CA.CS.CMA.MBA: Naveen.

Rohatgi Corporate Valuation

CORPORATE VALUATION

1.What is corporate valuation?

• Valuation is the process of determining the theoretically correct value of a company,

investment or asset, as opposed to its cost or current market value.
• Common reasons for performing a valuation are for M&A, strategic planning, capital financing
and investing in securities.
• The three most common valuation methods are: DCF analysis, comparable company analysis
and precedent transactions.

2.Reasons for performing a valuation

Valuation is an important exercise since it can help identify mispriced securities or determine
what projects a company should invest. Some of the main reasons for performing a valuation
are listed below.

1. Buying or selling a business

Buyers and sellers will normally have a difference in the value of a business. Both parties
would benefit from a valuation when making their ultimate decision on whether to buy or sell
and at what price.

2. Strategic planning

A company should only invest in projects that increase its net present value. Therefore, any
investment decision is essentially a mini-valuation based on the likelihood of future
profitability and value creation.

3. Capital financing

An objective valuation may be useful when negotiating with banks or any other potential
investors for funding. Documentation of a company’s worth, and its ability to generate cash
flow, enhances credibility to lenders and equity investors.

4. Securities investing

Investing in a security, such as a stock or a bond, is essentially a bet that the current market
price of the security is not reflective of its intrinsic value. A valuation is necessary in
determining that intrinsic value.

1
CA.CS.CMA.MBA: Naveen. Rohatgi Corporate Valuation

3. IMPORTANT TERMS ASSOCIATED WITH VALUATION

a. The Concept of PV (Present Value) of cash flows:

As we know that a receipt of ₹ 1,000 twelve months hence would not be the same as of
today, because of concept of Time Value of Money. Accordingly, the discounted value
of ₹ 1,000 a year at the rate of 10% shall be ₹ 909 approximately.

b. Perpetual Growth Rate (Gordon Model)

The Gordon growth model (GGM) is used to determine the intrinsic value of a stock
based on a future series of dividends that grow at a constant rate. It is a popular and
straightforward variant of the dividend discount model (DDM). The GGM assumes that
dividends grow at a constant rate in perpetuity and solves for the present value of the
infinite series of future dividends.

Because the model assumes a constant growth rate, it is generally only used for
companies with stable growth rates in dividends per share.

c. Terminal value (TV): is the value of a business or project beyond the forecast period
when future cash flows can be estimated. Terminal value assumes a business will grow
at a set growth rate forever after the forecast period

• Terminal value (TV) determines a company's value into perpetuity beyond a set
forecast period—usually five years.
• Analysts use the discounted cash flow model (DCF) to calculate the total value of a
business. DCF has two major components—the forecast period and terminal value.
• There are commonly used methods to calculate terminal value—perpetual growth
(Gordon Growth Model)
• The perpetual growth method assumes that a business will continue to generate cash
flows at a constant rate forever.

3. Methods of Corporate Valuation

A Net Asset Approach

The asset-based approach has many other common names such as the asset
accumulation method, the net asset value method, the adjusted book value
method and the asset build-up method. The purpose of the model is to study
and revaluate the company’s assets and liabilities obtaining the substance
value which also is the equity. The substance value is thus estimated as assets
minus liabilities. To be useful, the substance value must be positive, if
liabilities are bigger than assets there is no use of the method.

2
CA.CS.CMA.MBA: Naveen. Rohatgi Corporate Valuation

The basic idea is that the company’s value could be determined by looking
at the Balance Sheet. Unfortunately, the values on the balance sheet cannot
be used because the book value seldom is the same as the real value, except
for the case of liabilities that is often accounted in real value. The problem
is when following the principles of accounting, assets often are depreciated
over their life expectancy and when the asset-based approach is applied
the real value for these assets must be determined. In this case, the real
value is equivalent to the fair market value that is value of the asset on a
free market or present value of the future earnings from the asset or a group
of assets.

2. Income based Approach

The income approach business valuation has two main methods, namely the capitalization of
earnings and discounted cash flows approach. Both have been explained in detail below.

