CASE STUDY
Fifteen years ago, Manish Kothari set up a company called Manish Detergents to make detergent powder. After few years of teething problems the company established itself as low cost producer of good quality detergent powder branded as Manna. For the last decade Manish Detergents has grown profitably. The profit and loss account for year 0 (the year that just ended) and the balance sheet at the end of year 0 for Manish Detergents given below in Exhibit 1.
Exhibit 1Financials of Manish Detergents
Profit and Loss Account Balance Sheet
Rs in million Sources of Funds
900 Shareholders' funds
209 Loan funds
45
164 24 140
49
91
|
- Revenues
- PSDIT
- Depreciation
- PSIT
|
Application of Funds Net fixed assets
Net current assets
|
The paid up capital of Manish Detergents is Rs. 100 million divided into 10 million shares of Rs. 10 each. All the shares are presently held by Manish Kothari, who is planning to take the company public by selling 4 million of his existing shares. The purpose of the issue is to enable Manish Kothari to liquefy a portion of his equity. Once the equity of Manish Detergents is listed it will help the company in raising capital from the market as and when required in the future.
Manish Kothari called Ajay Kapoor, vice president of Indus Capital, a merchant banking firm, to help him in estimating the worth of his shares.
Ajay Kapoor asked Manish Kothari to spell out his plans for the next 5 to 10 years, develop the forecast for financial performance and investment requirements, and indicate
his target debt-equity ratio. '
Manish Detergents is currently operating mainly in western India but it had definite plans to set up a unit in Hyderabad in the next two years to serve the southern market. This will require substantial investment in factory, godowns, and current assets. Since this investment will take some time to start yielding results, Manish expects a short-term dip in profits. However, once the southern venture takes off Manish is confident that profits will improve.
Taking into account the above, Manish Kothari has developed forecasts of operating profit and investment requirements which are given in Exhibit 2. Beyond year 6 he expects that Manish Detergents will grow at a steady state of 10 percent and this will apply to its free cash flow as well.
Exhibit 2 IFinancial Forecasts
Part A : Forecasted Operating Profit
|
1
|
2
|
3
|
4
|
5
|
6
|
Revenues
|
950
|
1000
|
1200
|
1450
|
1660
|
1770
|
PBDIT
|
195
|
200
|
210
|
305
|
330
|
374
|
Depreciation
|
55
|
85
|
80
|
83
|
85
|
87
|
PBIT
|
140
|
115
|
130
|
222
|
245
|
287
|
Part B: Forecasted Investments
|
|
|
|
|
1
|
2
|
3
|
4
|
5
|
6
|
Gross investments in fixed assets
|
100
|
250
|
85
|
100
|
105
|
120
|
Investments in net current assets
|
10
|
15
|
70
|
70
|
70
|
54
|
Total
|
110
|
265
|
155
|
170
|
175
|
174
|
Manish Kothari is happy with the present debt-equity ratio of 0.4: 1.0 and plans to keep it that way.
Ajay Kapoor has come up with the following estimates:
• Tax rate : 35 percent
Pre-tax cost of debt : 12 percent
For Manish detergent
- Risk free rate : 8 percent
- Market risk premium : 8 percent
- Beta for the equity of Manish detergent
(using comparative analysis) 1.06
Questions :
- 1.Calculate the DCF value of the firm
- 2.Calculate the value of the equity, assuming that the market value of debt is the same as its book value. /'
- 3.Discuss the important guidelines for corporate valuation.