Financial Concepts & Instruments

8/3/2019 Financial Concepts & Instruments

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1Atul Parikh

Financial Concepts

&

Instruments


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Financial Concepts & InstrumentsFinancial Concepts & Instruments.

A The ABC Ltd. has as per the M & A of A, authorized capital of100 million Equity Shares(E S) of Rs.10 each. The Co decided toissue 5 million shares as application & allotment money of Rs.5/-

per share to the investors and balance as a call after 6 months.The application money was fully subscribed. All applicants exceptthose who subscribed to 2 lacs Equity shares have paid balancecall money of Rs. 5 per share.

Please ascertain the various capital components after the callmoney paid as to the clear capital structure picture of M/S ABCLtd.

B. M/S XYZ Ltd wants to raise Rs. fifteen million for theirdiversified project and is willing to invest from their holding Co.Rs.5 million. The promoters wants to examine whether they should

raise the money for their Rs.15 million projects through EquityShare route or by Debenture.

Please deliberate the advantages of Equity Shares and DebenturesPlease deliberate the advantages of Equity Shares and Debenturesin the context of Investors as well as issuer. If you were MD of M/Sin the context of Investors as well as issuer. If you were MD of M/S

XYZ Ltd. which route out of E S or Debenture would you opt for.XYZ Ltd. which route out of E S or Debenture would you opt for.

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Financial Concepts & Instruments.Financial Concepts & Instruments.

1. Authorised Capital: Rs.100 crores.( 10million Equityshares of Rs.10/- face value each).

2. Issued Capital: Rs.50crores. (50 lacs E S of Rs.10 face

value).

3. Subscribed Capital:Rs.50crores.(50 lacs ES of Rs.5+5).

4.Called up capital: Rs.50crores (50 lacs * Rs.5+5)

5.Paid up Capital: Rs.49.90crores.(50lacs*5 + 48lacs*5)

6. Calls in Arrears: Rs.10 lacs.(2lacs*Rs5)

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Financial Concepts & Instruments.

Performance Indicators of Equity Share ShareholdersPerformance Indicators of Equity Share Shareholders:1. EPSEPS: PAT/Nos.E S.

2.2. NWNW:: NW=Paid up Capital +Cash Reserves & Surplus.

3. RONW PAT/NW. Its the return generated on Shareholders funds. (Amechanism to leverage the capital to increase the return on capital &NW) to enhance BV & Creation of wealth.

4.4. P/E ratioP/E ratio: Higher the PE higher is the expectation of future profitabilityof the company; branding of Comp. & better prospects for the industry.

5.5. Dividend YieldDividend Yield: Div.PS/Current Market PriceDiv.PS/Current Market Price. How much return investormakes by buying a share from the market( Lower the cum dividend priceof share higher the yield & vice versa. sometime P/E ratio may be lowstill Dividend yield could be high.

6.6. DividendPayout %DividendPayout % == Dividend/PAT.Dividend/PAT. Indicates, the current earningIndicates, the current earningdistributed to the share holders which is permanent outflow of cash fordistributed to the share holders which is permanent outflow of cash forfuture leveraging of the company.future leveraging of the company.

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Investors perspective of Equity SharesInvestors perspective of Equity Shares Exercise.Exercise.

E x a m p l eE x a m p l e : M R . X b o u g h t 2 0 0 E S o f M/S AB C L t d @ R s . 4 0 0 / -

p e r s h a r e ( C u m D i v ) o n 3 0 /0 6/2 0 0 8 . Th e p a i d u p c a p i t a l o f C o . i s R s . 4 0 0 C r .w i t h R s . 1 0 / - F V o f E S . Th e NW i sR s . 6 0 0 0 C r s . o n 3 1/0 3/2 0 1 1 .Th e C o . d e c l a r e d 5 0 % & 8 0 %d i v i d e n d i n 2 0 0 8 -0 9 & 2 0 0 9 -1 0 r e s p e c t i v e l y .

