Cfii Presentation Part2 Nlahuja

8/2/2019 Cfii Presentation Part2 Nlahuja

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CORPORATE FINANCE II NOTES [PART 2] BY DR NL AHUJA . ALL RIGHTS RESERVED

CORPORATE FINANCE II NOTES [PART2]

Dr. N.L. Ahuja

Professor, IMT Ghaziabad

---------------------------

DIVIDEND DECISION

The IPO prospectus of a telecom company in 2002:

We have not declared or paid any cash dividends on our

equity shares since inception and do not expect to pay any

cash dividends for the foreseeable future. Investors seeking

cash dividends should not purchase our shares.

Would it adversely affect investors interest in the IPO?

MM POSITION: Irrelevance of dividend policy

Value of a firm depends solely on its earnings power and is

not influenced by the manner in which its earnings are splitbetween dividends and retained earnings. Do you agree?


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Assumptions: MM constructed their argument on thefollowing assumptions.

Capital markets are perfect and investors are rational

Information is freely available, securities are divisible,

and no investor can influence market prices.

Floatation and transaction costs are nil.

There are no taxes.

Investment opportunities and future profits of firms are knownwith certainty (MM drop this assumption later).

Investment and dividend decisions are independent.

Implications: Dividend decision can be treated as a residual decision.

Arguments in favour of the relevance of dividend decision:

Resolution of uncertainty (for investors).

Shareholders need for current income.

Transactions cost if investors have to sell a part of their

shareholding to meet current expenditure.

Possible future unwise investments by the company

Impact of taxes.

Formulating Dividend Policy:

Future investment opportunities


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Shareholders preferences

Control

Cost of raising equity externally

Liquidity position Access to capital markets

Stability of dividends

Applicable taxes and other legal aspects

Stability of dividends: DPS (say Rs. 3 per share) stability,

payout ratio stability ( say 50%), target payout ratio.

BONUS ISSUE: SEE CLASS EXERCISE

STOCK SPLITS: SEE CLASS EXERCISE

BUYBACK OF SHARES

PROF NL AHUJA

Reliance Industries, Indias most-valued firm,announced that its Rs 10,440 crore (Rs 104.40 billion)share buyback offer will start from February 1 and

closes on January 19, 2013. This is the largest suchbuy-back programme known in the history of theIndian capital market. The board of directors of thecompany approved the buy back.
http://realtime.rediff.com/instasearch#!reliance%20industries%20share%20buybackhttp://realtime.rediff.com/instasearch#!reliance%20industries%20share%20buyback


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WHY: Objectives of Buy Back

Distribute surplus cash

Increase earnings per share Increase promoters holding

Support share prices in a bear-phase of the stockmarket

Prevent takeover bids

JK Lakshmi cement (Feb 2012): buy-backs more taxeffective as compared to payment of dividend

Funding of Buy BacksA Company can purchase its own shares out of:

Retained profits and free reserves,

Share premium account; or

Proceeds of any shares or other specifiedsecurities (except the proceeds of an earlier issueof the same kind of shares or specified securities).

When can a company buy-back: Conditions for beingeligible to Buy Back shares:

Authorised by the Articles of association of theCompany;

A special resolution should be passed


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The buy-back of equity shares in any financial yearshall not exceed twenty-five per cent of its total paid-upequity capital in that financial year;

The buy-back can be made by a Board resolution If thequantity of buyback is or less than ten percent of thepaid up capital and free reserves;

The ratio of the debt owed by the company is not morethan twice the capital and its free reserves after suchbuy-back;

There has been no default in servicing debt orpreference shares.

Repurchase price

Assuming no income taxes and nil transaction costs, the two options

of dividends and repurchase of shares should theoretically not make a

difference to the shareholders wealth.

After a company has repurchased a part of its shares, lesser number

of shares would remain outstanding which would lead to higher

earnings per share and dividends. This would result in higher market

price of shares providing greater returns to investors by capital gains.

The company would like to offer such a price to buy-back its shares

that would leave investors not offering shares for sale no poorer than

the ones who render shares in a buy-back exercise. Such an

equilibrium price is determined as follows:

P* S x Po / (S -N)

Where P* is the share repurchase price, Po is the current market price of shares, S is the

number of shares outstanding prior to the buy-back, and N is the number of shares to be

purchased.


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RIGHTS ISSUE

PROF NL AHUJA

What is a Rights Issue?

What choices do holders of rights have?

Cum-Rights and ex-Rights price of shares

How to calculate value of a right? How to calculate

ex-rights price of shares?

