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Acknowledgement

Every project big or small is successful largely due to the effort of several wonderful
people who have always given their valuable advice or lent a helping hand. I sincerely
appreciate the inspiration; support and guidance of all those people who have been
instrumental in making this project a success.

Questions that we have covered.

1. Write short hypothetical cases, on project analysis and incorporate all project analysis tools like. Take data
hypothetical, each case should not exceed more than 30 lines, also solve the cases on excel.
Sensitivity analysis

Scenario analysis

Break even analysis

Operating leverage and breakeven point

2. Make 2 hypothetical case and assume data of outflows and inflows and calculate NPV and IRR of these
projects, solve it in excel and make decision which project to accept and which to reject.
3. Write down a 1 page hypothetical case on agency problems, and how to Measure and Reward Performance:
Residual Income and EVA. What is a true measure? Develop numeric case hypothetically.
5. Develop a hypothetical case, assume data, and calculate
What was the par value of each share?

What was the average price at which shares were sold?

How many shares had been repurchased?

What was the average price at which the shares were repurchased?

What was the net book value of companys common equity?

6. How companies issue securities? Write down the whole process.

~1~

Data:

Q#1: Answer.

Rs:
1.790
7m
5 year
2m

NPV
Years
Initial cost

FAR &Co is a company which operates in

constructing tunnels in mountainous areas.
Company is in process of submitting a bid for
Inflow
1m
Vehicles
100000
construction of 10 km large tunnel in
Per
vehicle
revenue
10
Baluchistan. As per the map of Economic
WACC
10%
Corridor. CFO got following data that was
anticipated by managers. The project initial investment is Rs.2 million with WACC of
10%. Inflow will be Rs.10 on each vehicle which passes the tunnel. It is anticipated
that almost 100,000 vehicles per year and project will benefit company till 5 years.
Project Manager has calculated NPV of Rs.

Sensitivity Analysis:
Change in NPV due to
change in WACC.
WACC = 9%

CFC 1
CFC 2
CFC 3
CFC 4
CFC 5
NPV

Change in initial investment.

initial cost= 1.5m

CFC 1
CFC 2
CFC 3
CFC 4
CFC 5
NPV

Rs:

0.917431
19
0.841679
99
0.772183
48
0.708425
21
0.649931
39
1.889651
26

Change in NPV
due to change in
per unit price
price= Rs 11
CFC 1
CFC 2

Rs:

CFC 3
0.909090
91
0.826446
28
0.751314
8
0.683013
46
0.620921
32
2.290786
77

CFC 4
CFC 5
NPV

~2~

Rs:

1
0.909090
91
0.826446
28
0.751314
8
0.683013
46
2.169865
45

Change in number of vehicles.

Rs:
units= 95,000
CFC 1
CFCin
2 life of project.
Change
CFC 3
years=3
4
CFC CFC
1
CFC 5
CFC 2
NPV

0.863636364
0.785123967
0.713749061
0.648862783
0.909090
0.589875257
91
0.826446
1.601247431
28
0.751314
8
0.486851
99

CFC 3
NPV

Scenario Analysis:
As in the base case we
have taken data as it is
given in the Case and
calculated NPV of the
project which is Rs.
1.7907m.

Base
case
Data:
NPV
Years
Initial cost
Inflow
Vehicle
Per vehicle
revenue
WACC

1
.7907 m
5
2m
1m
100,000

In the worst Case, we

have
changed
the
data in way that
harmful
for
the
project. Due to this
the NPV of the project
decreased
to
Rs.
1.0111m.

