Answer to MTP_Final_Syllabus 2016_Jun 2020_Set 1

Paper 20 - Strategic Performance Management & Business

Valuation

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 Answer to MTP_Final_Syllabus 2016_Jun 2020_Set 1

Paper 20 - Strategic Performance Management & Business Valuation

Full Marks: 100 Time allowed: 3 hours

The figures in the margin on the right side indicate full marks.
Working notes should form part of the answer.

Section - A

Answer Question No. 1 which is compulsory and any two from the rest of this section

1. Multiple choice questions: [5×2=10]

[1 mark for right choice and 1 mark for justification]
(i) The components of supply chain management are:
(A) Plan, source, make, deliver & return
(B) Plan, system, make, deliver & return
(C) Plan, source, supply & return
(D) Plan, source, make, deliver & warranty

(ii) The prices which are fixed and enforced by the Government and regulatory in nature,
is called:
(A) Dual Pricing
(B) Administered Pricing
(C) Shadow Pricing
(D) Multiple Product Pricing.

(iii) Which of the following is not a type of an OLAP system?

(A) ROLAP
(B) MOLAP
(C) RTOLAP
(D) ZTOLAP

(iv) J Ltd. is operating in a perfectly competitive market. The price elasticity of demand
and supply of the product estimated to be 3 and 2 respectively. The equilibrium price
of the product is Rs. 100. If the government imposes a specific tax of Rs.10 per unit,
what will be the new equilibrium price?
(A) Rs. 110
(B) Rs. 44
(C) Rs. 104
(D) Rs. 106

(v) Performance is a product of:

(A) Efficiency and Utilization
(B) Utilization and Productivity
(C) Efficiency and Productivity
(D) Efficiency, Utilization and Productivity.

Answer:
(i) (A) The five basic components of supply chain management are — plan, source, make,
deliver & return.

(ii) (B) Administered prices are the prices which are fixed and enforced by the Government.
The term administered prices was introduced by Keynes. These prices are regulatory in
nature.

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 Answer to MTP_Final_Syllabus 2016_Jun 2020_Set 1

(iii) (D) Except ZTOLAP, all other options like ROLAP (Relational OLAP), MOLAP
(Multidimensional OLAP), RTOLAP (Real-time OLAP) are the types of OLAP system.

(iv) (C) Distribution of tax burden between buyers and sellers is in ratio of elasticity of supply to elasticity
of demand.

Thus tax burden borne by the buyer = Rs. 10 × 2/5 = Rs. 4.

If the tax burden borne by buyer is Rs. 4, new equilibrium price will be Rs. (100 + 4) = Rs. 104.

(v) (D) Performance is a product of efficiency, utilization & productivity, since this option fully
covers all aspects of Performance.

2.(a) What is Performance Management? “Performance management and performance

appraisal are sometimes used synonymously but they are different”. Do you agree this
statement? Support your answer by highlighting bases of difference, if any, between
them. [2+8=10]

(b) State how six sigma methodology works through the use of its two sub methodologies:
DMAIC and DMADV. “Benchmarking is a powerful management tool because it
overcomes paradigm blindness” — Justify the statement. [5+5=10]

Answer:
(a) Performance management focuses mainly on the achievement of results. It differentiates
the aspects, such as being engaged and producing results- which means, being busy
should not necessarily be indicating that the results are being produced. There may be
times when employees seem to be very busy but in terms of their performance, the results
are in contrast to what has been expected. Systematic performance appraisal provides
much assistance in assessing the potentials of the employees. Thus, performance
management directs and leads the business to the overall achievement with the
assessment of employees’ effectiveness by the implementation of performance
appraisals at regular intervals.

