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    Corporate Finance

    Uploaded by

    jayesh jha
    The document discusses the calculation of weighted average cost of capital (WACC) for a company. It provides the formula for WACC and explains how to calculate each component: market value of equity using share price and shares outstanding, market value of debt using values of debentures and bank loans, cost of equity using the capital asset pricing model, cost of debt using interest rates on debentures and bank loans, tax rate using the corporate tax rate. It then calculates the WACC for the example company as 8.39% based on the values provided.

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    © All Rights Reserved
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    Corporate Finance

    Uploaded by

    jayesh jha
    21 views6 pages
    The document discusses the calculation of weighted average cost of capital (WACC) for a company. It provides the formula for WACC and explains how to calculate each component: market value of equity using share price and shares outstanding, market value of debt using values of debentures and bank loans, cost of equity using the capital asset pricing model, cost of debt using interest rates on debentures and bank loans, tax rate using the corporate tax rate. It then calculates the WACC for the example company as 8.39% based on the values provided.

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    CORPORATE FINANCE

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    The document discusses the calculation of weighted average cost of capital (WACC) for a company. It provides the formula for WACC and explains how to calculate each component: market value of equity using share price and shares outstanding, market value of debt using values of debentures and bank loans, cost of equity using the capital asset pricing model, cost of debt using interest rates on debentures and bank loans, tax rate using the corporate tax rate. It then calculates the WACC for the example company as 8.39% based on the values provided.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    21 views6 pages

    Corporate Finance

    Uploaded by

    jayesh jha
    The document discusses the calculation of weighted average cost of capital (WACC) for a company. It provides the formula for WACC and explains how to calculate each component: market value of equity using share price and shares outstanding, market value of debt using values of debentures and bank loans, cost of equity using the capital asset pricing model, cost of debt using interest rates on debentures and bank loans, tax rate using the corporate tax rate. It then calculates the WACC for the example company as 8.39% based on the values provided.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 6

    CORPORATE FINANCE

    1. Understanding and Usage of the formula: As we know, both the market


    value of equity and market capitalization are determined by multiplying the
    total number of outstanding shares by the current share price. Next would be
    to calculate the market value of debt as we have debentures and bank loans
    provided. We will then be using the Capital Asset Pricing Model (CAPM) to
    find the cost of equity. Then we would calculate the cost of debt, followed by
    the tax rate assumption. Once we have all these calculated, we can determine
    WACC for M/s Antara Limited by using the below formula.

    WACC = (E/V) * Ke + (D/V) * Kd * (1 - T)


    where:
    - E/V is the weight of equity in the company's capital structure
    - D/V is the weight of debt in the company's capital structure
    - The weighted average cost of capital (WACC), which includes ordinary
    stock, preferred stock, bonds, and other types of debt, is the average after-
    tax cost of capital for a company. WACC is the typical interest rate that a
    business anticipates paying to finance its assets.

    Procedure/Steps:

    Market value of equity = share price * number of shares outstanding

    Current shares price (price at year-end) = Rs. 55


    Number of shares outstanding = Book value of share capital + retained
    earnings
    Market value of equity = Rs. 55 * Rs.50,00,000 = Rs. 27,50,00,000

    Market value of debt = Debentures + Bank loan

    Market value of debt = Rs. 15,00,000 + Rs. 2,00,000 =Rs. 17,00,000

    Cost of equity (Ke)


    The Capital Asset Pricing Model (CAPM) may be used to estimate it as
    follows:

    Ke = Rf + β (Rm - Rf)
    where:
    - Rf is the risk-free rate of return
    - β is the beta of the company's stock
    - Rm is the market return
    The rate of return on government securities, which is now 4%, can be taken
    into consideration as the risk-free rate of return in this scenario. The
    company's stock has a beta of 0.6. A wide market index, like the Sensex, can
    be seen as representative of the market return. Over the previous ten years,
    the Sensex has returned an average of 12% annually.

    Therefore, the cost of equity can be calculated as follows:

    Ke = 4% + 0.6(12% - 4%) = 8.8%

    Cost of debt (Kd)

    The cost of debt is the interest rate that the company pays on its debt. In this
    case, the cost of debt is 8% for the debentures and the interest rate on the
    bank loan is not specified. However, we can assume that the interest rate on
    the bank loan is 10%, which is the current prime lending rate in India.
    Therefore, the weighted average cost of debt can be calculated as follows:

    Kd = (1500000/1700000) * 8% + (200000/1700000) * 10% = 8.21%

    Tax rate (T)


    The tax rate is the percentage of profits that the company pays in taxes. In
    this case, we will assume that the tax rate is 30% as per current corporate
    taxes in India.

    WACC (Weighted Average Capital Cost)

    Now that we have all of the necessary information, we can calculate the
    WACC for M/s Antara Limited:

    The weight of equity and debt can be calculated as follows:


    E/V = E / (E + D) = 27500000 / (27500000 + 1700000) = 91.67%
    D/V = D / (E + D) = 1700000 / (27500000 + 1700000) = 5.83%

    Therefore, the WACC can be calculated as follows:


    WACC = (91.67% * 8.8%) + (5.83% * 8.21% * (1 - 0.3)) = 8.39 %

    Correct Answer/Interpretation: The WACC for M/s Antara Limited is 8.39 %.


