sources of funds continue and concepts in valuation

8/11/2019 Sources of Funds Continue and Concepts in Valuation

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Project Financing

Managing and financing economic activities of large

infrastructural projects.

High cost with large volume of funds such as power stations,

fertilizer plants, satellites, oil, gas and hotel projects are some ofthe infrastructural projects in which special techniques are

required to manage its finances.

Is a series of techniques for assessing risks and calculation of

cash flows generated by a project.


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Loan Syndication

Is a service provided by merchant bankers for financing a

project or for working capital requirements of a company.

Financial institutions like IFCI, IDBI, ICICI, LIC, UTI, GIC and

SFCsare suppliers of finance for loan syndication.

Steps Involved:

Preparation of detailed project report by merchant bankers

Identification of lenders

Holding meetings and discussions and negotiate with lenders on

loan amount, rate of interest and other terms

Prepare a loan application and submit completed app to

financial institution

Merchant banker obtains letter of intent


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Loan Syndication

Steps Involved contd:

Negotiations regarding security offered on loans are made with

financial institutions.

When loan document is complete, merchant banker assists

financial institution to disburse the loan to borrower.

Advantages:

Merchant bankers helps company to identify potential sources of

finance for taking loans for a fee.

Best Price

Disbursal of loan quickly.

Disadvantages:

Payment of fees


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New Financial Institutions &

Instruments In India, several reforms were made to strengthen financial

system after 1991.

Financial reforms were intended to move from controlled

economy to a free economy with following objectives: Develop financial sector infrastructure

Bring about financial supervision for investor protection

Financial liberalization for moving from controlled economy to

efficient market driven economy.

Bring about improvement in quality of services and bring inconfidence amongst the savers for encouraging savings

Introduce new financial instruments for giving options to investor

Emphasize requirement of protection of investors from fraudulent

bills.


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New Financial Institutions &

InstrumentsContributors to Financial System

Household sector which are suppliers of funds

Firms that are engaged in commercial activities and require

funds for carrying on business activities

Government which regulates the market through policies and

regulations and gives direction.

Financial institutions which play role of giving funds and

putting savers and investors together.

Financial instrumentswhich facilitate transfer of money within

a country and internationally.


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Book Building

New Issue market/Primary market performs functions of

providing an environment for sale and purchase of new issues.

Stock market has the function of trading in securities after new

securities are allotted and then listed with it.

Book Building is used in context of sale of a new security

offered for the first time in New Issue market before trading of

this share begins in stock market.

Process of offering shares to public in new issue market through

public demand by bidding for the shares. Based on bids, price is

discovered.

A price band is given and public is asked to bid for price within

that band.

Fairly new concept and one of the developments in financial

sector to bring about a fair and just system of issuing shares

through openness and public demand.


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Depository or Paperless trading

Dematerialization of securities for electronic trading of shares is

one of the major steps for improving and modernizing stock

market and enhancing level of investor protection.

Advantages:

Eliminates risk as it does not have physical certificates.

Expedite transfer of shares through electronic transfer.

De-mat account which provides client identification number and

depository identification number.

Account statement which is similar as in case of a bank. No Stamp duty on transfer of securities as there is no physical

transfer.

Allows a nomination facility

Automatic credit of bonus amount and other benefits of

consolidation or merger


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Factoring

Is a financial service for financing credit sales in whichreceivables are sold by a company to specialized financial

intermediary called factor.

Factor provides several services to a company that draws an

agreement for managing its receivables.

Parties to factoring:

Sellersells goods on credit to buyer. He gives delivery invoice

and instructs buyer to pay amount due on credit sales to his

agent or factor.

Buyermakes an agreement with seller after negotiating terms

and signing a memorandum of understanding.

Factor is a financial intermediary between buyer and seller.

He is an agent of seller. Factor pays 80% of price in advance

and receives payment from buyer on due date, then remits

balance to seller after deducting his commission.


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Types of Factoring

With Recourse Factoring : factor does not take credit risks

which is associated with receivables. Factor has the right to

receive commission and his expenses for maintaining sales

ledger.

Without Recourse Factoring: Factor has to bear all losses that

arise out of irrecoverable receivables. For this he charges a

higher commission which is premium for higher risk.

Factor takes a great interest in business matters of client in thistype of factoring.


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Venture Capital

Is a private equity investment fund through which funds are

borrowed by investors who have technical know how.

Venture capitalists make an agreement whereby they support

the project and fund it, in return for monetary gains,shareholding and acquisition rights in business financed by

them.

Fist venture capital in India was established by IFCI in 1975.

Other venture capital funds in India are IDBI Venture capital fund

ICICI venture funds management company limited


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Credit Rating

Is a service provided by a credit rating agency for evaluating a

security and rating it by grading it according to its quality.

In India credit rating had its inception n 1987 with incorporation

of firsts service company named CRISIL Credit RatingInformation Services of India

Four rating agencies in India which are registered and regulated

by SEBI:

CRISIL

ICRAInvestment Information and Credit Rating Agency of India CARECredit analysis and Research Ltd.

Duff and Phleps.


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Objectives of Credit Rating

To analyze the risks of the company

Provide information to investor for selecting debt securities

Express an opinion of company by grading of debt securities

with technical expertise.

