Attempt all the questions.
Section-A
Question1) Intergalactic Software Company went public three months ago. You are a sophisticated investor who devotes time to fundamental analysis as a way of identifying mispriced stocks. Which of the following characteristics will you focus on in deciding whether to follow this stock?
• The market capitalization
• The average number of shares traded per day
• The bid-ask spread for the stock
• Whether the underwriter that brought the firm public is a Top Five investment banking firm
• Whether its audit company is a Big Four firm
• Whether there are analysts from major brokerage firms following the company
• Whether the stock is held mostly by retail or institutional investors
Question2)a) What are likely to be the long-term critical success factors for the following types of firms?
• a high technology company such as Microsoft’s take-over of Nokia mobile phone business.
• A large low-cost retailer such as Reliance Fresh.
b) How useful is financial accounting data for evaluating how well these two companies are managing their critical success factors? What other types of information will be useful in your evaluation? What are costs and benefits to these companies from disclosing this type of information to investors?
SECTION B
Case Study
Senior executives of Laxmi Rice Mill Ltd have been considering proposal to replace existing coal-fired furnace in the paddy boiling section by a new furnace is cyclone type husk-fired furnace. Capital cost of new furnace is expected to be Rs 1 lakh. It would have useful life of 10 years at the end of which period its residual value would be negligible. The current furnace has the book value of Rs 15,000 and could be used for another 10 years with only minor repairs. If scrapped now, it can fetch Rs 10,000 but it could not fetch any amount if scrapped after ten more years of use.
Basic advantage of new furnace is that it does not depend on coal whose supplies are becoming increasingly erratic in recent years. On a conservative estimate, the new furnace would result in the saving of Rs 25,000 per annum on account of eliminated coal cost. Though, the cost of electricity and other operating expenses are likely to go up by Rs 8,000 and Rs 4,000 per annum respectively.
The husk that results as a by-product during normal milling operations at 3,000 metric ton of paddy milled per year is considered adequate for operating the new furnace. On an average, for every metric ton of paddy milled, husk content is 20 per cent. At present, the husk resulting during milling operations is sold at a price of Rs 50 per metric ton. Once the new furnace is installed, the husk would be diverted for own use. ‘White Ash’ that constitutes about 5 percent of the husk burnt in the new furnace, would be collected in a separate ash-pit as it has considerable demand in the refractory industry. It could be sold very easily at a price of Rs 1,500 per metric ton.
The new furnace would require a motor of 15 HP, whose cost is not included in Rs 1 lakh, the capital cost of the furnace. A 15 HP motor is lying idle with the polishing section of the Mill which could fetch the amount of Rs 3,000 on sale. It has the net book value of Rs 5,000. The motor could be used for the new furnace. At the end of the ten years, it could be scrapped at zero residual value.
All the assets of the company are in the same block. Depreciation would be on straight-line basis and same is assumed to be acceptable for tax purpose as well. Applicable tax rate is 35 per cent and cost of capital is 12 per cent.
Questions:
(i) Formulate incremental net after-tax cash flows associated with the replacement project.
(ii) Also compute the project’s NPV.
(iii) Give your recommendation