INVESTMENT APPRAISAL

Bridgeford
Year 0 1 2 3 4 5 6
$'000 $'000 $'000 $'000 $'000 $'000 $'000
Investment -2000
Salvage Value 50
Sales 2625 3308 4052 4254 3829
Material Costs -550 -726 -932 -1025 -966
Labour Costs -825 -1089 -1464 -1611 -1611
Overhead Costs -315 -386 -405 -425 -447
Contribution -2000 935 1107 1251 1193 805
Tax Payments -327.3 -387.3 -437.8 -417.7 -281.9
TAD 175 131 98 74 204
Working Capital -200 -75 -88 -102.85 -46.585 512.435
Net Cash flows -2200 860 866 892 808 1024 -78
NPV 946
WORKING:

1 2 3 4 5 6
Book Value 1500 1125 844 633 50
Depreciation 500 375 281 211 583
TAD 175 131 98 74 204

Fisher Effect 12%

Working 3 of Working Capital

0 1 2 3 4 5
Total 200 275 363 465.85 512.435 0
Incremental -200 -75 -88 -102.85 -46.585 512.435

Depreciation Working
1 2 3 4 5 6 BAL
Allowance 500 375 281.25 210.94 582.81 2000
Tax Saving 175 131.25 98.44 73.83 203.98 1367.19
632.81
50
582.81
ADVANCED INVESTMENT APPRAISAL
Q FERNHURST ( SEP/DEC 16)

Year 0 1 2 3
Sales Units 132,500 159,000 206,700
Sales Revenue 13,250,000 16,695,000 22,788,675
Less: Variable Cost - 5,787,600 - 7,292,376 - 9,954,093
Contribution 7,462,400 9,402,624 12,834,582
Less: Fixed Cost - 900,000 - 945,000 - 992,250
Less: Marketing Expense - 1,500,000
Cash flows 5,062,400 8,457,624 11,842,332
Tax Payments - 1,265,600 - 2,114,406 - 2,960,583
Investment - 16,000,000
Tax Allowance 800,000 640,000 512,000
Working Capital - 1,025,000 - 41,000 - 53,300 - 55,965
Net Cashflows - 17,025,000 4,555,800 6,929,918 9,337,784
Discount Rate 11%
NPV 7,797,990

ALTERNATE METHOD ( we have to do this 0 1 2 3

Contribution 7,462 9,403 12,835
Fixed cost - 900 - 945 - 992
Marketing cost - 1,500
Tax depreciation - 3,200 - 2,560 - 2,048
Taxable income - 1,862 5,898 9,794
Tax payments - 466 - 1,474 - 2,449
Tax depreciation 3,200 2,560 2,048
Working capital - 1,025 - 41 - 53 - 56
Initial investmeent - 16,000
Net cash flow - 17,025 4,556 6,930 9,338
DR 11% 7,798

Decision : The NPV is positive , which represented the project should be undertaken because it is physically viable
Professional marks
1: Use the spread sheet functions and avoid long structure workings
2: Workings structure : Formatted
3: Workings should be labelled

Investment Appraisal: By pay Back Revision

years FCF DR 10% PV Cum PV

0 (1,000) 1.000 (1,000) (1,000)
1 300 0.909 273 (727)
2 400 0.826 331 (397)
3 500 0.751 376 (21)
4 700 0.683 478 457
5 600 0.621 373 830
6 200 0.564 113 943
NPV 943

Payback
3 Years 0.044

Years CF DF FCF Weightage

1 4,556 0.90 4,104 17%

2 6,930 0.81 5,624 23%
3 9,338 0.73 6,828 28%
4 12,549 0.66 8,266 33%
Total 33,373 24,823 100%

Comment
The result represents the weighted average 2.78 Years time period for the project
recover the investment with the consideration of time value and all the cash inflows
associated with investment.
 4 TAX DEPRECIATION 1 2 3
206,700 3200000 2560000 2048000
23,928,109 800000 640000 512000
- 10,451,798
13,476,311
- 1,041,863
Working Capital 0 1 2
12,434,448 1025000 1066000 1119300
- 3,108,612 -1025000 -41000 -53300

2,048,000
1,175,265
12,549,101

Workings 1 2 3
Contribution
Sale price 100 105 110.25
variable cost -43.68 -45.864 -48.1572
Contribution/ unit 56.320 59.136 62.093
Units 132.5 159 206.7
Contribution 7462.40 9402.62 12834.58

4
13,476 Tax depreciation 1 2 3
- 1,042 3200 2560 2048

- 8,192
4,242 Working Capital 0 1 2
- 1,061 1025 1066 1119.3
8,192 -1025 -41 -53.3
1,175

12,549

e it is physically viable
Duration

0.17
0.45
0.83
1.33
2.78
 4 BALANCING FIGURES
8192000 16000000
2048000

3 4
1175265
-55965 1175265

115.7625
-50.56506
65.197
206.7
13476.31

4
8192

3 4
1175.265
-55.965 1175.265
WACC/DR/Cost of capital
WACC= Calculation = With view point of investor

Investor required return: WACC Components

1: Valuation Method 1: Capital structure
2: CAPM Equity = MV of equity
Debt= MV of debts

2: Investor required return

ke
kd
2 methods valuation and capm

Valuation method

WACC
Capital structure
E= market value of equity 57.3 (mv of share should be ex dividend )
D= market value of debts 5.171 Debts
62.5 1: Non mkt= bank loan =BV=MV
Capital structure 2: MKT
E= market value of equity 92% redeemable =kd by IRR
D= market value of debts 8% irredeemable =kd= interest / MV of debts

ke 13.0%
kd 7.65%
WACC 12.38%

kd 8.5% redeemable bonds=IRR

IRR
Year FCF
0 MV -103.42
1 INT 8.5
2 INT 8.5
3 INT 8.5
4 INT 8.5
5 INT+ RED 108.5

IRR 7.65%

ke = Cost of equity ( valuation method )

ke=(Do*(1+g)/Po)+g

Do= Current dividend

Po= Current share price ex div
g= growth 1 geometric mean method 2 gordon model
growth
Do 0.62 GM method (Div current / div base )^(1/n)-1
Po 7.16 4%
growth 4%

ke 13.02%
nt / div base )^(1/n)-1
WACC WITH CAPM
EXPANSION B) DIVERSIFICATION

Cost of Equity MV of Debt 3000 42%

Company Equity Beta 1.45 MV of Equity 4200 58%
Risk Free Rate 6% 7200 100%
Market Return 14%
Cost Of Equity
Cost of Equity 17.60%
Equity Beta 1.25
Cost Of Debt Equity Asset
12% Bonds Equity Beta
0 -108 Risk Free 6%
1 12 Market return 14%
2 12
3 12
4 112

Cost Of Debt 9.5%

Market Value of Equity 7500000 78%

Market Value of Debt 2160000 22%
9660000 100%

WACC of Expansion 15.2%

ANSWER BY SIR HQ

Investor's Required return

CAPM= Return with the consideration of RISK
Ke= Rf+(Rm-Rf=Rp)*Be

Kd By CAPM Ba=(Be*(E/E+D(1-t))+(Bd*(D(1-t)/E+D(1-t))
Kd=Rf+(Rm-Rf)*Bd

Exam Point: If the Bd is given with the question then use CAPM for KD
otherwise other methods

In CAPM first go for

Portfolio Theory =
Systematic that can't be Avoided
Unsystematic risk that can be avoided by diversifying the portfolio

Assumption for CAPM

The investor is well diversified
(and it is also scepticism)

identify and welcome systematic risk BY CAPM

CAPM=SYS RISK
BETA ASSET

BASIC EXAMPLE
Ungeared Beta which doesn’t contain financial risk
Capital Structure
E 60
D 40
Tax Rate 25%'
Ba 0.93
Be ?

Ungeared to Geared Beta

Ba=Be*E/E+D(1-t) 1.395

Basic Example
Be 1.4
E 60
D 40
Tax rate 25%

Geared to Ungeared 0.933

A-PLC
EXP DIV Investment Opportunities
WACC 15.15% 12.4% [Link] No Change in Financial risk
RETURN
Ke 17.6% 14% 2. Diversification

APLC: Capital Structure

Be(systematic & financial) 1.45 1.00 Equity 7500 78%
Ba (reason for difference 1.21 0.8333 Debts 2160 22%
9660 100%

EXPANSION: Chemical
Ke=Rf+(Rp)*Be
Cost of Equity 17.6%
Be=Chemical 1.45
Ba= Chemical Industry 1.21 Geared to Ungeared Beta

Diversification :Food

Ba (from Proxy) (systmatic risk) A-PLC (Ungeared to geared beta)

E 4200 Be 1.00
D 3000 Ke 14%
Be 1.25 WACC 12.4%
Geared to Ungeared Beta
Ba 0.8333
No Change in Financial risk

Kd By IRR
12% Bonds
MV Bonds 0 -108
Interest 1 12
Interest 2 12
Interest 3 12
Interest+ Red 4 112

Cost Of Debt 9.5%

BONZA PLC

If the company is 100% equity finance

No financial risk
KE=WACC
BE=BA
TIMBER CEMENT

Capital Structure Ba=Be 1.5

MV of Equity 13.35 100% Ke=WACC 20.0%

Ke=WACC 14% Years C.F

0 -200
Be 0.5 1 100
Ba 0.5 2 100
3 79
NPV
Years C.F NPV -1.50
0 -150
1 75
2 48
3 75

NPV 3.347
Adjusted Present Value (APV)
Exam Scope:
1. Core area examine with this topic for both 25 and 50 marks questions
2. Main focus calculation
3. Theory can not be ignored

About topic
The APV method is only relevant where, capital structure going to change due to investment opportunity.

Investment Appraisal (with FCF and time Value)

2 Steps method:

Base case NPV X

Financing Side effects X
APV X

Base Case NPV

Take out all operating cash flows from the project
DR=Ke Un Geared (Assuming company 100% equity finance)

Ke Ungeared Calculation
1. By CAPM (Ke UG=Rf+Rp*Ba)
2. MM proposition 2

Financing Side effects

1. Issue Cost
2. Tax Shield ( Including the concept of debt capacity) DR=KD OR RF KD is preferrable
3. Subsidised Loan
APV
Base Case NPV W1 72.6
Financing Side effect W2 2.42
APV 75.1 ACCEPT

Base case NPV

DR= Ke UG BY CAPM
The case of diversification, take out the data from proxy co.

Be 0.92
Ke UG 15.55%

Base Case NPV

0 1 2 3
Operating Cash flows 450 450 450
Tax Dep -200 -150 -450
Taxable Income 250 300 0
Tax Payments -82.5 -99 0
Tax Dep 200 150 450
Investment -800
Net cash flows -800 367.5 351 450
Ke UG 15.55%
Base Case NPV 72.6

Financing Side Effects Issue Cost

Issue Cost -24.38 1. Related to Debts & Equity
Tax Shield 26.8 2. Assumptions
2.42 Always Relevant as cash outflow
Incurred at Year 0 (Now)
Arrangment:
Internal = Finance will arrange with net amount & no
External & Tax shi= Finance will arrange with gross amount & i

Exam Focus If question is silent then we will get any assumption

Rounding Plc
NET Issue Cost GROSS
Debts =2% 40% 320 6.5 326.5
Equity=4% 60% 480 20.0 500.0
800

Issue Cost Yr 0
Equity -20.0 No tax Adjustment
Debts -4.376 Tax allowable Expense
-24.38
 Tax Shield
Tax saving from interest
Debts*Interest*Tax Rate*DF(RF or KD)

DEBTS 326.5
Int 10% 32.65
will arrange with net amount & no effect on tax shield Tax ben/YR 33% 10.78
will arrange with gross amount & its part of tax shield DF= Annuity 2.487 10%, Simple Annuity= Yr1-Yr3

we will get any assumption Value of Tax shiel 26.8

APV Concept
Base Case NPV= Value of Project as ungeared
Financing SE= Value of Debt financing
 10%, Simple Annuity= Yr1-Yr3

oject as ungeared
Tax Shield: Complications
1. What if Tax= with delays= Annuity Factor with delays
2. Compound Interest= Tax shield calculations with discount table

EXAMPLE

ANSWER
Annual Installments= EAC= Borrowings/Annuity 160836

Years Bal Op Interest Payment Installment Bal End

1 400000 40000 160836 279164
2 279164 27916 160836 146244
3 146244 14624 160836 32

Years Interest Tax benefit DF 10% Tax Shield

1 40000 0.909
2 27916 12000 0.826 9917
3 14624 8374.9095295537 0.751 6292
4 4387.3100120627 0.683 2997
19206

DEBT CAPACITY
Theoritical Debt Capacity $2m
Actual Debt Arrange $1.50m
Tax Shield will calculate on theoritical debt capacity $2M
Subsidised Loan
Project Specific Benefit= Subsidised Financing from Govt.
For eg
Debt finance 100 M
Bank Offer 10% Kd
Govt. offer Sub Loan 4%
Subsidy 6%

Subsidy= Interest Savings= Benefit = After Tax

Subsidised Loan 100

Subsidy: Int savings 6%
6
After Tax benefits(30%) 4.2 Per Year
Discount Factor X
Value of Subsidised Loan X
BLADES CO.

Base Case NPV 5354.873

Financing Side Effects 2336.4091
APV 7691.282 ACCEPT

Base Case NPV

Be 1.368
Ba 1.2
Ke UG 16.00%

Years 0 1 2 3
Operating Cashflows 220,000 220,000 220,000
Tax Depreciation - 315,000 - 67,500 - 67,500
Taxable Income - 95,000 152,500 152,500
Tax Payment 28,500 - 45,750 - 45,750
Tax Depreciation 315,000 67,500 67,500
Investment - 450,000
Net Cashflows - 450,000 248,500 174,250 174,250
DR 0
NPV 5,355

Financing Side effects

Issue cost - 15,496
Tax shield 6,865
Subsidised Loan 10,968
2,336
Issue Cost Net Issue Cost Gross
Equity 5% 1 270,000 14,211 284,211
Debt 0
3% SL 90,000 - 90,000
10% BL 0 90,000 1,837 91,837
450,000 16,047 181,837

Issue Cost Yr 0
Equity - 14,211 No tax adjustment
Debt - 1,286 Tax Allowable expense
- 15,496

Tax Shield
3% subsidised Loan: 90 Simple Loan
D*IR*TR*AF 2,014

10% Bank Loan ( Compound Loan)

EAC=91837/2.487 36,927

Years Balance op Int Instal Bal end TR

1 91,837 9,184 36,927 64,093
2 64,093 6,409 36,927 33,576
3 33,576 3,358 36,927 6

Years Int Tax benefit DR 10% PV

1 9,184 2,755 1 2,505
2 6,409 1,923 1 1,589
3 3,358 1,007 1 757
4,851

Tax Shield Total 6,865

SUBSIDISED LOAN
3% Subsidised Loan
Subsidy (10-3) 0

SL*SUBSIDY*(1-TR)*AF 10,968
BURUNG CO.