The statement performance management and performance appraisal are sometimes

synonymously but they are different, is correct. Performance management is a
comprehensive, continuous and flexible approach to the management of organizations,
teams and individuals which involves the maximum amount of dialogue between those
concerned. Performance appraisal is a more limited approach which involves managers
making top-down assessments and rating the performance of their subordinates at an
annual performance appraisal meeting. Following few major differences can be
identified between these two:

Performance Appraisal Performance Management

It concerns with top-down assessment. It concerns with joint process through
dialogue.
Annual appraisal meeting is held. Continuous review with one or more
formal reviews, it is not an annual process.
It is monolithic system. It is flexible process.
It focuses on quantified objectives. It focuses on values and behaviors as well
as objectives.
Complex paperwork is needed - Documentation kept to a minimum -

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 Answer to MTP_Final_Syllabus 2016_Jun 2020_Set 1

bureaucratic approach managerial approach

It is owned by the Human Resource It is owned by line managers.
department.
Involves use of Ratings. Use of ratings less common.
Structured system, not open to change. Flexible system.
It is a part of Performance Management. It includes performance Appraisal, but
goes beyond.

(b) Six Sigma at many organizations simply means a measure of quality that strives for near
perfection. Six Sigma is a disciplined, data-driven approach and methodology for
eliminating defects (driving toward six standard deviations between the mean and the
nearest specification limit) in any process – from manufacturing to transactional and from
product to service.

The statistical representation of Six Sigma describes quantitatively how a process is

performing. To achieve Six Sigma, a process must not produce more than 3.4 defects per
million opportunities. A Six Sigma defect is defined as anything outside of customer
specifications. A Six Sigma opportunity is then the total quantity of chances for a defect.

The fundamental objective of the Six Sigma methodology is the implementation of a

measurement based strategy that focuses on process improvement and variation
reduction through the application of Six Sigma improvement projects. This is
accomplished through the use of two Six Sigma sub methodologies: DMAIC and DMADV.
The Six Sigma DMAIC process (define, measure, analyze, improve, control) is an
improvement system for existing processes falling below specification and looking for
incremental improvement. The Six Sigma DMADV process (define, measure, analyze,
design, verify) is an improvement system used to develop new processes or products at
Six Sigma quality levels. It can also be employed if a current process requires more than
just incremental improvement.

“Benchmarking is a powerful management tool because it overcomes paradigm

blindness”. Paradigm Blindness can be summed up as the mode of thinking, “the way we
do it is the best because this is the way we’ve always done it”. Benchmarking opens
organizations to new methods, ideas and tools to improve their effectiveness. It helps
crack through resistance to change by demonstrating other methods of solving problems
than the one currently employed and demonstrating that they work, because they are
being used by others. The steps are as follows:
1. Identify your problem areas.
2. Identify other industries that have similar processes.
3. Identify organizations that are leaders in these areas.
4. Survey companies for measures and practices
5. Visit the “best practice” companies to identify leading edge practices.
6. Implement new and improved business practices.

3.(a) The Demand function is x = 100 + 4p + 10p², where x is demand for the commodity at
price ‘p’. Compute marginal quantity of demand, average quantity of demand and
hence elasticity of demand, at p = 4. [8]

(b)(i) Write about the causes of sickness of a project.

(ii) Using Altman’s Multiple Discriminant Function, calculate Z-score of S & Co. Ltd., where
the five accounting ratios are as follows and comment about its financial position:

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 Answer to MTP_Final_Syllabus 2016_Jun 2020_Set 1

Working Capital to Total Assets = 0.350

Retained Earnings to Total Assets = 50%
EBIT to Total Assets = 19%
Book Value of Equity to Book Value of Total Debt = 1.65
Sales to Total Assets = 2 times. [5+7=12]

Answer:
(a) x = 100 + 4p + 10p2
dx
Marginal quantity of demand =
dq
dx
= 4 + 20p --------------- (1)
dq

x 100
Average quantity of demand = = + 4 +10p -------------------- (2)
p p

dx x 4 + 20p (4 + 20p)p
Ep = × = =
dq p 100 2
+10p + 4 100 +10p + 4p
p
At p = 4,

Elasticity of demand =
( 4 + 80 ) 4 =
28
= 1.22
100 +160 +16 23

(b)(i) “Prevention is better than cure’ is the proverb that reflects the need for knowing the
likely causes of industrial sickness so that one can plan to avoid the same, Just as
human beings fall sick by two ways, viz.. either born sick or acquiring sickness during
growth, an industry can either run into trouble even during the implementation stage
itself or develop sickness during its lifetime.