1. CAPITALIZATION OF EARNING METHOD

Capitalization of earnings is a method used to determine the value of a company by calculating
the net present value (NPV) of expected future profits or cash flows. This estimate is figured
out by taking the entity’s future earnings and dividing them by the capitalization rate.

Basically, it is an income approach with a business valuation formula that determines what a
company is worth by looking at the expected future value, the annual rate of return, and the
current cash flow. So, under this method, the value of the business is determined by discounting
its future earnings. Here is the income approach business valuation formula for this method:

Business Value = Annual Future Earnings/Required Rate of Return

2.DISCOUNTED CASH FLOW METHOD (FORMULA)

The Discounted Cash Flow (DCF) method is the second kind of income approach that many
companies use for their business valuation. The theory behind this method is that the total value
of a business is the present value of its projected future earnings plus the present value of the
terminal value. In this process, the expected cash flow of the business over a period of time in
the future is projected first.

After that, each discrete cash flow is discounted to a present value at a rate that reflects the risk
of receiving that amount at the time anticipated in the projection. And the best way to represent
these projections, items such as capital expenses, operating costs, revenue, and working capital
are forecasted.

These projections are then used to figure out the net cash flow generated by the business
discounted to present value using an appropriate risk-adjusted discount rate, often the weighted
average cost of capital or WACC. Under the discounted cash flow method, the first step is to
find the projected future cash flows.

3
CA.CS.CMA.MBA: Naveen. Rohatgi Corporate Valuation

To make this method a bit more simple, there is a way called the Gordon Growth Model where
the net cash flows are obtained for just one year and constant perpetual growth is assumed. The
formula for this is:

Business Value = Cash Flows during First Year/ Required Rate of Return – Growth Rate

The above equation is based on the formula for the present value of a perpetuity. But this is
just one approach. There is another approach called the multi-stage growth model. In this
model, the future is divided into two or more stages:

• The initial period of say 4 years, for which the net cash flows and growth rate for every
year can be found; and
• The period after the initial period for which year by year the projection is unreliable.

Under this income approach, cash flows of each year in the initial period are discounted
separately to time 0. The present value of the cash flows at the end of the last year, also called
the terminal value, is found using the Gordon Growth Model. The terminal value is discounted
back to time 0 and added to the present value of cash flows in the initial period. Let us
understand how the DCF method works.

3. CASH FLOW APPROACH

There are two types of Free Cash Flows: Free Cash Flow to Firm (FCFF) (also referred to as
Unlevered Free Cash Flow) and Free Cash Flow to Equity (FCFE), commonly referred to as
Levered Free Cash Flow. It is important to understand the difference between FCFF vs FCFE,
as the discount rate and numerator of valuation multiples depend on the type of cash flow used

Free Cash Flow

Before looking into the difference between FCFF vs FCFE, it is important to understand what
exactly is Free Cash Flow (FCF). Free Cash Flow is the amount of cash flow a firm generates
(net of taxes) after taking into account non-cash expenses, changes in operating assets and
liabilities, and capital expenditures.

Free Cash Flow is a more accurate metric than EBITDA, EBIT, and Net Income as they leave
out large capital expenditures and change in cash due to changes in operating assets and
liabilities. Also, metrics such as EBIT and Net Income include non-cash expenses, further
misrepresenting the true cash flow of a business.

Due to the reasons mentioned above, Free Cash Flow is often used in a DCF analysis and
therefore, a clearer understanding of the concept is important for finance interviews, especially
for Investment Banking and Corporate Finance roles.

Difference between FCFF vs FCFE

The key difference between Unlevered Free Cash Flow (FCFF) and Levered Free Cash Flow
(FCFE) is that Unlevered Free Cash Flow excludes the impact of interest expense and net debt

4
CA.CS.CMA.MBA: Naveen. Rohatgi Corporate Valuation

issuance (repayments), whereas Levered Free Cash Flow includes the impact of interest
expense and net debt issuance (repayments).