Base Case NPV 8.676

Financing Side Effects 1.77
APV 10.450 ACCEPT

Base Case NPV

Ba 1.25
Ke UG 12.00%

Years 0 1 2 3 4 5
Sales Revenue 24.86 42.69 61.81 36.92
Direct Project Cost -14.37 -23.75 -33.12 -19.05
Tax Depreciation -8.00 -2.00 -1.50 -1.13
Taxable Income 2.49 16.94 27.20 16.75
Tax Payment -0.50 -3.39 -5.44 -3.35
Tax Depreciation 8.00 2.00 1.50 1.13
Investment -38
Salvage Value 4.00
Working Capital -4.97 -3.57 -3.82 4.98 7.38
Net Cash flow -42.97 6.43 11.73 28.24 25.91
Discount factor 12.00%
Base Case NPV 8.676

FINANCING SIDE EFFECTS

Issue Cost -0.88
Tax Shield 0.780
Subsidised Loan 1.87

Issue Cost Net Issue Cost Gross

Debt 42.97 -0.88 43.85

Tax Shield
Subsidised Loan 0.077
Normal Loan 0.138
0.215
Annuity 3.63
Tax Shield 0.780

Subsidised Loan 1.87

Working For Ke UG

Similar Company Lintu Co.

Be 1.5
Shares 128
Debt 31.96
Ba 1.25

Working Capital 0 1 2 3 4
4.97 8.54 12.36 7.38
-4.97 -3.57 -3.82 4.98 7.38

SR 2.50%
AMBERLE CO

Base Case NPV -5.07

Financing Side effects 14.85
APV 9.79 ACCEPT

Base Case NPV

Ba 1.14
Ke=UG 12.0%

Year 0 1 2 3 4
Operating Cash flow 28.5 36.7 44.4 50.9
Investment -150
Reliasable Value 45
Working capital -6 -0.48 -0.39 -0.34 7.21
Net Cash Flows -156 28.02 36.31 44.06 103.11
Discount Factor 12.0%
Base Case NPV -5.07

Financing Side Effects

Issue Cost -2.47
Tax shield 7.1
Subsidised Loan 10.27

Issue Cost Net Issue Cost Gross

Debt
Normal Loan 70 0 70
Subsidised Loan 80 2.47 82.47

Tax Shield
Normal Bank Loan
EAC= 19.28

Year BAL op Interest Inst Payment Bal end

1 70 5.6 19.28 56.32
2 56.32 4.51 19.28 41.54
3 41.54 3.32 19.28 25.58
4 25.58 2.05 19.28 8.34

Years Interest Tax benefit DR 4% PV

1 5.6 1.68 0.962 1.615
2 4.51 1.35 0.925 1.250
3 3.32 1.00 0.889 0.886
 4 2.05 0.61 0.855 0.525
4.276

Subsidised Loan 2.78

Total Tax Shield 7.1 Assumption:
For financing side effect we used 4% as the DF
Subsidised Loan 10.27 We can also use 8% as the discount factor here
Working Capital 0 1 2 3 4
6 6.48 6.87 7.21
-6 -0.48 -0.39 -0.34 7.21

Working Capital finance will arrange from internal Sources

Example of M&M preposition

Ke with D 20: E: 80 = NOW= 12%

1. Ke I = Ke Ug
[Link] with D:25 : E:75=?

1.
Ke 12%
Debt Ratio 20
Equity 80
Kd 4%
Tax 30%

Ke i 10.81%
2.
Ke 12.40%
Tippletine Co.

Base Case NPV -886.64

Financing side Effects 1577.20764
APV 690.57 ACCEPT

Ke UG ?

Similar Company Humabuz Co.

KeG 10.50%
Pre tax Kd 5.40%
Tax Rate 30%
Capital Structure
Debt 240.75 38%
Equity 400 62%
640.75 100%

1. Ke i 8.97%

Base Case NPV 0 1 2 3 4 5

Operating CF Bef. Mrk 2000 14500 15225 15834
Marketing Cost -9000 -2000 -2000 -2000
Tax Depreciation -7650 -5737.5 -4303.125 590.6
Taxable Income -14650 6762.5 8921.875 14424.63
Tax Payments 0 0 -310.3125 -4327.388
Tax Depreciation 7650 5737.5 4303.125 -590.625
Investment -30600 13500
Working Capital -3000 -240 -194.4 -171.72 3606.12
Net Cashflows -33600 -7240 12305.6 13053.28 30629.81 -4327.388
DR (ke Ug) 8.97%
Base Case NPV -886.64

Financing Side Effects:

Issue Cost -1275
Tax Shield 682.0
Subsidised Loan 2170.19

ISSUE COST As it is arrange from Internal Source of finance Issue Cost is always relevant and based on this calcu
Subsidised Loan -1224 -1275

Tax Shield 682.0

Subsidised Loan 2170.19

Interest Saving Yr1-Yr4 100% SL*SUB RATE*ANNUITY 3038.213
Tax Adjustment Yr2-Yr5 70% SL*SUB RATE*TAX RATE*DELAYED ANNUITY -868.0241
 2170.189

ISSUE COST
Issue cost is based on gross finance= Loan/net%*Issue cost%
Internal Source
Issue cost= External= Incorporate/ Effect on the tax shield & sub Loan working
Issue cost= Internal= Not to Incorporate/ Effect on the tax shield & sub Loan working

Issue Cost= Tax Allowable if mention with the Question

Otherwise take any assumption= The simple way is to ignore Tax

Discussion
Investment Support= issue of Convertible Loan Notes?
Question Facts:
Verb: Discuss: Plus & Minus
With View point of other shareholders
CL= Issue to some of the directors
Convertible loan notes Vs Subsidised Loan

Drafting Steps:
1. Knowledge Recall
2. Understanding of the requirement & identify the facts from the question
3. PSM

Plan your answer:

1. Time management
2. Marks Management
a. How much to write= According to marks
b. What to write= Key Points identify
i) Discussion= Plus 2+ Minus 2
1. Plus
a. Redemption day=no need for cashflow.
2. Minus
a. Gearing level= interest cost higher.
b. Dilution of sharing.
c. What if coversion is not vaible?
 Working:

Basis Point
Example: 100 Basis point is equal to 1 percent (1%)

SR= 2.5-0.3 2.2%

KD 5%
Subsidy 2.8%

Working Capital 0 1 2 3 4
Total 3000 3240 3434.4 3606.12
Incremental -3000 -240 -194.4 -171.72 3606.12

Working 4 for Tax shield Yr1-Yr5 4.329

Delayed Annuity 0.952
3.377

relevant and based on this calculation

Foreign Investment Appraisal
Locally=Pakistan
Investment opportunity=Turkey
Foreign Investment Appraisal
NPV
APV

BY NPV METHOD:
2 Extreme points
1. Future cash flows= foreign currency
2. Final answer= NPV or APV= LC

Complications:
1. Foreign Exchange= Estimations
By Purchasing power Parity Theory Based on INFLATION (Preference)
Or
By interest rate parity Theory Based on INTEREST
If inflation rate not given in the question then use IRPT
Exchange rate estimation= Spot Rate Now*(1+Inf a OR Int a)/(1+inf b OR Int b)

Example
Spot Rate (NOW) PKR/USD 224.5/US$
Inflation rate Pak 5% and USA 3.5%
Inflation will constant over three years

Years Inf a Inf b Exc. Rate

Now 224.5
1 5% 3.50% 227.7536
2 5% 3.50% 231.0544
3 5% 3.50% 234.403

2. Operating Cash flows

In terms of Foreign currency
But may be some cash flows may be injected from parent investor and need to covert in foreign currency.

3. Tax Implications
Bilateral Tax Treaty
Case 1 Case 2
Tax Rates Tax Rates
Pakistan 35% 35%
Turkey 30% 40%
Extra Tax 5% 0%

*Extra Tax 5% will be applicable on FC taxable income but need to convert in LC

4. Foreign Government = Incentify
1. Tax Holiday for certain time period
2. Government Grants= Against Investment
NOVOROAST Co.

Foreign Investment Appraisal

NPV(Millions) 0 1 2 3 4 5
Foreign Cash Flows
Contribution W3 5.80 44.20 92.83 97.03 100.91
Fixed Cost - 12.00 - 14.40 - 16.56 - 19.04 - 21.90
Tax Depreciation P&M - 12.00 - 12.00 - 12.00 - 12.00 - 12.00
Taxable Income - 18.20 17.80 64.27 65.99 67.01
Tax Payments TAX HOLIDAYS - 16.50 - 16.75
Tax Depreciation P&M 12.00 12.00 12.00 12.00 12.00
Working capital - 20.00 - 29.00 - 7.35 - 8.45 - 9.72 74.52
Land and building - 50.00 104.94
Plant & Machinery - 60.00
Govt Grant (P&M) 6.00
Net Cash Flows FC - 124.00 - 35.20 22.45 67.81 51.77 241.72
Exchange Rate 13.42 15.64 17.29 19.12 21.14 23.38
Remittance to UK - 9.24 - 2.25 1.30 3.55 2.45 10.34
Additional CFs UK
Additional UK Tax on SA TI TAX HOLIDAYS - 0.16 - 0.14
Contribution (Pounds 3/Unit) 0.02 0.18 0.36 0.36 0.36
Tax on contribution (30%) - 0.01 - 0.05 - 0.11 - 0.11 - 0.11
Net Cash Flows UK - 9.24 - 2.23 1.42 3.80 2.54 10.45
Discount Rate 0.14
NPV(Millions) - 0.76
Workings
W1: DR= WACC

E 820 85%
D 144 15%
964 100%

Ke 16%
Kd 7.80%

WACC 14.43%

W2: Exchange Rate

Years 0 1 2 3 4 5
Inf a (SAC) 20% 15% 15% 15% 15%
Inf b (UK) 3% 4% 4% 4% 4%
Exchange rate 13.421 15.636 17.290 19.119 21.141 23.377

W3: Contribution (FC= Pesos)

1 2 3 4 5
Selling Price 1450.00 1595.00 1754.50 1929.95 2122.945
Variable Cost
Local: Previous R. inf -600 -720 -828 -952.2 -1095.03
Imported:Pounds 8/Unit -125.089 -138.319 -152.949 -169.127 -187.015
Contribution Per Unit 724.91 736.68 773.55 808.62 840.90
Units (Millions) 0.008 0.06 0.12 0.12 0.12

W4: Working Capital 0 1 2 3 4 5

Total 20 49 56.35 64.8025 74.52287
Incremental -20 -29 -7.35 -8.4525 -9.720375 74.52287

W5: Additional UK Tax

Year 4 -0.16
Year 5 -0.14
Colvin Co.
Appendix 1
Foreign Investment Appraisal
NPV (Millions) 0 1 2 3 4
Foreign Cash Flows
Pre Tax Contribution 419.4 500.2 671.3 961.2
Tax Depreciation -175 -175 -175 -175
Fixed Cost -270 -291.6 -314.9 -340.1
Taxable Income -25.6 33.6 181.4 446.1
Tax Payments 0 -2 -45.35 -111.525
Tax Depreciation 175 175 175 175
Working Capital (W2) -25 -2.5 -2.75 -3.03 33.28
Land And Building -75 214.21
Plant & Machinery -700
Net Cash Flows CL -800 146.9 203.85 308.03 757.06
Exchange Rate (W3) 9.91 10.48 11.09 11.96 12.89
Remittance to eurozone -80.73 14.01 18.39 25.76 58.72
Additional CFs EZ
Contribution(W5) 0.70 0.81 1.01 1.37
Net Cash Flows EZ -80.73 14.72 19.20 26.8 60.1
Discount Rate (W1) 16%
NPV (Millions) -3.437
Working 1: WACC

WACC Provided i.e. 16%

Working 2: Working Capital

0 1 2 3 4
Total 25 27.5 30.25 33.28
Incremental -25 -2.5 -2.75 -3.025 33.275

Working 3: Exchange Rate

0 1 2 3 4
Inf a (CL) 10% 10% 10% 10%
Inf b (EZ) 4% 4% 2% 2%
9.91 10.48 11.09 11.96 12.89

Working 4: Units

Millions 0.109725 0.121795 0.14859 0.197624

Working 5: Manufacturing Cost and transfer Price

1 2 3 4
Transfer Price 10 10.4 10.61 10.82
Less: Man. Cost -2 -2.08 -2.12 -2.16
Contribution 8 8.3 8.5 8.7
FIA BY APV
Base Case NPV:
Operating Cash Flows
FC
LC
Financing Side Effects
Issue Cost
Tax Shield What if the external finance: FC based
Sub Loan

Tax Shield Int*TR then convert *DR (Kd) (Local)

Discount factor is always used local

HW:
1. Review topic and Question: Novoroast
2. Colvin (AFM Specimen)
3. Youtube Video Link: Communication
4. Tramont Question: Self Attempt
Tramont Co.
Appendix 1 APV

Base Case NPV

Remittance from Gamala 2,015.46
Additional Cash flows in USA (Including any opportunity Cost & Closure CF) -637.624
Financing Side Effects 1,033
APV (Total) 2,410.92
APV Positive= Project Accepted

Base Case NPV (000) 0 1 2 3 4

Foreign Cash Flows(GR)
Contribution (W1) 27,802.14 52,712.27 116,314.21 153,158.58
Fixed Cost - 30,000.00 - 32,700.00 - 35,643.00 - 38,850.87
Tax Depreciation - 20,000.00 - 20,000.00 - 20,000.00 - 20,000.00
Taxable Income - 22,197.86 12.27 60,671.21 94,307.71
Tax Payments - - - 7,697.12 - 18,861.54
Tax Depreciation 20,000.00 20,000.00 20,000.00 20,000.00
Working Capital (W3) - 40,000 - 3,600 - 3,924 - 4,277 51,801
Land & Building - 150,000
Machinery - 80,000
Realisable Value (PR) 450,000
Net Cash Flows - 270,000 - 5,798 16,088 68,697 597,247
Exchange Rate (W2) 55 58 62 65 69
Remittance to USA - 4,909 - 100 261 1,054 8,658
DR W4 9.61%
Base Case NPV: Remit 2,015.46

Additional Cash flows in USA (Including any opportunity Cost & Closure CF)
0 1 2 3 4
Additional Contribution After Tax) 33.6 63.45 139.61 183.58
Additional Tax: Gamal IT 10% (W5) 0 0- 59.04 - 136.72
Opportunity Cost -560 -448 -358.4 -286.72
Closure Cost (Now) 600
Net Cash Flows 600 -526.4 -384.55 -277.83 -239.86
Cost Of Capital (Given) 7%
Base Case NPV ( Local) -637.624

Financing Side Effects

Note:
Project Financing: Loan Based on FC (GR)
There is no issue cost
Working Capital will arrange from external external finance
Total Finance Required: Borrowing: GR 270 Millions
100% Finance from subsidised Loan
Relevant FCFs= Tax Shield and Subsidised Loan
DF= Kd=5% (Locally at USA)

1 2 3 4
Tax Shield 3240 3240 3240 3240 =(270*IR* sub Rate)6%*TRG 20%
Subsidised Loan 15120 15120 15120 15120 270*IR saving7%*tax adjust 80%
18360 18360 18360 18360
Exchange Rate 58.20 61.59 65.18 68.98
Financing SE Benefits $ 315.44 298.08 281.67 266.17
DR 5% 5%
PV of FSE 1,033
Workings:

Contribution (W1)
1 2 3 4
Selling Price (US$ 70) 4074.27 4311.61 4562.77 4828.56
Variable Cost Local -1350 -1471.5 -1603.935 -1748.28915
Variable Cost Imported -407.43 -444.10 -484.06 -527.63
Contribution Per Unit 2316.84 2396.01 2474.77 2552.64
Units (000) 12 22 47 60
Contribution (W1) 27802.14 52712.27 116314.21 153158.58

Exchange Rate (W2)

