Strategic Financial Management

St. Joseph’s College of Commerce (Autonomous)

 

End Semester Examination – April 2011

M.Com – IV Semester

Strategic Financial Management

 

Duration: 3 Hours                                                                                   Max. Marks: 100

 

Section – A

 

I)Answer TEN questions.  Each carries 2 marks.                                            (10×2=20)

 

• What is a Strategy?
• What is the meaning of Cost of Capital?
• What is Demerger?
• What is Ethical Brand Equity?
• What is the meaning of Acquisition?
• What is role of Executive Compensation under value Based Management?
• What is the main objective of BCG Approach?
• What is the meaning of Enterprise Governance?
• What is the meaning of Indexed Stock options?
• Differentiate between EPS & EBIT?
• What is the importance of Market to Book Ratio?
• Explain the acronym CFROI.

 

Section – B

 

II)Answer any FOUR questions.  Each carries 5 marks.                            (4×5=20)

 

• Write a short note on Balanced Score Card.
• Differentiate between MVA & EVA.
• Explain the areas of Value thinking with reference to Mckinsey Approach.
• What are the features of Strategic Financial Management?
• What are the kinds of takeover?
• What are the Ethical Dilemmas faced by a Strategic Financial Manager?

 

Section – C

 

III) Answer any THREE questions.  Each carries 15 marks.                      (3×15=45)

 

• Briefly explain the interface of financial policy & strategic policy.
• Explain the Concept involved in EBITDA.
• What are the different approaches in calculation of Corporate Approach?
• What are the factors affecting Dividend Policy?
• What are the strategies used against anti-take over bids.

 

 

Section – D

 

1. IV) Compulsory

question –  Case Study                                                            (15 marks)

 

• Mergers and Acquisition – A Case Study and Analysis of HP-Compaq Merger

HP

It all began in the year 1938 when two electrical engineering graduates from Stanford University called William Hewlett and David Packard started their business in a garage in Palo Alto. In a year’s time, the partnership called Hewlett-Packard was made and by the year 1947, HP was incorporated. The company has been prospering ever since as its profits grew from five and half million dollars in 1951 to about 3 billion dollars in 1981. Starting with manufacturing audio oscillators, the company made its first computer in the year 1966 and it was by 1972 that it introduced the concept of personal computing by a calculator first which was further advanced into a personal computer in the year 1980. The company is also known for the laser-printer which it introduced in the year 1985.

 

Compaq

The company is better known as Compaq Computer Corporation. This was company that started itself as a personal computer company in the year 1982. It had the charm of being called the largest manufacturers of personal computing devices worldwide. The company was formed by two senior managers at Texas Instruments. The name of the company had come from-“Compatibility and Quality”. The company introduced its first computer in the year 1983 after at a price of 2995 dollars. In spite of being portable, the problem with the computer was that it seemed to be a suitcase. Nevertheless, there were huge commercial benefits from the computer as it sold more than 53,000 units in the first year with a revenue generation of 111 million dollars.

 

Reasons for the Merger

 

Carly Fiorina, who became the CEO of HP in the year 1999, had a key role to play in the merger that took place in 2001. She was the first woman to have taken over as CEO of such a big company and the first outsider too. She worked very efficiently as she travelled more than 250,000 miles in the first year as a CEO. Her basic aim was to modernize the culture of operation of HP. She laid great emphasis on the profitable sides of the business. This shows that she was very extravagant in her approach as a CEO. In spite of the growth in the market value of HP’s share from 54.43 to 74.48 dollars, the company was still inefficient. This was because it could not meet the targets due to a failure of both company and industry. HP was forced to cut down on jobs and also be eluded from the privilege of having Price Water House Cooper’s to take care of its audit. So, even the job of Fiorina was under threat. This meant that improvement in the internal strategies of the company was not going to be sufficient for the company’s success. Ultimately, the company had to certainly plan out something different. So, it