The causes of sickness can be categorized into two viz., internal causes and external
causes. Internal causes are those that are internal to the organization over which the
management of the organization has control. Sickness due to internal causes can be
avoided if the management is shrewd enough to identify the causes and eliminate
them at their initial stage itself. External causes are those that are external to the
organization over which the management of the organization has little control.
Government’s plans and actions, failure of monsoon which affects agriculture and
allied industries, emergence of strong competitors etc. are some of the external factors.
Though sickness may be caused either by internal or external factors, sometimes, the
management may be able to revamp its organization, plan suitable strategies and
take on the external factors to reduce their impact.

The areas/stages in which these causes may exist are as follows:

• Project formulation.
• Project implementation.
• Production.
• Marketing.
• Finance.
• General and personnel administration.

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(ii) As the Book Value of Equity to Book Value of Total Debt is given in the problem in place
of Market Value of Equity to Book Value of Total Debt, the value of Z-score is to be
computed as per Altman’s 1983 Model of Corporate Distress Prediction instead of
Altman’s 1968 Model of Corporate Distress Prediction that we followed earlier.
As per Altman’s Model (1983) of Corporate Distress Prediction,
Z = 0.717X1 + 0.847X2 + 3.107X3 + 0.420X4 + 0.998X5
Here, the five variables are as follows:
X1 = Working Capital to Total Assets = 0.350
X2 = Retained Earnings to Total Assets = 0.50
X3 = EBIT to Total Assets = 0.19
X4 = Book Value of Equity Shares to Book Value of Total Debt = 1.65
X5 = Sales to Total Assets = 2 times
Hence, Z-score = (0.717 x 0.35) + (0.847 x 0.50) + (3.107 x 0.19) + (0.420 x 1.65) + (0.998 x
2)
= 0.25095 + 0.4235 + 0.59033 + 0.693 + 1.996 = 3.95
Note: As the calculated value of Z-score is much higher than 2.9, it can be strongly
predicted that the company is a non-bankrupt company (i.e., non-failed company).

4.(a) What are Key Risk Indicators in the process of Risk Mapping? State the benefits of Risk
Mapping. [5+5=10]
(b) Describe the accounting techniques of financial performance analysis. State the
significance of financial performance analysis. [6+4=10]

Answer:
(a) Key Risk Indicators in the process of Risk Mapping Key risk indicators come out as the result
of the mapping process and should be used to provide anticipatory signals that can be
useful for both operational risk prevention and measurement. In particular, they should
provide early warning signals to anticipate the most critical operational events, and they
may also be partly derived from the experience of audit departments defining potential
risk scores for different business units as a tool for defining priorities in their audit action
plan.

A manufacturing enterprise may assess risks of operational losses by reviewing its

competitiveness in regard to technology adopted, competitors’ strengths, etc. Key
indicators should build up early signals of deficiencies through information system
interfacing between enterprise’s changing environment and its adaptive organization.
Such indicators may include the following:
• Market performance, customers’ feedback/complaints & competitors’ performance
• Orders-in-hand and inventory
• Input-output performance
• Cycle-times (e.g. work cycle times of different activities in value-chain, order-to-
delivery cycles in purchases & sales, etc.)
• Suppliers’ performance (in terms of delivery & quality compliance)
• Plant utilization (% usage of different machineries)
• Cost per unit of product/ service.
• Financial ratios (ROI, product profitability, capital turnover rate, liquidity ratio, debt-
equity ratio, etc).

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Benefits of Risk Mapping:

• Promotes awareness of significant risks through priority ranking, facilitating the
efficient planning of resources.
• Enables the delivery of solutions and services across the entire risk management value
chain.
• Serves as a powerful aid to strategic business planning.
• Aids the development of an action plan for the effective management of significant
risks.
• Assigns clear responsibilities to individuals for the management of particular risk areas.
• Provides an opportunity to leverage risk management as a competitive advantage.
• Facilitates the development of a strategic approach to insurance programme
design.
• Supports the design of the client’s risk financing and insurance programmes, through
the development of effective/optimal retention levels and scope of coverage etc.