Effect of different choices on shareholder wealth

RIGHTS ISSUE


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A rights issue is an offer to the existing shareholders to buy

additional shares of the company for a price on a pro rata basis.

Value of Rights

The theoretical market value of one right after the offering is

announced but while the stock is still selling cum-rights is

R0 =1

0

N

SP

where Ro is the market value of one right when stock is selling

rights-on, Po is the market value of a share selling cum-rights, S

is the subscription price per share, and N is the number of

rights required to purchase one additional share.

Ex-Rights Value of share: When the share goes ex-rights, the

market price theoretically declines.

Pxr =1

)( 0

N

SNP

Where Pxr is the market price of the stock when it goes ex-rights.

The rights give shareholders the option to purchase additional

shares according to the terms of the offer. The terms specify


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the number of rights required to subscribe for an additional

share, the subscription price per share, and the expiration date

of the offering.

The holder of rights has three choices: (1) exercise them and

subscribe for additional shares, (2) sell the right to subscribe

because these rights are transferable, or (3) do nothing and let

them expire.

Wealth of Shareholders The wealth of existing shareholders,

per se, is not affected by the rights offering, provided, of

course, the existing shareholders exercise their rights in full or

sell their rights. SEE CLASS EXAMPLE.

FORWARD AND FUTURES CONTRACTS

Issue Detail:

Issue Open: Feb 22, 2012 - Feb 24, 2012 Issue Type: 100% Book Built Issue IPO


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Issue Size: 6,427,378 Equity Shares of Rs. 10 Issue Size: Rs. 663.31 Crore Face Value: Rs. 10 Per Equity Share

Issue Price: Rs. 860 - Rs. 1032 Per Equity Share Market Lot: 6 Shares Minimum Order Quantity: 6 Shares Listing At: BSE

Number of Times Issue is Subscribed (BSE+ NSE) = 54.13 TIMES

Incorporated in 2003, Multi Commodity Exchange of IndiaLtd (MCX) is India based electronic commodity futuresexchange. MCX provides online trading facility along withclearing and settlement operations for commodity futuresacross India.

There are five officially recognized electronic multi-commodity national exchanges in India including MCX,NCDEX, NMCE, ICEX and ACE. These five national multi-commodity exchanges accounted for 99.5% of theturnover of commodity futures contracts traded in India.

MCX is the largest among these and have above 80% ofthe market share of the Indian commodity futuresexchange industry.


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MCX allows trading in more than 50 commodities acrosssectors like bullion, metals, energy, weather, andagricultural products. The Exchange is the world's largest

exchange in Silver, the second largest in Gold, Copperand Natural Gas and the third largest in Crude Oil futures,with respect to the number of futures contracts traded.

FORWARD CONTRACTSINVOLVES AN AGREEMENT TO BUY/SELL AN

ASSET ON A CERTAIN FUTURE DATE AT ANAGREED PRICE.

TWO PARTIES: ONE TAKES A LONG POSITION (BUYER),

AND THE OTHER TAKES A SHORT POSITION (SELLER).

THE AGREED FORWARD PRICE IS THE DELIVERY PRICE

WITH THE PASSAGE OF TIME, FORWARDPRICE CAN CHANGE DUE TO DEMAND-SUPPLYFORCES, WHILE THE DELIVERY PRICE

WOULD REMAIN UNCHANGED AT THEAGREED LEVEL. THIS CREATES ADIFFERENCE BETWEEN THE TWO, AND THEVALUE OF A CONTRACT DEPENDS ON THEMARKET VALUE OF THE UNDERLYING ASSET.


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EVALUATION:

FORWARD CONTRACTS REMOVE THE FUTURE PRICE

UNCERTAINTY FOR BOTH PARTIES.

HOWEVER:

NOT STANDARDIZED CONTRACTS ENTERED INTO ON A ONE-TOONE BASIS

NOT TRANSFERABLE; LACK LIQUIDITY

UNCERTAINTY OF PERFORMANCE

FUTURES CONTRACTS ATTEMPT TO REMOVE THESE

SHORTCOMINGS.

FORWARD CONTRACTS: OTC, LONG ANDSHORT POSITIONS, DEFAULT RISK.

FEATURES OF A FUTURES CONTRACT:

FUTURES EXCHANGES

STANDARDIZED CONTRACTS


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FACE-LESS TRADING

GUARANTEED FOR PERFORMANCE

MARKETABLE INSTRUMENTS, SO HIGH LIQUIDITY.

PARTIES CAN REVERSE OR CANCEL POSITION ON

ANY TRADING DAY.

