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## Assignment: Corporate Finance

Assignment: Corporate Finance

Contents

PART A.. 3

Question a) WACC.. 3

Question b) i: Cost of Debt (Kd):- 3

Question b) ii: Cost of Equity (Ke):- 3

Question b) iii: Capital Structure. 4

Question b) iv: WACC.. 4

Part B: Q2. 5

Question 1: Price to Book value. 5

Question 2: Price to Equity value. 6

Question 3: EV/ EBITDA.. 6

Question 4: EV/ Sales. 6

Question 5: Market Multiples. 7

Question 6: Negative PE ratio. 7

Question 7: Significance of EV/EBITDA.. 7

# PART A

## Question a) WACC

Companies raise funds from various sources to do their respective businesses which, mainly comprises of two major components including equity and debt. Both equity holders and lenders expect a definite return against the funds (money) or capital they have provided. This return that is expected by the financers is the cost (of capital) to the company (or business) which is required to be returned to debt holders and to shareholders. WACC basically is the average return that both of these financers are expecting from the company. It represents represent the opportunity cost of the risk that the investors (including both equity and debt) takes by putting their money into a business.

Hurdle rate is basically the minimum acceptable rate of return (MARR) on an investment or on a project as required by the investors. It helps businesses in making crucial decisions about whether to pursue a specific project or not. Now WACC is generally used as the hurdle rate while project appraisal because for the company, it is the minimum return that company must earn so as to return back to the investors.

= > Kd = 6.5 %

## Question b) ii: Cost of Equity (Ke):-

Ke as per CAPM is given by

Where:

• Rf = risk free rate of return
• β = Beta
• Rm – Rf = Risk premium
•
• Rf = 6%
• β = 0.91

Therefore,

=> Ke = 9.64 %

## Question b) iii: Capital Structure

 Capital Structure Amounts Total Equity 98359 Total Debt 83790 Total Capital 182149 Capital elements Weights % of equity 54% % of debt 46%

## Question b) iv: WACC

Costs of capital:

Ke = 9.64%

Kd = 6.5%

Weights:

We = 54%

Wd = 46%

Tax rate = 25%

=>

=> WACC = 7.5 %

The cost of debt (or Kd) is the fixed cost that the business has to pay back to the lender in addition to the principal amount. Kd (as calculated) of Bharti Airtel Ltd. is 6.5% whereas the risk free rate is 6.0%, the difference is just of 50 basis points. In other words the company has a very lower cost of debt. That means lower fixed cost obligations and less burden on liquid asset pools.

The cost of equity (or Ke) is the required rate of return that the equity investors expect against purchasing shareholding in the company. The Ke of Bharti Airtel Ltd is 9.64 % with a beta (measure of systematic risk) of 0.91 (close to 1), that means the stock of Bharti Airtel is expect to be same as volatile as the market and will be able to generate similar returns as that of market. The Ke of 9.64% with a beta of 0.91 can be considered to be steadier rather than volatile

Cost of capital (or WACC) represents a hurdle rate (or MARR) that a company must overcome before starting to start generating some value. The WACC of Bharti Airtel is 7.5% which is due to lower Kd with approx half of financing from debt. The company also has a lower WACC than the average industry WACC of 10%. This indicates that company will start generating value very early after overcoming the hurdle rate.

# Part B: Q2

Given:

 Share price on 29 Mar‘19 (per share) 305.6 No. of shares outstanding 545.325

## Question 1: Price to Book value

 Total Non-current assets 202165 Total Current assets 20520 Total Assets 222685
 Total Non-current liabilities 63863 Total Current liabilities 60463 Total Liabilities 124326

Book value = Total assets – Total liabilities

=> Book value = 98359

Book Value per share = Book value/ No. of shares outstanding

=> Book Value per share (BVPS) = 180.37

PB ratio = Market price / BVPS

=> PB ratio = 1.7

## Question 2: Price to Equity value

Profit/Loss for the Period (Net income) = -1829

EPS = Net income/ No. of shares outstanding

=> -1829/545.325

=> EPS = -3.35

PE ratio = Market price per share/ EPS

=> 305.6/ -3.35

=>PE ratio = -91.1

## Question 3: EV/ EBITDA

 EBITDA: Total Revenue 49858.7 Less: Purchase Of Stock-In Trade 0 Operating And Direct Expenses 29245.1 Employee Benefit Expenses 1471 EBITDA 19142.6

