Corporate Valuation1

Marakon Model
1. Mahesh International earns a return on equity of 25 percent. Its dividend payout ratio is 0.40.
Equity shareholders of Mahesh require a return of 18 percent. The book value per share is 50.
(a) What is the market price per share, according to the Marakon model?
(b) If the return on equity falls to 22 percent what should be the payout ratio to ensure that the
market price per share remains unchanged?

Marakon Approach
1. r = 25%, k = 18%, b = 0.4, g = (1-b)r = 15%
M 0.25−0.15 0.25−0.15
(a) = Or M = ×50=166.67
B 0.18−0.15 0.18−0.15

(b) r = 22%
166.67 0.22−g
= Or g=0.1628
50 0.18−g
g 0.1628
g= (1−b ) r Or ( 1−b )= = =0.74
r 0.22
So, b = 1-0.74 = 0.26 or 26%

Alcar Model
2. The income statement for year 0 (the year which has just ended) and the balance sheet at
the end of year 0 for Futura Limited are as follows:

Income Statement Balance Sheet

Sales 10,000 Equity 6000 Fixed Assets 4000
Gross Margin (20% 2,000 Current Assets 2000
S&GA (10%) 1,000 TOTAL 6000 TOTAL 6000
PBT 1,000
Tax 300
PAT 700
Futura Limited is debating whether it should maintain the status quo or adopt a new strategy. If
it maintains the status quo:
● The sales will remain constant at 10,000
● The gross margin will remain at 20% and the S,G&A expenses will be 10% of sales
● Depreciation charges will be equal to new investments
● The asset turnover ratios will remain constant
● The discount rate will be 15 percent
● The income tax rate will be 30 percent
If Futura Limited adopts a new strategy, its sales will grow at a rate of 20 percent per year for
three years. The margins, the turnover ratios, the capital structure, the income tax rate, and the
discount rate, however, will remain unchanged. Depreciation charges will be equal to 10 percent
of the net fixed assets at the beginning of the year. What value will the new strategy create?
Alcar Approach
2. The value created by the new strategy is calculated below:
Current Income Statement Projections Residual
Values Value
(Year 0)
1 2 3 3+
Sales 10,000 12,000 14,400 17,280 17,280
Gross Margin (20%) 2,000 2,400 2,880 3,456 3,456
S, G and A (10%) 1,000 1,200 1,440 1,728 1,728
PBT 1,000 1,200 1,440 1,728 1,728
Tax 300 360 432 518.4 518.4
PAT 700 840 1008 1209.6 1209.6
Balance Sheet Projections
Fixed Assets 4,000 4,800 5,760 6,912 6,912
Current Assets 2,000 2,400 2,800 3,456 3,456
Total Assets 6,000 7,200 8,640 10,368 10,368
Equity 6,000 7,200 8,640 10,368 10,368
Cash Flow Projections
Profit After Tax 840 1008 1209.6 1209.6
+ Depreciation 400 480 576 691.2
- Capital Expenditure 1200 1440 1728 691.2
- Increase in current 400 480 576 --
assets operating cash flow
(360) (432) (518.4) 1209.6
● Present value of the operating cash flow stream = (980.55)
● Residual Value = 1209.6/0.15 = 8064
● Present value of residual value = 8064/(1.15)3 = 5301.21
● Total shareholder value = 5302.21 – 980.55 = 4321.66
● Pre-strategy value = 700/0.15 = 4667.67
● Value of the strategy = 4321.66 – 4667.67 = -346.01

DCF Approach
3.Financial Statements of Matrix Limited for the Preceding Three Years (Years 1-3) (Rs. In Cr.)
Profit and Loss Account
1 2 3
Net Sales 180 200 229
Income from Marketable -- -- 11
 Securities
Non-operating Income -- -- --
Total Income 180 200 240
Cost of Goods Sold 100 105 125
Selling and General 30 35 45
Administration Expenses
Depreciation 12 15 18
Interest Expenses 12 15 16
Total Costs and Expenses 154 170 204
PBT 26 30 36
Tax Provision(40%) 8 9 12
PAT 18 21 24
Dividend 11 12 12
Retained Earnings 7 9 12
Balance Sheet
1 2 3
Equity Capital 60 90 90
Reserves and Surplus 40 49 61
Debt 100 119 134
Total 200 258 285
Fixed Assets 150 175 190
Investments -- 20 25
Net Current Assets* (CA-CL) 50 63 70
Total 200 258 285

Projected P&L for Five Years – Year 4 through 8

4 5 6 7 8
Net Sales 270 320 360 400 440
Income from excess 3 2 -- -- --
marketable securities
Non-operating income -- -- -- -- --
Total income 273 322 360 400 440
 COGS 144 173 193 218 245
Selling & GA 47 59 67 70 77
Depreciation 22 26 29 32 35
Interest Expense 18 20 21 23 25
Total costs and expense 231 278 310 343 382
PBT 42 44 50 57 58
Tax provision (40%) 13 16 18 19 18
PAT 29 28 32 38 40
Dividend 15 15 15 16 16
Retained Earnings 14 13 17 22 24
Projected Balance Sheet
Equity Capital 90 90 90 90 90
Reserves & Surplus 75 88 105 127 151
Debt 140 150 161 177 192
Total 305 328 356 394 433
FA 220 240 266 294 324
Investments 10 -- -- -- --
CA – CL 75 88 90 100 109
Total 305 328 356 394 433