How to Calculate FCFF

• EBIT * (1-Tax Rate) + Non-Cash Expenses – Changes in working capital – CapEx

How to Calculate FCFE

• NPAT + Non-Cash Charges – Changes in working capital – Capex + Net Debt

Issued.

Discount Rate: FCFF vs FCFE

Just like valuation multiples differ depending on the type of cash flow being used, the discount
rate in a DCF also differs depending on whether FCFF or FCFE are being discounted.

If FCFF, the firm’s Weighted Average Cost of Capital (WACC) is used as the discount rate
because one must take into account the entire capital structure of the company. Calculating
Enterprise Value means including the share of all investors.

If FCFE are used, the firm’s Cost of Equity should be used as the discount rate because it
involves only the amount left for equity investors. It ensures calculating Equity Value instead
of Enterprise Value.

4.Relative Valuation

• A relative valuation model compares a firm's value to that of its competitors to

determine the firm's financial worth.
• One of the most popular relative valuation multiples is the price-to-earnings (P/E)
ratio.
• A relative valuation model differs from an absolute valuation model which makes no
reference to any other company or industry average.
• A relative valuation model can be used to assess the value of a company's stock price
compared to other companies or an industry average.
• Relative valuation models are used to value companies by comparing them to other
businesses based on certain metrics such as EV/Revenue, EV/EBITDA, and P/E ratios.
The logic is that if similar companies are worth 10x earnings, then the company that’s
being valued should also be worth 10x its earnings. This guide will provide detailed
examples of how to perform relative valuation analysis.

5
CA.CS.CMA.MBA: Naveen. Rohatgi Corporate Valuation

Practical Questions
Q1) Eagle Ltd. reported a profit of Rs 77 lakhs after 30% tax for the financial year 2011-
12. An analysis of the accounts revealed that the income included extraordinary items
of Rs 8 lakhs and an extraordinary loss of Rs10 lakhs. The existing operations, except
for the extraordinary items, are expected to continue in the future. In addition, the results
of the launch of a new product are expected to be as follows:

Rs In lakhs
Sales 70
Material costs 20
Labour costs 12
Fixed costs 10
You are required to:
(i) Calculate the value of the business based on FMP, given that the
capitalization rate is 14%.
(ii) Determine the market price per equity share of Eagle Ltd.‘s share capital
being comprised of 1,00,000 13% preference shares of Rs 100 each and
5,00,000 equity shares of Rs 10 each and the P/E ratio being 10 times.

Q2)H Ltd. agrees to buy over the business of B Ltd. effective 1st April, 2012.The
summarized Balance Sheets of H Ltd. and B Ltd. as on 31st March 2012 are as
follows:

Balance sheet as at 31st March, 2012 (In Crores of Rupees)

Liabilities: H. Ltd B. Ltd.
Paid up Share Capital
-Equity Shares of Rs100 each 350.00
-Equity Shares of Rs10 each 6.50
Reserve & Surplus 950.00 25.00
Total 1,300.00 31.50
Assets:
Net Fixed Assets 220.00 0.50
Net Current Assets 1,020.00 29.00
Deferred Tax Assets 60.00 2.00
Total 1,300.00 31.50
H Ltd. proposes to buy out B Ltd. and the following information is provided to
you as part of the scheme of buying:
(1) The weighted average post tax maintainable profits of H Ltd. and B Ltd. for
the last 4 years are Rs 300 crores and Rs10 crores respectively.
(2) Both the companies envisage a capitalization rate of 8%.
(3) H Ltd. has a contingent liability of Rs 300 crores as on 31st March, 2012.