 EV Market Cap 166651 Add: Total Debt 83790 Less Cash and cash equivalents 219 EV 250222

=> EV/EBITDA = 13.07

## Question 4: EV/ Sales

=> EV/Sales = 5.02

## Question 5: Market Multiples

Market multiples are financial measurement tools that helps in quantifying the values of a company. However, these types of valuation metrics are generally not used in isolation but while comparing a company with another. E.g. the PE ratio of SBI of 9.81 (Yahoo Finance) alone provides very less material information about the valuation of the company, but when it is compared with the PE ratio of HDFC Bank of 17.75, it can be said that to claim a single rupee of earnings stock of SBI is cheaper than HDFC.

Accounting ratios determines the financial health and periodical performance of the company while valuation ratios provide value to the company on the basis of such health and performance. Valuation ratios include and uses market related for various ratio calculations data.

## Question 6: Negative PE ratio

The PE ratio determines the value that investors are willing to pay per share on the basis of its past periodical (annual) earnings. However, a negative PE ratio for a stock is possible and indicates that EPS, or earnings of the company remain negative in other words the company reported a net loss.

The PE ratio in terms that investors are willing to receive money against purchasing Bharti Airtel’s shares will not be an accurate interpretation, but still PE ratio can determine various material information if comparative analysis is done. The PE ratio of current year can be compared with previous year’s ratio, if the company is continuously showing negative PE values, and then there are possibilities of bankruptcy. In telecom and tech companies, it is not uncommon that companies shows negative PEs, therefore, it is required to compare PE of Bharti Airtel with other telecom players.

## Question 7: Significance of EV/EBITDA

EV/EBITDA compares Enterprise Value (EV) of a company with its Earnings before Interest, Tax, Depreciation & Amortization (EBITDA).  The ratio is typically used as a valuation tool to “compare the relative values” of businesses. It determines the amount in EBBITDA times that investors needs to pay to acquire the overall business. A low EV/ EBITDA value is generally preferred.

This is a popular relative valuation tool and in order to value a business, the ratio of the company is compare with the industry average. E.g. the EV/ EBITDA measure of Bharti Airtel (as calculated) was 13, now if the industry average is less than 13, then the stock is over values and vice versa.

The metric is also used in calculating the terminal value in a Discounted Cash Flow DCF model

# Part B: Q3

## Question 1: Operating Cash Flow

 2019 2020 2021 2022 2023 2024 Revenue 50,000,000 55,000,000 60,500,000 66,550,000 73,205,000 80,525,500 Expenses 25,000,000 27,500,000 30,250,000 33,275,000 36,602,500 40,262,750 EBITDA 25,000,000 27,500,000 30,250,000 33,275,000 36,602,500 40,262,750 Depreciation 20,000,000 15,000,000 11,250,000 8,437,500 6,328,125 4,746,094 EBIT 5,000,000 12,500,000 19,000,000 24,837,500 30,274,375 35,516,656 Tax expenses 1,500,000 3,750,000 5,700,000 7,451,250 9,082,313 10,654,997 NOPAT 3,500,000 8,750,000 13,300,000 17,386,250 21,192,063 24,861,659 Add: Depreciation 20,000,000 15,000,000 11,250,000 8,437,500 6,328,125 4,746,094 Less: Increase in WC 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000 Operating Cash Flow 13,500,000 13,750,000 14,550,000 15,823,750 17,520,188 19,607,753

## Question 2: Terminal Cash Flow

Terminal Value = Rs. 168,299,881

## Question 3: Enterprise Value

 2019 2020 2021 2022 2023 2024 PERPETUITY WACC 15.00% YEARS 1 2 3 4 5 Discount Factor 0.870 0.756 0.658 0.572 0.497 OCF (PV) 11,956,522 11,001,890 10,404,372 10,017,224 9,748,519 83,674,785

