fm assing cec

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INTERNATIONAL SCHOOLINTERNATIONAL SCHOOL

OF BUSINESS AND MEDIAOF BUSINESS AND MEDIA

FINANCIAL MANAGEMENT II

ASSIGNMENTASSIGNMENT

BY :BY :NIKITA VYASNIKITA VYAS

1206912069



Background of the co.Background of the co.• CEC was started in late 50’s as a

government co. and it was a most important co. in the public sector.• CEC’s 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 millionshares of 100 each.

•

In the last decades co. sales haveincreased from 1804 million to 3042million.

• Net profit has increased to 17.1 to 43.5 and in the yr 2003-04 the profit

was 50.3 million.



EXPANTION PROJECTEXPANTION PROJECT

The co. felt the need of expansionbecause 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 CASEISSUES IN THE CASE

The CMD feels that given the government’scurrent 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 meetingbut large no of board members did not agree with use of debt for expansion

project.



• Issues raised in thecase for and againstthe use of debt ????



Mr. Tandon decided to determineMr. Tandon decided to determinethe co. should sell Rs 1000 bondsthe co. should sell Rs 1000 bondsfor Rs 200 million….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 ratewas 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 % ondividend

The control will not be diluted as in debt theholders are not considered the owners of



NEGATIVE ASPECT OF IN VOLVINGNEGATIVE ASPECT OF IN VOLVING

DEBT AND BOARD OF MEMBER’S…DEBT AND BOARD OF MEMBER’S…

The bonds will be secured against the co.’sasset .

CEC being a new co. in the market wil have tosell 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 redeemingthe bonds after 3 yrs so hence there will lot of annual cash outflow.

This will add to the co.’s risk by pressurizing itsliquidity. 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 theexisting business and new project.



• OTHERCONSIDERATION AND

SHOULD THE CO.EMPYOYEE DEBT TOFINANCE OR WHAT

ARE THE PROBABLESOLUTIONS……!!



OTHER CONSIDERATIONS….OTHER CONSIDERATIONS….

The liability of the co. will increase.

Bond holders will have the right toappoint one nominee director onthe board of the co. which shall utilized by the bond trustees.

•

If the whole amount is takenthrough equity then the control

will be diluted .



DECISION..!!!!DECISION..!!!!

The co. should employ debt but it should also be combined withequity 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 inlong run.



• Relationship between

debt and value of thefirm??



the value of a business based on the going

concern expectation is the present value of all the

expected future cash flows to begenerated

By the assets, discounted at the company’sweighted average cost of capital (WACC) . From this it can be seen that the WACC has

a direct impact on the value of abusiness.

the debt structure may be considered as asignal to the market. Ross’s (1977)model suggests that the values of firms will risewith leverage, since increasing themarket’s perception of value.



• that firm value is an increasingthat firm value is an increasingfunction of leverage due to the tax function of leverage due to the tax deductibility of deductibility of interest payments at the corporateinterest payments at the corporate

level.level.

Splitting a fund into some mix of Splitting a fund into some mix of shares relating to debt, dividend shares relating to debt, dividend

and capital directly adds value toand capital directly adds value tothe company.the company.

fm assing cec

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