Year 0 1 2 3
Inf a 9% 9% 9%
Inf b 3% 3% 3%
ER (G/US) 55 58.20 61.59 65.18

Working Capital (W3) 0 1 2 3

Total 40000 43600 47524 51801.16
Incremental -40000 -3600 -3924 -4277.16

Discount Rate (W4)

Equity 60000 51%
Debt 57120 49%
117120

Project Related Ba
Geared To Ungeared
Be (given) 1.17
E 60000
D 57120
Tax Rate USA 30%
Beta Asset 0.70
Project specific Ba 1.10
Ke UG BY CAPM 9.61%

Additional Tax: Gamal IT 10% (W5)

Year 3 Year 4
Taxable Income GR 38,485.62 94,307.71
 Exchange Rate 65.18 68.98
Taxable Income US 590.43 1,367.19
Additional Tax 10% 10%
59.04 136.72

0*IR* sub Rate)6%*TRG 20%

IR saving7%*tax adjust 80%
 4
9%
3%
68.98

51801.16
MIRR
Investment Appraisal
By IRR Method
IRR means= Investment Potential
Decision Making = Project Accept if IRR> DR
IRR is a point where NPV become zero
Example:
Years CFs DR 10% PV DR 20% PV
0 -200 1.00 -200 1.00 -200
1 50 0.91 45.45 0.83 41.67
2 60 0.83 49.59 0.69 41.67
3 90 0.75 67.62 0.58 52.08
4 70 0.68 47.81 0.48 33.76
5 30 0.62 18.63 0.40 12.06
29.10 -18.77
IRR 16% IRR
a= DR lower 10%
IRR b= DR higher 20%
1. Spreadsheet Function A= NPV Lower -18.77
2. Trail and error Method B= NPV Higher 29.10
3. Graphical
IRR= a+(A/A-B)*(b-a)
IRR 16.17%
IRR Limitations
1. Multiple IRR
2. Mutually Exclusive Projects
3. Re- Investment Rate

1. Multiple IRR
Years CFs 000
0 -200
1 50
2 -60
Non Convential Cash Flows
3 90
4 70
5 30

2. Mutually Exclusive Projects

A B But it may possible: Contradiction b/w NPV & IRR
NPV 1200 1000
IRR 15% 11%
A B
NPV 1200 1000
IRR 11% 15%
3. Re- Investment Rate
0 1 2 3 4
Net Cash flows -200 70 80 90 50 IRR
DR 10% WACC 1 0.909 0.826 0.751 0.683
NPV -200 63.636 66.116 67.618 34.151 31.521

NPV BY IRR
DR=IRR=17% 1 0.853 0.727 0.620 0.528
-200 59.676 58.143 55.763 26.411 0.0 NPV

Re Investment Rate Assumption= NPV method is more realistic than IRR

MIRR= To cover the IRR Limitations

Years CFs 000
0 -150
1 60
2 -50
3 100
4 70
5 30
DR= Cost of Capital=8%
Mirr is calculated on cost of capital

Years Inv Phase Return Phase DR 8% PV I.P PV R.P

0 -150 1 -150
1 60 0.926 55.56
2 -50 0.857 -42.87
3 100 0.794 79.38
4 70 0.735 51.45
5 30 0.681 20.42
-192.8669 206.81

MIRR Formula =(PVr/Pvi)^1/n*(1+re)-1

MIRR 9.52% Through mathematical Formula and negative sign would not incurred
MIRR 9.52% Through Spreadsheet Formula
17%
Option Valuation
Exam Scope:
1. Integrate with any investment appraisal or other part of syllabus.
2. Part of 50 Marks question or 25 marks question
3. Calculation+ Theory
4. Recent change: ????

About Topic
Option Valuation
Basic Discussion: Investor Rights Issue: Share Option (Option Holder)

Now 1 1 Year 2 3
MV of Shares 100 100 100
Exercise Price 80 100 110
Intrinsic Value 20 0 0
Time Value 5 12 10
Value of Option 25 12 10

Option Valuation: BSOP (Black-Scholes Option Pricing)

Option Holder:
[Link] to BUY= CALL Option
2. Contract to SELL= PUT Option

Basic Example: Call Option

Option Valuation: By BSOP= VARIABLES
1. MV of Share Pa
INT. Values
2. Exercise Price Pe

3. Time Expiry Time

4. DR Rf Time Value
Variation Standard Deviation

Market Price= Pa 100

Exercise Price= Pe 80
DR= RF 10%
Time 1 Year
SD 40%

Now 1 Year
Market Price= Pa 100
Exercise Price= Pe 80 Future Value Example
FCF 120
DR 10%
Option Value PV=Now Time 1 Yr
PV 109.0909
FCF 120
Exponential (Constant) 2.7183
FCF*e^(-r*t) 108.5804
Cathlynn Plc
Option Valuation By BSOP
Pa= MV of Shares 3.5
Pe= Exercise Price 3.3
Time = 3Months 0.25
DR= Rf 0.08
Standard Deviation 0.35

Call Option Value 0.385

d1 0.54
N(d1) Table Values 0.5 0.2054 0.7054
d2 0.37
N(d2) Table Values 0.5 0.1443 0.6443

Call Option Value= C 0.385

MV of Share 3.5
Exercise Price 3.3
Int Value 0.2
Time 0.185
Call Option 0.385
AVT Co.
Part A
Evaluate the bonus scheme:
1. Cash Form $5000 to 7000
2. 5000 share options

1. Call Option Value ?

BSOP Model Apply

Pa 5.9
Pe 5.0
Time 1 Year
Rf 0.06
Standard Deviation 0.38

d1 0.77
N(d1) Table Values 0.5 0.2852 0.7852
d2 0.39
N(d2) Table Values 0.5 0.1591 0.6591

Call Option Value= C 1.501

MV of Share 5.9
Exercise Price 5.0
Int Value 0.9
Time 0.637
Call Option 1.501

Put Option Value ( Right to sell)

0.346

Put option value< Call Option Value

Call Option (Holder)= Right to Buy shares = Align with shareholder's objective

Put Option (Holder)= Right to sell Shares= For manager= is not making sense as it contradict with the objectives of the shareho
 Share Value 6.1
Less: expected Dividend during exercise time 0.2 PV of future dividend
Pa 5.9

as it contradict with the objectives of the shareholders as the managers wanted to reduce the share price to earn more
Real Options

Strategic NPV Real Options

NPV( Conventional) X 1. Expansion/Follow on

Option Valuation X 2. Delay

Strategic NPV X 3. Withdraw/Sell

4. Switch

1. Expansion/Follow on

Q1. Handout Page no 51

NPV( Conventional) X

Option Valuation X

Strategic NPV X

3. Withdraw/Sell/Option to Withdraw

Put Option

Right to Sell

Case 1 Case 2

MV of Share 100 100 Forgone the future benefit

Exercise Price 90 110 Selling Right Fixed @90

Int Value NO 10

2. Option to Delay CALL Option

Conventional NPV

Years 0 1 2 3 4

FCF -1200 300 400 500 300

DR 10% 1 0.909 0.826 0.751 0.683

PV -1200 272.727 330.579 375.657 204.904

NPV -16.133
NPV with the option of 1 year delay= Strategic NPV

Pa= MV of share=PV of inflows 1183.867

Pe= Investment 1200 INT. Value 0

Time 1

Rf 8%

SD 50%

Option to Delay= Call Option Value 178

Int Value 0

Time Value 178

 ACCA AFM BSOP CALCULATOR
Pa Pe r t s KEY
4.000 5.000 0.050 1.000 0.400 Pa
Pe
d1 -0.2329 r
d2 -0.6329 Conv NPV -2 t
Nd1 0.4079 Call Opt 0.38 s
Nd2 0.2634 Str. NPV -1.62
c 0.38 c
p 1.14 p

Designed by Ivan Zizinga, [Link](2020-2023)

 KEY
Price of underlying asset (Market price)
Exercise price
Risk Free rate
Time to expiry in years
Standard deviation/Volatility of Pa Recall: s = square root of variance

Call option value

Put option value
 ACCA AFM BSOP CALCULATOR
Pa Pe r t s KEY
11.349 20.000 0.050 5.000 0.250 Pa
Pe
d1 -0.2869 r
d2 -0.8459 Conv NPV -0.5 t
Nd1 0.3871 Call Opt 1.3 s
Nd2 0.1988 Str. NPV 0.8
c 1.30 c
p 5.52 p

Designed by Ivan Zizinga, [Link](2020-2023)

 KEY
Price of underlying asset (Market price)
Exercise price
Risk Free rate
Time to expiry in years
Standard deviation/Volatility of Pa Recall: s = square root of variance

Call option value

Put option value
 ACCA AFM BSOP CALCULATOR
Pa Pe r t s KEY
65.000 70.000 0.050 2.000 0.200 Pa
Pe
d1 0.2330 r
d2 -0.0499 Conv NPV -8 t
Nd1 0.5921 Put Opt. 6.42 s
Nd2 0.4801 Str. NPV -1.584009
c 8.08 c
p 6.42 p

Designed by Ivan Zizinga, [Link](2020-2023)

 KEY
Price of underlying asset (Market price)
Exercise price
Risk Free rate
Time to expiry in years
Standard deviation/Volatility of Pa Recall: s = square root of variance

Call option value

Put option value
 ACCA AFM BSOP CALCULATOR
Pa Pe r t s KEY
190.500 150.000 0.070 5.000 0.300 Pa
Pe
d1 1.2135 r
d2 0.5426 Conv NPV 4 t
Nd1 0.8875 Put Opt. 9.62 s
Nd2 0.7063 Str. NPV 13.617
c 94.41 c
p 9.62 p

Designed by Ivan Zizinga, [Link](2020-2023)

 KEY
Price of underlying asset (Market price)
Exercise price
Risk Free rate
Time to expiry in years
Standard deviation/Volatility of Pa Recall: s = square root of variance

Call option value

Put option value
 ACCA AFM BSOP CALCULATOR
Pa Pe r t s KEY
1183.867 1200.000 0.080 1.000 0.300 Pa
Pe
d1 0.3715 r
d2 0.0715 t
Nd1 0.6449 s
Nd2 0.5285
c 178.00 c
p 101.87 p

Designed by Ivan Zizinga, [Link](2020-2023)

 KEY
Price of underlying asset (Market price)
Exercise price
Risk Free rate
Time to expiry in years
Standard deviation/Volatility of Pa Recall: s = square root of variance

Call option value

Put option value
Hathway Co.
Appendix 1

Project Chi.
Year 0 1 2 3 4 5
Contribution (W1) 15 16 17 18
Fixed Cost (8.70) (8.96) (9.23) (9.51)
Tax Depreciation (2.40) (2.40) (2.40) (4.80)
Taxable Income 3.90 4.70 5.58 4.12
Tax Payment (0.78) (0.94) (1.12) (0.82)
Tax Depreciation 2.40 2.40 2.40 4.80
Investment (12)
Net Cash flows (12) 5.52 6.16 6.86 8.10
Discount Rate 12%
NPV 7.87
Working

Working 1: Contribution 0 1 2 3 4
Sales Units (000) 3 3.15 3.308 3.473
Contribution Per Unit 5 5.1 5.202 5.306
Contribution 15 16.065 17 18
Furlion Co.

Pa Pe r t s
10.68 15 0.04 3 0.3

d1 -0.164
d2 -0.683
Nd1 0.435
Nd2 0.247
c 1.355
p 3.983

Conventional Cash flows -1.01

Option to Expand 1.355
Strategic NPV 0.35

Exam Focus Point

Marks Management

Technical Marks
Professional Marks

1. BSOP Calulation
2. Final Comments
3. Assumption
4. Other Factors

2. Final Comments
Relevant facts/values/ Strategic NPV
However
More information= Option to delay, option to switch

3. Assumption

A. BSOP
1. Pa= MV of Shares= Does INV. Have the MV??
2. Constant Variable= Rf/SD
3. Returns Volatility= ND Table

B. REAL OPTIONS
Project = Int Value= 0
But expecting to generate more inflows
in future (Pa) considering all uncertainities.
Management will response accordingly

4. Other Factors
Land Reclamation
Finance
Paradise Villa Co.

Pa Pe r t s
28.00 24 0.05 2 0.25

d1 0.896
d2 0.542
Nd1 0.815
Nd2 0.706
c 7.480
p 1.196

Conventional NPV 4
Strategic NPV with option to delay 7.480

More Explanation
The conventional present value is 4 if the project starts immediately and the strategic NPV with option to delay
is 7.480 which shows the project should be accepted.
Answer By Sir
Intrinsic value $4m (if the projects starts immediately)
The time value represents the additional value of being
able to "wait and see" what the decision the government
makes.

The flexibility allows Paradise Villas to neutralise much of the

down side risk of the project (if government makes decision, not allowing
the foreigners to buy land) but on the other hand unlimited upside
potential/benefit (if the government allows foreigners to buy holidays
homes and the return will unexpected very high)

Conclusively the value of the project = Expected NPV (IV) & Time
value of option to delay=4+3=7.48
with option to delay
Formex Ltd.

20 5 5 5
Pa Pe r t s 10%
18.95 20 0.07 5 0.3 -1.046

d1 0.777
d2 0.106
Nd1 0.781
Nd2 0.542
c 7.168
p 2.308

Conventional NPV -1.05

Strategic NPV with option to delay 7.168

Option to delay the project implications:

Project with conventional NPV (negative 1.05)
Project with strategic NPV
Having instrinsic value NIL But
Time value=7.17
More Explanation
Variables of time value of money
represents the additional value of being able
to 'wait and see' what the consequences
about the clearification of uncertainity.
5 5
Advance WACC
Cost of Equity: Complex Issues with CAPM

WACC= Investor's required Return

WACC by CAPM= Consideration about Risk as well
WACC= Return includes= Ke and Kd

Here we are particularly discussing KE

Be= Systematic and financial Risk

Particular about = Systematic Risk WEIGHTED AVERAGE BETA ASSETS

B&H Company= Divisional Based Company= Telecom Business & Investment Market
B&H Company= Systematic Risk= 2 Industries

Ba Asset Business Equity Value

Ba= TC = 0.88 65% Telecom
Ba= IM = 1.24 35% Inv Market

B&H Co.= Ba Weighted Average= (Ba TC*65%)+(Ba IM*35%) 1.006 It incorporates the risk of both the different mark
Capital Structure= E70%+D30%
Tax Ratee 30%

B&H Co= Beta Equity What will be the Ke What will be the WACC
Ba=Be*E/E+D(1-t) Rf= 6% Kd 7%
Be 1.3078 Rp= 4% WACC 9.3% That WACC cannot be used for specifi

Ke 11.23%

Be 1.3078
By formula
Geared to Ungeared
Ba 1.006
Equity Proportion: 65% Telco & 35% Inv. Market
Ba= IM=1.24

Ba= Telco ????

Ba WA 1.006= (Ba IM 1.24*35%)+(Ba Telco*65%)

Ba Telco 0.88
sk of both the different market

CC cannot be used for specific project as it contain weighted average beta assets
Tisa Co.