 

was decided that the company would be acquiring Compaq in a stock transaction whose net worth was 25 billion dollars. Initially, this merger was not planned. It started with a telephonic conversation between CEO HP, Fiorina and Chairman and CEO Compaq, Capellas. The idea behind the conversation was to discuss on a licensing agreement but it continued as a discussion on competitive strategy and finally a merger. It took two months for further studies and by September, 2001, the boards of the two companies approved of the merger. In spite of the decision coming from the CEO of HP, the merger was strongly opposed in the company. The two CEOs believed that the only way to fight the growing competition in terms of prices was to have a merger. But the investors and the other stakeholders thought that the company would never be able to have the loyalty of the Compaq customers, if products are sold with an HP logo on it. Other than this, there were questions on the synchronization of the organization’s members with each other. This was because of the change in the organization culture as well. Even though these were supposed to serious problems with respect to the merger, the CEO of HP, Fiorina justified the same with the fact that the merger would remove one serious competitor in the over-supplied PC market of those days. She said that the market share of the company is bound to increase with the merger and also the working unit would double.

 

Question:

 

Critically analyse the decision for merger in the above case and put forward your justifications.

 

 

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1
ST. JOSEPH’S COLLEGE OF COMMERCE (AUTONOMOUS)
END SEMESTER EXAMINATIONS – OCTOBER 2013
M.COM – III SEMESTER
STRATEGIC FINANCIAL MANAGEMENT
Duration: 3 hrs Max. Marks: 100
SECTION – A
I) Answer any SEVEN questions. Each question carries 5 marks. (7 x 5 =35)
1) What do you understand by interface of financial policy and strategic
management?
2) “Financial planning is the backbone of the business planning and corporate
planning”. Comment.
3) Explain the importance of the study of SFM in business decision making?
4) “A well conceived incentive compensation plan goes a long way in aligning the
interest of managers and shareholders”. Comment.
5) Explain the five sins of acquisitions
6) Write short answers to the following (One or two sentences):
What is ROIC?
What is Leveraged Buyout?
What is strategic cost management?
What is Demergers?
What is TBR?
7) Explain the key steps involved in using the cash flow approach to valuing a firm.
8) Mahesh International earns a return on equity of 30 percent. Its dividend payout
ratio is 0.35. Equity shareholders of Mahesh require a return of 20 percent. The
book value per share is Rs. 40.
(i) What is the market price per share, according to the Marakon model?
(ii) If the return on equity falls to 25 percent, what should be the payout ratio to ensure
that the market price per share remains unchanged?
9) An equipment costs Rs. 10,00,000 and has an economic life of 4 years, at the end
of which its expected salvage value is Rs. 2,00,000. If the cost of capital is 14
percent, what will be the depreciation schedule under the sinking fund method?
10) ABC Ltd. plans to acquire XYZ Ltd. The relevant financial details of the two
firms, prior to merger announcement, are given below:
ABC Ltd. XYZ Ltd.
Market price per share
Rs. 60 Rs. 25
Number of shares 3,00,000 2,00,000
2
The merger is expected to bring gains which have a present value of Rs. 4 million. Firm
ABC Ltd. offers one share in exchange for every two shares to the shareholders of firm
XYS Ltd.
Required:
(a) What is the true cost acquisition?