6
 CA.CS.CMA.MBA: Naveen. Rohatgi Corporate Valuation

(4) H Ltd. to issue shares of Rs 100 each to the shareholders of B Ltd. in terms
of the exchange ratio as arrived on a Fair Value basis. (Please consider
weights of 1 and 3 for the value of shares arrived on Net Asset basis and
Earnings capitalization method respectively for both H Ltd. and B Ltd.)
You are required to arrive at the value of the shares of both H Ltd. and B Ltd. under:
(i) Net Asset Value Method
(ii) Earnings Capitalization Method
(iii) Exchange ratio of shares of H Ltd. to be issued to the shareholders of B
Ltd. on a Fair value basis (taking into consideration the assumption
mentioned in point 4 above.)
Q3) Shah Ltd had earned a PAT of Rs48 Lakhs for the year just ended. It wants you to
ascertain the value of its business, based on the following information.
Tax Rate for the year just ended was 36%. Future Tax rate is estimated at 34%.
The Company’s Equity Shares are quoted at Rs120 at the Balance Sheet date.
The Company had an Equity Capital of Rs100 Lakhs, divided into Shares of
Rs50 each
Profits for the year have been calculated after considering the following in the
P & L Account:-
1. Subsidy Rs2 Lakhs received from Government towards fulfillment of
certain social obligations.
2. The Government has withdrawn this subsidy and hence, this amount will
not be received in future.
3. Interest Rs8 Lakhs on Term Loan. The final instalment of this Term Loan was
fully settled in the last year.
4. Managerial Remuneration Rs15 Lakhs. The Shareholders have approved
an increase of Rs6 Lakhs in the overall Managerial Remuneration, from
the next year onwards.
5. Loss on sale of Fixed Assets and Investments amounting to Rs8 Lakhs.
(Ignore Tax Effect thereon)
Q4) Idea Ltd was incorporated on 1st April, 2016 for the purpose of acquiring P Ltd, Q Ltd and R
Ltd. The summarized Balance Sheets of the Companies as at 31st March 2016 are given below (Rs
000’s)-

Liabilities P Ltd Q Ltd R Ltd Asset P Ltd Q Ltd R Ltd

s
Equity Shares 20,00,000 25,00,000 12,50,000 Fixed Assets - -- 3,00,000 --
(Rs10) Goodwill
Reserves & Surplus 7,50,000 5,50,000 3,00,000 Land & Buildings 5,00,000 4,00,000 3,00,000
10% Term Loan 3,50,000 2,00,000 2,00,000 Plant & Equipment 20,00,000 16,00,000 12,00,000
Current Liabilities 7,00,000 4,50,000 4,75,000 Other Fixed Assets 3,00,000 8,00,000 2,25,000
Current Assets - 4,00,000 2,50,000 2,00,000
Stocks
Debtors 5,00,000 3,00,000 2,50,000
Cash & Bank 1,00,000 50,000 50,000

7
 CA.CS.CMA.MBA: Naveen. Rohatgi Corporate Valuation

Total 38,00,000 37,00,000 22,25,000 Total 38,00,000 37,00,000 22,25,000

Other relevant particulars –

1) Average Annual Profits before interest: P Ltd - Rs4,50,000; Q Ltd - Rs6, 00,000;
and R Ltd - Rs2,50,000
2) Tangible Fixed Assets have been valued by professionals at 31st March 2016 as-

Particulars P Ltd Q Ltd R Ltd

Land & Buildings Rs 8,00,000 Rs 9,00,000 Rs5,00,000
Plant & Equipment’s Rs16,00,000 Rs14,00,000 Rs12,00,000
Other Fixed Assets Rs1,75,000 Rs 9,00,000 Rs3,25,000
1) The Directors of Idea Ltd in their negotiations agreed to the following-
(a) The recorded value of Goodwill is to be ignored;
(b) Professional valuations are to be accepted in respect of Fixed Assets.
(c) Current Assets are to be accepted at their reported amounts.
(d) Valuation Adjustments are to be made by individual Companies before
completion of acquisition.
(e) Idea Ltd will issue 12% debentures at par in amount equal to the Net Assets
of each acquired Company.
(f) Idea Ltd will issue Equity Shares of Rs10 each at par for the capitalized
value of the Average Profits of each acquired company in excess of Net
Assets (The capitalization rate is 10%)
• Calculate amounts of Debentures and Equity Shares to be issued by Idea Ltd to
Shareholders of P Ltd, Q Ltd, and R Ltd.
• Calculate the effect of the scheme on Q Ltd’ profitability, if Idea Ltd earns a
Net Profit of Rs25,00,000 before interest for the year ended 31st March 2016.

