NARSEE MONJEE INSTITUTE OF MANAGEMENT STUDIES (NMIMS)

GLOBAL ACCESS SCHOOL FOR CONTINUING EDUCATION

(NGA-SCE)

INTERNAL ASSIGNMENT

COURSE: STRATEGIC FINANCIAL MANAGEMENT

APPLICABLE FOR DECEMBER 2022 EXAMINATION
NMIMS GLOBAL ACCESS SCHOOL FOR CONTINUING EDUCATION (NGA-
SCE)
COURSE: STRATEGIC FINANCIAL MANAGEMENT
INTERNAL ASSIGNMENT APPLICABLE FOR DECEMBER 2022
EXAMINATION

QUES 1.) Bharat Limited has to make a decision to select any one project. The projects
are: project 1 – investment in rubber rollers and project 2 – manufacture of automobile
components. The initial investments are Rs.1,35,000 for project 1 and Rs.2,40,000 for
project 2. There will be no scrap value at the end of the life of both projects. The
opportunity cost of capital of the company is 16 percent. The annual incomes are as
under:
Year Project 1 Project 2
1 - 60000
2 30000 84000
3 132000 96000
4 84000 102000
5 84000 90000
You are required to compute the Net present value for Project 1 and Project 2. Discuss
the criteria to accept or reject a project based on NPV. What other criteria can be looked
into to decide on which project to accept?
(10 Marks)
ANSW 1.) CALCULATION OF NPV OF THE PROJECTS
PROJECT 1
YEAR PROJECT 1 RATE@16% CUMULATIVE
AMOUNT
1 - 0.862 -
2 30000 0.7431 22293
3 132000 0.6406 84559
4 84000 0.5523 46393
5 84000 0.4761 39992
TOTAL INVESTMENT 193237
LESS: INITIAL INVESTMENT 135000
NPV 58237
 PROJECT 2
YEAR PROJECT 1 RATE@16% CUMULATIVE
AMOUNT
1 60000 0.862 51720
2 84000 0.7431 62420
3 96000 0.6406 61498
4 102000 0.5523 56335
5 90000 0.4761 42849
TOTAL INVESTMENT 274822
LESS: INITIAL INVESTMENT 240000
NPV 34822

NPV of project 1 is Rs. 58,237 and project 2 is 34,822.

On the basis of the criteria of NPV whether to select project 1 or project 2, NPV of
project 1 is more than NPV of project 2 and therefore project 1 must be accepted and
implemented in place of project 2.

Other criteria to be looked into to decide which project to accept are as follows-
 Cost involved
The costs involved to accept or implement the project plays a major part in
deciding whether to accept the project or not. It is to be ascertained whether the
cost involved is reasonable or not. If it involves high cost, then it must be least
preferred by the person who is accepting the project and if the cost is normal then
also the response will be different and vice versa.

 Initial outlay
Initial outlay means initial investment in the organization which is there for the
purpose of introduction of the same to the organization. If the amount is huge it
signifies the project is on large scale as compared to the costs which are least
involved or less amount of initial investment.

 Time period
The time period plays an important role in selection of whether to accept the
project or reject it. If the project involves less time to get fruitful, then the project
must be accepted as compared to the other projects which take more time but are
same in nature. But if the project is different in nature then it must be considered
accordingly which project to be accepted or not.
  Profitability
The term profitability refers to the profit earning capability of the project. If a
project yields more profit then it must be accepted but if the project yields lower
profits then automatically the project which has more profits are accepted for the
longer period of time to promote growth and sustainability of the organization.

 Mobility
The term mobility means that the resources must be mobile enough to generate
the revenue in the short run as well as the long run. Therefore one must
understand before accepting any project it must be mobile so that it can move
from one place to another in an efficient and an effective manner.

 Management of resources
 The management of resources should be done in such a manner so as to ensure
the efficient and effective utilization of resources in the short run as well as the
long run. And resources should be managed so that there is optimum utilization
of resources and there must be elimination of wastages in the same.

