The Hindu Business Line : There's a school bus to lease out

The bus can be purchased for Rs 5,00,000 and, in turn, be leased out at Rs 1,25,000 per year for eight years with payments occurring at the end of each year:

Estimate the internal rate of return for the company assuming tax is ignored.

What should be the yearly lease payment charged by the company in order to earn a 20 per cent annual compounded rate of return before expenses and taxes?

Calculate the annual lease rent to be charged so as to amount to 20 per cent after tax annual compound rate of return, based on the following assumptions: Tax rate, 40 per cent; straight-line depreciation; annual expenses of Rs 50,000; and resale value of Rs 1,00,000 after the turn. (16 marks)

Solution: The lease rental per annum and the discounted cash-flow are presented in Tables 10 and 11 respectively. By solving the equation:

2.30232x + 95930 + (115116) + 13956 = 500000

2.30232x = 505230

x = 219444

Therefore, the lease rent is Rs 2,19,444

Note: In case of depreciation, the full cost is considered. Alternatively, the charge can be effected on the depreciable portion.

MM model

X Ltd has 8-lakh equity shares outstanding at the beginning of 2003. The current market price per share is Rs 120. The board of directors of the company is contemplating Rs 6.4 per share as dividend. The rate of capitalisation, appropriate to the risk-class to which the company belongs is 9.6 per cent. Based on the M-M Approach, calculate the market price of the share of the company, when the dividend is a) declared; and b) not declared.

How many new shares are to be issued by the company if it desires to fund an investment budget of Rs 3.20 crore by the end of the year assuming that the net income for the year will be Rs 1.60 crore? (10 marks)

The solution is presented in Table 9.

Mutual return

A MUTUAL fund that had a net asset value of Rs 20 at the beginning of the month made income and capital gain distribution of Re 0.0375 and Re 0.03 per share respectively during the month, and then ended the month with a net asset value of Rs 20.06. Calculate monthly return. (4 marks)

Po = 20

MI = 0.0375

Capital gains = 0.03

Pt = 20.06

Monthly return = 0.0375 + 0.03 + 0.06 / 20

= 0.6375 per cent

EPS, before and after

XYZ Ltd is considering merger with ABC Ltd. XYZ Ltd's shares are currently traded at Rs 20. It has 2,50,000 shares outstanding and its earnings after taxes (EAT) amount to Rs 5,00,000. ABC Ltd has 1,25,000 shares outstanding; its current market price is Rs 10 and its EAT is Rs 1,25,000.

The merger will be effected by means of a stock swap (exchange). ABC Ltd has agreed to a plan, under which, XYZ Ltd will offer the current market value of ABC Ltd's shares:

What is the pre-merger earnings per share (EPS) and PE ratios of both the companies if ABC Ltd's PE ratio is 6.4? What is its current market price? What is the exchange ratio? What will XYZ Ltd's post-merger EPS be?

What should be the exchange ratio if XYZ Ltd's pre-merger and post-merger EPS are to be the same? (10 marks)

The solution is presented in Table 12.

CAP model

Assuming a risk-free rate of 15 per cent, calculate the expected rate of return in each, using the Capital Asset Pricing Model (CAPM) and the average return of the portfolio. (6 marks)

Under CAPM: r{-s} = r{-f} + (r{-m} - r{-f} x ß)

Average return of the portfolio = 10,800 / 68,000 = 15.88 per cent.

Interest coverage

A COMPANY is presently working with an earning before interest and taxes (EBIT) of Rs 45 lakh. Its present borrowings are:

12 per cent term loan — Rs 150 lakh

Working capital: Borrowing from bank at 15 per cent — Rs 100 lakh;

public deposit at 11 per cent — Rs 45 lakh

The sales of the company are growing and, to support this, the company proposes to obtain additional borrowing of Rs 50 lakh expected to cost 16 per cent.

The increase in EBIT is expected to be 16 per cent.

Calculate the change in interest-coverage ratio after the additional borrowing and commitment.

The solution is presented in Table 15.

Share buyback

WRITE a note on buyback of shares by companies. (10 marks)

By virtue of Sections 77A and 77B of the Companies (Amendment) Act, the profitable and cash-rich companies can utilise their earnings and reserves to reduce the outstanding equity shares. The advantages of these include: i) revival of capital market; ii) liquidity to dormant shares; iii) odd lots; iv) re-structuring of capital base by companies with special reference to public sector units; v) increasing EPS and PE ratio to investors; and vi) proper utilisation of surplus funds.

Commercial paper

WRITE short notes on commercial paper. (6 marks)

It is a "usance promissory note" issued by a company, and approved by the RBI. It is negotiable by endorsement and delivery and issued at such discount on the face value as may be determined by the issuing company. These are issued to raise funds for a short period, varying from a few days to a few months. It may be issued in multiples of Rs 5 lakh.

Commercial paper is preferred, as the cost of borrowing is much lower.

(Concluded)

(Suggested answers to the May 2003 CA (Final) paper on management accounting and financial analysis.)

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