10
10%

Best
case
Data:
4.8344
7m
5
1m

NPV
Years
Initial cost
Inflow
Vehicles
Per
vehicle
revenue

1.5 m
100,000
15

WACC

9%

Worst
Case
Data:
NPV
Years
Initial cost

Break-Even Analysis:
Base Case
Best Case

PER YEAR
CALCULATIONS

PER YEAR
CALCULATIONS

WorstInflow
Case
PER YEAR
CALCULATIONS

~3~

Vehicles
Per vehicle
revenue
WACC

1.01110m
5
2.5
m
.95
m
95,000
10
11%

FIXED COST
DEPRECIATIION
PER YEAR
CACULATIONS
VARIABLE EXP
FIXED
PRICECOST
DEPRICIATION
BEAR EVEN POINT
PER UNIT PRICE
NO. OF VEHICLES
PROFIT ON 40,000
VARIABLE
vehicles COST
DOL
if sales INCEASES
BY 1
OI WILL INCREASE

40000
0
0
10
400,0
00
40000
10
100,0
00
0
0
1.666
6
10%
16.66
66

FIXED COST
DEPRECIATIION
PER YEAR
CACULATIONS

FIXED COST
50000 DEPRECIATIION
0 PER YEAR
CACULATIONS

VARIABLE EXP
FIXED
PRICE COST

200000

VARIABLE EXP
FIXED COST
PRICE

DEPRICIATION
BEAR EVEN POINT
PER UNIT PRICE

0
10
500,00
0
50000
10

0
15

NO. OF VEHICLES
PROFIT ON 50,000
VARIABLE
COST
vehicles

95,000
0
0

NO. OF VEHICLES
PROFIT ON 20,000
VARIABLE COST
vehicles

DEPRICIATION
BEAR EVEN
PER UNIT PRICE
POINT

200,000
13333.333
3 15

2.111
1 DOL
if sales INCEASES
10% BY
21.111
11 OI WILL INCREASE

DOL
if sales INCEASES
BY
OI WILL INCREASE

100,000
0
0
1.153846
15
10%
11.53846
154

Degree of Operating leverage:

Base Case
Best Case

Worst Case

Q#2: Answer.
Case#01:
COMPANY ABC:
There is a company ABC limited who is operating in Pakistan in construction sector with the vision to
have largest market share in Pakistan. In recent times company has option to choose one of the two projects.
Both projects have 10 years of life and WACC is 10% further details of these projects are as,
Project should be chosen when IRR > Cost of Capital.

PROJECT A:
The initial cost of project a is $10,000.
Cash inflows:
1
2,000

10

1500

1500

2000

2500

3000

2000

1500

2500

3500

Excel Calculations

~4~

Project B:
The initial outlay/ cost of project B is (20,000)
Cash inflows:
1
5,000

10

4000

3000

3000

4000

3500

4000

3000

2500

5000

Now we must select anyone from these two projects based on NPV and IRR analysis.

If we see the result and analyze the project and decide about any project only based on NPV then we will
select project B because its NPV is bit higher (3054). But when we analyze and make decisions based on
NPV and IRR then it differ our decision however, the NPV of project b is slightly high but the IRR of
project A is high (16%) which depicts that rate of return of project A is high it is because of low investment
in project A.
Since the rate of return is high in project A (16%) as compare to return of project B (14%) therefor company
should select project A instead of B.

Case#02: Hypothetical cash inflows and outflows:

Company XYZ:
There is a company XYZ limited who is operating in Pakistan in food sector with the vision to have
highest market share in Pakistan. In recent times company has option to choose one of the two projects. Both
projects have 10 years of life and WACC is 10% further details of these projects are as.
Project should be chosen when IRR > Cost of Capital.

PROJECT X:
The initial cost of project a is 30,000.

~5~

Cash inflows:
1

10

9,000

15000

2500

3000

2500

3000

2000

1500

2500

35000

Excel calculations,

Project Y
The initial outlay/ cost of project B is = (30,000)
Cash inflows:
1

8,000

10

7000

6000

6000

4000

3500

4000

8000

1000

5000

Excel calculations,

Now we must select anyone from these two projects based on NPV and IRR analysis.
Since there is a high difference in NPV of two projects therefore we can make decision on the basis of NPV
only. There is no need to see IRR because we know that IRR will be will be high of project X due to its high
NPV. We will select project X.

Q#3: Answer.
In corporations, there is separation of ownership. Owners (shareholder) appoint agents (managers) to run the
business efficiently and effectively. Separation of ownership leads to a problem faced by majority of
corporation that is Agency problem.
Agency problem occur when management doesnt fulfill their responsibility of maximizing wealth of
shareholders. One of simplest way of doing this is to spend time in searching positive NPV projects.