    WACC is a crucial tool in valuing the business. Investors can figure out the
    present value of the company's future cash flows by computing the WACC.
    This is crucial for potential investors in the firm since it enables them to
    assess whether the company is cheap or overvalued.
    2. Understanding and Usage of the formula: The fundamental distinction
    between the phrases gross operating cycle and net operating cycle is that the
    former gives a more thorough examination of the entire process of turning
    purchased raw materials into sales, while the latter refers to the difference
    between paying for inventory and receiving payment. In order to calculate the
    Gross Operating Cycle and Net Operating Cycle for Vishal & Co. Ltd., we
    need to use the following formulas:

    Gross Operating Cycle (GOC) = Average Inventory Holding Period +


    Average Receivables Collection Period

    Net Operating Cycle (NOC) = Gross Operating Cycle - Average Payables


    Deferral Period

    Procedure/Steps:

    Now we shall compute the various components:

    Average Inventory = (Opening Raw Material + Closing Raw Material +


    Opening WIP + Closing WIP + Opening Finished Goods + Closing Finished
    Goods) / 2

    Average Receivables = (Opening Debtors + Closing Debtors) / 2

    Average Payables = (Opening Creditors + Closing Creditors) / 2

    Average Inventory Holding Period = (Average Inventory / Annual Cost of


    Goods Sold) x 360

    Average Inventory
    = (200,000 + 300,000 + 60,000 + 65,000 + 600,000 + 725,000) / 2
    = (1,950,000) / 2
    = 975,000

    Average Inventory Holding Period


    = (975,000 / (3,200,000 + 550,000)) x 360
    = (975,000 / 3,750,000) x 360
    = 97.5 days

    Average Receivables Collection Period = (Average Receivables / Annual


    Sales) x 360

    Average Receivables
    = (250,000 + 215,000) / 2
    = 465,000 / 2
    = 232,500
    Average Receivables Collection Period
    = (232,500 / 4,480,000) x 360
    =18.75 days

    Average Payables Deferral Period = (Average Payables / Annual Cost of


    Goods Sold) x 360

    Average Payables
    = (550,000 + 575,000) / 2
    = 1,125,000 / 2
    = 562,500

    Average Payables Deferral Period


    = (562,500 / (3,200,000 + 550,000)) x 360
    = (562,500 / 3,750,000) x 360
    = 64.8 days

    Now, calculate the Gross Operating Cycle (GOC):

    GOC = Average Inventory Holding Period + Average Receivables Collection


    Period
    GOC = 97.5 days + 18.75 days
    GOC = 116.25 days

    Finally, calculate the Net Operating Cycle (NOC):

    NOC = GOC - Average Payables Deferral Period


    NOC = 116.25 days - 64.8 days
    NOC = 51.45 days

    Correct Answer/Interpretation: So, the Gross Operating Cycle for Vishal &
    Co. Ltd. is approximately 116.25 days, and the Net Operating Cycle is
    approximately 51.45 days.

    3.

    A. Understanding and Usage of the formula: A stream of monetary flow


    is an annuity. A perpetuity is a kind of annuity that is perpetual, lasting
    eternally. An unlimited period of time passes while the stream of cash
    flows continuously. In order to determine the present value of a
    company's cash flows when discounted back at a specific rate, one
    utilizes the perpetuity calculation in valuation approaches.

    PV = A/I

    - Where:

    - PV, is the amount to be invested.

    - A, is the annual return.

    - I, is the interest rate.

    Procedure/Steps: Let's calculate as per the data given:

    i) To receive Rs. 2,00,000 per annum in perpetuity at an interest rate of


    8%:

    A = 2,00,000

    I = 8%

    Then, PV= A/I= 2,00,000/0.08= 25,00,000

    So, the amount to be invested is Rs. 25,00,000.

    ii) if a growth rate of 3% is expected every year to receive Rs 4,00,000 per


    annum in perpetuity at an interest rate of 5%, as per the Gordon Growth
    Model the formula we would use for our calculation would be
    A
    PV =
    I−b
    b stands for growth rate

    so, PV = 4,00,000/ (0.05-0.03) = 2,00,00,000

    Correct Answer/Interpretation:

    i. To receive Rs. 2,00,000 per annum in perpetuity at an interest rate


    of 8%, the amount should be Rs. 25,00,000.

    ii. if a growth rate of 3% is expected every year to receive Rs 4,00,000


    per annum in perpetuity at an interest rate of 5%, the amount
    invested should be Rs. 2,00,00,000
    B. Understanding and Usage of the formula: The acid-test ratio and the
    current ratio, commonly referred to as the working capital ratio, both
    gauge a company's capacity to earn enough cash in the short term to
    pay off all obligations should they fall due at once. The acid-test ratio,
    however, is seen as being more cautious than the current ratio since its
    computation disregards things like inventories, which could be
    challenging to swiftly unload.

    Procedure/steps:

    - Current Assets = Debtors + Cash and Bank + inventory

    Current Assets = 5,00,000 + 2,00,000 + 4,00,000 = 11,00,000

    - Current Liabilities = Trade Payables + Bank OD

    Current Liabilities = 1,50,000 + 50,000 = 2,00,000

    Current ratio = Current Assets / Current Liabilities

    Current ratio = 11,00,000 /2,00,000 = 5.5

    Acid -Test Ratio = (Cash and Bank + Debtors) / Current Liabilities

    Acid -Test Ratio = (5,00,000+2,00,000) / 2,00,000 = 3.5

    Correct Answer/Interpretation:
    Current Ratio = 5.5, the higher the current ratio, the better debt-paying
    capacity is for the company, and the balance sheet is strong.
    Acid Test ratio = 3.5, the stronger the ratio, the more liquid the firm is and
    the healthier its overall finances are. If the ratio is 3.5, it means that the
    company's liquid assets are Rs.3.5 more than its current liabilities.

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