(b) Accounting techniques of financial performance analysis: Various accounting

techniques such as Comparative Financial Analysis, Common-size Financial Analysis,
Trend Analysis, Fund Flow Analysis, Cash Flow Analysis, CVP Analysis, Ratio Analysis,
Value Added Analysis etc. may be used for the purpose of financial analysis. Some of
the important techniques which are suitable for the financial analysis are discussed
hereunder:

• Ratio Analysis: In order to evaluate financial condition and performance of a firm, the
financial analyst needs certain tools to be applied on various financial aspects. One
of the widely used and powerful tools is ratio or index. Ratios express the numerical
relationship between two or more things. This relationship can be expressed as
percentages (say, 25% of revenue), fraction (one-fourth of revenue), or proportion of
numbers (1:4). Accounting ratios are used to describe significant relationships, which
exist between figures shown on a balance sheet, in a profit and loss account, in a
budgetary control system or in any other part of the accounting organization. Ratio
analysis plays an important role in determining the financial strengths and weaknesses
of a company relative to that of other companies in the same industry. The analysis
also reveals whether the company’s financial position has been improving or
deteriorating over time. Ratios can be classified into four broad groups on the basis of
items used: (i) Liquidity Ratio, (ii) Capital Structure/Leverage Ratios, (iii) Profitability
Ratios, and (iv) Activity Ratios.

• Common-Size Financial Analysis: Common-size statement is also known as

component percentage statement or vertical statement. In this technique net
revenue, total assets or total liabilities is taken as 100 per cent and the percentage of
individual items are calculated likewise. It highlights the relative change in each
group of expenses, assets and liabilities. Common size ratios are used to compare
financial statements of different-size companies or of the same company over
different periods. By expressing the items in proportion to some size-related measure,
standardized financial statements can be created, revealing trends and providing
insight into how the different companies compare.

• Trend Analysis: Trend analysis indicates changes in an item or a group of items over a
period of time and helps to draw the conclusion regarding the changes in data. In
this technique, a base year is chosen and the amount of item for that year is taken as

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one hundred for that year. On the basis of that the index numbers for other years are
calculated. It shows the direction in which concern is going.

Significance of financial performance analysis: Interest of various related groups is

affected by the financial performance of a firm. Therefore, these groups analyze the
financial performance of the firm. The type of analysis varies according to the specific
interest of the party involved.

(A) Trade creditors: interested in the liquidity of the firm (appraisal of firm’s liquidity)
(B) Bond holders: interested in the cash-flow ability of the firm (appraisal of firm’s capital
structure, the major sources and uses of funds, profitability over time, and projection
of future profitability)
(C) Investors: interested in present and expected future earnings as well as stability of
these earnings (appraisal of firm’s profitability and financial condition)
(D) Management: interested in internal control, better financial condition and better
performance (appraisal of firm’s present financial condition, evaluation of
opportunities in relation to this current position, return on investment provided by
various assets of the company, etc).

Section - B
Answer Question No. 5 which is compulsory and any two from the rest of this section

5. Multiple choice questions: [5×2=10]

[1 mark for right choice and 1 mark for justification]

(i) Which one of the following statements is not true about efficient market?
(A) Share prices behave randomly and do not show any systematic pattern in the
behavior
(B) Price of one share is independent of the price of other shares in the market
(C) Share prices fully reflect all available information
(D) None can earn abnormally high profits on a constant basis.

(ii) Assume that in a Stock Market, the CAPM is working. A company has presently beta
of 0.84 and its going to finance its new project through debt. This would increase its
Debt/Equity Ratio to 1.56 from the existing 1.26. Due to increased Debt/Equity Ratio,
the Company’s beta would:
(A) Increase
(B) Decrease
(C) Remain unchanged
(D) Nothing can be concluded.