Q5)

Equity and Liability Rs (in Asset Rs (in

(1) Shareholders Fund:
(a) Share Capital
Equity Share Capital of Rs 100
10 each
(b) Reserve & Surplus
— General Reserve
(2) Current Liabilities:
(a) Trade Payables
— Sundry Creditors
Lakh) s Lakh)
(1) Non-Current Assets:
(a) Fixed Assets
(i) Tangible Assets:
— Land and Building 40
40 — Plant and Machinery 80
(b) Non-Current Investments 10
(2) Current Assets:
30 (a) Inventories 20
(b) Trade Receivables

8
 CA.CS.CMA.MBA: Naveen. Rohatgi Corporate Valuation

— Sundry Debtors 15
(c) Cash & Cash Equivalents 5
Total 170 Total 170
Given below is the Balance Sheet of Khan Ltd. as on 31.3.2016:

You are required to work out the value of the Company’s, shares on the basis
of Net Assets method and Profit- earning capacity (Capitalisation) method and
arrive at the fair price of the shares, by considering the following information:
(i) Profit for the current year Rs64 lakhs includes Rs4 lakhs extraordinary
income and Rs1 lakh income from investments of surplus funds; such
surplus funds are unlikely to recur.
(ii) In subsequent years, additional advertisement expenses of Rs5 lakhs are expected to
be incurred each year.
(iii) Market values of Land and Building & Plant and Machinery have been
ascertained at Rs96 lakhs and Rs100 lakhs respectively. This will entail
additional depreciation of Rs6 lakhs each year.
(iv) Effective Income-tax rate is 30%.
(v) The capitalization rate applicable to similar business is 16%.

Q6) AB Ltd., is planning to acquire and absorb the running business of XY Ltd. The
valuation is to be based on the recommendation of merchant bankers and the
consideration is to be discharged in the form of equity shares to be issued by AB
Ltd. As on 31.3.2006, the paid up capital of AB Ltd. consists of 80 lakhs shares
of Rs 10 each. The highest and the lowest market quotation during the last 6
months were Rs 570 and Rs 430. For the purpose of the exchange, the price per
share is to be reckoned as the average of the highest and lowest market price during
the last 6 months ended on 31.3.06.
XY Ltd.’s Balance Sheet as at 31.3.2006 is summarised below:
Rs lakhs
Sources
Share Capital
20 lakhs equity shares of Rs10 each fully paid 200
10 lakhs equity shares of Rs10 each, Rs5 paid 50
Loans 100
Total 350
Uses
Fixed Assets (Net) 150
Net Current Assets 200
350
An independent firm of merchant bankers engaged for the negotiation, have
produced the following estimates of cash flows from the business of XY Ltd.:

9
CA.CS.CMA.MBA: Naveen. Rohatgi Corporate Valuation

Year ended By way of Rs lakhs

31.3.07 after tax earnings for equity 105
31.3.08 do 120
31.3.09 Do 125
31.3.10 Do 120
31.3.11 Do 300
It is the recommendation of the merchant banker that the business of XY Ltd.
may be valued on the basis of the average of (i) Aggregate of discounted cash
flows at 8% and (ii) Net assets value.
Present value factors at 8% for years

1-5: 0.93 0.86 0.79 0.74 0.68

You are required to:
(i) Calculate the total value of the business of XY Ltd.
(ii) The number of shares to be issued by AB Ltd.; and
(iii) The basis of allocation of the shares among the shareholders of XY Ltd.

