
(2).

1) D2006 = D2002(1+g)4
1.90
√
or, g= 4 1.30 - 1
= (1.46154)1 /4 −1
= 10%
2) We can use the concept of time value of money in determining the growth
rate as the growth rate follows the geometric series. Here the dividend of
2002 will be considered as the present value and the dividend of 2006 will be
taken as future value. By taking the formula, we get:
1.30
PVIF=
1.90
= 0.6842
Now we must have a look at present value interest factor table which shows the
PV factor for 4 years closest to .6842 is 10% (.683).
The growth rate indicates that the dividend grows at a constant rate of 10%.
When the dividend of 2002 was 1.30, in the next year the dividend would rise by
(1.30*0.10) or Rs.0.13 and might be Rs.1.43 which is close to the actual dividend of
2003 Rs.1.40. The deviation occurs because the company didn’t follow complete
constant growth rate.
4

Using the constant growth rate model to calculate the value of the firm’s common
Page

stock.
 D1 1.90(1+0.1) 2.09
P 0=
k s−g
= = = Rs.52.25
0.14−0.1 0.04

Here, P0= Value of the bond today

D1= Dividend of 2006
Ks= required rate of return
g= constant growth rate
The value of bonds and stocks is nothing but the present value of all the future cash
flows at a required rate of return over its maturity. But the common stock has no
maturity and so we cannot get the potential cash flows from the stock. So we take it as
a perpetuity. By taking the formula of perpetuity, we have got the value of the above
common stock Rs.52.25. The main reasons of the valuation of common stock are
comparing with another stock and making decisions whether to buy it. If the market
value of this stock is above Rs.52.25, we should not buy it; on the other hand, we
decide to buy if is priced below.

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 b) Value of common stock if risky investment is made
The overall task of determining the value of common stock is to assess the effect
in the value of the common stock for undertaking the risky investment. We all
know that people accept risky investment expecting a higher return. And here we
are evaluating whether the value of the common stock rises for taking this risky
investment.
D1 1.90(1+0.13) 2.15
P 0=
k s−g
= = 0.3
= Rs.71.67
0.16−0.13
The higher growth rate associated with undertaking the investment increases the
market value of the stock.

c) The firm should undertake the proposed project as the price per share
increases by Rs.19.42 (from Rs.52.25 to Rs.71.67) that means a particular
shareholder having 1000 common stock of that firm now has a worth of
Rs.71670 (71.67*1000) in the company which is much higher than the value if
the project is not be undertaken. We know that higher risk and higher required
rate of return decreases the value of the common stock, but the higher dividend
growth offsets this higher risk resulting in a net increase in value.

d) We all know that a typical coin has always two sides. One bears the good side
for a certain person while the other may have the possibility of loss. Like the
coin, an investment can be seen from two different scenario, one is optimistic
and the other is pessimistic. We have realized a higher value of the common
stock in the optimistic scenario. The pessimistic scenario has a different look
that is—its growth rate will return the previous after three consecutive years.

The dividend from 2007 to 2010 can be determined by multiplying the growth
rate with the dividend of instant previous year. In 2010, the growth rate will
return to the rate which was experienced in the period from 2002 to 2007 that is
10% .Thus the dividends will be:

D 2007 =2 .15 ( Stated above )

D 2008 =2 .15∗( 1+ 0 .13 )=2 . 43

D 2009 =2 . 43∗( 1+0 . 13 )=2 . 75

6

D 2010 =2 .75∗( 1+ 0 .10 )=3 . 03

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 D 2010 3.03
P2009 = = =$ 50.05
k s−g 0.16−0.1

At the beginning of 2010 the common stock will have an intrinsic value of Rs.51.83
Year Cash Flow PVIF16%,n PV

2007 2.15 .862 $ 1.85

2008 2.43 .743 1.81
2009 2.75 + 50.05 .641 34.13
P0 = $37.79

If we use formula to determine the value of bond at the beginning of 2007, we have to
move through the following process:

2.15 2.43 2.75+50.05

P2007= + +
(1+0.16) (1+ 0.16) (1+0.16)3
2

= 37.79

Now the firm should not undertake the proposed project. The price per share decreases
by $13.60 (from $52.25 to $38.65). Now the increase in risk and increased the required
return is not offset by the increase in cash flows. The longer term of the growth is an
important factor in this decision.

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Page 8
 SPREADSHEET EXERCISE AND SOLUTION
Chapter 3
Case
You are interested in purchasing the common stock of Assar Corporation. The firm
recently paid a dividend of Rs. 3per share. It expects its earnings—and hence its
dividends—to grow at a rate of 7 percent for the foreseeable future. Currently, similar-
risk stocks have required returns of 10 percent.

TO DO

a. Given the data above, calculate the present value of this security. Use the constant growth
rate model to find the stock value.
b. One year later, your broker offers to sell additional shares of Assar Rs.73. The most recent
dividend paid was Rs. 3.21, and the expected growth rate for earning remains at 7 percent.
To determine the required rate of return, you decide to use the capital asset pricing model
(CAPM). The risk free rate, RF, currently 5.25 percent; the market return, km, is 11.55
percent; and the stock’s beta, bAssasr, is 1.07. Substitute the appropriate values into the
CAPM to determine the firms current required return, kAssar.
c. Determine the value of the stock using the new dividend and required return from part b.
d. Given the calculation in part c, would you buy the additional shares from your brokerat Rs.
73 per share? Explain.
e. Given your calculation in part c, would you sell your old shares for Rs. 73? Explain.

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Solution
a) The present value of the stock can be calculated as follows:

Here,

D0= last dividend paid by the firm

g= constant growth rate
rs= required rate of return.
P0= present value of the stock.

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b) The current rate of required return is as follows:

Here,

D0= last dividend paid by the firm

g= constant growth rate
RF= risk-free rate of return
Km= the market return
bAssar= beta of the stock

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c) The value of the stock is:

d) According to the value gained in c, the stock value is Rs. 69. It will be an act of fool to
buy the shares for Rs. 73. If there is any opportunity to buy the shares for less than Rs.
69, then it will bring some profits to me. We know a stock with a significantly lower
intrinsic value than the current market price may indicate the stock is overvalued. But it
does not necessarily mean that the stock should be avoided.

e) Selling the shares for Rs. 73 is apparently profitable as the stock value is less than
Rs. 73. There is a premium on trading overvalued stocks. Overvalued stocks are ideal
for investors looking to short a position, which is selling shares with the intention of
buying them when the price is in line with the market.

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 Chapter
CONCLUSION
4
Financial Management is an essential part of the economic and non-economic activities
which leads to decide the efficient procurement and utilization of finance with profitable
manner. In the olden days the subject Financial Management was a part of accountancy
with the traditional approaches. Now a days it has been enlarged with innovative and
multi-dimensional functions in the field of business with the effect of industrialization,
Financial Management has become a vital part of the business concern and they are
concentrating more in the field of Financial Management. Financial Management also
developed as corporate finance, business finance, financial economics, financial
mathematics and financial engineering. Understanding the basic concept about the
financial management becomes an essential part for the students of economics,
commerce and management.

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Works Cited
C. Paramasivan, T. S. (2001). Financial Management. New Delhi: New Age International Publisher.

Lawrence J. Gitman, C. J. (2011). Principles of Managerial Finance. In C. J. Lawrence J. Gitman, Chapter 7:

Stock Valuation (pp. 314-315). Delhi: Pearson.

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