(iii) X Ltd. has Rs. 100 crores worth of common equity on its balance sheet comprising of
50 lakhs shares. The company’s Market Value Added (MVA) is Rs. 24 crores. What is
company’s stock price?
(A) Rs. 230
(B) Rs. 238
(C) Rs. 248
(D) Rs. 264

(iv) Rico Ltd. has PAT of Rs. 40.20 lakhs with extra ordinary income of Rs. 7.00 lakhs. If the
cost of capital is 20% and the applicable tax rate is 40% the value of Rico Ltd. will be:
(A) Rs. 250 lakhs

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 Answer to MTP_Final_Syllabus 2016_Jun 2020_Set 1

(B) Rs. 180 lakhs

(C) Rs. 150 lakhs
(D) Insufficient information.

(v) Identify which of the following is not a financial liability?

(A) X Ltd. has 1 lakh Rs. 10 ordinary shares issued
(B) X Ltd. has 1 lakh 8% Rs. 10 redeemable preference shares issued
(C) X Ltd. has Rs. 2,00,000 of 6% bonds issued
(D) Both (A) and (B).

Answer:
(i) (B) Price of one share is independent of the price of other shares in the market. All other
points are related to the characteristic of the efficient market.

(ii) (C) Here, the company’s beta would remain unchanged, because as per CAPM, the
company specific risk has no impact on the systematic risk.

(iii) (C) Rs. (100+24) crores / 50 lakhs shares = Rs. 248.

(iv) (B) PAT — Rs. 40.20 Lakhs

Extraordinary income = Rs. 7 lakhs
Tax @ 40% = Rs. 2.8 lakhs
PAT of Extraordinary income = Rs. 4.2 lakhs
PAT excluding extra ordinary income = Rs. 40.2 lakhs – Rs. 4.2 lakhs
= Rs. 36 lakhs
Cost of capital = 20%
Value of firm = Rs. 36 lakhs/ 0.20 = Rs. 180 lakhs.

(v) (A) X Ltd. has 1 lakh Rs. 10 ordinary shares issued. A share is an indivisible unit of capital,
expressing the proprietary relationship between the company and the shareholder.

6.(a) The following informations are furnished in respect of a certain firm:

Earnings per Share = Rs. 3.15
Capital Expenditure per Share = Rs. 3.15
Depreciation per Share = Rs. 2.78
Change in Working Capital per Share = Rs. 0.50
Debt Financing Ratio = 25%

Earnings, Capital Expenditure, Depreciation and Working Capital are all expected to
grow at 6% per year. The beta for stock is 0.90. Treasury bond rate is 7.50%. A premium
of 5.5% is used for the market.
Calculate the value of stock. [8]

(b) Find out the average capital employed of ND Ltd. From its Balance Sheet as at 31st
March, 2019:
Equity and Liability Rs. in Assets Rs. in
Lakhs Lakhs
(1) Shareholders Fund: (1) Non-Current Assets:
(a) Share Capital (a) Fixed Assets

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(i) Equity Share Capital 50.00 (i) Tangible Assets:

of Rs. 10 each
─ Land and Building 25.00
(ii) 9% Preference
10.00 ─ Plant and Machinery 80.25
Shares fully paid up
─ Furniture and Fixtures 5.50
(b) Reserve & Surplus
─ Vehicles 5.00
(i) General Reserve 12.00
(b) Non-Current Investments 10.00
(ii) Profit & Loss Account 20.00
(c) Other Non-Current Assets 0.50
(2) Non-Current Liabilities:
─ Preliminary Expenses
Long Term Borrowings
(i) 16% Debentures 5.00
(ii) 16% Term Loan 18.00 (2) Current Assets:
(iii) Cash Credit 13.30 (a) Inventories 6.75
(3) Current Liabilities: (b) Trade Receivables 4.90
(a) Trade Payables - 2.70 ─ Sundry Debtors
Sundry Creditors (c) Cash and Cash 10.40
(b) Short Term Provision Equivalents
– Provision for Taxation 6.40
(Net)
─ Proposed Dividend
Equity Shares 10.00
Preference Shares 0.90
Total 148.30 Total 148.30
Non-trade investments were 20% of the total investments.
Balances as on 1.4.2018 to the following accounts were:
Profit and Loss account Rs.8.70 lakhs, General reserve Rs.6.50 lakhs. [12]

