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Compre BAV QP 2020-21 1
Compre BAV QP 2020-21 1
3. ABC bank in northern India is showing the rapid growth due to the speedy growth of banking
market in India. ABC bank reported a ROE of 25% in 2018 and paid out dividends per share of Rs.
6.50 that year (on reported EPS of Rs. 35). We will assume that its protected position will allow
the bank to maintain its current ROE and retention ratio for the next five years.
The cost of equity for the high-growth period is estimated using a beta of 1.1 for ABC bank,
the Indian rupee risk-free rate of 6.5% and a market risk premium of 7%. After year 5, we
assume that the beta will decline toward 1 in stable growth (which will occur after the 10th
year) and that the risk premium for India will also drop to 5.5%.
We assume that competition will pick up after year 5, pushing the ROE down to the stable-
period COE by the 10th year. The payout ratio in stable growth period can then be estimated
using the stable growth rate of 4%. The terminal price can be calculated based on the earning
1
per share in year 10, stable period growth rate, COE and payout ratio. Estimate the value of the
ABC bank and give your recommendation if the ABC bank was trading at Rs. 355 per share in
November 2018. (Marks 15)
4. In 2017, Amazon announced that it would be buying high-end organic grocery chain Whole
Foods for $13.7 billion; the deal officially closed at the end of August. While the acquisition has
been off to a rocky start, it gives Amazon hundreds of physical stores and provides the company
a strong entryway into the competitive grocery and food industry. Do the valuation of synergy
based on the below assumptions.
Amazon had EBIT of $12,000 million on revenues of $62,550 million. The tax rate for the
firm is 35%. The firm had total capital invested of $40,210 million. The firm had a debt-to-capital
ratio of 12%, a beta of 0.8 and a pretax cost of debt of 5%. Based on the risk-free rate of 4.25%
and a risk premium of 4% estimate the cost of capital. The average reinvestment rate for the
firm is 40% over the past five years and it will continue to hold in the future. After year 5,
operating income and revenues are expected to grow 4.25% a year forever, and the firm will
earn no excess returns; the after tax return on capital will be equal to the cost of capital of
6.95%.
Whole Foods had EBIT of $3,400 million on revenues of $12,540 million. The tax rate for
the firm is 35%. The firm had total capital invested of $12,580 million. The firm had a debt-to-
capital ratio of 12%, a beta of 0.9, and a pretax cost of debt of 5%. Assume the risk-free rate of
4.25% and a risk premium of 4% to estimate the cost of capital. Firm has the average
reinvestment rate of approximately 50% over the prior five years will continue to hold in the
future. After year 5, operating income and revenues are expected to grow 4.25% a year forever,
and the firm will earn no excess returns; the after-tax return on capital will be equal to the cost
of capital of 7.29%.
To value the synergy, make the following assumptions about the way in which synergy
would affect cash flows and discount rates at the combined firm.
a) The combined firm will have some economies of scale, allowing it to increase its
current pretax operating income by $250 million. Assume the reinvestment rate for
combined firm as 42%.
b) The combined firm will also be able to generate a slightly higher after-tax return on
capital (an increase of about 1%) for the next five years, while maintaining the same
reinvestment rate as the independent firms would have. Terminal value of
combined firm is estimated using the cash flows in the terminal year, the cost of
capital in perpetuity and the expected growth rate of 4.25%. (Marks 20)