COMMODITY AND FINANCIAL FUTURES: DIFFERENCE:

CASH SETTLEMENT VS DELIVERY, CONTRACT LIFE.

INITIAL AND MAINTENANCE MARGINS: SEE CLASS

EXERCISE.

Options: Meaning, call and put options.

Options: an option gives the option holder the

right, but not the obligation, to buy or sell a

specific asset at a predetermined price (called theexercise or strike price) on or before a given date

in future. It is up to the holder whether or not to


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exercise the option. But the seller (called writer)

of the option is committed. So, risk lies with the

writer of the option for which he charges apremium.

Types of options:

A call option gives the right to buy.

A put option gives the right to sell the underlying

asset.

Traders in futures and options markets:

Hedgers

Speculators

Arbitrageurs

Functions of the derivatives markets:

Transfer of risk


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Price discovery

Market completion.

EXAMPLE: HEDGING WITH FUTURES:

A FARMER EXPECTS TO HARVEST 500 QUINTALS OF

BASMATI RICE IN LATE APRIL. IN MID MARCH, THE

PRICE OF BASMATI RICE IS RS. 4000 PER QUINTAL, BUT

THE FARMER IS AFRAID THE PRICE MIGHT FALL BEFORE

HIS SUPPLIES BECOME AVAILABLE IN LATE APRIL. THE

APRIL BASMATI RICE FUTURES PRICE IS RS. 3900 PER

QUINTAL. IN ORDER TO HEDGE HIS POSITION, THE

FARMER ENTERS INTO APRIL FUTURES CONTRACT TOSELL 500 QUINTALS OF BASMATI RICE.

BY LATE APRIL, THE SPOT PRICE OF BASMATI RICE FELL

TO RS. 3500 PER QUINTAL. ASSUMING THE FUTURES

CONTRACT WAS SETTLED IN CASH,

(i)CALCULATE HIS GAIN/LOSS FROM FUTURES

CONTRACT, AND


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(ii) SHOW HOW THE HEDGING WORKED FOR THE

FARMER?

SWAPS

A SWAP IS AN AGREEMENT BETWEEN TWO COMPANIES TO

EXCHANGE CASH FLOWS IN THE FUTURE. THE AGREEMENT

DEFINES THE DATES WHEN THE CASH FLOWS ARE TO BE PAID

AND THE WAY IN WHICH THEY ARE TO BE CALCULATED.

MECHANICS OF INTEREST RATE SWAPS:

INTEREST RATE SWAPS ARE OVER-THE-COUNTER (OTC)

DERIVATIVE INSTRUMENTS AVAILABLE IN THE CURRENCY

MARKET.

THE MOST COMMON TYPE OF INTEREST RATE SWAP IS A

PLAIN VANILA INTEREST RATE SWAP. IN THIS SWAP, A

COMPANY AGREES TO PAY CASH FLOWS EQUAL TO INTERESTAT A PREDETERMINED FIXED RATE ON A NOTIONAL

PRINCIPAL FOR A NUMBER OF YEARS. IN RETURN, IT RECEIVES


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INTEREST AT A FLOATING RATE ON THE SAME NOTIONAL

PRINCIPAL FOR THE SAME PERIOD OF TIME.

EXAMPLE: SUPPOSE MICROSOFT AND INTEL AGREED ON ATHREE YEAR SWAP INITIATED ON 1st MARCH 2012, IN WHICH

MICROSOFT AGREED TO PAY TO INTEL AN INTEREST RATE OF

5% PER ANNUM ON A NOTIONAL PRINCIPAL OF $100

MILLION, AND IN RETURN INTEL AGREED TO PAY MICROSOFT

THE SIX-MONTH LIBOR RATE ON THE SAME NOTIONAL

PRINCIPAL AMOUNT. THE PAYMENTS ARE TO BE EXCHANGEDEVERY SIX MONTHS.

THE SIX-MONTH LIBOR RATE ON 1st MARCH 2012 IS 4.2%, SO

THAT THERE IS NO UNCERTAINTY ABOUT THE FIRST

EXCHNAGE OF PAYMENTS. INTEL PAYS MICROSOFT 0.5 * 0.042

* $100 = $2.1 MILLION ON 1ST SEPT. 2012. MICROSOFT WOULD

PAY INTEL $2.5 MILLION ON EACH 1st SEPT AND 1st MARCH.

NOTE THAT THE FLOATING RATE PAYMENTS ON A PAYMENT

DATE ARE CALCULATED USING THE 6-MONTH LIBOR RATE

PREVAILING SIX MONTHS BEFORE THE PAYMENT DATE. ON

EACH PAYMENT DATE, ONE SIDE WOULD REMIT THE

DIFFERENCE BETWEEN THE TWO PAYMENTS TO THE OTHER

SIDE.