QUES 2.) Walter and Gordon both proposed a model of share valuation which states the
relationship between dividend policies and the market value of the firm. Both models are
similar to each other yet have differences. Discuss the similarities and differences of
both models using a numerical example. :
(10 Marks)
ANSW 2.) WALTER’S MODEL
Walter’s model was developed by Professor James E Walter. He stated that the firm’s
dividend policy always affect its value and the market price of its share. In the long run,
the share price starts reflecting the present value of the expected dividends.
The investors rationalize that the amount of retained earnings will affect the dividend
payment and hence the share price. Walter’s model discusses the effect of dividend
payouts on the value of the firm and its stock price by comparing the firm’s cost of
capital k with its rate of return r.
FORMULA
P0 = Div + (r/k)(RE)
k

GORDON’S MODEL
The Gordon’s model was developed by Myron J. Gordon in his work, The Investment,
Financing and Valuation of the Corporation, developed dividend growth capitalization
model. In this model Gordon made a basic assumption that future dividend receipts on a
stock determines the value of the equity. The basic rationale behind Gordon’s model is
that the worth of the share of a given company is no more than a current and future
dividend receipts of its shareholders.

Formula
P0 = EPS(1-b)
k-br
SIMILARITIES AND DIFFERENCE OF GORDON AND WALTER’S MODEL
WITH THE NUMERICAL EXAMPLE
There are various statements on the basis of which the similarities and the differences of
Walter and Gordon’s model can be identified and understood by below explained points
as follows-
SIMILARITIES
 In both the Walter’s model as well as in the Gordon’s model, the rate of return r
and the cost of capital k are constant and remains constant. The required rate of
return on investment r is always constant unlike the assumptions made by the
model. In real world r changes with time, with government policies and with
capital market activities. Large gestation period of projects may also lower r but
in this model it remains same.
The cost of capital can never be constant even when taken from same sources but
in this model it remains same. With increase in debt amounts, the cost may
change. Different debt sources offer different costs. This is the reason why
companies have various debt components in their capital structure.
 The retained earnings are the only source of financing or source of funds for the
firm. The firm is an all equity firm and does not go for external borrowings. As it
is explained in other words that the source of financing of the firm is internal
source. Thus, retained earnings is only source of money of the firm. The firm is an
all equity firm with zero external borrowings. But we all know the fact that it is
not possible generally as most of the firms have some level of external financing
but this is not the case in the case of these models.
 The firm has a long perpetual life and long perpetual earnings which can be
predetermined.

Example-

A firm has INR 5 as EPS and pays INR 2 as dividend per share. Its actual
capitalization rate is 15% and normal capitalization rate is 10%. What is the
value of the firm according to Walter’s formula?
 P0 = Div + (r/k)(EPS- Div)
k

P0 = 2 + (15% / 10%(5-2)
10%

= INR 65

For a given growth firm, r is 30% and k is 20%. Earnings per share is INR 5.
What will be the value of P0 when the value of b is 0.25

Given r is 30% and k is 20% and EPS is INR 5. Therefore the price of the share
will be

P0 = EPS(1-b)
k-br

P0 = 5(1-0.25)
0.20-0.25*0.3

= INR 30

DIFFERENCE

 There is a no tax environment existing for the firm.

 There is a perpetual life which can be predetermined in the Gordon’s model as
well as in the Walter’s model.
 100% payout or retention which means that the firm opts for complete retention
of the earnings or the complete payout of the earnings in order to maximize its
value.

Example-

For a given firm, the expected return (r) is 14%, the cost of capital (k) is 10%, the
earnings per share is INR 7 and the dividend per share is INR 3. Base on the
information, determine the market price share for the firm.

P0 = 3+[(0.14 / 0.10)(7-3)]
0.10

= INR 86

given growth firm, r is 30% and k is 20%. Earnings per share is INR 5. What will
be the value of P0 when the value of b is 0.50

P0 = 5(1 – 0.50)
 0.20 – 0.50 * 0.3
= INR 50

QUES 3.) Government of India has approved the issue of Deep discount bonds of Rural
Electrification Corporation Limited with a face value of Rs 30,000 having a life of 10
years. The planned yield for the investors is 12 percent.
a. Assuming a yield of 12 percent, at what price would you buy the bond?
(5 Marks)
b. If the bond is issued at Rs. 8,000, compute the yield assuming the bond is held till
maturity?
(5 Marks)
Answ 3.) a. P0 = Pn
[ 1+ kd]10
12% = Pn
(1 + 0.12)10
12% = Pn
(1.12)10
12% = Pn
3.1058
Pn = 0. 3726 * 100
= Rs.37.26 - Answer

b. P0 = Pn
[ 1+ kd]10
P0 = 8000
( 1 +0.12)10
P0 = 8000
(1.12)10
P0 = 8000
3.1058
= Rs. 2,575.82 - Answer