Part B:
Appendix 1
Process Omega
Investment -3800
Cash flows 1220
Cash flows 1153
Cash flows 1386
Cash flows 3829
IRR 27%
MIRR 23%

Mine ;)
The internal rate of return has some limitations i.e Non conventional Cash flows
mutually exclusive projects and re-investment project and here MIRR eliminate those
deficiencies as a result MIRR is preferrable rather than IRR however, sensitivity analysis
should be performed for all significant variables.
Working of WACC (W1)
Appendix 1
Capital Structure of Tisa
Equity 18 83% Be Tisa Co 1.89
Debt 3.6 17% Ke 14%
21.6 100% WACC 12.78%

After tax Kd 4.50%

Capital Structure of Elfu Co. (Proxy)

Be 1.4
Ba WA 1.22
Equity 480 83%
Debt 96 17%
576 100%

Related to Component Related to Others

Equity 120 86% Equity 360 82%
Debt 19.2 14% Debt 76.8 18%
139.2 100% 436.8 100%

Be 1.08 Be 1.25
Ba WA 1.22 (1.08*75%)+(Ba Comp*25%) Ba 1.08
Ba 1.64

Geared Beta
Topic: Acquisition Merger

Investment:
Appraisal:
Investment -100000
PV of FCF 120000 Value of Investment
NPV 20000

Acquisition
Investment
Value of Investment= Target Company Business:
Business Valuation Total Assets Total Debt
1. Equity Valuation Total Equity
2. Debt Valuation

EQUITY VALUATION:
1. Net Assets Method (Balance Sheet Approach)
Realisable Value of (Total Assets less Total Liabs.) To determine the minimum value of the business
Ignore: Goodwill & Intangible Assets Having no Realisable Value
and if we divide with the no of shares we can calculate the Per share Value.

Income Based Approach

2.P/E Ratio Method Telco:
EPS*P/E Ratio= Value of Share Target Co: Telco= EPS=PKR 25
P/E Ratio= Potential= Telco Industry= 10 Times
To determine the industry Value of Per Equity Share= 25*10=250
potential base Valuation No. of equity Shares 100,000
Value of Equity 25,000,000

3. Earning Yield Method EY= EPS/MV of Share

Value of Share= EPS/EY(%)

4. Cash Flow Based Approach

i) Dividend Valuation Model DVM

Par Value (PV) 10
Market Value (Po) 50
Do( Current Dividend) 2.5
ROI 5% Ke

Ke= Do/Po
Po=Do/Ke Without Growth
Po=Do(1+g)/Ke-g With Growth
ii) Free Cash Flow Method
a) Free Cash Flow
b) Free Cash flow Firm/ Equity= 1 Year
c) Free Cash Flow Valuation = Firm/ Equity

a) Free Cash Flow

Example 1;
A Business expects to generate a free cash flow for equity of $140,000 in the next
accounting period. The WACC is 9%, the cost of equity is 10% and the free cash flow
for equity is expected to grow 5% per year to infinity.
What is the value of the equity of the business?

Answer
Free CF (1 Year) 140000
Growth Rate 5%
Ke 10%

Value of Equity= Free CF*(1+g)/Ke-g

Free CF*(1+g) 140,000

Value of equity 2,800,000

Free Cash Flows Valuation = Complex Issues The right way sir HQ Performed.
FRANCESCA CO.
Working for Free Cash flows Value of Business/ Firm'
Delayed Perpetuity Appendix 1
Valuation of Business/Firm
Yr1 to Yr3
Yr 3 Onwards
FRANCESCA CO.
Free Cash flow-Equity Value of Debts
Appendix 1 Value of Equity
Year 1 Year 2 Year 3
Sales revenue 85,000 92,000 102,000 Sales revenue
Costs Excluding DEP - 45,000 - 49,000 - 58,000 Costs Excluding DEP
Cash flows 40,000 43,000 44,000 Cash flows
Tax Payments - 12,000 - 12,900 - 13,200 Tax Payments
Necessary C.E - 3,000 - 32,000 - 5,000 Necessary C.E
Finance Cost - 11,000 - 11,000 - 11,000 Free cash flow firm
Free cash flow-E 14,000 - 12,900 14,800 WACC
DF 14% 0.877 0.769 PV
PV 12,281 - 9,926 138,582
Value of Business 140,936 Yr 3 Onwards
Value of Debts -70000 Delayed Perpetuity
Value of Equity 70,936

[Link] VALUATION
Non Marketable= Bank Loan
Marketable= Bank Issue

Marketable= Bonds/Pref Shares/Debentures (Always Lender Perspective)

Redemption Yield Method

Bond Value= Future Benefit= Interest+Redemption (Premium If any)

Basic Example: Redeemable Bonds

8% Bonds= Par Value 100
Redemption time 5 Years
Redemption at par
Market rate of interest/kd 7.50%

Years C.F DF 7.5% P.V

Interest 1-5 8 4.046 32.37
Redemp 5 100 0.697 69.66
Value of 8% Bonds 102.02

Basic Example: Irredeemable Bonds

8% Bonds= Par Value 100
Redemption time 5 Years
Redemption at par
Market rate of interest/kd 7.50%

Value of 8% Bonds= PV of future Benefit= interest with infinity

Interest/Kd 106.6667 Value of 8% Bonds

Convertible Bonds: Value By Redemption Yield Method= With Time Specific

Consider of Higher of redemption Value OR Conversion Value
 Operations
Income Statement
Revenue
Operating Expenses
Operating Profit= PBIT

um value of the business

way sir HQ Performed.

Business/ Firm'

of Business/Firm
39,845
242,883

- 70,000
212,728
Year 1 Year 2 Year 3
85,000 92,000 102,000
- 45,000 - 49,000 - 58,000
40,000 43,000 44,000
- 12,000 - 12,900 - 13,200
- 3,000 - 32,000 - 5,000
25,000 - 1,900 25,800
11%
39,845

242,883
Paxis
Part A
Synergy Why Synergy Creates?
Value of individual company Cost Synergy
Paxis W1 38558.48 Revenue Synergy
Wragger W2 50997.69 Financial Synergy
Total Value 89556.17

Value: Combine Co W3 105143.9 Exam Point: Expertise required for Explanation &
Synergy (If CV>TV) 15587.8 Application Refer the Notes

Valuation by Free Cash Flow Value: Combine Co W3

Paxis W1
Free Cash Flow: Business/Firm

Year 1 to 4 7478.42
Year 4 Onwards 31080.062
Total Value 38558.48

WACC
Capital Structure
Equity 70%
Debt 30%

Ke (CAPM) 12.26%
Kd 6%

WACC 9.84%

Year 1 to 4 1 2 3 4
PBIT 3360 3528 3704.4 3889.6
Tax: Operating Profit -1008 -1058.4 -1111.32 -1166.9
Tax Depreciation 1522.5 1598.625 1678.556 1762.5
Cap Ex -1680 -1764 -1852.2 -1944.8
Free Cash Flow 2194.5 2304.225 2419.436 2540.4
DR: WACC 9.84%
Valuation Yr1-Yr4 7478.42

Year 4 Onwards 31080.062

Wragger W2
Year 1 to 4 6998.71
Year 4 Onwards 43998.974
Total Value 50997.69

WACC
Capital Structure
Equity 45%
Debt 55%

Ke (CAPM) 13.66%
Kd 7.5%

WACC 9.03%

Year 1 to 4 1 2 3 4
PBIT 3035.25 3232.5 3442.656 3666.4
Tax: Operating Profit -910.575 -969.8 -1032.797 -1099.9
Tax Depreciation 1171.5 1247.6 1328.745 1415.1
Cap Ex -1320.6 -1406.4 -1497.858 -1595.2
Free Cash Flow 1975.575 2104.0 2240.747 2386.4
DR: WACC 9.03%
Valuation Yr1-Yr4 6998.71

Year 4 Onwards 43998.974

Paxis Perpective:
Wragger: Market Value 15360
Paxis Offer to Wragger:Value 19072
Premium Offer 3712
The reason for offering premium is due to synergy of 15328

Synergy Allocation Paxis Offer to Wragger:Value 19072

Wragger: Premium 3712 24% Add: Part Of Synergy 11616
Pasix: Balance 11616 76% Maximum Offer 30688
15328 Where Paxis shareholders
wouldn’t face loss
Shareholder: Return/ ROI
Paxis: Market Capitalisation 20860
ROI (11616/20860) 56%

Mode Of Consideration
Acquirer Perspective Acquiree Perspective

CASH CASH
[Link] up the business w/o [Link] Value what we are getting
acquire S/Hs involvement [Link] Flexible

[Link] Arrangement [Link] Burden

i) Debts= Gearing Issues [Link] future involvement= Post Acquisition
ii) Equity= Like Right Issue= S/H required to inject
Any other Option

SHARE EXCHANGE SHARE EXCHANGE

1. No Cash arrangement 1. Although control dilute but existence with new busine
but dilution with equity proportion 2. Become Flexible= Sale the shares after acquisition.
3. No tax burden as compare to cash offer

4. Difficult to determine absolute value of share exchang

DEBTS DEBTS
1. Gearing Level Increase 1. Fixed Return= Interest

Loss= Equity Stake

All Above analysis also need to consider ROI for each mode of consideration
or Explanation &

WACC (Combine)

Paxis Paxis
Equity 31% 20.86 Ke 12.26%
Debt 13% 8.94 Kd 6.00%

Wragger Wragger
Equity 28% 19.072 Ke 13.66%
Equity Related to debt 15.36 Kd 7.50%
Debt 28% 18.77
67.65

Combine WACC 9.64%

Year 1 to 4 1 2 3 4
Sales 24096.98 25542.8 27075.37 28699.89
Operating Profit 30% 7229.094 7662.84 8122.61 8609.967
Taxation -2168.7282 -2298.852 -2436.783 -2582.99
Tax Depreciation 2703 2865.18 3037.091 3219.316
Cap Ex -3010.4 -3191.024 -3382.485 -3585.435
Free Cash Flows 4752.9658 5038.144 5340.432 5660.858
WACC 9.64%
Valuation yr1-yr4 16494.18398

Year 4 Onwards 88649.7

istence with new business arrangement.
res after acquisition.

e value of share exchange offer. It’s a challenge not a drawback

ation
Sigra Co. Working
Mode of Consideration Dentro Equity Valuation: P/E Ratio Method
% Gain: Dentro (Target Co.) EPS*P/E ratio 4.5
Cash Offer 11.11%
Shares Offer 21.46% EPS(DENTRO) P/E Ratio
2% Bonds Offer 29% PAT 625 Assumption: P/E Of Sigra
No of Shares 1250 Value Per Share
Cash Offer EPS(DENTRO) 0.5 EPS
Per Share: PAT
Receive 5 No of Shares
Forgone 4.5 EPS
Total Gain 0.5 P/E Ratio of Sigra
Gain In percentage 11.11% P/E Ratio with adjustment (

Share offer evaluation: Target Co (Perspective)

Two Possibilities
1. Shares Value: Acquirer = Now Value
2. Shares Value: Acquirer= Post Equisition (Estimate)

Here the case: Sigra Post Acquisition Shares Valuation

Shares Offer Sigra Value: Given 39600

Per Share: Dentro Value: As cal Above 5625
Receive: 3 shares 10.93 Synergy 30% of Dentro 1687.5
Forgone: 2 shares 9 Post acq. Value 46912.5
Gain for 2 Shares 1.93
Gain Per Share 0.97 Sigra Shares Now 11000
Gain In percentage 21.46% Sigra Offer Dentro 1875 Use Dentro shares as the sha
Post Acq No of Shares 12875

Post Acq: Value of shares 3.64

Calculation for KD
2% Bonds Offer Yr 0 1 2
Receive 93.01 C.F -104 6 6
Forgone 72.00 IRR 5%
Gain 21.01
Gain Per Share 1.31
Gain In percentage 29%
Value of 2% Bonds Yrs C.F D.F
Interest 1-3 2 2.747
Redemption 3 100 0.875
Assumption: P/E Of Sigra ACQUIRER PERSPECTIVE
Value Per Share 3.6 Given
Synergy Allocation Dentro
4950 Cash Offer 37%
No of Shares 11000 Shares Offer 72%
0.45 2% Bonds Offer 97%
P/E Ratio of Sigra 8.00
P/E Ratio with adjustment (12.5%) 9.00
Cash Offer
Synergy 1687.5
Dentro Premium/Gain 625
Balance:Sigra 1062.5

Shares Offer
(Applied Below) Synergy 1687.5
Dentro Premium/Gain 1206.9
Balance:Sigra 480.6

2% Bonds Offer
Synergy 1687.5
Dentro Premium/Gain 1641.7
Balance:Sigra 45.8

Use Dentro shares as the shares are bought by Sigra

3
106

PV
5.49
87.52
93.01
ERSPECTIVE

Sigra Sigra: Acquirer: (Shareholder Return)

63% MV NOW Syn. Alloc./Share Return
28% Cash Offer 3.6 0.10 2.7%
3% Shares Offer 3.6 0.04 1.2%
2% Bonds Offer 3.6 0.0042 0.12%

37%
63%

72%
28%

97%
3%
Example CW
CIV METHOD

Operating Profit of CXM 137.4

Asset Base 307
WACC 6.50%

Similar Company
Operating Profit 315
Asset Employed 1583
ROA 19.9%

Operating Profit of CXM 137.4

Less: App. ROA*[Link] -61.09
Spread 76.31

Post Tax Spread 53.417

CIV 821.8032 (That can be premium demand by the Target Co.)
Asset Base 307
Value of the Firm 1128.803

Business Valuation by CIV= CIV Valuation by spread+ Asset Base

HAV Co.
Part B: Maximum Premium
Appendix 1
$ %
Strand Co. 2,276 40%
Hav Co. 1,698 30%

Strand Co: (Premium Based on Excessive earning)

Excessive Earning
Pre-Tax Earning- Avg 373
Capital employed-Avg 869
Excessive Earning-Pre Tax 199.13 Earning pre tax-(CE Av*20%)
Excessive Earning-Post Tax 159
Premium:PV of [Link](Post Tax) 2,276

Hav Co: (Premium Based on Synergy:Valuation by PE Ratio)

Synergy Strand Valuation by P/E Ratio W1 (Calcalate because it a pri
Individual Co: Values PAT 318
Hav: Given 22,176 P/E Ratio: Adjusted 18
Strand: W1 5,730 Equity Valuation 5,730
27,906 Value per share 4.77
Combine Valuation W2 29,603
Synergy Maximum Premium 1,698 W2: Combine Value
Combine Earning Post Tax
HAV 1,584
Strand 318
Synergy 140
2,042
P/E Combine co.(Given) 15
Total Value 29,603

Part C: Premium % received by Strand Gain %

Cash Offer 20%
Cash+ Shares Offer 31%
Cash+ Bonds Offer 25%

Cash Offer
Per Share
Receive 5.72
Forgone 4.77
Gain 0.95
Gain % 20%

Cash+ Bonds Offer

Per Share
Receive
Cash Per Share 1.25
3% Convertible Bonds 5
6.25
Forgone 4.77
Gain 1.48
Gain % 31%

Cash+ Shares Offer

Per Share
Receive
Cash per Share 1.33
Shares of Hav Co. 4.62
5.95
Forgone 4.77 With this analysis: (Share Exchange) either using current value of share (H
Gain 1.18 or Post acquisition value both are acceptable.
Gain % 25%

Part C (Justification+ Explanation)