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CASHFLOWS TO MICROSOFT ($ MILLION):

DATE 6-MONTH FLOATING FIXED NET

LIBOR % CF RECD. CF PAID CF01/03/12 4.20 0 0 0

01/09/12 4.80 2.10 -2.5 -0.40

01/03/13 5.30 2.40 -2.5 -0.10

01/09/13 5.50 2.65 -2.5 +0.15

01/03/14 5.60 2.75 -2.5 +0.25

01/09/14 5.90 2.80 -2.5 +0.30

01/03/15 6.40 2.95 -2.5 +0.45

ROLE OF FINANCIAL INTERMEDIARY: USUALLY TWO

NONFINANCIAL COMPANIES DO NOT GET INTO AGREEMENTSWITH EACH OTHER DIRECTLY. THEY MAY EACH DEAL WITH A

FINANCIAL INSTITUTION SUCH AS A BANK. THE FI/BANK

WOULD EARN SOME COMMISSION ON ARRANGING THE

TRANSACTION.

CURRENCY SWAPS:


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A SIMPLE CURRENCY SWAP INVOLVES EXCHANGING

PRINCIPAL AND INTEREST PAYMENTS IN ONE CURRENCY FOR

PRINCIPAL AND INTEREST PAYMENTS IN ANOTHER

CURRENCY.

CONSIDER A FIVE YEAR CURRENCY SWAP AGREEMENT

BETWEEN IBM AND BP ENTERED INTO ON 15th JANUARY 2011,

WHEN IBM PAYS $15 MILLION TO BP AND RECEIVES GBP10

MILLION FROM BP. IBM PAYS A FIXED RATE OF INTEREST OF

11% IN STERLING AND RECEIVES A FIXED RATE OF INTEREST

OF 8% IN DOLLARS FROM BP. INTEREST RATE PAYMENTS ARE

MADE ONCE A YEAR. AT THE END OF THE SWAP, IBM PAYS A

PRINCIPAL OF GBP10 MILLION AND RECEIVES $15 MILLION.

CALCULATE IBMS CASH FLOWS FROM THE SWAP FOR THE

FIVE YEAR PERIOD.

CASH FLOWS TO IBM IN CURRENCY SWAP:

DATE $ CF (Mn.) GBP CF (Mn.)

15/1/11 -15.00 +10.00

15/1/12 +1.20 -1.10

15/1/13 +1.20 -1.10

15/1/14 +1.20 -1.10


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15/1/15 +1.20 -1.10

15/1/16 +16.20 -11.10

CORPORATE GOVERNANCE

PROF NL AHUJA

EXTRACTS FROM A COMPANYS ANNUAL REPORT:

Corporate Governance Report for the year 2010-11Corporate governance helps to serve corporate

purposes by providing a framework within which

stakeholders can pursue the objectives of the

organization most effectively. Corporate governance

signifies acceptance by management of the inalienable

rights of shareholders as the true owners of the

organization and of their own role as trustees on

behalf of the shareholders. The Company has a strong

legacy of fair, transparent and ethical governance

practices.

QUESTIONS:

CAN YOU GUESS WHICH GROUP OR COMPANY IS THIS?

WHAT DO YOU UNDERSTAND AS THE MEANING OFCORPORATE GOVERNANCE?

WHAT IS THE NATURE OF RELATIONSHIP BETWEEN OWNERSAND MANAGERS?


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WHAT IS THE MAIN FUNCTION OF CORPORATEGOVERNANCE?

THEORIES OF CORPORATE GOVERNANCE

1.Agency Theory

2.Stewardship Theory

3.Stakeholder Theory

4.Political Theory

CONSIDER THE FOLLOWING:

"The current board has failed to do what

they are supposed to do. The credibility of

the IT industry should not be allowed to

suffer."

[MIN OF CORP AFFAIRS, 10 JAN 2009]


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SATYAM SCANDAL

The founder of Satyam was arrested two days after headmitted to falsifying the firm's accounts. RamalingaRaju is charged with several offences, includingcriminal conspiracy, breach of trust, and forgery.

Satyam's shares fell to 11.50 rupees on 10 January2009, their lowest level since March 1998, compared to

a high of 544 rupees in 2008. In New York StockExchange Satyam shares peaked in 2008 at US$ 29.10;by March 2009 they were trading around US $1.80.

On 10 January 2009, the Company Law Board

decided to bar the current board of Satyam from

functioning and appoint 10 nominal directors.