~6~

Mr. Rayan, CFO of Timberland, a largest shoe manufacturing public listed company, situated in Pakistan and
listed on Karachi stock exchange. Company has acquired so many small companies in horizontal, vertical,
and diversified market.
Agency problem put substantial coast on company thats why it receives attention of top management.
Because in many cases top management have larger stake in business. Mr. Rayan is also having a lions
share in Timberland stock.

From the past 5 years Timberland is facing higher agency cost in form of law suits by employees, losing
human capital (employee who was beneficial for company were leaving) and management attitude towards
risk has also changed. Most of employees at Timberland were senior and near to retirement, although many
of the retirements take place during past few years.
Younger managers have different point of view about risk. Timberland was well established company and
enjoy ample of cash flow and growth opportunities. But the situation worse when turnover of new staff
increase.
Senior employees reduce efforts in searching for growth opportunities and spend much of their time in
enjoying rewards provided by company. Due to their risk, aversive behavior many excellent opportunities of
growth were lost. Senior managers were involved in practices of empire building because they want to
control larger project then smaller. This attitude leads to entrenching investment in which project is designed
in a way that require skills of existing manager. Rather than investing in a new project managers continue to
invest more in existing project.
Due to this risk, aversive behavior of existing employees, company decided to offer Golden Handshake to
employees who are near to their retirement. Timberland believes that young and motivated staff will lead to
success and Timberland will regain its position of being market leader in shoe manufacturing industry.
To motivate the new employees, Mr. Rayan decided to revise compensation and incentive plan of top
management with the help of HR department. Top management is highly paid not only in Pakistan but in
whole world. Mr. Rayan identifies two main things that should be changed. First was compensation plan of
top management and second was incentives composition.
To offer an attractive carrot to new employees pay scale was revised and salaries were increased. Keeping
in view the point that salary is basic motivation to work. This increment not only motivates existing
executives but also middle management who dream to reach at executive level.
Compensation committee was established in HR department who specialized in compensating executives. In
deciding the pay scale Mr. Rayan keep in focus that, level of management pay depend on: Short of talent
and poor governance.
Furthermore, to increase shareholders stake, company arranged a meeting to involve shareholders in
deciding compensation of executive. In meeting, per voting power of shareholder used by his or by proxy, he
can vote for the pay scale.
After one year company witness a substantial decrease in Agency cost and problem and ride on a fast speed
on track of success.

Residual income or EVA:

Net income after deducting the dollar return required by investor is called residual income or EVA.
EVA = Income earned Income required

~7~

Income required = cost of capital * investment

Economic profit is better measure of return than accounting profit. Economic profit is equal to difference
between return on investment and cost of capital.
Based on EVA manager can take better decision of investment. Apparently which project seems better can be
worse based on EVA if it doesnt greater earning greater than cost of capital. Manager will take investment
decision only of the earning of project will be high enough to cover cost of capital.

EVA makes the cost of capital apparent to manager and help to reduce it by increasing earning and reducing
capital employed.
For example, if the company is expecting to earn $6m net income from project and its cost of capital is 10%
and project requires investment of 50m, then EVA will be:
EVA = 6 50*.10 = 1million
Keeping all other thing constant, if cost of capital increase from 10% to 13% than EVA will be negative and
project will be accepted.
EVA = 6 50*.13 = (0.5) million

Q#5: Answer.
Aslam ltd, a public listed well recognized energy producing company issue 1million share to finance its new
project of solar energy. This project has positive NPV but due to high cost of interest company goes for
issuance of equity. Project was also ranked as having above average level of risk. Face value of each share is
Rs.10. Flotation cost per share including cost of underwriter was Rs.1. Net proceeds equal 9million. Life of
project is expected to be 10 years thats why 10-year Treasury bond return is used as risk free rate in
calculation of required rate of return. Project required rate of return is 15% (calculated by using CAPM
model).
In first year of project company require initial investment of 0.5 million and keep .5 million for additional
issue in year 4 and 6. Now authorized share capital is 1million but company issues only half of them in year
1 @ Rs.10 per share. Shares were taken as hot cake by investors due to credibility of underwriter.
Information about issue is provided in table below:
No of share
400,000 shares
100,000 shares