Answer:
(a) Estimating Value:
Long term bond rate 7.5%
Cost of equity = 7.5% + (0.90 x 5.5%) = 12.45%
Expected growth rate 6%

Base year Free Cash flow to Equity (FCFE)

= Earnings per share - (Capital Expenditure - Depreciation) (1- Debt Ratio) - Change in
working capital (1 - Debt Ratio)
= 3.15 - (3.15 - 2.78) (1 - 0.25) - 0.50 (1 - 0.25) = 2.50

Value per share

= 2.50 x 1.06 / (0.1245 – 0.06) = Rs. 41.09 or Rs. 41.

(b) Computation of Average Capital employed

(Rs. in Lakhs)
Total Assets as per Balance Sheet 148.30
Less: Preliminary Expenses 0.50
Non-trade investments (20% of Rs. 10 lakhs) 2.00
145.80

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Less: Outside Liabilities:

16% Debentures 5.00
16% Term Loan 18.00
Cash Credit 13.30
Sundry Creditors 2.70
Provision for Taxation 6.40
Closing Capital Employed 100.40
Capital Employed as on 31.03.2019
Less: ½ of profit earned:
Increase in reserve balance 5.50
Increase in Profit & Loss A/c 11.30
Proposed Dividend 10.90
Profit earned during the year 27.70
50% of Profit earned during the year i.e. Rs. 27.70 lakhs x ½ 13.85
Average capital employed 86.55

7.(a) The bidding company B Ltd. is contemplating a merger with the target company, T Ltd.
so as to form the merged B Ltd. under two distinct situations X and Y. You are provided
with the following information about the proposed merger:
Company B Ltd. T Ltd.
EAT (Rs. lakhs) 40 12.5
No. of Equity Shares (in lakhs) 5 2
P/E ratio 12.5 20

Situation X: There is no synergy in earnings, but P/E of merged B Ltd. will stand at 15.
Merger is based on market value of shares.

Situation Y: Post merger P/E stands at that of stand-alone B Ltd., but earnings of the
merged entity rises by 20% over the aggregate earnings of B Ltd. and T Ltd. Swap ratio is
1.3 for every share of T Ltd.

Find for both the situations X and Y:

(i) Post merger EPS.
(ii) Post merger market value per share.
(iii) Synergy due to merger.
(iv) Gain/loss for merger to shareholders of B Ltd. and T Ltd. (A) in value of share
holdings and (B) in earnings available to them. [2+2+2+4=10]

(b) Pure Drugs Limited is in the Pharmaceutical Industry and has a business strategy of
growing inorganically. It is contemplating to acquire Solid Drugs Limited which has a
strong hold in cardiac segment. Pure Drugs Limited has 30 crore shares outstanding
which are trading on an average price of Rs. 300 while Solid Drugs Limited has
outstanding shares 20 crore and are selling at an average price of Rs. 200 per share.
The EPS are of Rs. 12 and Rs. 6 for Pure Drugs Limited and Solid Drugs Limited
respectively. Recently, the management of both the companies had a meeting
wherein number of alternative proposals was considered for exchange of shares. They
are —
(i) Exchange Ratio should be in proportion to the relative EPS of two companies.
(ii) Exchange Ratio should be in proportion to the relative share prices of two
companies.

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(iii) Exchange Ratio should be 3 shares of Pure Drugs Limited for every 5 shares of Solid
Drugs Limited.