Attributes of a good corporate governance system

Clause 49 of the Listing Agreement which companieshave to enter with the stock exchanges stipulates thepolicies and practices required as a part of the goodcorporate governance.

Board of Directors
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(A)Composition of Board

(B) Other provisions as to Board and Committees

(C ) Information to be placed before Board of Directors

Audit Committee

(A) Qualified and Independent Audit Committee

(B) Meeting of Audit Committee

(D) Role of Audit Committee

Whistle Blower Policy

Remuneration Committee

Management Analysis

Shareholders/Investors Grievance Committee

I. Board of Directors

(A) Composition of Board

i. optimum combination of executive and non-executive

directors with not less than fifty percent of the board of directors

comprising of non-executive directors.


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ii. Where the Chairman of the Board is a non-executive director,

at least one-third of the Board should comprise of independent

directors and in case he is an executive director, at least half of the

Board should comprise of independent directors.

iii. For the purpose of the sub-clause (ii), the expression

independent director shall mean a non-executive director of the

company who, apart from receiving directors remuneration, does not

have any material pecuniary relationships or transactions with the

company, its promoters, its directors, its senior management or its

holding company, its subsidiaries and associates which may affect

independence of the director.

(B) Other provisions as to Board and Committees

i. The board shall meet at least four times a year, with a

maximum time gap of four months between any two meetings.

ii. A director shall not be a member in more than 10 committeesor act as Chairman of more than five committees across all companies inwhich he is a director.

(C ) Information to be placed before Board of Directors

1. Annual operating plans and budgets and any updates.

2. Capital budgets and any updates.

3. Quarterly results for the company and its operating divisions or business

segments.

4. Minutes of meetings of audit committee and other committees of theboard.

5. The information on recruitment and remuneration of senior officers such

as Chief Financial Officer and the Company Secretary.


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6. Show cause, demand, prosecution notices and penalty notices which are

materially important

7. Fatal or serious accidents or pollution problems.

8. Any material default in financial obligations to and by the company

9. possible public or product liability claims

10. Details ofany joint venture or collaboration agreement.

11. Transactions that involve substantial payment towards goodwill, brand

equity, or intellectual property.

12. Significant labour problems

13. Sale of material nature, of investments, subsidiaries, assets, which is not in

normal course of business.

14. Quarterly details of foreign exchange exposures and the steps taken by

management to limit the risks of adverse exchange rate movement, if material.

15. Non-compliance of any regulatory, statutory or listing requirements and

shareholders service such as non-payment of dividend, delay in share transfer

etc.

II. Audit Committee

(A) Qualified and Independent Audit Committee

i. The audit committee shall have minimum three directors as members.

Two-thirds of the members of audit committee shall be independent

directors.


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ii. All members of audit committee shall be financially literateand at

least one member shall have accounting or related financial management

expertise.iii. The Chairman of the Audit Committee shall be an independent director;

(B) Meeting of Audit Committee

The audit committee should meet at least four times in a year and not more than

four months shall elapse between two meetings.

(D) Role of Audit Committee

The role of the audit committee shall include the following:

1. Oversight of the companys financial reporting process to ensure that the

financial statement is correct, sufficient and credible.

2. Recommending to the Board, the appointment, or removal of the statutory

auditor and the fixation of audit fees.

4. Reviewing, with the management, the annual financial statements before

submission to the board for approval, with particular reference to:

b. Changes, if any, in accounting policies and practices and reasons for

the same

c. Major accounting entries involving estimates based on the exercise of

judgment by management


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d. Significant adjustments made in the financial statements arising out of

audit findings

e. Compliance with listing and other legal requirements relating to

financial statements

5. Reviewing, with the management, the quarterly financial statements before

submission to the board for approval

5. Reviewing, with the management, the statement of uses / application of funds

raised through an issue (public issue, rights issue, preferential issue, etc.).

6. Reviewing, with the management, performance of statutory and internal

auditors, adequacy of the internal control systems.

7. Other relevant aspects.

Whistle Blower Policy

Remuneration Committee

Management Analysis

1. Industry structure and developments.

2. Opportunities and Threats.

3. Segmentwise or product-wise performance.

4. Outlook

5. Risks and concerns.

6. Internal control systems and their adequacy.


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7. Discussion on financial performance with respect to operational

performance.

8. Material developments in Human Resources / Industrial Relations

front, including number of people employed.

Shareholders/Investors Grievance Committee

The committee headed by an independent director would be responsible for

investors grievances relating to transfer of shares and non-receipt of dividends etc.

Cfii Presentation Part2 Nlahuja

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