(b) What is the present value of the mergers to ABC Ltd. and XYZ Ltd.
SECTION – B
II) Answer any THREE questions. Each carries 15 marks (3 x 15 = 45)
11) Explain in detail some of the specific issues of financial policy of a firm.
12) Explain the strategic aspects of investment and dividend policies of a firm.
13) Explain the plausible and dubious reasons for merger.
14) A new plant entails an investment of Rs. 300 million (250 million in fixed assets
and Rs. 50 million in net working capital). The plant has an economic life of 14
years and is expected to produce a NOPAT of Rs. 21.085 million every year. After
14 years, the net working capital will be realized at par whereas fixed assets will
fetch nothing. The cost of capital for the project is 10%. The straight line method
of depreciation is used.
(a) What will be the ROCE for year 5? Assume that the capital employed is
measured at the beginning of the year.
(b) What will be the ROGI for year 5?
(c) What will be the Economic Depreciation for year 5?
15) The accounts of Joel Ltd. engaged in manufacturing business are summarized
below:
Income statement for the year ended March 31. 2013. (Amount in Rs. Million)
Sales Revenue
Less: Cost of goods sold
General expenses
Administrative expenses
Selling and distribution
expenses
Interest on loan
EBT
Less: Corporate Taxes (35%)
Earnings after taxes
59.10
6.80
7.80
2.90
1.80
95.00
78.40
16.60
5.81
10.79
3
Balance Sheet as at March 31, 2013 (Amount in Rs. Million)
Liabilities Rs. Assets Rs.
Equity share capital(10 Lakh
shares of Rs. 10 each)
Reserves and surplus
10%Loan
Creditors and other liabilities
10.00
31.50
18.00
18.00
Freehold Land and
Buildings(net)
P&M (net)
Current Assets:
Stock
Debtors
Bank and cash balances
20.00
28.50
10.00
15.00
4.00
Total 77.50 Total 77.50
Additional Information:
1. The risk free rate of return in the economy is 8% and the premium expected
from business in general is 5%. The beta of Joel Ltd. shares is currently 1.27.
2. The equity shares of this company quoted in the market as on 31.03.2013 are
Rs. 50 per share.
3. General expenses include R&D expenses of Rs. 0.50 million (For EVA
computation R&D expenses are to be considered as an investment.
Requirements:
(i) Determine the EVA for the year ended March 31, 2013; and
(ii) Determine the amount of MVA for the year ended March 31, 2013
SECTION – D
III) Compulsory question carries ( 20 marks)
ABC Corporation is expected to grow at a higher rate for 4 years; thereafter the growth
rate will fall and stabilize at a lower level. The following information has been
assembled:
Base year (year 0) information
Revenues : Rs. 3000 million
EBIT : Rs. 500 million
Capital expenditure : Rs. 350 million
Depreciation : Rs. 250 million
Working capital as a percentage of revenues : 25%
Corporate tax rate (for all time) : 30%
Paid up equity capital (Rs. 10 par) : Rs. 400 million
Market value of debt : Rs. 1200million
Inputs for the High Growth Period
Length of the high growth phase : 4 years
Growth rate in revenues, depreciation, EBIT and capital expenditure : 20%
4
Working capital as a percentage of revenues : 25%
Cost of debt(pre-tax) : 13%
Debt equity ratio : 1:1
Risk-free rate : 11%
Market risk premium : 7%
Equity beta : 1.129
Inputs for the stable growth period
Expected growth rate in revenues and EBIT : 10%
Capital expenditures are offset by depreciation
Working capital as a percentage of revenues : 25%
Cost of debt : 12.14% (pre-tax)
Risk-free rate : 10%
Debt-equity ratio : 2:3
Market risk premium : 6%
Equity beta : 1.00
Required:
(i) What is the WACC for the high growth phase and the stable growth phase?
(ii) What is the value of the firm?