3.
Year 1 Year 2 Year 3
Operating Invested Capital 200 238 260
Calculation of NOPLAT
PBT 26 30 36
+ Interest Expense 12 15 16
- Interest Income -- -- 3
- Non-operating Income -- -- 8
= EBIT 38 45 41
Tax Provision from 8 9 12
income statement
+ Tax Shield on Interest 4.8 6 6.4
 Expense
- Tax on Interest Income -- -- 1.2
- Tax on Non-operating -- -- 3.2
Income
= Taxes on EBIT 12.8 15 14.0
NOPLAT 25.2 30 27.0
ROIC NOPLAT/ Invested Capital
30/200 = 15% 27/328 = 11.3%
Net Investment Gross Investment – Depreciation
[Net FA at the end of year + Net CA at the end of year]-[Net FA at the beginning of year + Net
CA at the beginning of year]
Net FA at the end of the year 175 190
+ Net CA at the end of the year 63 70
- Net FA at the beginning of the year 150 175
- Net CA at the beginning of the year 50 63
38 22

FCF = NOPLAT – Net Investment

FCF = (NOPLAT + Depreciation )– (Net Investment + Depreciation)
FCF = Gross Cash flow – Gross Investment
NOPLAT 25.2 30.0 27.0
+ Depreciation 12 15 18
Gross Cash Flow 37.2 45 45
Increase/(decrease in WC) 13 7
Capital Expenditure 40 33
Gross Investment 53 40
Free Cash Flow (8) 5
Cash Available to Investors
FCF (8) 5
+ Non-Operating Cash Flow -- 4.8
= Cash Available to investors (8) 9.8
 After-tax interest expense 9.0 9.6
+ Cash dividend on equity 12 12.0
+ Redemption of debt -- --
- New borrowings 19 15
+ Share buybacks -- --
- Share Issues 30 --
+ ∆ Excess marketable securities 20 5
- After tax income on excess securities -- 1.8
= Financing flow (8) 9.8
Drivers of FCF
Invested Capital 200 238
ROIC = NOPLAT/Invested Capital 15.00% 11.3%
Growth Rate = Net Investment / Invested Capital 19.00% 9.2%
WACC = (3/5)x(18.27%) + (2/5)x(12.67%)x(1-0.4)
= 10.96 + 3.04 = 14 percent

Free Cash Flow Forecast for Five Years – Year 4 through 8

4 5 6 7 8
1. PBT 42 44 50 57 58
2. Interest Expense 18 20 21 23 25
3. Interest Income 3 2 -- -- --
4. Non-operating Income -- -- -- -- --
A. EBIT: 1+2-3-4 57 62 71 80 83
5. Tax Provision 13 16 18 19 18
6. Tax shield on interest 7.2 8.0 8.4 9.2 10.0
expense
7. Tax on interest income 1.2 0.8 -- -- --
8. Tax on non-operating -- -- -- -- --
income
B: Taxes on EBIT:5+6-7-8 19.0 23.2 26.4 28.2 28.0
C: NOPLAT: A-B 38.0 38.8 44.6 51.8 55.0
 D: NET INVESTMENT 35.0 33.0 28.0 38.0 39.0
E: FREE CASH FLOW (C-D) 3.0 5.8 16.6 13.8 16.0

3.0 5.8 16.6 13.8 16.0

PV ( FCF ) = + + + + =₹ 34.78 crore
(1.14) (1.14 ) (1.14) (1.14) (1.14)5
2 3 4

440
PV ( CV )= 5
=₹ 228.52 crore
(1.14 )
Value of non-operating assets = Rs. 25 crore
Value of Matrix Ltd = 34.78 + 228.52 + 25.0 = Rs. 288.3 crore.

4. The profit and loss account and balance sheet of Zenith Corporation for two years (years 1
and 2) are given below:
Profit and Loss Account (Rs. In Million) Year 1 Year 2
Net Sales 5600 6440
Income from marketable securities 140 210
Non-operating income 70 140
Total income 5810 6790
Cost of goods sold 3220 3780
Selling and administrative expenses 700 770
Depreciation 350 420
Interest expenses 336 392
Total costs and expenses 4606 5362
PBT 1204 1428
Tax provision 364 448
PAT 840 980
Dividend 420 560
Retained Earnings 420 420
Balance Sheet
Equity Capital 2100 2100
Reserves and Surplus 1680 2100
Debt 2520 2940
6300 7140
Fixed Assets 4200 4550
 Investments 1260 1400
Net current assets 840 1190
6300 7140
(i) What is the EBIT for year 2?
(ii) What is the tax on EBIT for year 2?
(iii) What is the NOPLAT for year 2?
(iv) What is the free cash flow to the firm (FCFF) for year 2?
(v) Give the breakup of the financing flow for year 2?

4. (i) EBIT for Zenith Corporation for year 2 is calculated below:

Profit Before Tax 1428
+ Interest Expense +392
- Interest Income -210
- Non-operating income -140
1470
(ii) Taxes on EBIT for year 2 is calculated below:
Tax provision from income statement 448
+ Tax shield on interest expense +156.8
- Tax on interest income - 84
- Tax on non-operating income - 56
464.8
(iii) NOPLAT for year 2 is:
EBIT 1470
- Tax on EBIT 464.8
1005.2
(iv) FCFF for year 2 is:
NOPLAT 1005.2
- Net Investment -700.0
+ Non-operating cash flow + 84.0
389.2
(v) The break-up of the financing flow is as follows:
After-tax interest expense 235.2
+ Cash dividend + 560
- Net borrowing - 420
+ ∆ Excess marketable securities - 140
- After-tax income on excess marketable securities - 126
389.2