INTERNATIONAL SCHOOL OF BUSINESS AND MEDIA

FINANCIAL MANAGEMENT II

ASSIGNMENT
BY : NIKITA VYAS 12069

 CEC was started in late 50s as a government co. and it was a most important co. in the public sector. CECs product include industrial machinery and equipments for chemicals, papers, cement , fertilizers etc. CEC started with a paid up capital of Rs 180 million divided into 1.5 million shares of 100 each. In the last decades co. sales have increased from 1804 million to 3042 million. Net profit has increased to 17.1 to 43.5 and in the yr 2003-04 the profit was 50.3 million.

Background of the co.

EXPANTION PROJECT

The co. felt the need of expansion because the market was growing. And also because the co. had already utilized its existing capacity The expansion project expected to cost Rs. 200 million which will give a average revenues of Rs 40 million per annum

ISSUES IN THE CASE

The CMD feels that given the governments current attitude where by it would like profitable co. to raise funds from the capital markets for their investment. It may look odd to CEC to obtain budgetary support from the government. Co. decided to raise fund through debt and hence they will avoid there co.s policy of not using long term debt. This proposal was put in the board meeting but large no of board members did not agree with use of debt for expansion project.

Issues raised in the case for and against the use of debt ????

Mr. Tandon decided to determine the co. should sell Rs 1000 bonds for Rs 200 million.

POSITIVE ASPECT :Bond was the cheaper source of finance. Since interest amount is tax deductible. The co. tax rate is 35% ,10% interest rate was equal to 6.5% from co point of view. CEC is currently paying a dividend of 15% and according to government now they will have to pay 12.5% tax on dividend distribution. So the co. will have to pay double taxes of 6.5% as corporate tax and 12.5 % on dividend The control will not be diluted as in debt the holders are not considered the owners of

NEGATIVE ASPECT OF IN VOLVING DEBT AND BOARD OF MEMBERS

The bonds will be secured against the co.s asset . CEC being a new co. in the market wil have to sell its bond to financial institutions. The flotation cost will , be high in case of bond as there are more legal obligations. The bond holders have the option of redeeming the bonds after 3 yrs so hence there will lot of annual cash outflow. This will add to the co.s risk by pressurizing its liquidity. The post expansion equity return would significantly increase if the funds are raised by issuing bonds. Equity returns could be diluted if the co. was unable to earn sufficient profit from the existing business and new project.

OTHER CONSIDERATION AND SHOULD THE CO. EMPYOYEE DEBT TO FINANCE OR WHAT ARE THE PROBABLE SOLUTIONS!!

OTHER CONSIDERATIONS.
Bond

The liability of the co. will increase. holders will have the right to appoint one nominee director on the board of the co. which shall utilized by the bond trustees. the whole amount is taken through equity then the control will be diluted .

If

DECISION..!!!!
The co. should employ debt but it should also be combined with equity i.e if there is 200 million , it can be divided into 100 million debt and 100 million equity. Hence the new EPS of the co. will be 0.17 million . So the risk and uncertainty will be reduced and the co. will grow in long run.

Relationship between debt and value of the firm??

the value of a business based on the going concern expectation is the present value of all the expected future cash flows to be generated By the assets, discounted at the companys weighted average cost of capital (WACC) . From this it can be seen that the WACC has a direct impact on the value of a business. the debt structure may be considered as a signal to the market. Rosss (1977)model suggests that the values of firms will rise with leverage, since increasing the markets perception of value.

 that firm value is an increasing function of leverage due to the tax deductibility of interest payments at the corporate level. Splitting a fund into some mix of shares relating to debt, dividend and capital directly adds value to the company.