The cash offer provide the gain of 20% which is the lowest return and having tax burden but certain and immediate,
cash and share offer provide the gain of 25% which is higher than the previous offer and it will also provide the
ownership right but containing tax burden and risk of fall in share price and last but not the least cash plus bonds offer where s
can make a gain of 31% which is the highest gain among all offers so it might be acceptable as this gain is also nearest
to the premium ask by Strand Co. i.e. 40%. However, in cash plus bonds strand co can get the benefit later which is after
six years and on the other hand Hav Co.'s shareholders will also be happy with this offer as it wouldn’t dilute their shareholding
(Calcalate because it a private company)
g current value of share (Hav)

and immediate,
provide the
sh plus bonds offer where strand co.
gain is also nearest
t later which is after
n’t dilute their shareholding in the company.
Opao Co.
Appendix 1
Part C
Opao Co. Tai Co.
Value of equity before
Acquisition 5,000 1,000
Value of equity After Acquisition
6719

Value of Equity Before Acquisition

Opao Co.( Million) 5,000

Tai Co.
From Free Cash Flow-Equity
(Million)
Profit before interest and tax 132
Add: Depreciation 27.4
Tax On operating Cash flows - 26.40
Less: Investment and Working Capital - 24.3
Free Cash Flow-Equity 108.7
PV of Cash Flows 1,400
Market Value of Debts - 400
Value of Equity before Acquisition 1,000

Value of Equity After Acquisition

Year 1-4 2,706

Year 4 Onwards 8,492
Total Valuation 11,199

Year 1-4 1 2 3 4
Sales Revenue 7,351 7,720 8,108 8,515
Pre-Tax Profit Margin 1,132 1,189 1,249 1,311
Tax On Operating Cash flows - 226.41 - 237.78 - 249.71 - 262.25
Necessary Capital Expenditure - 109 - 114 - 120 - 126
Free Cash Flow 797 837 879 923
Combine WACC 10%
Valuation Yr1-Yr4 2706.21

Valuation Yr4 Onwards 8,492

Total Valuation 11,199
Valuation Of Equity 6,719.22
Offers Gain % Tai Co. Receive
Cash Payment 15.8%
Share for share Exchange 40%
Cash and Share Offer 23%
Gain % Opao Co. Receive
Cash Payment 11.2%
Share for share Exchange 6%
Cash and Share Offer 10%

Cash Payment
Shares MV Pre Acq Shares
Opao Co. 2,000 5,000 2,000
Tai Co. 263 1,000
6,000

Share for Share Exchange

Additional value
Shares MV Pre Acq Shares
Opao Co. 2,000 5,000 2,000
Tai Co. 263 1,000 526
6,000

Share Exchange Ratio

Cash and Share Offer

Shares MV Pre Acq Shares
Opao Co. 2,000 5,000 2,000
Tai Co. 263 1,000 200
6,000
MV Post Acq Synergy Gain %
5,562 562 11%
1,157 158 16%
6,719

MV Post Acq Synergy Gain %

2.66 5,320 320 6%
2.66 1,399 399 40%
6,719 720

2 Opao Co. offered its two shares in exchange Tai co. 1 share

MV Post Acq Synergy Gain %

2.74 5,486 486 10%
2.74 550 234 23%
684 720
6,719
Nutourne Co.

Forward Contract 12676.79

Futures Contract 12740.34
Options Exercise 12654.03
Options Lapse 12634.99
Forward Contracts
Spot 1.0292
Three Months Forward 1.0327
Six Months Forward 1.0358
1.0306
Forward Receipt 12676.79

Futures Contracts
Sell Now: Buy Later
June Contracts
No. Of Contracts 98.4
Under Hedging 50

Lock In Rate
June Futures 1.0369
BR Remaining -0.0011
Effective Rate 1.0358
Total Receipts 12740.34

Options
Exercise Price 1.0375
Buy June Put Option
No. Of Contracts 98.4
Under Hedging 50
Premium Payment 105.35

Outcome
Exercise Price 1.0375
Est. Forward 1.0358
Assume the options will be excercised

Net Outcome
Exercise 12709.375 Spot 12740.34
Premium Payment -105.35 Premium Payment -105.35
Under Heding 50 12634.99
Total Receipts 12654.0
NUBO CO.
Part A
Sell off (Super Market) 581 We will assume to go with Sell off
Divest (Super Market) 511.07

Divest
Proportion of Assets belongs to super Market Division
Non Current Asset 385
Current Assets 85.4

Relisable Value
Sale of Assets 511.07

Sell Of
Value of Super market Division by P/E Ratio.
PAT (50% of total Business) 83
P/E Ratio (Supermarket Division) 7 Times
Sell of 581

Restructure Balance Sheet

Total Liabilities before resturcturing (CL 95+NCL 387)=482

Although both the above options generate sufficient funds to pay off for the
liabilities, the sale of the supermarket division as a going concern would generate
higher cash flows and the spare or remaining cash flows of (581-482)=$99m
can be used by Nubo Co for reinvestment in Aircraft Division

*Assume the accuracy of equity valuation by P/E Ratio

Debt Capacity
Debt Capacity based on downsized company equals to Aircraft Division only.

Remaining Assets belongs to Aircraft Division = 30%

Total Assets
Previous Assets 201.6
Spare cash after pay off Liabs 99
Total Assets of DS Co.(Air Div) 300.6

Debt Capacity equals to total Assets of downsized Company 300.6

Coeden Co.

Before Proposal After Proposal Workings

Cost of Equity 10.60% 9.60% 1. Value of 5.2% Bond by Red. Yi
WACC 7.27% 8.23%
Yrs
Before Proposal 1
2
Kd by Spread 4.9% RF+ Spread 3
Capital Structure
Equity( By Free Cash flow) 42,614 50%
Debt (By [Link] Method) 42,344 50%
84,958
2. Equity Value: By Free Cash flow
WACC 7.27% Free Cash Flow
Growth
After Proposal By Gordon Model (b*r)
Change in Financial Risk b=40% , r(ke)= 10.6%
Debts Repayment 70%
Debt Revise level 12600 Book Value' Equity
Kd= Rf+Spread 4.6%

After Selling Property the Systematic Risk will also Change

Proxy Company
Ba WA=(Ba HP 0.4*40%)+(Ba HS?*60%) 0.75 Ba HS

Ba WA= Now =1.1*50/50+50(1-0.8) 0.6111

1. Revised Value of 5.2% Bond by
Business Reorginasation Implications Here
1. Financial Risk Reduces Yrs
2. But Systematic risk Becomes Increases 1
2
3
Ke 9.60%
Kd Rf + Spread 4.6%
Capital Structure
E= MV of Equity (Assumption Remain Same) 42,614 77%
D= MV of Debts 12,807 23% 4. Equity Beta: With new Capital
55,421
Ba HS
WACC 8.23% Be

Before After
Ba 0.6111 0.75 Systematic Risk
Financial Risk High Low
Be 1.1 0.9 Financial Risk
Ke 10.60% 9.60%
WACC 7.27% 8.23% Debt As Cheaper finance as compare to equity, Low pr
1. Value of 5.2% Bond by Red. Yield Method

CFs DR 4.9% PVs

5.2 0.953 4.957
5.2 0.909 4.726
105.2 0.866 91.136
Value of 5.2% Bonds 100.82
Value:Total Bonds 42343.77322

2. Equity Value: By Free Cash flow Method

Free Cash Flow 2600

By Gordon Model (b*r)

b=40% , r(ke)= 10.6% 4.24%

42613.836

1. Revised Value of 5.2% Bond by Red. Yield Method

CFs DR 4.6% PVs

5.2 0.956 4.971
5.2 0.914 4.753
105.2 0.874 91.922
Value of 5.2% Bonds 101.65
Value:Total Bonds 12807.430414

4. Equity Beta: With new Capital Structure

0.75
0.93
ance as compare to equity, Low proportion
Newimber Co.
Business Reorganisation
Unbundling:

Management Buy Out

Management Buy In

Management Buy Out

Bento Co.
Part B
1 2 3 4

Covenant (D/D+E) 75% 60% 50% 40%

Breach Yes Or No
Gearing Ratio (D/D+E) 73% 61% 47% 32%
Breach (Yes/NO) No Yes No No

1 2 3 4
Equity 15,965 23,144 31659.49 41649.21
Debt 43342.38 36152.14 28386.69 20,000 Working 8% Compound Int
Total 59,308 59295.88 60046.18 61649.21 EAC
Yrs
Projected: MBO PAT & Res 1 2 3 4 1
Operating Profit 13542 15031.62 16685.1 18520.46 2
Finance cost 3
6% Conv Loan (simp Loan) - 1,200 - 1,200 - 1,200 - 1,200 4
8% Compound Int - 2,400 - 1,867 - 1,292 - 671
Profit Before Tax 9,942 11,964 14,193 16,650
Taxation - 1,988 - 2,393 - 2,839 - 3,330
PAT 7,954 9,571 11,354 13,320
Dividend 25% - 1,988 - 2,393 - 2,839 - 3,330
Profit to RE 5,965 7,179 8,516 9,990

Comment:
The gearing covenant is forecast to be reached in the second year only, and by a marginal amount.
it is forcast to be in all other years and it is unlikely that Dofu Co. will be too concerned about the
covenant breach.

Part C:

Answer Planning
1. Evaluate the offer made by Bento $60M
2. How, by comparing valuation of business
3. Business Valuation/ Equity Valuation
1. NA Based Valuation 57440
2. Dividend Valuation 58372.16

4. Other Points

NA Based Valuation Dividend Valuation: Fundamental Value

Realisable Values: Dividend Yr1-Yr4 7,819.58
NCA 53040 Dividend Yr5- Inf 50552.58
CA 12300 58372.16
Total Liabilities -7900
Total MV 57440 Dividend Valuation= Equity Valuation
PV of future Dividends

Dividend Yr1-Yr4
Years Dividend DF PV
1 1,988 0.893 1,775.36
2 2,393 0.797 1,907.56
3 2,839 0.712 2,020.45
4 3,330 0.636 2,116.21
7,819.58

Years 4 onwards
Delayed Perpetuity With Growth

Div. Growth 18.75% Yr1-Yr4

7.50% Yr4 Onwards

Value 50552.58
Working 8% Compound Int
9057.624
Bal OP Int Inst Bal End
30000 2400 9057.624 23342.38
23342.38 1867.39 9057.624 16152.14
16152.14 1292.171 9057.624 8386.689
8386.689 670.9351 9057.624 -
 Do(1+g)/Ke-g
Growth with perpetuity

Yr4 Onwards
Kawa Co.
Appendix 1
Kawa Equity Value: Demerged Co. (By Free Cash Flow)
Value of the Business
Year 1-Year 4 494.27
Year 4 Onwards 1388.589
Total Value 1882.86
Value of Equity 75% 1412.15 Kawa Cap structure remains same
KAWA No of Shares 2000
Per Share Value: As Demerge 0.71
Per Share Value: Now 0.60
Gain in case of Demerger 0.11
Gain In % 17.68%

Year 1- Year 4 1 2
Sales Revenue 954.00 1011.24
Operating Profit 200.34 212.36
Tax Payment 20% -40.07 -42.47
Additional Cap Ex -13.5 -14.31
Free Cash Flows 146.77 155.58
DR 0.11
NPV 494.27

Year 4 Onwards 1388.589358

Appendix 2
Additional Equity Value: Combine Company: KAWA and Lahla
Value as Independent Company
KAWA 1200
Lahla W4 2402.379
Total Value 3602.379
Equity Value : Combine W5 4253.88
Additional Value= Synergy 651.50

Appendix 3:
% Gain to each of Lahla's Co and Kawa Co's Shareholder

Mode Of Payment KAWA LAHLA

Cash Offer W6 10% 22%
Share Offer W7 26.60% 14%

Appendix 4
Impact on Lahla Capital Structure under each payment Method
Debt
Now 40%
If,
Cash Offer W9 47%
Share Offer W10 32%
ap structure remains same after unbundling

3 4
1071.91 1136.23
225.10 238.61
-45.02 -47.72
-15.17 -16.08
164.91 174.81
Equity
60%

53%
68%
Workings
W1: Cost of Capital (KAWA)
Market Value of Equity 1200.5 75%
Market Value of Debts 400 25%
1600.5
Be 1.46
Kd Post Tax 3.52%
Ke 13.5%
WACC 11.0%

W4: Value of Lahla Company ( PE Ratio Method)

PAT Given 171
PE Ratio Adjusted 14.049
Equity Value 2402.379
No of Shares 1200
Per Value Share 2.0019825

W5: Equity Valuation Combine Co. (P/E Ratio)

PAT Combine CO.
Lahla Co. 171
Kawa Co. 117.1
Increase In PAT 62
Combine CO Profit 350.1

P/E Ratio
Lahla ( As Above) 14.049
Kawa 10.252
Mid Point 12.150

Combine Value 4253.88

Cash Offer W6
Kawa
Receive: Cash Per Share 0.66
Forgone: Value per share 0.60
Gain per Share 0.06
Gain % 10%

Lahla
Value of Equity Now 2402.379
Synergy Allocation
Total Synergy 651.50
Less: Premium to KAWA -120
Balance: Synergy to Lahla 531.50
Gain% 22%

Share Offer W7
Kawa
Receive post Acq est W8 2.28
Receive: KAWA per Share 0.76
Forgone 0.6
Gain 0.16
Gain% 27%

Lahla
Value of Equity Now 2402.379
Synergy allocation
Total Synergy 651.50
Less; premium -319.24
Balance Synergy 332.26
Gain % 14%

Cash Offer W9
Debt Now:
Equity Value of Lahla: 60% 2402.379
Total Value 4003.965
Debt Now: 1601.586
Kawa Loan B 400
Cash Offer Value 1320
Total Debts after Acquisition 3321.586
Total equity: Before Acq 2402.38
Synergy Allocation [Link] offer 531.50
Total Equity After Acq 2933.88

Total Value 6255.46

Debt 53%
Equity 47%

Share Offer W10

Debt Now:
Equity Value of Lahla: 60% 2402.379
Total Value 4003.965
Debt Now: 1601.586
Kawa Loan B 400
Total Debts after Acquisition 2001.586

Total equity: Before Acq 2402.379

Synergy Allocation [Link] offer 332.26
Total Equity After Acq 2734.635
Share offer Value 1520
Equity Value after Acq 4254.63
Total Value 6256.22
Debt 32%
Equity 68%
W8 Post Acq value of Share
Combine Equity Value 4253.88
No of Shares 1200
New Shares 666.67
Total Shares 1866.7
Value per Share 2.28
FINANCIAL RECONSTRUCTION

Information available through a question. For report writing we required:

What examiner expect? 1. Appendix 1: The case of liquidition
2. Appendix 2: The case of financial Reconstructio
Report to stakeholder as consultant
3. Report Writing
1. Liquidate
OR Complexities:
2. Financial Reconstruction Liquidition:
Relisable Values of Total Assets
Payment Structure:
1. Debts
a) Secured Debts
b) Unsecured Debts
2. Liquidation Cost
3. Redundancy Payments
4. Penalties (Govt./Supplier/Customer)
5. Remaining to Shareholders.
we required:
case of liquidition
case of financial Reconstruction

Financial Reconstruction:
Total Assets Balance Sheet Restructure
1. Debt to Equity= SWAP
2. Equity (Par Value OR Nos) Restructure
3. Balance Sheet = Going Concern Basis= RV
bts
Equity Structure (Revise)
ments 1. Previous Share Holder= Holding
/Supplier/Customer) 2. VC= New= Holdings
areholders. 3. Debt to Equity SWAP = Holdings
4. Management Part of Equity= Holdings