1. JOSEPH’S COLLEGE OF COMMERCE (AUTONOMOUS)

End Semester Examinations – OCTOBER 2014

m.com – III semester

 STRATEGIC FINANCIAL MANAGEMENT

Duration: 3 Hrs                                                                                                  Max. Marks: 100

Section – A

 

1. Answer any SEVEN Each carries 5 marks.                          (7 x 5  = 35)

 

1. Write a short note on “Functions of Strategic Financial Management”.
2. Write a short note on “Financial Planning”
3. Explain the factors/determinants for determining Dividend Policy?
4. Explain the traditional methods of Valuation.
5. Following information of Zoya Limited is given:

Balance sheet as at 31st March, 2014

Liabilities	Amount (Rs. mn)	Assets	Amount (Rs. mn)
Equity	100	Fixed assets	140
Debt	100	Net current assets	60
	200		200

                  Income statement for the year ending 31st March, 2011

Net sales	300
Cost of goods sold	258
PBIT	42
Interest	12
PBT	30
Tax (30%)	9
PAT	21

Company’s cost of equity is 18%. The interest rate on debt (pre-tax) 12%,  Calculate the Economic Value Added (EVA) of the company.

6. Write short notes on reasons for merger.
7. Give a brief note on Future Growth Value.
8. Explain stock refunding as strategic planning.
9. Explain the process of Shareholder Value Creation.
10.      Write a note on Balanced Score Card.

 

Section – B

 

1. Answer any THREE Each carries 15 marks.                                   (3 x 15   = 45)

11) Explain dividend policies, Employee stock options and Indexed options and Buyback of shares as a value based management.

 

12) Explain five waves of merger and antitakeover strategies and defenses.

 

13) K. Ltd. is considering acquiring N. Ltd., the following information is available:

Company Profit after tax Number of Equity Shares Market value per share

200. Ltd. 50,00,000 10,00,000 200.00
201. Ltd. 15,00,000 2,50,000    160.00

Exchange of equity shares for acquisition is based on current market value as above.

There is no synergy advantage available   Find the earning per share for company K. Ltd. after merger. Find the exchange ratio so that shareholders of N. Ltd. would not be at a loss.

 

14) Write a note on Valuation of Intangible & Knowledge Assets.

 

15) Bring out the implications of Demergers.

 

Section – C

 

• Compulsory Case study.                                                                               ( 20 marks)

16.

1. Mr. PRATHEEK established the following spread on the Delta Corporation’s stock :
   1. Purchased one 3-month call option with a premium of Rs.30 and an exercise price of Rs.550.
   2. Purchased one 3-month put option with a premium of Rs.5 and an exercise price ofRs.450.

Delta Corporation’s stock is currently selling at Rs.500. Determine profit or loss, if the price of Delta Corporation’s:

1. Remains at Rs.500 after 3 months.
2. Falls at Rs.350 after 3 months.
3. Rises to Rs.600.Assume the size option is 100 shares of Delta Corporation.

 

2014. XL  Ispat Ltd. has made an issue of 14 per cent non-convertible debentures on January 1, 2014. These debentures have a face value of Rs.100 and is currently traded in the market at a price of Rs.90.Interest on these NCDs will be paid through post-dated cheques dated June 30 and December 31. Interest payments for the first 3 years will be paid in advance through post-dated cheques while for the last 2 years post-dated cheques will be issued at the third year. The bond is redeemable at par on December 31, 2011 at the end of 5 years.

Required:

1. Estimate the current yield at the YTM of the bond.
2. Calculate the duration of the NCD.
3. Assuming that intermediate coupon payments are, not available for reinvestment calculate the realized yield on the NCD.

(10+10)

 

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SCHEME

m.coM- III  semester

SUB: STRATEGIC FINANCIAL MANAGEMENT

Duration: 3 Hrs                                                                                Max. Marks: 100

 

 

Section – A

 

 

 

1. Strategic Financial Management is the portfolio constituent of the corporate strategic plan-that embraces the optimum investment and financing decisions required to attain the overall specified objectives. In this connection, it is necessary to distinguish between strategic, tactical and operational financial planning. While strategy is a long-term course of action, tactics are intermediate plan, while operational are short-term functions. Senior management decides strategy, middle levels decides tactics and operational are looked after line management. Irrespective of the time horizon, the investment and financial decisions functions involve the following functions

– Continual search for best investment opportunities

– Selection of the best profitable opportunities

– Determination of optimal mix of funds for the opportunities

– Establishment of systems for internal controls

– Analysis of results for future decision-making.