 PV for 1-5 year 53,128,527 sum of PV PV for terminal value 83,674,785 perpetuity growth Total PV 136,803,313 (sum of PV) + (perpetuity growth net debt level - Enterprise Value 136,803,313 total PV - net debt level
 2019 2020 2021 2022 2023 2024 PERPETUITY WACC 15.00% YEARS 1 2 3 4 5 Discount Factor 0.870 0.756 0.658 0.572 0.497 OCF (PV) 11,956,522 11,001,890 10,404,372 10,017,224 9,748,519 83,674,785

## Question 4: Interpretation of Enterprise Value

Enterprise value (or EV) determines the total value of a company, which is often considered to be a more comprehensive or all-inclusive substitute of equity market capitalization (Market Cap). EV includes the market capitalization of a company in its calculation along with company’s long-term debt and short-term as well as the cash pools on the balance sheet.

The EV computed above basically represents the economic value of the company which comes out to be Rs. 136,803,313(or approx. 137 million). During a potential takeover, the enterprise value can be considered to be the minimum amount that acquirer company have to pay to the host company (the company for which EV is calculated). If this is a public listed company, the price per share of the stocks of the company can be calculated by dividing the EV by outstanding number of shares. Thus the financial manager can identify, whether the stock is overvalued or undervalued (or rightly valued).

# Part B: Q4

Calculation of bond price using excel function of present Value (= PV)

Function = PV (YTM, N, PMT, FV)

Where:-

• YTM = yield to maturity
• N = no. of periods
• PMT = Periodical Payments
• FV = face value

## Question 1 to 3: Price of the bond @ YTM 6%, 7% and 6.5%

Given

 Government Bonds 10-year Government of India bond (G-Sec) Face Value 1000 Semi annual Coupon Rate 6.50% Period left till maturity 7

 Q1 Q2 Q3 YTM 6% 7% 6.50% N 14 14 14 PMT 32.5 32.5 32.5 FV 1000 1000 1000 PV \$1,028.24 \$972.70 \$1,000.00

## Question 4: Price of the bond, one year left for maturity

 Government Bonds 10-year Government of India bond (G-Sec) Face Value 1000 Semi annual Coupon Rate 6.50% Period left till maturity 1

 YTM 6% 7% 6.50% N 2 2 2 PMT 32.5 32.5 32.5 FV 1000 1000 1000 PV \$1,004.78 \$995.25 \$1,000.00

## Question 5: price of the bond right before the final coupon payment

The Price right before the final coupon payment will be the price (clean price) before 6 months including the accrued interest for the 6 months. That means when one wants to sell the bond right before the coupon payment will get the bond price at that date and the 6 months accrued interest which is basically called the dirty price.

The clean price of the bonds before 6 months is:-

 YTM 6% 7% 6.50% N 1 1 1 PMT 32.5 32.5 32.5 FV 1000 1000 1000 PV \$1,002.43 \$997.58 \$1,000.00

The accrued interest for the 6 months period is 32.5 for each bond and the dirty price is given by:-

Dirty price = Clean price + accrued interest

Therefore, the required (dirty) price is as follows:-

## Question 6: price of the bond after the final coupon payment

The price of the bond as the final coupon payment is being paid is the clean price when the period remaining for the maturity is 6 months. The clean price is given as follows:-

 YTM 6% 7% 6.50% N 1 1 1 PMT 32.5 32.5 32.5 FV 1000 1000 1000 PV \$1,002.43 \$997.58 \$1,000.00

## Question 7: price yield curve

It can be clearly observed from the above graph that the price is inversely related to the yield of the bond (or YTM). As yield is increasing from 6% to 7%, the price of the bond is continuously decreasing. The price-yield curve relates the price of a coupon bond to its annual yield.

The price at 6% YTM was \$1028, when the YTM increases to 6.5%, the price decreased to \$1000. The price gets further decreased to \$973 when the YTM increases to 7%.

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