You are required to estimate EPS and Market Price under the three options, assuming
the P/E of Pure Drugs Limited after merger will remain unchanged. Assume that there
will not be any synergy gains due the said merger. [5+5=10]

Answer:
(a)
X Y
B T Merged B T Merged
EAT (Rs. lakh) 40 12.5 52.5 40 12.5 63
No. of Equity Shares (n) (Lakhs) 5 2 5 2
P/E (Given) 12.5 20 15 12.5 20 12.5
EPS (EAT/n) 8 6.25 8 6.25
P = Market value per share 100 125 100 125
(P/E*EPS)
Market Capitalization (MC) 500 250 787.50 500 250 787.50
(n*P) (Rs. Lakh)
No. of shares to be issued to T 2.5 2.6
(Lakh)#
No. of shares to Merged B Ltd. 7.5 7.6
(n) [(5+2.5) & (5+2.6)] (Lakh)
EPS for Merged B Ltd. (EAT/N)$ 7 8.29
Synergy (Merged Value - 37.5 37.50
Aggregate MC) [787.5-
(500+250)]
Share of Pre-merger B in 0.667 0.6579
Merged B
Share of Pre-merger T in 0.333 0.3421
Merged B
Value to B [share * merged 525 518.09
MC]
Gain in Value to B [Value to B - 25 18.09
MC of stand-alone B Ltd]
Value to T [share * merged 262.5 269.41
MC]
Gain in Value to T [Value to T - 12.5 19.41
MC of stand-alone T Ltd]
Share of Earnings from Merged 35 17.5 52.5 41.45 21.55
B**
Gain /(loss) [Earnings from (5) 5 0 1.45 9.05 10.50
Merged - Stand alone
Earnings]
Market value per Share of 105 103.62
Merged B [Merged
MC/Merged Number of
Shares] (787.5/7.5 & 787.5/7.6)

@ MC = EAT × P/E = 52.5 × 15 = 787.50 & 63 x 12.5 = 787.50

# (125/100) × 2 = 2.5 for X and 1.3 × 2 =2.6 for Y
$ (52.5/7.5) = 7 for X and (63/7.6) = 8.29 for Y
** (0.667 × 52.5) = 35 (rounded off) for B and (0.333 × 52.5) = 17.5 (rounded off) for T under
X;
(0.6579 × 63) = 41.45 (rounded off) for B and (0.3421× 63) = 21.55 (rounded off) for T
under Y.

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 Answer to MTP_Final_Syllabus 2016_Jun 2020_Set 1

(b)
Pure Drugs Solid Drugs
Limited Limited
EPS (Rs.) 12 6
No. of Outstanding Shares (in crores) 30 20
Net Profit (in Rs. crores) 360 120
Net Profit (in Rs. crores) after Acquisition 480
Price of Share 300 200
P/E Ratio 25.00 33.33
Alternative- Alternative-II Alternative-III
I (Basis-EPS) (Basis-Prices) (Basis-3 shares
for 5 shares)
Exchange Ratio (No. of Shares of Pure 0.50 0.67 0.60
Drugs Limited for each share of Solid
Drugs Limited)
New Shares to be issued (in Crores) 10 13.40 12
Total No. of Shares after Acquisition (in 40 (30+10) 43.40 42 (30+12)
crores) (30+13.40)
EPS (in Rs.) after Acquisition Given Rs. 12.00 11.06 11.43
480 crores of Profit Acquisition
Given the P/E Ratio of 25, the Share 300.00 276.50 285.71
Price of Pure Drugs Limited will be - (in
Rs.)

8.(a) Following is the Profit & Loss Account (extract) and Balance Sheet (extract) for M/s. X
Ltd.
(Rs. in Lakhs)
2018 2019
Turnover 652 760
Pre-tax accounting profit 134 168
Taxation 46 58
Profit after tax 88 110
Dividends 30 36
Retained earnings 58 74

Balance Sheet extracts are as follows:

(Rs. in Lakhs)
2018 2019
Fixed Assets 240 312
Net Current Assets 260 320
Total 500 632
Equity Shareholders Funds 390 472
Medium and Long-term Bank Loan 110 160
The Company's performance in regard to turnover had increased by 17% along with
increase in pre-tax profit by 25% but shareholders are not satisfied by the Company's
preference in the last 2 years. You are required to calculate the Economic Value
Added, as suggested by X Ltd., so that reasons of non-satisfaction can be evaluated.
You are also given:
Particulars 2018 2019
Pre-tax Cost of Debt 9% 10%
Cost of Equity 15% 17%
Tax rate 35% 35%
Interest Expenses (in lakhs) Rs. 8 Rs.12
[10]