 

2. Financial planning is the backbone of the business planning and corporate planning. It helps in defining the feasible area of operation for all types of activities and thereby defines the overall planning framework. Financial planning is a systematic approach whereby the financial planner helps the customer to maximize his existing financial resources by utilizing financial tools to achieve his financial goals. Financial planning is simple mathematics. There are 3 major components:

Financial Resources (FR)

Financial Tools (FT)

Financial Goals (FG)

Financial Planning: FR + FT = FG

 

3. The factors are

Legal Considerations

Stability of Earnings

Opportunities for Reinvestment and Growth:

Cash flow

Level of Inflation in the Economy

Effect on Market Prices

Tax Considerations

4. EPS, RDI, EBIT, ROCE etc.
5. EVA is computed as:

NOPAT = PBIT (1-t) = 42 (1-0.30) = 29.4

Post tax cost of debt = 0.12 (1-0.30) = 0.084

WACC = (0.5 x 0.18) + (0.5 x 0.084) = 0.132

ROC = NOPAT / CAPITAL = 29.4/200 = 0.147

1) EVA = NOPAT – (WACC x CAPITAL)

= 29.4 – (0.132 x 200)   = Rs. 3 million

2) EVA = (ROC – WACC) x CAPITAL

= (0.147 – 0.132) x 200 = Rs. 3 million

3) EVA = [PAT + INT (1-t)] – WACC x CAPITAL

= 21+ 12 (1-0.30)] – 0.132 x 200 = Rs. 3 million

4) EVA = PAT – (kE   x EQUITY)

= 21 – (0.18 x 100) = Rs. 3 million

6. Tax advantages, Increases liquidity for owners, Gaining access to funds, Growth, Diversification, Related diversification, Synergistic benefits, Protection against a hostile takeover, Acquisition of required managerial skills, assets or technology.
7. A social unit of people that is structured and managed to meet a need or to pursue collective goals is called an “Organization”. Organizational Structure consists of activities such as task allocation, coordination and supervision, which are directed towards the achievement of organizational goals. A business organization makes changes in personnel and departments and change how workers and departments report to one another to meet market conditions. • Some companies shift organizational structure to expand to serve growing markets & other companies reorganize downsize or eliminate departments to conserve overhead.
8. A bond that retires another bond before the first bond matures. A company may issue a refunding bond for a number of reasons, butmainly because of a decline in interestrates, which reduces the cost of funding. Refunding bonds deprive bondholders of the firstbond from future coupon payments to which they would otherwise of have been entitled. Most bonds are nonrefundable.
9. Shareholder Value is driven by Long-term Free Cash Flows Shareholder Value is created when Long-term Returns, Cost of Capital and vice versa Stock price => market’s interpretation of value Stocks could be undervalued or overvalued. Profitability, Capital Efficiency, Growth, Real Options, Cost of Capital.
10. Most companies have a performance measurement system that includes financial measures as well as non financial measures. The balanced scorecard approach pioneered by Robert Kaplan, David Norton and others to develop an integrated performance measurement system, The balanced scorecard is a strategy driven.The balanced scorecard covers four important perspectives in a business. They are:Financial, Customers, Internal business, Innovation & Learning. The balanced scorecard represents a linked a series of objectives and measures.
11. A privilege, sold by one party to another, that gives the buyer the right, but not the obligation, to buy (call) or sell (put) a stock at an agreed-upon price within a certain period or on a specific date.
12. There are two main categories of buyers of companies: strategic buyers and financial buyers. Strategic buyers are corporations who want to acquire another company for strategic business reasons. Financial buyers are buyers who want to acquire another company purely as a financial investment. Financial buyers are typically LBO (Leveraged Buyout) Funds or other private equity funds.
13. Earning per share for company K. Ltd. after Merger : Exchange Ratio 160 : 200 = 4: 5 That is 4 shares of K. Ltd. for every 5 shares of N. Ltd.

Total number of shares to be issued = 4/5 × 2,50,000 = 2,00,000 shares

 Total number of shares of K. Ltd. and N .Ltd.= 10,00,000 K. Ltd.+ 2,00,000 N. Ltd 12,00,000

Total profit after Tax = Rs. 50,00,000 K. Ltd. Rs. 15,00,000 N Ltd. Rs. 65,00,000

 E.P.S. (Earning per share) of K. Ltd. after Merger = Rs.12,00,000/65,00,000 = Rs.5.42 Per Share

 

To find the Exchange Ratio so that shareholders of N. Ltd. would not be at a Loss:

Present Earnings per share for company K. Ltd.= Rs.5.00 Rs.10,00,000  Rs.50,00,000

Present Earnings Per share for company N. Ltd.= Rs.6.00 Rs.2,50,000   Rs.15,00,000

Exchange Ratio should be 6 shares of K. Ltd. for every 5 shares of N Ltd.