Debenture Rating Symbols Fixed Deposit Rating Symbols

AAA Highest Safety FAAA Highest Safety

AA High Safety FAA High Safety

A Adequate safety FA Adequate safety

BBB moderate safety FB Moderate safety


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Commercial Paper (CP)

Is an unsecured short term negotiable instrument with fixed

maturity. Used for raising short term debt.

Is a promise by borrowing company to return loan on specified

date of payment.

Unsecured promissory note which is issued for a period of 7

days and three months.

In India CP are popularly used between 91 to 180 days.

Corporate organization can directly issue commercial papers to

investors (direct paper) or can be indirectly issued through a

bank or a dealer (dealer paper).


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Certificate of Deposit (CDs)

Is a securitized short term deposit issued by banks at high ratesof interest during period of low liquidity.

Liquidity gap is met by banks by issuing CDs for short period.

In India, CDs are being issued by banks directly or through

dealers.

Are part of bank deposits and issued for 90 days but maturity

period vary acc to corporate organizations

Min issue of CDs to single investor is 10 lakh rupees.

Advantages: Reliable

Liquidity

Flexible

Trading


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International Depository Receipts

American Depository Receipts

Are a method of raising funds in America in US stock markets.

First ADR was issued in 1920 to invest in oversees markets and

to provide a base to non-USA companies to invest in stock

market in USA. ADRs could be traded only in USA.

European Depository Receipts

EDRs are issued in Europe and denominated in European

currency.

EDRs have a small market and are not attractive instruments.

Are not well developed like ADRs and GDRs.


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Global Depository Receipts

Are a method of raising equity capital by organizations which

are in Asian countries.

Are placed in USA, Europe and Asia. Have a low cost and help in bringing liquidity.

Govt of India allowed Indian cos to mobilize funds from foreign

markets through Euro issues of GDRs and foreign currency

convertible bonds.

Cos with good track record can issue GDRs for developinginfrastructure projects in power, telecommunications and

petroleum and in construction and development of roads,

airports and ports in India.


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Indian Depository Receipts

Are like ADRs and GDRs.

A new instrument as a source of raising finance.

Instrument provides global companies to have an entry in Indiancapital market.

Global companies can issue IDRs and raise money from India.

Although this instrument has been accepted as an international

financial instrument for raising funds, legal formalities are still

being worked out by Department of Company Affairs.


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Chapter 3Concepts in Valuation


19/31

Time Value of Money

Value of a unit of money is different in different time

periods i.e. Value of a sum of money received today

is more than its value received after sometime.

Due to reinvestment opportunities for funds which are

received early.

Since a rupee received today has more value,rational investors would prefer current receipts to

future receipts.


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Time Value of Money

Mr. X has option of receiving Rs 1000 now or one

year later. What would be his choice?

He can deposit this amount received now and earnnominal rate of interest (3%). At the end of the year,

amount accumulates to Rs 1030.

As a rational person, he should be expected to preferthe larger amount (Rs 1030 here).

Same principle applies to a business firm.


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Relevance of Time Value of Money

Money received today is higher in value than after a

certain period because of uncertainties, inflation and

preference for current consumption and opportunities

for reinvestment to get a higher yield.

Importance of money can be analyzed for three

reasons:

Compensation for Uncertainty

Preference for Current Consumption

Reinvestment Opportunity


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Techniques of Time Value of Money

Basic techniques are:

Compounding for Future Values

Discounting for present Value


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Future Value

If you were to invest Rs 10,000 at 5-percent interest for one

year, your investment would grow to Rs 10,500

Rs 500 would be interest (Rs 10,000

.05)Rs 10,000 is the principal repayment (Rs10,000 1)

Rs 10,500 is the total due. It can be calculated as:

Rs10,500 = Rs10,000(1.05).

The total amount due at the end of the investment is call the

Future Value(FV).


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Compound / Future Value

In the one-period case, the formula for FVcan be

written as:

FV= PV (1 + i)n

Where PV is cash flow today (time zero), present

value

i is the appropriate interest rate for 1 periodn is the number of years


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Compound / Future Value

In the multi- period case, the formula for FVcan be

written as:

FV= PV (1 + i/m)nm


value


m is number of compounding per year


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Compound Value of Annuity

Compound Value = Annuity Amount * Compound

Value Annuity Factor

FV = A * CVAF


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Present Value

PV can be calculated through discounting approach.

If you were to be promised Rs10,000 due in one year wheninterest rates are at 5-percent, your investment be worthRs9,523.81 in todays rupees.

RS 9523.81 = Rs 10000/1.05

The amount that a borrower would need to set aside todayto be able to meet the promised payment of Rs10,000 inone year is call the Present Value(PV) of Rs10,000.

Note that Rs10,000 = Rs9,523.81(1.05).


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Present Value

In the one-period case, the formula for PVcan be

written as:

PV = FV/ (1 + i)n


value



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Present Value

In the multi- period case, the formula for FVcan be

written as:

PV = FV/ (1 + i/m)nm


value


m is number of compounding per year


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Practical Applications


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Valuation of Securities

Valuation of Debentures

Valuation of Preference shares

Valuation of Equity Shares

sources of funds continue and concepts in valuation

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