Business Finance

Assessment-1

Prepared By:

Wishways Srinivas
Question 1:

The following Financial Statement is taken from the Annual Report of Nestle
India Limited:
1(a) Please write any one item from the Balance Sheet which is impacted by the
following financial decisions. Also, state your reasons:
Answer:

1. Investment Decisions or Capital Budgeting Decisions.

One of the balance sheet items which is impacted by capital budgeting decisions
is Property, plant & equipment.

Investment decisions include analysing the feasibility of investment opportunities

using techniques such as NPV, IRR, etc. In investments decisions, decisions like
whether the company should invest in property, plant, and equipment or progress of
the capitals, which company has invested in the assets, which are started, not yet
completed but will be completed gradually, or should a company invest in intangible
assets. The decisions result in either acceptance or rejection of an investment proposal.
When a project is considered feasible and the investment is made, it usually involves
purchase of property, plant & equipment, which increases the value of property, plant
& equipment on the balance sheet.

2. Financing Decisions.

One of the balance sheet items which is impacted by financing decisions is Equity
share capital.

Financing decisions include evaluating the optimal way to raise funds for a project,
such as equity, loans, bonds, retained earnings. When a financial manager decides to
raise funds for a project via issue of fresh equity capital, it increases the value of
'Equity share Capital' on the balance sheet. Basically, Financing Decision is more
focused on the borrowing and allocation of funds that are required for the investment
decisions of the company. This decides the capital structure of the company.

3. Dividend Decisions.

One of the balance sheet items which is impacted by Dividend decisions is cash
and cash equivalents

When a company makes a dividend decision, it includes deciding the amount of

dividend they want to shell out to the shareholders. When the dividend is paid, it
reduces company's cash and cash equivalents, and thus cash and cash equivalents are
reduced on the balance sheet. The important role of the decision is to ensure the
improvement of the financial health of the firm, as well as take care of the
shareholder's wealth since the shareholder of the company plays a very important role
in the firm's growth. So the impacted item from the dividend decision is other equity
from the equity section.

4. Working Capital decisions.

One of the balance sheet items which is impacted by working capital decisions is
Inventories

These decisions are also called short-term decisions or liquidity decisions. Working
capital decisions include managing the cash flow of the business efficiently so that the
operations are conducted smoothly and the business is able to handle its operating
costs and short-term debt obligations. It includes deciding the level of inventories that
are required for smooth functioning of operations. When the working capital manager
makes a decision to change the level of inventories that are required, it directly affects
the 'Inventories' item on the balance sheet. If the company’s working capital decision
goes bad then it will affect the liquidity and profitability of a business.

1(b) There is a drastic decrease in the value of Other Equity – from Rs.35, 773.20
to Rs.18, 358.40. Write the probable financial decision behind it.
Answer:

'Other Equity' section includes components of equity other equity share capital such as
reserves & surplus, other comprehensive income, etc.

In this case, there has been a significant fall in the value of other equity from Rs.35,
773.2 to Rs.18, 358.4. This is most likely to be a result of a financial decision to pay
dividend to shareholders. When the dividend is paid, it is paid out of the reserves &
surplus on the balance sheet, due to which the dividend payment results in the
reduction of reserves & surplus and hence the 'other equity' figure in the balance sheet.
Since the amount of reduction in value of 'other equity's is so large, it is most likely
due to the payment of dividend.

Question 2: 
2(a). A person has purchased a bond on June 21, 2019, at a price of Rs.105. The
bond has a face value of Rs.100 and a coupon of 10% p.a. payable half-yearly on
June 30 and December 31 of each year. He sold the bond on September 12, 2020,
at a price of Rs.108. You are required to determine the holding period return on
the bond.
Answer:

Calculation of holding period return:

Sale value of bond: Rs.108

Purchase price of bond: Rs.105

Interest received on 30-06-2019 (Rs100*10%1/2) = Rs.5

Add: Interest received on 31-12-2019 (Rs100*10%1/2) = Rs.5

Add: Interest received on 30-06-2020 (Rs100*10%1/2) = Rs.5

Total cash inflow = sale value + Interest received on 30-06-2019 + Interest

received on 31-12-2019 + Interest received on 30-06-2020

= 108 + 5 + 5 + 5

Total cash inflow = Rs.123

Hold Period Return = (Selling price + cash flow during holding period –
purchase price) / purchase price

Holding period return = (108+5+5+5-105)/105

= (123-105)/105

= 18/105

= 0.1714 = 17.14%

Holding period return on the bond = 17.14%

2(b). Historical index and share price data of Infosys Ltd., ONGC, Tata Motors,
Indigo Aviation & BSE S&P 500 are given here. You are required to determine
the following for the above-mentioned companies and BSE S&P 500 index:   

Mean Return 
Risk (in terms of standard deviation)
Systematic Risk(beta) 
Comment on which company would be a better investment option in terms of low
risk.