Shares to be issued to N. Ltd.= 2,50,0006/5 = 3,00,000 Shares

Total No. of Shares of K.Ltd. and N. Ltd.= 10,00,000 K. Ltd. + 3,00,000 N. Ltd =13,00,000

E.P.S. After Merger 13,00,000/65,00,000 = Rs.5.00 Per Share

Total Earnings Available to Shareholders of N. Ltd. after Merger = Rs.3,00,000 × Rs.5.00 = Rs.15,00,000

This is equal to Earnings prior Merger for N. Ltd.

 Exchange Ratio on the Basis of Earnings per Share is recommended.

 

 

14. Despite the relatively high value of knowledge, determining a precise figure for the value of knowledge has proven very difficult. One of the reasons that precise measures for the value of knowledge are in short supply is that knowledge, being an intangible, is often lumped in with other intangibles in valuation approaches. Another problem stems from not being able to distinguish between the effects of different knowledge assets.1. Determine an estimate of annual earnings. This can be, for example, an average of the past three years 2. Determine the expected earnings from tangible capital 3. Determine the expected earnings from intangibles. This is arrived at by subtracting earnings due to tangible capital from total earnings.4. Discount the figure in Step 3 to arrive at the present value of intangible capital.
15. A demerger is a form of corporate restructuring in which the entity’s business operations are segregated into one or more components.[1] It is the converse of a merger or acquisition. A demerger can take place through a spin-off by distributed or transferring the shares in a subsidiary holding the business to company shareholders carrying out the demerger. The demerger can also occur by transferring the relevant business to a new company or business to which then that company’s shareholders are issued shares of. In contrast, divestment can also “undo” a merger or acquisition, but the assets are sold off rather than retained under a renamed corporate entity. Demergers can be undertaken for various business and non-business reasons, such as government intervention, by way of anti-trust law, or through decartelization.
16. Solution
    1. Total premium paid on purchasing a call and put option

= (Rs.30 per share × 100) + (Rs.5 per share × 100).

= 3,000 + 500 = Rs.3,500

In this case, X exercises neither the call option nor the put optionas both will result in a loss for him.

Ending value = – Rs.3,500 + zero gain= – Rs.3,500

i.e Net loss = Rs.3,500

 

Since the price of the stock is below the exercise price of the call, the call will not be exercised. Only put is valuable and is exercised.

Total premium paid = Rs.3,500

Ending value = – Rs.3,500 + Rs.[(450 – 350) × 100]

= – Rs.3,500 + Rs.10,000 = Rs.6,500

Net gain = Rs.6,500

 

In this situation, the put is worthless, since the price of the stock exceeds the put’s exercise price. Only call option is valuable and is exercised.

Total premium paid = Rs.3,500

Ending value = -3,500 +[(600 – 550) × 100]

Net Gain = -3,500 + 5,000 = Rs.1,500

 

1. Current yield =14/90 = 0.1555 or 15.55%

YTM can be determined from the following equation

14 × PVIFA (YTM, 5) + 100 × PVIF (YTM, 5) = 90

YTM = 17.14%

The duration can be calculated as follows:

 

 

 

Year	CashFlow	PV at 17.14%	Proportion of NCD value	Proportion of NCDvalue × time
1	14	11.952	0.1328	0.1328
2	14	10.203	0.1134	0.2268
3	14	8.710	0.0968	0.2904
4	14	7.435	0.826	0.3304
5	114	51685	0.5744	2.8720
		89.985		3.8524

 

Duration = 3.8524 years.

Realized Yield can be calculated as follows:

90

(1 R)

(14 * 5) + 100/(1+R)⁵   = 90

(1+R)⁵ =170/90

R= 0.1356 or 13.56%