Debt Structure
Financial Gearing
Interest Cover

Cash Position

Profitability

Valuation= Post Reconstructure

Share Capital ($1) 100,000

Par Value Now 0.5/Share

Or
No. share now 50%

DR: Share Capital 50,000

CR: Retained Earning 50,000
Dricom Co.
Appendix 1: Liquidation Appendix 2: Financial Reconstruction
Reliasable Values of Total Assets Equity Structure Revise
Share capital
Land and Building 1200 Venture Capital
Plant and Machinery Remaining 1300 Management
Machinery 300 Convertible Debts
Stocks 670
Debtors 1090
Cash 35 Share Premium
Total Reliasable Value 4595 Venture Capital
Management
Allocation Convertible Debts
Secured Debts:
12% Term Loan 800 Total Equity
9% Debenture 500
8% Convertible Debts 1000 2300 Debt: New Structure
Remaining Funds 2295
Redundancy Payment 1000 Secured
Remaining Funds 1295 13% Term Loan
Unsecured Debts: 9% Debenture
10% Loan Stocks 500 10% Bank OD
10% Bank Overdraft 620
Other Creditors 940 2060 Unsecured
10% Loan Stock
Proportion: Unsecured Debts 63%
Long Term Debts
Note: Other Creditors
1. Secured Debts 100%
2. Unsecured Debts 63% At Restructing Point
Shareholders NIL LT Debts
Equity

Gearing Ratio (D/E)

Interest Cover Ratio (PBIT/Interest)

Report Writing: Key Points

Existing Shareholders
In case of Liquidation=Receive=NIL
In case of Restructure= offer to receive =0.28/share

Venture Capital
In case of Restructuring
1. Equity Stake 39%
Investment 1 Million
Returns
EPS 1st 2 Years 0.185
EPS after 2 Years 0.124
ROI
1st 2years 129.5 13%
After 2 years 86.765 9%

8% Convertible Loans
Equity Stake (600) 33%
Investment 1000 Incase of liquidation
Returns
EPS 1st 2 Years 0.185
EPS after 2 Years 0.124
ROI
1st 2years 111 11%
After 2 years 74.4 7%

Management
Job secure but they have to invest
but they become equity holders in the company

10% Loan Stock

In case of Liquidation 315
In case of restructuring
10% Loan Stock= Unsecured
Loan Save by 100% 500
There loan will not be written off
Loan would be continue
ROI
Interest 16%
 Shares % PV Amount Cash Position
700 39% 0.25 175 Now 35
500 28% 0.25 125 Projected: Inflows
600 33% 0.25 150 VC: equity Fund 1000
1800 100% Mang:Equity Fund 750
Term Loan 1200
MV Sale Machine 300
700 1.18 1.4 826 3285
500 1.25 1.5 625 Projected: Outflows
600 1.32 1.57 792 Shareholder 280
Redundancy 500
2693 Machine Inv 2250
3030
Net Surplus Cash 255
Debts Interest Information lack about working Capital Requirement

2000 260
500 45 Income Positions: After Restructing
620 62 1st 2 Years After 2yrs
PBIT 750 750
Interest Cost -417 -417
500 50 PBT 333 333
Taxation 0 -109.89
3620 417 PAT 333 223.11
940
P/E Ratio
Industry P/E Ratio 12 Times Potential
3620
2693 P/E (Potential) Dricom
Price of shares 1.5 1.5
134% EPS 0.185 0.124
1.80 P/E (Potential) Dricom 8.11 12.10

Average Price of Shares 1.5

Valuation of business is missing in this question

 StakeHolders:

Term Loan: BXT Bank Secured

9% Debentures Secured
8% Convertible Debentures Secured
10% Loan Stock Unsecured
Bank Overdraft Unsecured
Trade Creditors

Share Holders

Venture Capital

Management= Equity Holders

l Requirement
Floating Able to Sold
Fixed Not able to sold
Floating Able to Sold

After reconstruction it become secured

Treasury Management

ForEx: Risk Management

Interest Rate: Risk Management
SWAP

ForEx: Risk Management

1. For Ex= Risk ?

Import = ForEx payment = BUY= RISK= FC Value UP OR LC Value Down
Export= For Ex Receive = SELL= RISK= FC Value Down OR LC Value UP

2. Risk Management
STRATEGIES:
Transfer Avoid
Insured Avoid Travelling 100%

Reduce Accept
Reduce ActivityDo Nothing for Risk Management

3. ForEx: Risk Management

Strategies:
1. Currency Invoicing = FC Transaction but invoice based on LC
2. leading and Lagging = Lead means Upfront payments & lag means delay the payments.
3. Netting = Transaction net (cut off), payments and receipts ( Condition: Timings & currency shou
4. Bilateral & Multilateral Netting
Matching
6. Money Market Hedging

Hedge Instruments
7. Forward Contract OTC
8. Future Contracts MSC

9. Option Contract OTC

10. Option Contract MSC

11. SWAP
ans delay the payments.
dition: Timings & currency should be same)
Forward Contract

Basic Example

LC: PKR & FC US$ Case 1

Pakistan Based Company 1. If estimated Spot = PKR 2

FC Exposure

Now 1/1/23 Spot Market ($10000*267)

FC Payment after 2 Months 1/3/2023: $10,000 FWD Cont Sett (267-265)

Spot Rate Now: 260 Total Payments

Risk: PKR will weak in future Effective rate

Bank Offer Forward Rate= PKR 265/USD Case 2

1. If estimated Spot = PKR 2

What will be out come if the estimated spot 1/1/23 become

1. PKR 267/USD Spot Market ($10000*262)

2. PKR 262/USD FWD Cont Sett

Total Payments

Forward Contract Meaning? Effective rate

1. After 2 months ABC co will take up the physical delivery $10000 @265 from bank
2. After 2 months ABC co will settle the forward rate on net basis (Betting Contract)

Exam Solution: Forward Contract

The total Estimated Payments for $10000 with forward contract

 estimated Spot = PKR 267/USD

PKR

t Market ($10000*267) 2670000

D Cont Sett (267-265) -20000 Gain=Receive = 2PKR/$

al Payments 2650000

ctive rate 265

estimated Spot = PKR 262/USD

PKR

t Market ($10000*262) 2620000

D Cont Sett 30000 Loss= Payment = 3 PKR/$

al Payments 2650000

ctive rate 265

00 @265 from bank

is (Betting Contract)

2650000 PKR
Forward Contract:

1. Legal Binding Contract

2. OTC: With respect to contract holder

Customise Contract:

a) Nature of Currency

b) Volume of Currency

c) Contract Settlement Date

Future Contract
Basic Example
LC: PKR & FC US$
Pakistan Based Company
FC Exposure
Now 1/1/23
FC Payment after 2 Months 1/3/2023: $10,000
Spot Rate Now: 260
Risk: PKR will weak in future

Risk Management = Future Market Now 1/1//23

Forex Market : Spot
PKR/US$ March Futures
Spot Market 260 Basis Risk
Future Market
March Futures 263 Assumption: Basis risk will

Future Contract Meaning?

1. After 2 months ABC co will take up the physical delivery $10000 @265 from bank
2. After 2 months ABC co will settle the Future rate on net basis (Betting Contract)

What will be out come if the estimated spot 1/1/23 become

1. PKR 264/USD Outcome 1/3/2023
2. PKR 262/USD
Future Market Close
01/01/2023: Buy $
1/3/2023: Sell $
Gain

Future Contract
Basic Example
LC: PKR & FC US$
Pakistan Based Company
FC Exposure
Now 1/1/23
FC Payment after 2 Months 1/3/2023: $10,000
Spot Rate Now: 260
Risk: PKR will weak in future
Now 1/1//23
Risk Management = Future Market Spot
Forex Market : March Futures
PKR/US$ Basis Risk
Spot Market 255
Future Market
March Futures 261
Case 1: What will be out come if the estimated spot 1/1/23 become
1. PKR 262/USD
Case 2: What will be out come if the estimated spot 1/1/23 become
1. PKR 252/USD

Future Contract: Solution by Lock in rate

Future Rates (Now) 261

Add: Basis Risk Remaining -2
(At transaction date)
Effective Rate 259
 Transac. Date Settlement Date
3/1/2023 3/31/2023
260 EST. SPOT 264
263 EST. Futures 265
-3 BASIS RISK REM -1 0
The difference between spot and march futures
ption: Basis risk will reduce gradually/There is no basis risk

-3/Months/Total Standard Moths 3*Remaining Months 1

@265 from bank

tting Contract)
 Spot Market
263 Low Future Market
265 High Net Payment
2 Gain on Futures Effective Rate

Transac. Date Settlement Date

3/1/2023 3/31/2023
255 EST. SPOT 262
261 EST. Futures 264
-6 BASIS RISK REM -2 0

Outcome 1/3/2023
Future Market Close
01/01/2023: Buy $ 261 Low
1/3/2023: Sell $ 264 High
Gain 3 Gain on Futures

Transac. Date
Now 1/1//23 3/1/2023
Spot 255 EST. SPOT 252
March Futures 261 EST. Futures 254
Basis Risk -6 BASIS RISK REM -2

Outcome 1/3/2023

Future Market Close

01/01/2023: Buy $ 261 Low
1/3/2023: Sell $ 254 High
Loss -7 Gain on Futures
 Future Contract:
1. Legal Binding Contract
2. MSC: With respect to contract holder
Customise Contract:
a) Nature of Currency
b) Volume of Currency
c) Contract Settlement Date
ment Date

ing Months 1
 2640000
20000
2620000
262

ment Date

If we DO nothing: Spot Loss 7

Future Gain 3

Hedge efficiency 43%

 Spot Market 2620000
Future Market 30000
Net Payment 2590000
n Futures Effective Rate 259

Settlement Date
3/31/2023

Spot Market 2520000

Future Market -70000
Net Payment 2590000
n Futures Effective Rate 259
FOREX CODES
[Link] Code
Local Currency PKR Direct Code = FC Denomination
Foreign Currency US$ Indirect Code = LC Denomination

DIRECT CODE: PKR/1US$ With view point of Bank/Exchanger

265 270
BUY SELL Direct Code= Conversion = Multiply X
Indirect Code= Conversion = Divide /

Direct Code = Lower Rate = BUY

Example:
Importer = FC US$ Buy = $2000 = how much need to pay in PKR = $2000*270/$
Exporter = FC US$ Sell = $800 = how to will receive in PKR = 800*265/$

INDIRECT CODE: 1US$/PKR

0.0038 0.0037
BUY SELL

Example:
Importer = FC US$ Buy = $2000 = how much need to pay in PKR = $2000/0.0037/$
Exporter = FC US$ Sell = $800 = how to will receive in PKR = 800/0.0038/$
Code = FC Denomination
t Code = LC Denomination

ew point of Bank/Exchanger

Code= Conversion = Multiply X

t Code= Conversion = Divide /

Code = Lower Rate = BUY

PKR
in PKR = $2000*270/$ 540000
R = 800*265/$ 212000

PKR
in PKR = $2000/0.0037/$ 540000
R = 800/0.0038/$ 212000
KYT INC
Now 1/ July
LC US$: FC YEN
FC Exposure: Yen140m = Payment by 1st September
Total Estimated Payment with future Contract

Which Contract? September Future Contract

Type of Contract? Business Model: Risk FC Yen UP OR LC $ Down
Future Contract = Bases = Y
Buy Yen Now and Sell Yen later
Number of Contracts? 11 Say 11 Contracts
Under Hedging ? 2,500,000 Unhedged Risk

Outcomes (1st September)

Future Market LC $
1/July Buy Yen Now 1,097,980 Buy = low
1/Sept Sell Yen Later 1,155,203.32 Sell = High
Gain On futures 57,224

Spot Market
Buy YEN 140m 1,166,667
Futures Gain 57,224
Net Payment 1,109,443
Effective Rate 126.19
Solution By Lock In rate Y/$
Sept Futures Now 125
Basis Risk Remaining (1/Sept) 0.97
Effective Rate 126.20

EXAM Solution
September future Contract
Buy Yen now and sell later
11 Contracts

Lock in Rate Y/$

Sept Futures Now 125
Basis Risk Remaining (1/Sept) 0.97
Effective Rate 126.20

Hedge Efficiency
Spot Market Loss
Now 1,097,980
01/Sept 1,166,666.67 68,687
Futures Gain 57,224
Hedge Efficiency 83%
If the basis risk is reduce gradually then you can use lock in rate
UP OR LC $ Down Working Y/$
Now 1/July
Spot 128
1 Contracts Sep: Futures 125
dged Risk Basis Risk 3
Working Y/$
Now 1/July Trans Date 1/September
Spot 128 Est Spot
Sep: Futures 125 EST futures
Basis Risk 3 Basis Risk
Trans Date 1/September
Est Spot 120
EST futures 119
Basis Risk 0.97
Date 1/September
120
119
0.97
Allbrit Co.

Now: 1st May

FC Transaction: 31st Oct

[Link] Invoicing 550,000 Pounds

[Link] $ 669,500

FC Hedging
Forward Contract 443,377
Future Contract 443,304

Future Contract
Which Contract
December Futures (sterling) Contract
Sell Pounds Now: Buy Pounds later (Short Positioning)
Contracts 7.16 7 Contracts
Under Hedging 14,563 $

Lock In Rate: $/P

December Futures 1.497
Basis Risk Remaining 0.01325
Effective Rate 1.510

Total Est Payments 443,304

Detailed Solution
Outcome

Future Market $ FC
Sell Now 654,938 Low
Buy Later 685,453 High
Loss On Futures - 30,516

Spot Market
Buy 443,048
Effective Rate ($/P) 1.51
 Spot 1.55 1.552
Premium - 0.04000 - 0.03950
1.5100 1.5125

Premium for Forward Rates

ID Code Less
Direct Code Add

tioning) The reason is that the contract is based on local currency

Now 1 May $/P

Spot 1.55
D Futures 1.497
 BR 0.05

Note:
1. Future/Option Contract = Based on LC= Outcome= FC
2. Vice Versa
is based on local currency

31/Oct
Est Spot 1.58
Est. Futures 1.567
BR Remaining 0.01325
Example 1
LC= $
FC= Pound FC Denominator= Direct Code
Buy Euro Now; Sell Euro later
Payment 720,000
Contract 5.76
Under Hedging 95,000
Working
Lock In Rate Spot
Future December 0.9245 D Futures
BR Remaining - 0.00120 BR
Effective Rate 0.9233

Total Est payments 664,776

 0.9221 Est Spot 0.9355
0.92450 Est Futures 0.9367
- 0.00240 BR Remaining - 0.0012
Option Contract:

We as Contract Holder

Situation:

Favourable = Exercise = GAIN

Unfavourable = Lapse = No Chance of loss

Upfront Premium Payment = Most of the cases = US$

Rates: Exercise Prices

Option:

Call Option= Option to Buy

Put Option= Option to Sell

Example: Pongo PLC.