Q7) Yes Ltd. wants to acquire No Ltd. and the cash flows of Yes Ltd. and the
merged entity are given below:

(Rs In lakhs)
Year 1 2 3 4 5
Yes Ltd. 175 200 320 340 350
Merged 400 450 525 590 620
Entity
Earnings would have witnessed 5% constant growth rate without merger and 6% with
merger on account of economies of operations after 5 years in each case. The cost of capital
is 15%.
The number of shares outstanding in both the companies before the merger is the same and
the companies agree to an exchange ratio of 0.5 shares of Yes Ltd. for each share of No Ltd.
PV factor at 15% for years 1-5 are 0.870, 0.756; 0.658, 0.572, 0.497 respectively. You are
required to:
(i) Compute the Value of Yes Ltd. before and after merger.
(ii) Value of Acquisition and
(iii) Gain to shareholders of Yes Ltd

10
 CA.CS.CMA.MBA: Naveen. Rohatgi Corporate Valuation

Q8) The free cash flow of S Ltd is projected to grow at a compound annual average rate of
35% for the next 5 years. Growth is then expected to slow down to a normal 5% annual growth
rate. The current year’s cash flow of S Ltd is Rs4 lakh. S Ltd’s cost of capital during the high
growth period is 18% and 12% beyond the fifth year, as growth stabilizes. Calculate the value
of the S Ltd.

Q9) Alpha India Ltd. is trying to buy Beta India Ltd. Beta India Ltd., is a small
biotechnology firm that develops products that are licensed to major pharmaceutical
firms. The development costs are expected to generate negative cash flows of Rs10
lakh during the first year of the forecast period. Licensing fee is expected to generate
positive cash flows of Rs5, 10, 15 and 20 lakh during 2-5 years respectively. Due to the
emergence of competitive products cash flows are expected to grow annually at a
modest 5% after the fifth year. The discount rate for the first five years is estimated to
be 15% and then drop to 8% beyond the fifth year. Calculate the value of the firm

Q10) ABC Ltd Company currently sells for Rs32.50 per share. In an attempt
to determine if ABC Ltd is fairly priced, an analyst has assembled the following
information.
The before-tax required rates of return on ABC Ltd debt, preferred stock, and
common stock are 7.0 percent, 6.8 percent, and 11.0 percent, respectively.
The company’s target capital structure is 30 percent debt, 20 percent
preferred stock, and 50 percent common stock.
The market value of the company’s debt is Rs145 million and its preferred stock
is valued at Rs65 million.

ABC Ltd’s FCFF for the year just ended is Rs28 million. FCFF is expected to
grow at a constant rate of 4 percent for the foreseeable future.
The tax rate is 35 percent.
ABC Ltd has 8 million outstanding common shares.
What is ABC Ltd’s estimated value per share? Is ABC Ltd’s stock under priced?

Q11) Following information is given in respect of WXY Ltd., which is expected to grow at a
rate of 20% p.a. for the next three years, after which the growth rate will stabilize at 8% p.a.
normal level, in perpetuity.
For the year ended March 31, 2014
Revenues Rs 7,500 Crores
Cost of Goods Sold (COGS) Rs 3,000 Crores
Operating Expenses Rs 2,250 Crores
Capital Expenditure Rs 750 Crores
Depreciation (included in Operating Rs 600 Crores
Expenses)
During high growth period, revenues & Earnings before Interest & Tax (EBIT)
will grow at 20% p.a. and capital expenditure net of depreciation will grow at 15
% p.a. From year 3 onwards, i.e. normal growth period revenues and EBIT will

11
CA.CS.CMA.MBA: Naveen. Rohatgi Corporate Valuation

grow at 8% p.a. and incremental capital expenditure will be offset by the

depreciation. During both high growth & normal growth period, net working
capital requirement will be 25% of revenues.
The Weighted Average Cost of Capital (WACC) of WXY
Ltd. is 15%. Corporate Income Tax rate will be 30%.
Required:
Estimate the value of WXY Ltd. using Free Cash Flows to Firm (FCFF) &
WACC methodology.
The PVIF @ 15 % for the three years are as below:
Year t1 t2 t3
PVIF 0.8696 0.7561 0.6575

