CASE STUDY 1:
GPSC is a fast growing profitable company. The company is situated in Western India. Its sales are expected to grow about three times from 360 million in 2009 to Rs.1,100 in 2010. The company is considering of commissioning a 35 km. pipeline between two areas to carry gas to a state electricity board. The project would cost Rs.250 million. The pipeline will have a capacity of 2.5 MMSCM. The company will enter into a contract with the state electricity board (SEB) to supply gas. The revenue from the sale to SEB is expected to be Rs.120 million per annum. The pipeline will also be used for transportation of LNG to other users in the area. This is expected to bring additional revenue of 80 million per annum. The company management considers the useful life of the pipeline to be 20 years. The financial manager estimates cash profit to sales ratio of 20% p.a. for the first 12 years of the projects operations and 17% p.a. for the remaining life of the project. The project has no salvage value. The project being in a backward area is exempt from paying any taxes. The company requires a rate of return of 15% from the project.
Questions:
Q1. What is the project's payback and return on investment (ROI)?
Q2. Compute project's NPV and IRR?
Q3. Should the project be accepted? Why?
CASE STUDY 2:
Hindustan Unilever Limited (HUL) was known as Hindustan Lever Limited (HLL) until 18 May, 2007. The company was set up in 1933. It completed 75 years of operations in India on 17 October, 2007. It is an important subsidiary of Unilever. Unilever has a large number of subsidiary and associate companies in more than 100 countries. HUL's business areas include home and personal care, foods and beverages, industrial, agricultural and other products. It is one of the largest producers of soaps and detergents in India. The company has grown organically as well as through acquisitions.
HUL places equal focus on serving both the employees and shareholders, and it is committed to add value to both. Over years, the company has built diversified portfolio of powerful brands, a number of them being household names.
The company requires the cost of capital estimates for evaluating its acquisitions, investment decisions and the performance of its businesses and for determining the value added to shareholders. It needs to develop a methodology of calculating cost of equity and debt and determine the weighted average cost of capital.
HUL's Performance
Table 1.1 contains a summary of HUL's EPS, DPS, share price and market capitalization. The company has been paying dividends regularly. HUL's shares have enjoyed high price in the stock market. The company's share price has increased from Rs.138.35 in 1997 to Rs.213.90 in 2007. The company's sales and assets have shown significant growth and company's profitability has also increased over years (Table 1.2). The company is conservatively financed. (Table 1.2)
Table 1.1: HUL : EPS, DPS and Share Price
|
Year
|
1997
|
1998
|
1999
|
2000
|
2001
|
2002
|
2003
|
2004
|
2005
|
2006
|
2007
|
|
DPS (Rs)
|
1.70
|
2.20
|
2.90
|
3.50
|
5.00
|
5.16
|
5.50
|
5.00
|
5.00
|
6.00
|
9.00
|
|
EPS (Rs.)
|
2.81
|
3.67
|
4.86
|
5.95
|
7.46
|
8.04
|
8.05
|
5.44
|
6.40
|
8.41
|
8.73
|
|
Share Price (Rs.)
|
138.35
|
166.36
|
225.00
|
206.35
|
223.65
|
181.75
|
204.70
|
143.50
|
197.25
|
216.55
|
213.90
|
|
MCap.Rs. (billion)
|
275.55
|
365.25
|
495.13
|
454.09
|
492.31
|
400.08
|
450.59
|
315.87
|
434.19
|
477.88
|
465.75
|
Table 1.2: HUL's Financial Performance
(Rs. Million)
|
|
2005
|
2006
|
2007
|
|
Net Sales
|
110,606
|
121,034
|
137,178
|
|
Total Income
|
112,130
|
122,949
|
139,426
|
|
PBDIT
|
15,958
|
18,395
|
21,105
|
|
Interest Expense
|
192
|
107
|
255
|
|
PBT
|
16,045
|
18,617
|
21,845
|
|
PAT (Before exceptional items)
|
13,545
|
15,397
|
17,691
|
|
Net Profit
|
14,081
|
18,554
|
19,255
|
|
Share Capital
|
2,201
|
2,207
|
2,177
|
|
Reserves and Surplus
|
20,855
|
25,028
|
12,215
|
|
Loan Funds
|
569
|
736
|
885
|
The company considers cost of its debt as the effective rate of interest applicable to an 'AAA' rated company. It thinks that considering the trends over years, this rate is 9.5% in 2007. The risk-free rate is assumed as the yield on long-term government bonds, which the company regards as about 8%. HUL regards the market risk premium to be equal to 11%. The company uses CAPM to calculate its cost of equity. The alternative model is constant growth model. The beta is estimated to be 0.78.
Questions:
Q1. Calculate HUL's cost of equity using the dividend growth model.
Q2. Calculate HUL's cost of equity using the capital asset pricing model.
Q3. Between the dividend growth model and CAPM, which method do you recommend and why?
Q4. What is HUL's before tax and after tax weighted average cost of capital (WACC)?