Illustration 8 (Chapter 1):

Equity Share Capital ₹5,00,000

13% Preference Share Capital ₹2,00,000
Reserves and Surplus ₹6,00,000
Non trade investments (Face Value ₹1,00,000) Rate of interest 10%
14% Debentures ₹3,00,000
Profits before tax ₹2,00,000
Tax rate 40%
WACC 13%
Calculate EVA

Solution:
Economic Value Added = (Return on Capital Employed – Weighted Average Cost
of Capital) x Operating Capital

Working Note 1: Calculation of Return on Operating Capital (NOPAT)

Particulars ₹
Profit Before Tax 2,00,000
Less: Non-Operating Income (10,000)

Operating EBIT 1,90,000

Less: Tax @ 40% (76,000)

NOPAT 1,14,000
Working Note 1: Calculation of Operating Capital
Particulars ₹
Equity Share Capital 5,00,000
13% Preference Share Capital 2,00,000
Reserves and Surplus 6,00,000
14% Debentures 3,00,000

Total 16,00,000
Less: Non-Operating Assets (1,00,000)

Operating Capital 15,00,000

Return on Operating Capital = NOPAT/ Operating Capital x 100

= 1,14,000 / 15,00,000 x 100
= 7.6%

EVA = (Return on Capital Employed – Weighted Average Cost of Capital) x

Operating Capital
= (7.6% - 13%) x 15,00,000
= (81,000) i.e. Negative EVA of ₹81,000

Illustration 6 (Chapter 2):

A Ltd. wants to acquire T Ltd. by exchanging 0.5 of its shares for each share of T
Ltd. Relevant financial data are available:
 Particulars A Ltd. T Ltd.
EAT (₹) 18,00,000 3,60,000
Equity shares outstanding 6,00,000 1,80,000
(₹)
EPS (₹)
3 2
P/E Ratio
10 times 7 times
Market Price (₹)
30 (₹3 x 10) 14 (₹2 x 7)

Requires:

(i) The number of equity shares required to be issued by A Ltd for acquisition of T
Ltd.
(ii) What is the EPS of A Ltd. after the acquisition?
(iii) Determine the equivalent earnings per share of T Ltd.
(iv) What is the expected market price per share of A Ltd after the acquisition,
assuming its P/E
(v) Determine the market value of the merged firm.

Solution:
(i) The number of equity shares required to be issued by A Ltd for acquisition of T
Ltd.
= Exchange ratio x Number of shares of T Ltd.
= 0.5 x 1,80,000=90,000
 Total earnings after tax
(ii) EPS of A Ltd. after the acquisition = Total number of shares

18 ,00,000+ 3 ,60,000
= 6 ,00,000+ 90,000
21 ,60,000
= 8 ,90,000

= 3.13 approx.
(iii) The equivalent earnings per share of T Ltd. 3.13 x 0.5 = 1.57 appx.
(iv) The expected market price per share of A Ltd. after the acquisition = 3.13 × 10
= ₹31.30
(v) The market value of the merged firm = 31.30 x 6,90,000 = ₹2,15,97,000

Illustration 8 (Chapter 3):

The following is the Balance Sheet of AB Ltd. and PQ Ltd. as on 31st March, 2018

Particulars AB Ltd. PQ Ltd. Particulars AB Ltd. PQ Ltd.

 Share Capital: Fixed Assets:
Equity Shares of Net Value of
100 each fully paid Depreciation 2,700 850
2,000 1,000
up
Investments 700 -
Reserves and
800 - Sundry Debtors 400 150
Surplus
- Cash and Bank 250 -
10% Debentures 500
Profit and Loss A/c - 800
Loan from Financial
Institution 250 400
Bank Overdraft - 100
Sundry Creditors 300 300
Proposed Dividend 200 -

4,050 1,800 4,050 1,800

It was decided that PQ Ltd. will acquire the business of AB Ltd. for enjoying the
benefits of carry forward of business loss. After acquisition PQ Ltd. will be
renamed as POR Ltd.
The following scheme has been approved for the merger
1. PQ Ltd. will reduce its shares to 10 each and then consolidate 10 such shares
into one share of ₹100 each.
2. Financial institutions agree to waive 15% of the loan of PQ Ltd.
3. Shareholders of AB Ltd. will be given on new share of PQ Ltd. in exchange of
every share held in AB Ltd.
4. AB Ltd. will cancel 20% holding of PQ Ltd. Investments were held at 2,50,000.
5. After merger, the proposed dividend of AB Ltd. will be paid to the shareholders
of AB Ltd.
6. Authorized Capital of PQ Ltd. will be raised accordingly to carry out the
scheme.
7. Creditors of PQ Ltd. includes payable to AB Ltd. ₹ 1,00,000.

Analyze the accounts of AB Ltd. Prepare a Balance Sheet of PQR Ltd. showing
relevant working notes.

Solution:
PQ Ltd. is a financially sick company. It is going through internal reconstruction
and trying to takeover AB Ltd., which is a sound company. This is thus a case of
reverse merger. AB Ltd. is already holding certain shares in PQ Ltd., the value of
which will be reduced first, while discharging the purchase consideration, the
number of shares will be reduced.

Effect of Reconstruction on PQ Ltd.