Q12) Following information are available in respect of XYZ Ltd. which is

expected to grow at a higher rate for 4 years after which growth rate will stabilize
at a lower level:
Base year information:

Revenue - Rs 2,000
crores
EBIT - Rs 300 crores
Capital expenditure - Rs 280 crores
Depreciation - Rs200 crores
Information for high growth and stable growth period are as follows:
High Stable
Growth Growth
Growth in Revenue & EBIT 20% 10%
Growth in capital expenditure and 20% Capital expenditure are
depreciation offset by depreciation
Risk free rate 10% 9%
Equity beta 1.15 1
Market risk premium 6% 5%
Pre tax cost of debt 13% 12.86%;
Debt equity ratio 1:1 2:3
For all time, working capital is 25% of revenue and corporate tax rate
is 30%. What is the value of the firm?
Q13) True Value Ltd. (TVL) is planning to raise funds through issue of common stock for the
first time. However, the management of the company is not sure about the value of the company
and, therefore, they attempted to study similar companies in the same line which are
comparable to True value in most of the aspects.
Company True- value Ltd Jewel – Value Real- value Ltd Unique- Value
Ltd Ltd
Sales 250 190 210 270

12
CA.CS.CMA.MBA: Naveen. Rohatgi Corporate Valuation

Profit after tax 40 30 44 50

Book – Value 100 96 110 128
Market – Value 230 290 440

TVL feels that 50% weightage should be given to Price/ earnings in the valuation process; Price
/ sales and Price/ book value may be given equal weightage.
Q14) A task has been assigned to a research analyst in a mutual fund to find out at what
price the fund should subscribe to an IPO issue (through Book Building) of a transformer
company X Ltd. The following details of the company from 31.3.13 Annual Report are
available:
Amount in lakhs
Particulars 31.03.13
Revenues 248.79
Operating expenses 214.41
EBIDTA 34.38
Other Income 3.84
Interest expense 1.00
Preliminary Expenses W/O 0.00
Depreciation 1.92
Profit before taxes 35.30
Income taxes 12.35
Tax at the rate of 35%
Net profit 22.95
To calculate future cash flows, the following projections for the financial
year ended 31.3.2014 till 31.3.2018 is available:
Amount in lakhs
FY14 FY15 FY1 FY17 FY18
6
Revenue growth 55% 50% 28% 20% 14%
Operating exp 50% 50% 30% 20% 16%
Other Income 2.50 2.20 2.50 2.50 2.50
Interest expense 2.00 3.00 3.00 3.00 3.00
Preliminary Expenses W/O 5.00 4.00 3.00 2.00 1.00
Depreciation 2.60 3.50 4.10 3.90 3.70
Capital spending 2.00 5.00 5.00 2.00 2.00
Incremental Working capital 2.00 5.00 5.00 2.00 2.00

It is given that revenues would grow at 0% after the explicit forecast period. X Ltd. total
assets of Rs219.98 lakhs are financed with equity of Rs208.66 lakhs and balance debts
sourced at 8% p.a. Assume risk free rate of 7.5%, risk premium of 7.5% and beta of
stock as 1.07. The firm falls in the 35% tax bracket. The company including the
shares floated in this issue would have issued a total of 1.02 lakhs shares. Find out the

13
 CA.CS.CMA.MBA: Naveen. Rohatgi Corporate Valuation

intrinsic value of share using Discounted Cash Flow Analysis. If the price band
announced by X Ltd. stands at Rs345 - Rs365, should this fund subscribe to this book
built issue.
Q15) Tridev Ltd is in the business of making sports equipment. The Company operates
from Thailand. To globalise its operations Tridev has identified Try Toys Ltd, an Indian
Company, as a potential takeover candidate. After due diligence of Try Toys Ltd, the
following information is available :-

(a) Cash Flow Forecasts (Rs in Crores)

Year 10 9 8 7 6 5 4 3 2 1
Try Toys Ltd 24 21 15 16 15 12 10 8 6 3
Tridev Ltd 108 70 55 60 52 44 32 30 20 16
The Net Worth of Try Toys Ltd (in Lakh Rs) after considering certain
adjustments suggested by the due diligence team reads as under —