Th e C o m a d e PAT o f R s . 2 4 0 0 c r . i n 2 0 1 0 -1 1 & d e c l a r e d D i v i d e n d o f 1 0 0 % i n t h e AGM h e l d i n J u n e 2 0 1 1 . D i v . w a s

p a i d i n J u l y 1 1 .Th e b a l a n c e p r o f i t i s t r a n s f e r r e d t oG e n e r a l R e s e r v e i n Ap r i l 2 0 1 1 . S u b s e q u e n t l y t h e m a r k e t

p r i c e o f t h e s h a r e r o s e t o R s . 8 0 0 / - p e r s h a r e ( c u mD i v i d e n d ) a f t e r d i v i d e n d a g a i n i n o n e w e e k p r i c er e g a i n e d t o R s . 8 0 0 / -

A s c e r t a i n t h e ( 1)B V ; ( 2) EPS ; ( 3 )P/E ; ( 4) D i v . Pa y o u t ( 5)D i v i d e n d Y i e l d ( 6)M a r k e t C a p i t a l i z a t i o n o f t h e c o .

( 7) Wh a t i s t o ta l r e t u r n i n v a l ue f o r M r. X i n t h ec o m p a n y d u r i n g h i s e n t i r e h o l d i n g p e r i o d ?

( 8)Wh a t i s a n n u a l i z e d i n c o m e I f M r. X s e l l s h i s 2 0 0 E S @R s . 8 0 0 /s h a r e s i n J u l y 2 0 1 1 .

( 9) A l s o f i n d t a x i m p l i c a t i o n s fo r M r. X a n d a l s o f o r t h ec o m p a n y .

E x a m p l eE x a m p l e : M R . X b o u g h t 2 0 0 E S o f M/S AB C L t d @ R s . 4 0 0 / -

p e r s h a r e ( C u m D i v ) o n 3 0 /0 6/2 0 0 8 . Th e p a i d u p c a p i t a l o f C o . i s R s . 4 0 0 C r .w i t h R s . 1 0 / - F V o f E S . Th e NW i sR s . 6 0 0 0 C r s . o n 3 1/0 3/2 0 1 1 .Th e C o . d e c l a r e d 5 0 % & 8 0 %d i v i d e n d i n 2 0 0 8 -0 9 & 2 0 0 9 -1 0 r e s p e c t i v e l y .

Th e C o m a d e PAT o f R s . 2 4 0 0 c r . i n 2 0 1 0 -1 1 & d e c l a r e d D i v i d e n d o f 1 0 0 % i n t h e AGM h e l d i n J u n e 2 0 1 1 . D i v . w a s

p a i d i n J u l y 1 1 .Th e b a l a n c e p r o f i t i s t r a n s f e r r e d t oG e n e r a l R e s e r v e i n Ap r i l 2 0 1 1 . S u b s e q u e n t l y t h e m a r k e t

p r i c e o f t h e s h a r e r o s e t o R s . 8 0 0 / - p e r s h a r e ( c u mD i v i d e n d ) a f t e r d i v i d e n d a g a i n i n o n e w e e k p r i c er e g a i n e d t o R s . 8 0 0 / -

A s c e r t a i n t h e ( 1)B V ; ( 2) EPS ; ( 3 )P/E ; ( 4) D i v . Pa y o u t ( 5)D i v i d e n d Y i e l d ( 6)M a r k e t C a p i t a l i z a t i o n o f t h e c o .

( 7) Wh a t i s t o ta l r e t u r n i n v a l ue f o r M r. X i n t h ec o m p a n y d u r i n g h i s e n t i r e h o l d i n g p e r i o d ?

( 8)Wh a t i s a n n u a l i z e d i n c o m e I f M r. X s e l l s h i s 2 0 0 E S @R s . 8 0 0 /s h a r e s i n J u l y 2 0 1 1 .

( 9) A l s o f i n d t a x i m p l i c a t i o n s fo r M r. X a n d a l s o f o r t h ec o m p a n y .

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Issuers perspective of Equity CapitalIssuers perspective of Equity Capital

a. Equity Capital (E C) is more expensive than Debt.

b. Servicing Interest on debt is deductible in P&L a/c;

C Servicing of dividend attracts Div. Distribution tax@15% & thesame is not deductible in P&L a/c.

Still EC is preferable to Debt.(Reasons).

1. E C is permanent Capital & does not involve committed cost.

2. It does not involve fixed servicing cost. Hence reducesfinancial leveraging & fixed cost. This helps to improve profit.

3. The free pricing of equity unfolds several benefits toCompany.

4. Increases NW BV and EPS & thereby creates wealth.

5. reduces Debt/Equity ratio & Increases opportunity forfinancial leveraging for the Co.

6. Expansion of EC base temporarily may reduce EPS & alsoRONW and in turn the market price but does not effect MarketCapitalization.