Answer:

We are assuming 250 working days in a year to calculate Mean return, Risk and
Systematic Risk
   Infosys ONGC Tata Indigo BSE
Motors Close
Mean return 0.25% 0.23% 0.34% 0.19% 0.18%
Annualised return 62% 58% 85% 48% 44%
Variance 0.000200 0.000529 0.0008741 0.0004995 0.000107
443 945 16 49 065
Risk 1.42% 2.30% 2.96% 2.24% 1.03%
Annualised Risk ( Standard 22% 36% 47% 35% 16%
Deviation )
Systematic risk (Beta) 0.099 0.049 0.557 0.165 1.000

WE ARE ASSUMING 250 WORKING DAYS IN A YEAR

After seeing the results of our calculations it looks like Infosys would be a better
investment option in terms of low risk as it has the lowest calculated systematic risk
compared to others.

Question 3:

ESTIMATION OF RELEVANT CASH FLOWS: Master Pasta, Ltd., has projected

a sales volume of Rs.1,432 lakhs for the second year of a proposed expansion
project. Costs estimated to be incurred in this (second) year are Rs.1,002 lakhs.
The depreciation expense will be Rs.80 lakhs (calculated annually), and the tax
rate is 34%. What is the operating cash flow?

Answer:

MASTER PLASTA LTD: INCOME STATEMENT

Projected Sales - Rs.1432 lakhs

Cost Estimated for 2nd year - Rs.1002 lakhs

Depreciation - Rs.80 lakhs

Tax rate – 34%

Earnings before taxes = Sales-Cost-Depreciation Expenses

= 1432-1002-80

= 350

Earnings before taxes = Rs.350 lakhs

Less Taxes = 350*34/100

 = Rs.119 lakhs

Net Income = Earnings before taxes – Less taxes

= 350-119

= 231

Net Income = Rs.231 lakhs

Operating cash flow = Add Back: Depreciation + Net Income

= 231+80

= 311

Hence the operating cash flow will be Rs.311 lakhs

OR

Operating Cash flow = Earning Before Taxes + Depreciation – Taxes

= 350+80-119

= 311
Question 4:
A firm is considering the following two projects:

PROJECT-A CASH FLOWS PROJECT-B CASH FLOWS

YEARS CASH FLOWS YEARS CASH FLOWS

0 (Rs.4,500.00) 0 (Rs.4,000.00)

1 Rs.600.00 1 Rs.800.00

2 Rs.800.00 2 Rs.950.00

3 Rs.1,000.00 3 Rs.1,080.00

4 Rs.1,200.00 4 Rs.1,220.00

5 Rs.1,400.00 5 Rs.1,500.00

6 Rs.1,500.00 6 Rs.1,000.00

7 Rs.1,600.00 7 Rs.800.00

Required:
4(a). Calculate the Payback Period in years for both projects.
4(b). Calculate NPVs for both projects. 
4(c). Calculate IRRs for both projects.
4(d). On the basis of the calculated Payback Period, NPVs, and IRRs above, decide
which project should be selected by the firm.

Please note: Assume the discount rate to be at 12% for the above question.
Answer:

4(a). Calculate the Payback Period in years for both projects.

Project A Payback Period:

Project -A Cash Flows

YEARS CASH FLOWS Cumulative Cash Inflows
0 (Rs.4,500) (Rs.4,500)
1 Rs.600 (Rs.3,900)
2 Rs.800 (Rs.3,100)
3 Rs.1,000 (Rs.2,100)
4 Rs.1,200 (Rs.900)
5 Rs.1,400 Rs.500
6 Rs.1,500 Rs.2,000
7 Rs.1,600 Rs.3,600

Project -A Cash Flows

Pay Back
Period 4.642857143
Pay Back 4 Years & 7
Period Months  

Project B Payback Period:

Project -B Cash Flows

YEARS CASH FLOWS Cumulative Cash Inflows
0 (Rs.4,000) (Rs.4,000)
1 Rs.800 (Rs.3,200)
2 Rs.950 (Rs.2,250)
3 Rs.1,080 (Rs.1,170)
4 Rs.1,220 Rs.50
5 Rs.1,500 Rs.1,550
6 Rs.1,000 Rs.2,550
7 Rs.800 Rs.3,350

Project -B Cash Flows

Pay Back
Period 3.959016393
Pay Back 3 Years & 11  
Period months
4(b). Calculate NPVs for both projects.