Tangible 750
Inventories 145
Receivables 75 970
Less: Creditors 165
Bank Loans 250 (415)
Represented by Equity Shares of Rs1000 each 555

Talks for the takeover have crystallized on the following –

Tridev Ltd will not be able to use Machinery worth Rs75 Lakhs which will be disposed off
by them subsequent to take over. The expected realization will be Rs50 Lakhs.
The inventories and receivables are agreed for takeover at values of Rs100 and Rs50 Lakhs
respectively, which is the price they will realize on disposal.
The liabilities of Try Toys Ltd will be discharged in full on take over along with an
employee settlement of Rs90Lakhs for the employees who are not interested in
continuing under the new management.
Tridev Ltd will invest a sum of Rs150 Lakhs for upgrading the Plant of Try Toys Ltd on
takeover. A further sum ofRs50 Lakhs will also be incurred in the second year to revamp
the machine shop floor of Try Toys Ltd.
The anticipated cash flow (in Rs Crore) post takeover are as follows-

Year 1 2 3 4 5 6 7 8 9 10
Cash Flows 18 24 36 44 60 80 96 100 140 200
You are required to advise the management the maximum price which they
can pay per share of Try Toys Ltd., if a discount factor of 15% is considered

14
 CA.CS.CMA.MBA: Naveen. Rohatgi Corporate Valuation

appropriate.

Q16) ABC Ltd has FCFF of Rs170 Crores and FCFE of Rs130 Crores. ABC
Ltd’s WACC is 13% and its cost of equity is 15%. FCFF is expected to grow
forever at 7% and FCFE is expected to grow forever at 7.5%. ABC Ltd has debt
outstanding at Rs1500 Crores. Find the value of ABC Ltd using FCFF
approach and FCFE approach.

Q17) Adonis Ltd., makes thermal clothing for winter sports and outdoor work, and is
considering acquiring Sking Ltd. which manufacturing and sells ski clothing. Sking Ltd. is
about one quarter – size and manufactures its entire product line in a small rented factory on a
mountaintop in Manali. It costs about 10,00,000 a year in overhead to operate in the factory.
Adonis Ltd. produces its North – east locations. Its Factory has at least 50% excess capacity.
Adonis plan is to acquire Sking Ltd., and combine production operations in its north – eastern
factory. But otherwise run the companies separately. Sking Ltd. beta is 2.0 Treasury bills
currently yield 5% and the Nifty index is yielding 9%. The corporate income tax rate for both
firms is 40%. Because Sking Ltd. will longer be maintaining its own production facilities, it
can be assumed that minimal amount of cash will have to be reinvested. This amount is
estimated 1,00,000 per year.
The financial information for Sking Ltd. id as follows:
Revenue ₹ 1,25,00,000
EAT ₹ 13,00,000
Depreciation ₹ 6,00,000

(a) Calculate the appropriate discount rate for evaluating the Sking Ltd. acquisition.
(b) Determine the annual cash flow expected by Adonis Ltd. from Sking Ltd. if the
acquisition is made (considering the synergy).
(c) Calculate the value of the acquisition to Adonis Ltd. assuming the benefits
(1) five years, (2) 10 years, and (3) 15 years.
(d) Sking Ltd. has 2,50,000 shares outstanding. Calculate the maximum price should be willing
to pay per share to acquire the firm under the three alternatives as per ©
(e) If Adonis Ltd is willing to assume the benefits of Sking Limited will last indefinitely
without growth, what should it be willing to pay per share.
(f) Assume that the cash flow the Sking Ltd. acquisition grows at 10% from its initial value for
three year and then grows at 5% indefinitely thereafter. Calculate the value of the firm and the
implied stock price under these conditions. What price premium is implied in rupees if Sking
Ltd. stock is current selling at ₹ 62 ?

15
CA.CS.CMA.MBA: Naveen. Rohatgi Corporate Valuation

16