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Investors Perspective of Debt SecurityInvestors Perspective of Debt Security.

Debt security offers stable and assured return & no fluctuation. Even in case of variable coupon rate, the interest rate in short

term is predictable.

Interest rate risk is corresponding to the rating awarded by the

rating agency to the security.

Interest is fully taxable.

There is higher demand forGovt. debt/PSU bonds as risk free

securities.

Only in case of Infrastructure projects funds by FIs or for projects

on Rural Electrification, special tax free bond approval can begranted .(e.g. L&TInfra Bond now floated in Feb.2011e.g. L&TInfra Bond now floated in Feb.2011).

Funds get blocked for long term bonds & investment is not liquid.

The papers which are listed in secondary market are liquid.

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Debt SecuritiesDebt Securities-- InvestorsInvestors

Perspectives.Perspectives.

AA Decision to invest In pure debt v/s Convertible bonds (PCD/FCD)the evaluation is made on Net Present Value(NPV) of the exercise

price v/s market price on conversion date and the interest earned till

date of conversion.

BB Incase of pure debt the NPV is the present value of investment

and the value of future interest flows. The difference between A & Bgives the comparative alternatives for the investment.

Securitised paper such as Pass Through Securities (PTC) is the

latest in the primary debt market. They are often credit

enhanced & offer good option for mutual funds & otherinstitutions. So far Securitised papers are outside the purview

of retail investors since the regulatory framework is yet not in

place.

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Issuers PerspectiveIssuers Perspective Debt SecuritiesDebt Securities.

The debt capital is cheaper than Equity Capital due to limited risk profile.

The cost is capped based on credit rating & coupon rate.

The interest cost is deductible in P&L a/c of the Co. The post tax cost of

debt is cheaper than post tax cost of Equity.

No voting rights and need not send them copy of Balance Sheets etc.

Unlike Institutional loans spread over Cos assets, the risk is spread overseveral investors and hence the coupon rate is cheaper than loan rates.

The issuer has option to issue ZCB with sweetener attached to bond like

EquityWarrant or conversion of ZCB on maturity.

APCD or FCD is a cheaper source of debt capital till such time the

company has leveraged the bottom line to absorb equity expansion basewith mild impact on EPS.Also option is to issue OPCD or OFCD.

In ZCB there is no outflow of interest which adds cost to the profit, BV &

EPS. The return to the investor is factored into conversion price on

underlying shares. Thus Co. offsets a revenue interest cost with reductionin capital receipt through Share Premium.(For long gestation project).

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SOLUTIONSOLUTION

Book Value= N W /Nos. ofBook Value= N W /Nos. of

SharesShares

8000/40 = Rs.200/8000/40 = Rs.200/--

EPS = PAT / SharesEPS = PAT / Shares

= 2400/400 = Rs.60/share.= 2400/400 = Rs.60/share.

P/E=Price / EPS = 800/60 = 13.33P/E=Price / EPS = 800/60 = 13.33

Dividend Yield% = DPS/CMPDividend Yield% = DPS/CMP

= 10/800 = 1.25%= 10/800 = 1.25%

Div. Yield% on Rs.400/Div. Yield% on Rs.400/-- = 2.50%= 2.50%

Div.PayoutDiv.Payout= Div/PAT =400/2400= Div/PAT =400/2400

= 16.66%= 16.66%

Market CapitalizationMarket Capitalization = Paid up= Paid up

Capital * Current Market Price.Capital * Current Market Price.

= Rs.40cr.*Rs.800 = Rs.32000cr.= Rs.40cr.*Rs.800 = Rs.32000cr.

Return toReturn to Mr.XMr.X during entire holdingduring entire holding

Div.3yrs:Div.3yrs:Rs.1,000+Rs.1600+Rs.2000Rs.1,000+Rs.1600+Rs.2000

Capital gain 200* 400 = Rs.80,000Capital gain 200* 400 = Rs.80,000

Total earning = Rs.84,600/Total earning = Rs.84,600/--=105.75%=105.75%

AnnuaizedAnnuaized avg. earning = Rs.42,300/avg. earning = Rs.42,300/

% earning on Rs.80,000 investment% earning on Rs.80,000 investment= 52.87%= 52.87%

Tax Implications to Co.=Tax Implications to Co.=

Dividend Distribution Tax.Dividend Distribution Tax.

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Financial Concepts & Instruments