LC = Pound
FC= $

Spot ($/P) 1.5190 Buy $1.519 in exchange of 1 pounds

Risk = $ Up or Pounds Down

Option Market

Exercise Price: 1.5

Transaction Price: 30th June

Exam Solution

Which Contract June Contract

Type of Contract Buy Put Option ( Pounds) Sell Now: Base

Exercise Price 1.50

Contracts 9.33

Under Hedging 12,500 US$

Premium Payment 0.1240 Converting cents in to dollar

Premium Payment 18,367 Pounds

Outcome: If estimated spot 30 june = 1.4810

Option Market $/P Net Outcome (30 June)

Est. Spot 1.4810 Spot Market

Exercise Price 1.50 Premium Paid

Intrinsic Value Yes Gain/Lapse Total Payment for $350K

Gain 0.019 $ Effective Rate

Total Gain 4,275 $

Exercise Price 1.45

Exam Solution

Transaction Price: 30th June

Which Contract June Contract

Type of Contract Buy Put Option ( Pounds) Sell Now: Base

Exercise Price 1.45

Contracts 9.66

Under Hedging 23,750 US$

Premium Payment 0.1020 Converting cents in to dollar

Premium Payment 15,109 Pounds

Outcome: If estimated spot 30 june = 1.4810

Option Market $/P Net Outcome (30 June)

Est. Spot 1.4810 Spot Market

Exercise Price 1.45 Premium Paid

Intrinsic Value No Gain/Lapse Total Payment for $350K

Lapse Effective Rate

of 1 pounds

Net Outcome

Option Exercise Value 225,000.00

Unhedged Amount 8,440

Premium Paid 18,367

251,808
ome (30 June) Local C Pounds

233,440

18,367

ment for $350K 251,808

1.39

Case 2: Option is not Excercisable

Spot Market 236,327

Premium Paid 15,109

251,435
ome (30 June) Local C Pounds

236,327

15,109

ment for $350K 251,435

1.39
Pongo PLC

Payment

Indirect Code

Put Option

Contracts 9.33

Under hedging 12,500

Premium 18,367
Exam Handling Points

1. If est. Spot is not given in the question, then use forward rate as estimated spot

2. Forward Rate Complications

Spot

Forward (2 Months)

Forward (7 Months)

Forward (5 Months)

Lammer PLC.

Indirect Code

LC Pound

FC $

Company 1 490,000 Receive

Company 2 890,000 Payments

Company 3 750,000 Payments

Netting $ 1,150,000
Futures

Payment 1,150,000

Contracts 9.7

Under Hedging 82,038

Lock In Rate

December Futures 1.8986

Basis Risk Remaining 0.0049

Effective rate 1.903

Total Estimated payment 604,164

Forward Contract

3 Months Forward 1.9066

1 Year Forward 1.8901

7 Months forward rate 1.9029

Total Estimated Payment 604,330

Option Contract Put Options

Type of Contract

Exercise Price 1.8800 1.9000

Contract 19.6 19.4

Under Hedging 33,750 21,875

Puts Cents to $ 0.0296 0.0434

Premium Payment 9,175 13,452

Estimated Spot 1.9029 1.9029

Option Contract Lapse Lapse

Forward Contract 604,330 604,330

Exercise Value - -

Under Hedging - -

Premium 9,175 13,452

Total Est. Payment 613,505 617,782

Money Market Hedging

Payment Case

FC: Asset 1,140,533.6

LC: Borrow 595,392

Interest Payment 13,644

Total Payment 609,037

orward rate as estimated spot

260

263

268

266
 1.9200

19.2

10,000

0.0655

20,302

1.9029

Exercise

593,750

5,255

20,302

619,307
EXAMPLE

Owed By Owed to Amount Basic Rate= pounds

P S CAN 3 2.00

P R USS 5 3.13

Q R USS 4 2.50

Q S CAN 7 4.67

R S CAN 2 1.33

R P USS 6 3.75

S Q EUR 12 10.00

S P CAN 5 3.33
 Amount Paid By

Amount Paid to P Q R S

P 3.13 2.00

Q 2.50 4.67

R 3.75 1.33

S 3.33 10.00

Total Payment -5.13 -7.17 -5.08 -13.33

Total Receipt 7.08 10.00 5.63 8.00

Net R/P 1.96 2.83 0.54 -5.33

Implications of Multilateral Netting

Overall, at group level the foreign currency exposure

become reduces:
Here S needs to pay

To R 0.54

To Q 2.83

To P 1.96
Kenduri Co.
Part A
Kenduri Foreign Currency Exposure with Lakama
$
Payment In 3 Months 4,500,000
Receive In 3 Months 2,100,000
Net Payment in 3 Months 2,400,000

Payment In Local Currency Pounds by 3 Months By

Forward Contract 1,500,375 Viable
Money Market Hedging 1,509,197
Option Contracts
Exercise Price 1.6 1,519,576
Exercise Price 1.62 1,512,888

Money Market Hedging

Stept 1: Asset in US 2,381,543
Step 2: Borrow Pounds 1,494,255
Step 3: Interest Payment 14,943
Total Payment 1,509,197

Option Contract
Exercise Price 2 Exercise Price
3 Months Option Contract 3 Months Option Contrac
Buy Put option Buy Put option
Contracts 24 Contracts
Premium (Pounds) 19,576 Under Hedging
Outcome with Option Contract Premium (Pounds)
Forward Rate 2 Outcome with Option Con
Exercise Price 2 Forward Rate
Exercise Price
Exercise Value 1,500,000
Premium 19,576 Exercise Value
Total Payments 1,519,576 Premium
Under Hedge By Forward
Total Payments

Owed By Owed to Amount Basic Rate= pounds

K L USD 4.5 2.82
K J CAD 1.1 0.70
G J CAD 3.2 2.04
G L USD 1.4 0.88
J L USD 1.5 0.94
J K CAD 3.4 2.17
L G JPY 320 2.41
L K USD 2.1 1.32
Example Question
Case 1
Exercise the Option USS =LC
Exercise Value 821,918
Premium Paid 12,300
834,218

Case 2
Spot Market 762,680
Premium Paid 12,300
774,980
 Comment:
1. Forward & Money Market Comparison
2. Option= 100% not to ignore
3. Final Comments

0.775

2
nths Option Contract
ut option
24
Hedging 71,250
um (Pounds) 30,846
me with Option Contract
rd Rate 2
2

se Value 1,437,500
30,846
Hedge By Forward 44,542
Payments 1,512,888

Amount Paid to
Amount Paid By K G J L
K 0.70 2.82
G 2.04 0.88
J 2.17 0.94
L 1.32 2.41
Total Payment -3.52 -2.92 -3.11 -3.73
Total Receipt 3.48 2.41 2.74 4.64
Net R/P -0.04 -0.51 -0.37 0.91
Here L Has to Pay
To K - 0.04
To G - 0.51
To J - 0.37
Gogarth Co.

Part A: Hedging Strategies

Netting $000

Receive 37,400

Payment - 14,500

Receive 22,900

Future Contract 96,461.67

Futures 96,461.67

Options 96,132.23

Forward Contract

Forward Rate 0.2374

Total Estimated Receipt 96,461.67

Futures Contracts

Buy September Contract

Buy Now; Sell Later

Contracts 192.60

Over hedging (Rounded up) -47.7

Lock In Rate

September Futures 0.2378

Basis Risk Remaining -0.0004

Effective Rate 0.2374

Total Est. Receipts 96,461.67

Options

Call Option

Exercise Price 0.2368

Contracts 193.41

Under hedging 48.8

Muhammad Hannan:
It is always calculate
Premium 573.67 using the selling rate
as it is provided by the
bank
 using the selling rate
as it is provided by the
bank

Net Outcome

Option Exercise Value 96,500.00

Under Hedging 206

Premium Paid -574

Total Est. Receipts 96,132.23

Working

MR LC

US$ FC

Indirect Code FC/LC

 0.0014

Muhammad Hannan:
It is always calculate
using the selling rate
as it is provided by the
bank
using the selling rate
as it is provided by the
bank
Bollain Co.
Forward Contract 16235.940
Currency Futures 16271.540
Options Contract 16178.280

Forward Contract
Forward Rate 0.8729
Total Est. Receipts 16235.94

Currency Futures
September Contract
Call Option
Buy Now and Sell Later
Contracts 81.422
Under Hedging 96.36

Lock In Rate
September Contract 1.1422
Basis Risk Remaining 0.0009 1.1485
Effective Rate 1.1431
Total Est. receipts 16271.5

Options Contract
Exercise Price 1.1420
Call Option 0.0077
Contracts 81.436
Under Hedging 99.6
Premium Payment 108.66

Net Outcome
Exercise Value 16200
Under Hedge 86.9
Premium Payment -108.66
Total est Receipts 16178.280
Workings
Direct Code
Euro LC
US$ FC

Contract LC
Call Option
Interest Rate Risk Management

Hedging Strategies
OTC
Forward Contract= FRA
1. Rate Fix
2. Position Indifferent = Predefine Rate
Chances= Gain/ Loss

MSC
Note
1. Interest Rate= As commodity
Value of Bonds & Interest Rate = Inverse Relationship
Market Term Interest= As Commodity= For Eg 4% (100-4=96)
[Link] Solution either by % OR Amount

Interest Rate Future Contract

Example 1: Future Contracts
March Contract
Sell Now; buy later (Short Position)
Contracts 4
Outcomes
Future Market
Sell Now 94.9 High
Buy Later 92.9 Low
Gain 2

Net Outcome
Est. Spot 7%
Gains on Futures -2%
Effective Rate 5%

Solution By Lock In rate

Futures Now 94.9
Basis Risk Remaining 0.1
95
Convert Interest Rate 5
Add Spread 0
Effective IR 5

Sopoph Company
June Contract
Sell Now; Buy Later
Contracts 2 By Default 3 months contracts

Lock In rate
June Futures Now 95.48
Basis Risk Remaining -0.08
95.4
Interest Rate Conversion 4.6
Spread Adjustment 0
Effective Interest Rate 4.6

Detail Solution working is written in the workbook

Interest Rate Future Options

September Put Option
Contracts 40
Exercise Price 95 5%
Premium 0.65 32500
32500

Outcomes
Option Contract Exc. Price 95 Exc. Price 94.75
Exercise Price 95 5% 5.25%
Est. Futures 93 7% 7%
Gain On Futures Option -2% -1.75%

Net Outcome
Spot Market adj with Spread 7.50% 7.50%
Premium 0.65% 0.18%
Option Gain (if Any) -2% -1.75%
Effective Interest Rate 6.15% 5.93%
Interest Rate Guarantee
1. FRA= Option Contract
2. Position=
Favourable = Interest Rate Inc= Option Exercise
Un Fav Movt= Option Lapse
No chances of Loss
3. Upfront Premium Payment

Interest Rate Future Options

Now
Spot 95 5%
Futures 94.9 5.10%
3 months contracts
Preferrable

Exc. Price 94.25

4.75%
7%
-2.25%

7.50%
1.12%
-2.25%
6.37%
Borrowing Case
 Risk = IR Increase = Bond Value = Decrease
Sell Now; Buy Later Future Contract
Buy Put Option Option Contract

Lending Case
Risk = IR Decrease = Bond Buy = Bond Value Increase
Buy Now; Sell Later Future Contract
Buy Call Option Option Contract

Trans Date 25/3/22

Est. Spot 93 7
Est. Futures 92.9 7.1
Contracts Nos.
Amount Bor/len Duration B/L
X
Contract Size Contract Duration
By Default= 3 Months
Collars Option

Here you are an option holder

Buy put Option= Set Cap
Premium Payment Upfront
You get unlimited advantage of it

Borrower
Put Option Holder
Call Option Writer

Became IR option writer

Sell Call Option
Lower Rate= Set Floor

Here you will receive premium

But here, your unlimited advantage become limited.

Collars:Borrower
Put Option Buy 8% (Set Cap/ Max Limit =Holder
Spot 7%
At that time, Sell Call Option 4% (Set Floor/Lower Limit= Writer)

Exam Easy Marks

Buy Put Set Cap= Higher Rate = 8%
Sell Call Set Floor= Lower Rate = 4%

Collars Outcomes
Gain OR Lapse OR Loss

Basic Example
Collars: March Contract
Buy Put (Set Cap) 92
Sell Call (Set Floor) 93

Premium
Buy Put (Set Cap) Premium Pay
Sell Call (Set Floor) Premium Receive
Net Payment
 Lender Borrower
Put Option Writer Buy put Option
Call Option Holder Holder
Premium Pay
Lender
Buy Call Option
Holder
Premium Pay

p/ Max Limit =Holder Upfront Premium Payment

% (Set Floor/Lower Limit= Writer) Premium Received

=Net Payment/0/ Receive

Premium Pay
Premium Receive
Net Premium

Outcome:
Case 1: If IR increase: Est Futures = 9.8%
8%
7% Exercise Price
Est. Futures
We as Borrower Gain/ Lapse
0.2
-0.15 Net Outcome
0.05 Est. Spot (L+2%)
Premium Pay
Gain On Collars
Lender
Sell Put Option
Writer
Premium Receive
Borrower
Sell Call Option
Writer
Premium Receive
 Collars

Outcome
Est Futures = 9.8% Case 2: If IR Increases: Est Futures=3.9%

8% Exercise Price 7
9.8% Est. Futures 3.9
-1.800% Counter Party Lender Loss
Loss 3.1
Net Outcome
11.5 Est. Spot (L+2%) 6.5
0.05 Premium Paid 0.05
-1.8 Loss on Collars 3.1
9.75 9.65
From Us
From Market
Loss/Lapse
Interest Rate Risk Management

Case: Lending (Reciept)

Risk: IR Decrease= Bonds Value Increase

Futures Contract= Buy Now; Sell Later (Long Position)

Option Contract= Buy Call Option (Set Floor) = Premium Payment

Collars

Sell Put (Set Cap) Contract Writer

Buy Call (set Floor) Contract Holders

um Payment

Premium Receive

Premium pay
Alecto Co.
Now 1st January
Transaction date 1 May
Duration 5 Months

IR Risk Management Analysis

IR UP IR Down
IR Futures 4.46 4.46
IR Futures Options
Ex Price 96 4.763 3.763
Ex Price 96.5 4.701 4.181
Collars 4.673 4.193

IR Futures
June Future Contract
Sell Now; Buy Later
37 Contracts 36.67 (Rounding Up due to some reason)

Lock In Rate
June Futures 96.16
BR Remaining 0.18
96.34
IR Conversion 3.66
Spread 0.8
Effective IR 4.46

IR Futures Options
June Put Option
Contracts 36.67
Exercise Price 96 4
Premium 15077.5
IR UP 0.5% IR Down 0.5%
Option Outcome
Exercise Price 4% 4%
Est. futures 3.98 2.98
Gain Or Lapse Lapse Lapse

Net Outcome
Estimated Spot (L+0.8%) 4.6 3.6
Premium 0.163 0.163
Option Gain 0 0
Effective IR 4.763 3.763

IR Futures Options
June Put Option
Contracts 36.67
Exercise Price 96.5 3.5
Premium 53742.5

Option Outcome IR UP 0.5% IR Down 0.5%

Exercise Price 3.5 3.5
Est. futures 3.98 2.98
Gain Or Lapse -0.48 Lapse

Net Outcome
Estimated Spot (L+0.8%) 4.6 3.6
Premium 0.581 0.581
Option Gain -0.48 0
Effective IR 4.701 4.181

Collars
June Contract
Buy Put 96 4
Sell Call 96.5 3.5

Premium
Buy Put Premium Pay 0.163
Sell Call Premium Receive -0.09
Net Pay 0.073

Contracts 37 As Calculated above

 Working
Now 1/Jan IR UP
Spot 96.7 3.3
June Futures 96.16 3.84
Basis Risk 0.54

Basis Risk Based On Comodity Structure

ome reason)
Outcome Outcome
Case 1: If IR increases Est Futures= 3.98% Case 2: If IR Decreases [Link]

Exercise Price 4 Exercise Price

Est. futures 3.98 Est. futures
We as Borrower/Lapse Lapse
 Counter Party Lender
Net Outcome Net Outcome
Est Spot 4.6 Est. Spot
Premium Pay 0.073 Premium Pay
Effective rate 4.673 Loss on Collars
Effective rate
Trans Date 1 May
Est. Spot
Est. Futures
BR Remaining
R Decreases [Link] =2.98%

3.5
2.98
Loss
arty Lender 0.52

3.6
0.073
0.52
4.193
IR UP 0.5% IR Down0.5%
96.2 3.8 97.2 2.80
96.02 3.98 97.02 2.98
0.18 0.18
Awan Co.