Particulars ₹
Share Capital before Reconstruction (10,000 Shares 10,00,000
of 100 each)
1,00,000
After Reconstruction: (10,000 Shares of ₹10 each)
1,00,000
After Consolidation: (1,000 Shares of ₹ 100 each)

Effect of Investment of AB Ltd in PQ Ltd.

Particulars ₹
Share held in PQ Ltd. before Reconstruction (2,000 2,00,000
Shares of ₹10 each)
After Reconstruction: (2,000 Shares of ₹10 each)
20,000
After Consolidation: (200 Shares of ₹100 each)
20,000
 Calculation of Purchase Consideration
Particulars ₹
Share Capital of AB Ltd. 20,00,000
Shares to be given in PQ Ltd. in the ratio of 1:1
Therefore, shares of 100 each to be issued 20,000
(-) Shares already held (200)

Net shares issued by PQ Ltd. 19,800

(x) Face Value per Share 100

Amount of Purchase Consideration (19,800 x 100) 19,80,000

Analysis of Account of AB Ltd.

Profit/Loss on Reconstruction
Particulars ₹
Fixed Assets 27,00,000
Investments (7,00,000 – 2,50,000) 4,50,000
Sundry Debtors 4,00,000
Bank 2,50,000

Total Assets (I) 38,00,000

Debentures 5,00,000
Loans 2,50,000
Creditors 3,00,000
Proposed Dividend 2,00,000
Purchase Consideration 19,80,000

Total Liabilities(II) 32,30,000

Therefore, Loss to AB Ltd. (I - II) 5,70,000

Status of Shareholders
Particulars ₹
Share Capital Opening 20,00,000
Add: Reserves and Surplus 8,00,000

Total 28,00,000
Less: Decline in the value of Investment in PQ Ltd. (2,50,00 –
20,000)
(2,30,000)
Less: Loss on Sale to PQ Ltd.
(5,70,000)

Net Equity Share Value in PQ Ltd.

20,00,000

Balance Sheet of PQR Ltd. after Reconstruction/Merger

Particulars Sch. No ₹
A. Liabilities and Equities
I. Shareholder Funds
1. Share Capital 1 20,80,000
2. Reserves and Surplus 2 7,30,000
II. Non-Current Liabilities
1. Long-term Borrowings 3 10,90,000
2. Long-term Provisions 4
III. Current Liabilities
1. Trade Payables (Sundry Creditors) (3,00,000+
3,00,000 - 1,00,000)
5 5,00,000
2. Short-term Borrowings (Bank O/D)
6 1,00,000
3. Others
7
Total (A)
45,00,000

B. Assets
1. Non-Current Assets
a. Fixed Assets
8
1. Intangible
9 35,50,000
2. Tangible (27,00,000 + 8,50,000)
10 4,50,000
b. Non-Current Investments (7,00,000-2,50,000)
II. Current Assets
1. Inventories
11 -
2. Trade Receivables (4,00,000 + 1,50,000-1,00,000)
12 4,50,000
3. Cash and Cash Equivalents (2,50,000-2,00,000)
13 50,000
 4. Others 14

Total (B) 45,00,000

Schedules ₹
Schedule 1: Share Capital
Authorized ?
Issued/Paid-up:

20,800 Equity Shares of 100 each (1,000 Equity Shares of 20,80,000

PQ Ltd.)
(19,800 Equity Shares issued as Purchase Consideration)

Schedule 2: Reserves and Surplus

Profit/(Loss)
Add Reduction in Value of Equity Shares (8,00,000)
Add: Reduction in Value of Loan to Financial Institution 9,00,000
(4,00,000 x 15%) 60,000
Capital Reserve
Reserve and Surplus of AB Ltd. 1,60,000

Less: Loss in the Value of Investment 8,00,000

Other Reserves (2,30,000)
Total 5,70,000
7,30,000
Schedule 3: Long Term Borrowings
10% Debentures 5,00,000
Loans from Financial Institutions (2,50,000 + 4,00,000 –
60,000) 5,90,000

Total 10,90,000

Illustration 4 (Chapter 4):

PQR Leasing Ltd. has been approached by a client to write a five years lease on
assets costing ₹10.00,000 and having estimated salvage value of ₹1,00,000
thereafter. The company has a required rate of return of 10% and its tax rate is
50%. It provides depreciation @ 33.33% on written down value of the asset.
What lease rental will provide the company its after tax required rate of return?

Solution:

Cash Flow from the Asset

Year Depreciatio Tax Benefit Cash flow PV factor 10% PV
n
1 3,33,333 1,66,667 1,66,666 0.909 1,51,499
2 2,22,222 1,11,111 1,11,111 0.826 91,778
3 1,48,148 79,074 74,074 0.756 55,630
4 98,766 49,383 49,383 0.683 33,729
5 65,844 32,922 32,922 0.621 20,455
5 *1,00,000 0.621 62,100
 Present Value of Inflows. 4,15,181
Outflows 10,00,000

Net Present Value (NPV) 5,84,819

* Salvage Value
The firm therefore, should have total recovery of 5,84,820 through the lease
rentals.
Cost of Assets (Total Recovery Required) 5 ,84,819
Lease Rental (After Tax) = = 3.791
PV Factor 10 % for 5Years

= 1,54,265
KLease Rental (Before Tax) = 1,54,265/ 0.5 = 3,08,530

Therefore, the firm should charge a lease rental of 3,08,530 in order to earn a
required rats return of 10% after tax.