Net Present Value for Project A:

Discount rate 12%

PROJECT-A CASH FLOWS

YEA CASH CUMULATIVE DISCOUNTING PV OF
RS FLOWS CASH FLOW FACTOR (12%) CASH
FLOWS
0 -4,500.00 -4,500.00 1.00 -4,500.00
1 600 -3,900.00 0.89 535.74
2 800 -3,100.00 0.80 637.76
3 1,000.00 -2,100.00 0.71 711.80
4 1,200.00 -900.00 0.64 762.60
5 1,400.00 500.00 0.57 794.36
6 1,500.00 2,000.00 0.51 759.90
7 1,600.00 3,600.00 0.45 723.68
      NET PRESENT 425.84
VALUE

Project – A Net Present Value = Rs.425.84

Net Present Value for Project B:

Discount rate 12%

PROJECT-B CASH FLOWS

YEA CASH CUMULATIVE DISCOUNTING PV OF
RS FLOWS CASH FLOW FACTOR (12%) CASH
FLOWS
0 -4,000.00 -4,000.00 1.00 -4,000.00
1 800 -3,200.00 0.89 714.32
2 950 -2,250.00 0.80 757.34
3 1,080.00 -1,170.00 0.71 768.74
4 1,220.00 50.00 0.64 775.31
5 1,500.00 1,550.00 0.57 851.10
6 1,000.00 2,550.00 0.51 506.60
7 800 3,350.00 0.45 361.84
      NET PRESENT 735.25
VALUE

Project -B Net Present Value = Rs.735.25

4(c). Calculate IRRs for both projects.

IRRs for Project A:

CALCULATION OF INTERNAL RATE OF RETURN

(IRR) OF A PROJECT - A
Project-A
Years
Cash Flows
0 (Rs.4,500)
1 Rs.600
2 Rs.800
3 Rs.1,000
4 Rs.1,200
5 Rs.1,400
6 Rs.1,500
7 Rs.1,600
IRR 14%

IRRs for Project A is 14%

IRRs for Project B:

CALCULATION OF INTERNAL RATE OF RETURN

(IRR) OF A PROJECT - B
Project-B
Years
Cash Flows
0 (Rs.4,000)
1 Rs.800
2 Rs.950
3 Rs.1,080
4 Rs.1,220
5 Rs.1,500
6 Rs.1,000
7 Rs.800
IRR 17%

IRRs for Project B is 17%

4(d). On the basis of the calculated Payback Period, NPVs, and IRRs above,
decide which project should be selected by the firm.
Taking Discount rate 12%

Project -A Cash Flows Project -B Cash Flows

YEARS CASH FLOWS YEARS CASH FLOWS
0 (Rs.4,500) 0 (Rs.4,000)
1 Rs.600 1 Rs.800
2 Rs.800 2 Rs.950
3 Rs.1,000 3 Rs.1,080
4 Rs.1,200 4 Rs.1,220
5 Rs.1,400 5 Rs.1,500
6 Rs.1,500 6 Rs.1,000
7 Rs.1,600 7 Rs.800

  Project-A Project-B
PAY BACK PERIOD
(in years) 4.642857143 3.959016393
NPV RS.425.84 RS.735.25
IRR 14% 17%

Based on the results we got Project B should be selected by the firm.

As the results are better with B.
Project-B
PAY BACK PERIOD
(in years) 3.959016393
NPV RS.735.25
IRR 17%

Question 5: 

a) Skylark Limited’s share has a beta of 1.5. The risk-free rate prevailing in the
bond market is 6.75% and the market expected rate of return is 15.50%.
Using the Capital Asset Pricing Model, you are required to determine the cost
of equity.

Answer:

Beta β = 1.5
Risk free rate Rf = 6.75%
Market Return RM = 15.50%
 Using CAPM, one can determine cost of an equity

Expected return = [6.75% + (15.50% - 6.75%) 1.5]

= [6.75% + (8.75%) 1.5]
= 6.75% + 13.125%
= 19.875%
Cost of equity = 19.875%

b) A company’s preference share is trading at BSE at Rs.110. The preference

share is a redeemable share and the Company will redeem them after 15
years at a premium of 5% - that is, it will be redeemed after 15 years at
Rs.105; and it is 10% Preference Share – the company will pay a dividend of
Rs.10 every year. You are required to determine the cost of preference shares
to the Company.

Answer:

Nper, period = 15 years

PMT, payments = Rs10 per year

PV, present value = Rs110 (this is the current market price)

FV, future value = Rs105 (this is the redemption value)

We can find the cost of preference shares using the RATE function in excel

=RATE (nper, PMT, PV, FV)

No of Periods (nper) 15
Yearly Payment ( PMT) 10
Present Value (PV) -110
Future Valur (FV) 105
Cost of preference share 9%