IR Risk Management Analysis

IR Down
IR Futures 4.58
Forward Rate Agreement 4.62
IR Futures Options
Ex Price 94.5 4.41
Ex Price 95 4.22
Collars 4.34

Forward Rate Agreement

FRA Contract with Bank 3-7 @4.82%
Spread -0.2
FRA 4.62

IR Futures
March Future Contract
Buy Now; Sell Later (Long Positioning)
Contracts 32

Lock In Rate
March Futures 94.76
BR Remaining 0.46
95.22
Interest Rate Conversion 4.78
Less: Spread -0.2
Effective Rate 4.58

IR Futures Options
March Call Option
Contracts 32
Exercise Price 94.5
Premium 6912

IR Down 0.9% IR UP 0.9%

Option Outcome
Exercise Price 5.5 5.5
Est. futures 3.65 5.45
Gain Or Lapse Gain Gain
1.85 0.05
Net Outcome
Estimated Spot (L-0.2%) 2.99 4.79
Premium -0.432 -0.432
Option Gain 1.85 0.05
Effective IR 4.408 4.408
Collars
March Contract
Sell Put 94.5 5.5
Buy Call 95 5

Premium
Sell Put Premium Payment 0.121
Buy Call Premium Receive 0.119
Net Payment 0.002

Contracts 32 As Calculated above

IR Up
4.58
4.62

4.41
4.67
4.788

FRA Detail Solution

Case 1: If ES Down (4.09-0.9) 3.19
Spot Market (3.19-0.2) 2.99
FRA Settlement (4.82-3.19) 1.63
4.62
IR Futures Options
March Call Option
Contracts 32
Exercise Price 95
Premium 1936

IR Down 0.9% IR UP 0.9%

Option Outcome
Exercise Price 5 5
Est. futures 3.65 5.45
Gain Or Lapse Gain Lapse
1.35
Net Outcome
Estimated Spot (L-0.2%) 2.99 4.79
Premium -0.121 -0.121
Option Gain 1.35
Effective IR 4.22 4.669
 Outcome
Case 1: If IR decreases Est Futures= 3.65%

Exercise Price 5
Est. futures 3.65
We as Lender/ Gain 1.35

Net Outcome
Est Spot 2.99
Premium Pay -0.002
ulated above Gain 1.35
Effective rate 4.34
Working
Now 1/Jan
Spot 95.91 4.09
June Futures 94.76 5.24
Basis Risk 1.15

Case 2: If ES Increase (4.09+0.9) 4.99

Spot Market 4.79
Gain/Receive FRA Settlement -0.17
4.62
Outcome
Case 2: If IR Increases [Link] =5.45%

Exercise Price 5.5

Est. futures 5.45
Counter Party Lender Lapse
Counter Party Lender
Net Outcome
Est. Spot 4.79
Premium Pay -0.002
Effective rate 4.788
Trans Date 1 Fe IR Down0.9% IR UP 0.9%
Est. Spot 96.81 3.19 95.01 4.99
Est. Futures 96.35 3.65 94.55 5.45
BR Remaining 0.46 0.46

Loss/ Pay
SWAP
Hedging Strategies: Majority Long Term but Short Term Also
OTC

Classification
Interest Rate SWAP
1. With Counter Party= Most Fovourable Topic of AFM Examiner
2. With Bank/ Financial Intermediary

Currency SWAP
1. Investment/ Principal Only
2. Interest Only (Same as Interest Rate SWAP)
3. Forex Swap
Interest Rate SWAP: Counter Party

Concept: More Comparative Advantage

An Ordinary Example Related to Borrowing

1st Step: More CA Fixed Rate Floating Rate

Sameer 8% L+1% Stronger

Hussain 10% L+2% Weaker

Comparative Advantage 2% 1%

More Comp. Advantage= Fixed Rate= (2%-1%=1%)

Note: Benefit will Share 50:50

2nd Step: SWAP Arrangement

Game will start by stronger and the weaker will be against him and they wouldn’t cha

Stronger Weaker

Sameer Hussain

Actual Borrowing 8% L+2%

Swap

Sameer: Receive -8% 8%

Sameer: Pay L+0.5% -L+0.5%

EIR with SWAP L+0.5% 9.50%

EIR without SWAP L+1% 10%

Saving SWAP 0.50% 0.50% Total Benefit= 1%

Example 1:

Fixed Floating

Sinclair 6% L+2% Stronger

Walford 8% L+3% Weaker

Comparative advantage 2% 1%

More Comparative Advantage= Fixed Rate=2%-1%=1%

Assume Benefit will share 50:50

Swap is like a Long term Forward Contract

2nd: SWAp Arrangement Stronger Weaker

Sinclair Walford

Actual Borrowing 6% L+3%

Swap

Sinclair: Receive -6% 6%

Sinclair: Pay L+1.5% -L+1.5%

EIR with SWAP L+1.5% 7.50%

EIR without SWAP L+2% 8%

Saving SWAP 0.50% 0.50% Total Benefit= 1%

2nd: SWAp Arrangement Stronger Weaker

Sinclair Walford

Actual Borrowing 6% L+3%

Swap

Sinclair: Receive -6% 6%

Sinclair: Pay L+1.5% -L+1.5%

EIR with SWAP L+1.5% 7.50%

Bank Charges 0.2 0.2

EIR with SWAP L+1.7% 7.70%

An Ordinary Example Related to Borrowing

1st Step: More CA Fixed Rate Floating Rate

Sameer 9.5% L+1% Stronger

Hussain 10% L+2% Weaker

Comparative Advantage 0.5% 1%

More Comp. Advantage= Floating Rate= (1%-0.5%=0.5%)

Note: Benefit will Share 50:50

2nd Step: SWAP Arrangement

 Stronger Weaker

Sameer Hussain

Actual Borrowing L+1% 10%

Swap

Sameer: Receive -L+1% L+1%

Sameer: Pay 9.25 -9.25

EIR with SWAP 9.25 L+1.75%

EIR without SWAP 9.50% L+2%

Saving SWAP 0.25% 0.25% Total Benefit= 0.5%

Arrangement directly from Bank no counter Party

Interest Rate SWAP: With Bank/FI

IR SWAP Arrangement without any concept about CA

IR Example

Actual Borrowing Now P Fixed

SWAP
Receive R -Fixed

Payment P Floating

Example 1: Theta Inc

Part A

Actual Borrowing Now L+1%

SWAP

Receive -L

Payment 8.5

Effective IR 9.5
nd they wouldn’t change their places means stronger remains stronger and weaker remains w

Sameer Payment:

Floating Payment

L+1%
 Less: 1%*50%= 0.5%

L+0.5%

enefit= 1%
 Sinclair Payment

Floating Payment

L+2%

Less: 1%*50%= 0.5%

L+1.5%

enefit= 1%

Sinclair Payment

Floating Payment

L+2%

Less: 1%*50%= 0.5%

L+1.5%
Bank Charges

1. Yearly Basis

2. One Off

3. Both
 Sameer Payment:

Fixed Payment

9.50%

Less: 0.5%*50%= 0.25%

9.25

enefit= 0.5%

Example

Floating
-Floating

Fixed

Part B

10% 7.5%

11% 8.50%

-10% -7.50%

8.50% 8.50%

9.5% 9.50%
weaker remains weaker
Part A:
Now: 1st May WORKING
Interest rate exposure: Lurgshall need to borrow $84 M NOW 1/MAY
by 1st September for the duration of 6 months SPOT
Evaluation of Hedging Techniques SEP FUTURES
Forward Contract 5.38 BASIS RISK
Futures Contract 5.6 BR TOTAL
SWAP 5.45
Future Option Contracts 5.571

Future Option Contracts

Buy September Put Options
No of contracts 84
Premium cost 0.411% 172620 172620

Option Evaluation %
Exercise Price (95.25) 4.75
Estimated Future Options 5.19
Intrinsic Value YES BORROWING CASE = IF EST FUTURES IR > EX PTICE IR = INT V
GAIN 0.44

Net out come %

Spot Market (BR + 0.5) 5.6
Premium Paid 0.411
Option Gain -0.44
Effective Interest Rate 5.571

Interest Rate SWAP (With Counter Party)

1st Step: More Comparative Advantage
Fixed Rate Floating Rate
Lurgshall 5.6 L + 0.5
Counter Party 6.1 L + 1.5
Comparative Advantage 0.5 1
More Comparative/Incremental advantage (Floating over Fixed) 1 - 0.5 = 0.5%
Sharing of comparative advantage 50:50

2nd Step: SWAP Arrangement

Lurgshall Counter Party
Actual Borrowing L + 0.5 6.1
SWAP
Lurgsall: Receive -L + 0.5 L + 0.5
Lurgsall: Payment W2 5.35 -5.35
Bank Charges 0.1
Effective Rate with SWAP 5.45
 1-Sep
4.5 EST SPOT 5.1 RISE BY 0.6%
4.95 95.05 EST FUTURES 5.19
-0.45 B.R. REM. -0.09
5 MONTHS

Borrowing
Future Contract Sell Now: Buy Later
Option Contract Buy Put Option

No of Contracts B/L AMOUNT / CONTRACT SIZE * B/L DU

TURES IR > EX PTICE IR = INT VALUE = YES

W2: Lurgsall Payment

Payment of Fixed Rate 5.6
Less: Sharing of Comp Advantage -0.25
5.35
NT / CONTRACT SIZE * B/L DURATION/CONTRACT DURATION
Example 2

Swap Arrangement
Actual Borrowing 5%
SWAP
Receive -4.90%
Pay Libor

EIR Libor+0.1+0.12 (Spread)

Example 3

Swap Arrangement
Actual Borrowing Libor+0.15
SWAP
Receive -L
Pay Fix 4.95%

EIR 4.95%
Currency SWAP

1. Investment/ Principal Only

2. Interest Only (Same as Interest Rate SWAP)

3. Forex Swap

1. Investment/ Principal Only

USA Based Company

Investment Opportunity at Pakistan

0 1

Investment -270

FCF 290

Net Cash -270 290

Ex Rate 270 300

Remittance -1 0.967

DR

NPV Negative NPV

Example 1: HUGO

NPV (Ignoring SWAP)

0 1

Investment -20

Returns 25

Net Cash flows -20 25

Exchange Rate 1.53 1.31

Remittance -30.6 32.8

DR 10%

NPV (Ignoring SWAP) -0.83

Example 2: Goldsmith CO. Ignore Dividend and Interest

Investment Appraisal
With Forward Contract

0 1

Investment -800

Returns 1000

Net Cash flows -800 1000

Exchange Rate 28 30 Forward

Remittance -28.57 33.33

DR 15% 15%

NPV 0.41

Investment Appraisal

With SWAP and Forward

0 1

Investment -800

Returns 1000

Net Cash flows -800 1000

SWAP in @ 22 -36.36

SWAP out @ 22 36.36

By Forward Contract 6.67

Remittance -36.36 43.03

DR 15%

NPV 1.05
Currency SWAP

SWAP IN Rate

SWAP OUT Rate

NPV (With SWAP)

0 1

Investment -20

Returns 25

Net Cash flows -20 25

SWAP in @1.53 -30.60

SWAP out @1.55 31.00 SWAP =20 Only

Unhedged Amount @1.31 6.55

Remittance -30.60 37.55

DR 10%

NPV (With SWAP) 3.54

=20 Only
Currency SWAP
3. Forex SWAP

BORROWINGS
Foreigner ko borrowings mhengi milengi as compared to nationals
UK National
UK National B 4%
PKR B 8%

Pakistan National
PKR B 7%
UK STERLING 5%

Example 1
Comparative Advantage
Fixed Rate (1.5-1.2) 0.3
Floating Rate 0.1
Total CA 0.4

Effective IR with SWAP

W Co (Japnese) SOFR+0.5
M Co (American) 1.2
SWAP Arrangement
W M
Actual Borrowings Y 2400 $20
Interest Rate 1.2 SOFR+0.5

SWAP
IR SWAP 1 SOFR -SOFR
Bank Charges 0 0
IR SWAP 2 -0.7 0.7
Effective IR with SWAP SOFR+0.5 1.2
IR without SWAP SOFR+0.6 1.5
Difference 0.1 0.3 0.4
1st SWAP settle Floating Rate

Balancing Figure

=Total CA
Buryecs CO.
Currency Swap: B (i)
Benefits Of SWAP Buyrecs Count. Party
Fixed Rate 4 5.8
Floating W+0.6 W+0.4
Gain On SWAP:60:40 1.2 0.8
Bank Charges 0.3 0.2
Gain on SWAP after Bank Chrgs 0.9 0.6

EIR with SWAP Buyrecs Count. Party

Eir W/O SWAP W+0.6 5.8
Gain on SWAP after Bank Chrgs -0.9 -0.6
EIR with SWAP W-0.3 5.2

SWAP Arrangement
Actual Borrowings 4 W+0.4
SWAP
Buyrecs Payment W -W
Buyrecs Receive -4.6 4.6
EIR with SWAP Before Bank Chrgs W-0.6 5
Bank Chrgs -0.3 -0.2
EIR with SWAP After Bank Chrgs W-0.3 5.2
Forex SWAP: B (ii)
Investment Appraisal (With SWAP Arrangement)
0 1
Cash Flows (FC $)
License Fees -5000
Annual Income 600
Realisable Value
Net Cash Flows -5000 600
Exchange Rate E/$ 0.143 0.1472
Remittance
SWAP In -715
SWAP out
Remaining CFs 88.30
Net Cash Flows LC E -715 88.30
DR 14%
NPV $185.64
Benefit Currency SWAP:
1.8 1. SWAP of Borrowings
0.2 2. SWAP: Interest Rate
2 3. Forex SWAP: To support Foreign Investment
0.5
1.5
 2 3

600 600
7500
600 8100
0.1417 0.1315

715
85.03 407.65
85.03 1122.65
Bond Valuation

1. Borrower Perspective

2. Lender (Investor) Perspective

1. Borrower Perspective

Marketable Loans

Value of Bonds= Redemption Yield Method

This Includes more complications= Bond Valuation= Yield Curve

This Topic is Also Connect with SWAP

Cost of Debts= Kd= EIR

Methods:

Valuatuon Moded (Includes IRR)

CAPM

Yield Method
Yield Method

1. Estimating Yield Curve

Govt. Yield Curve

Incorporate the Spread (Credit Rating)

Interest Rates (Govt Yield)

Years Govt. Yield Spread AA rating

1 3.8 0.2

2 4.4 0.6

3 5.6 0.4

4 6.5 0.5

Bond Valuation Years FCF DR

4%: PV 100 1 4 4

Redemption 4 Years 2 4 5

Redeem at Par 3 4 6
Value of Bonds 4 104 7
 Kd

DF PV

0.9615 3.8462

0.9070 3.6281

0.8396 3.3585
0.7629 79.3411

90.1739