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 Answer to MTP_Final_Syllabus 2016_Jun 2020_Set 1

(b) The shareholders of A Co. Ltd., have voted in favour of a buyout offer from B Co. Ltd.
Information about each firm is given here below. Moreover, A Co. Ltd.’s shareholders
will receive one share of B Co. Ltd. stock for every three shares they hold in A Co. Ltd.
Particulars B Co. Ltd. A Co. Ltd.
Present earnings (in Rs. lakhs) 6.75 3.00
EPS (in Rs.) 3.97 5.00
Number of shares (Lakhs) 1.70 0.60
P/E ratio 20 5

(i) What will be the EPS of B Co. Ltd. after the merger?
(ii) What will be the PE ratio if the NPV of the acquisition is zero?
(iii) What must B Co. Ltd. feel would be the value of the synergy between these firms?
[10]

Answer:
(a) Calculation of Return on Operating Capital (ROOC):
(Rs. in lakhs)
NOPAT 2018 2019
PBT 134 168
Add: Interest Expenses 8 12
142 180
Less: Taxes @35% 49.7 63
NOPAT (A) 92.3 117
Operating Capital:
Equity Shareholder's Funds 390 472
Long term Debt 110 160
Operating Capital (B) 500 632
ROOC=(A/B)×100 18.46% 18.51%

Calculation of Weighted Average Cost of Capital (WACC):

Particulars 2018 2019
Kd 9%(1-0.35)× 110/500 10%(1-0.35)× 160/632
1.287% 1.646%
Ke 15%×(390/500) 17%×(472/632)
11.7% 12.7%
WACC 1.287%+11.7%=12.99% 1.646%+12.7% = 14.35%
EVA:
ROOC 18.46% 18.51%
Less: WACC 12.99% 14.35%
EVA Spread 5.47% 4.16%
EVA= Spread x Operating Capital 5.47% × Rs. 500 lakhs 4.16% × Rs. 632 lakhs =
= 27.35Lakhs 26.29 Lakhs

Since EVA has declined in year 2019 by Rs. 1.06 Lakhs, this can be attributed as reason for
non-satisfaction.

(b)
(i) The EPS of the combined company will be the sum of the earnings of both companies
divided by the shares in the combined company. Since the stock offer is one share of the
acquiring firm for three shares of the target firm, new shares in the acquiring firm will
increase by one-third (Exchange ratio = 1/3).
So, the new EPS will be = (Rs. 3,00,000 + Rs. 6,75,000) / [1,70,000 + (1/3)(60,000)] = (Rs.
9,75,000/ 1,90,000) = Rs. 5.13.

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 Answer to MTP_Final_Syllabus 2016_Jun 2020_Set 1

The market price of B Co. will remain unchanged if it is a zero NPV acquisition. Using the
P/E ratio, we find the current market price of B Co. stock, which is = P/E x EPS = 20 x (Rs.
6.75 lakhs / 1.70 lakhs) = 20 x Rs. 3.97 = Rs. 79.40.

(ii) If the acquisition has a zero NPV, the stock price should remain unchanged. Therefore,
the new P/E will be = P/E = Rs. 79.40 / Rs. 5.132 = 15.47.

(iii) If the NPV of the acquisition is zero, it would mean that B Co. would pay just the
market value of A Co. i.e., Number of shares x market price of A Co. i.e.,
= 60,000 x Rs. 25 (MPS = P/E x EPS = 5 x Rs. 5 = Rs. 25)
The market value received by B Co. = Rs. 15,00,000.
The cost of the acquisition is the number of shares offered at the share price, so the
cost is = (1/3) (60,000) (Rs. 79.40) = Rs. 15,88,000.
The difference is synergy i.e., Rs. 88,000.

DoS, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 15