Price per share

Rs.10
Rs.10

Total
Rs. 4000,000
Rs. 1000,000

Initially company sold .4million shares to underwriter but due to large demand Green shoe option was given to
underwriter that is .1million.
In year 4, company sold additional .3 million shares to underwriter. Information of issue is summarized as:
No of shares
300,000 shares

Price per share

Rs. 12

Total
Rs. 3600,000

As the project requirement explained above, company issue .2million in year 6 details are as follows:

~8~

No of shares
200,000 shares

Price per share

Rs. 11

Total
Rs. 2200,000

During this 10-year company, has not only issued share three times but buy back and took advantage of low price.
When the price of share went down company buy back share and due to increased demand pressure price of stock
increase.
Date

No of shares

Market price

Price of buyback

Year 2
Year 5
Year 7

100,000
200,000
200,000

Rs. 8
Rs. 6
Rs. 7

Rs. 9
Rs. 8
Rs. 8

At the end of year 11 company will buyback all the shares issued to finance project.
A) What was the par value of each share?
Par value of each share is Rs. 10
B) What was the average price at which shares were sold?
Issue was made 3 times during 10 years. Average price calculation is shown below:

Date
Year 1
Year 4
Year 6

Price per share

Rs. 10
Rs. 12
Rs. 11

Average price= (10+12+11) / 3 = Rs. 11

C) How many shares had been repurchased?

Company repurchases share three times first in year 2 then in year 5 and 7.
Date
Year 2
Year 5
Year 7

No of shares
100,000
200,000
200,000

D) What was the average price at which the shares were repurchased?
Date
Year 2
Year 5
Year 7

No of shares
100,000
200,000
200,000

Price of buyback
Rs. 9
Rs. 8
Rs. 8

Average price= (9+8+8) / 3 = Rs. 8.33

~9~

Amount paid by
company
Rs. 900,000
Rs. 1600,000
Rs. 1600,000

E) What was the net book value of companys common equity?

Par value of share is Rs.10. At the end of year 10 total number of share were 500,000 shares.
Book value is equal to Rs. 5000,000.

Q#6: Answer.
At the point when an organization needs to raise reserves, it often does as such by issuing and offering new
securities, for example, stocks or bonds. An underwriter often helps in this procedure by giving ability and
buyer to purchase the securities. An organization does not have to utilize an underwriter, but rather it
typically does. Since, it is less costly than attempting to issue and offer securities specifically to public.
When Companies want to issue securities, they must change their status from private to public company.
When companies go public they can easily generate fund from public. First time raising find from public, is
called initial public offerings(IPO). There are certain steps in initial public offering.

Process of Issuing Securities:

Hiring the underwriters/ banks:

When want to generate fund from public investment banks or underwriters are there to guide them.
They show the process of IPO. And figure it out the financial need. At the point when firm needs
finances, it will first examine the alternatives and potential outcomes with a venture broker, how
much cash will be required, what kind of security to offer and any uncommon elements it may have,
at what cost, and at what cost to the organization.
Submitting Document with SEC:
After the organization and underwriter consent to a guaranteeing bargain, the bank submits document
with the SEC. This paper has point by point data about the offering and organization information, for
example, budgetary articulations, administration foundation, any lawful issues, where the cash is to
be utilized. The SEC will explore the organization to ensure all the data submitted to it is right and
that all pertinent money related information has been uncovered.
In the case of all is well, the SEC will work with the organization to set a date for the IPO. After SEC
endorsement for the IPO, the guarantor must assemble a plan; that is, all finance related data on the
organization that is doing the IPO.
Going on the road show:
The next step is to going on the road show. To attempt and find out the interest for the IPO, the
investment bank takes the plan and exhibits it to investors. This is what's known as a road show.
Finalizing the price of IPO:
As with the help of SEC company has decided the IPO date. When the date of IPO is company and
underwriters decide the price of IPO by looking at the demand and the result of road show.
Finally, distribution of IPO share:
When company has finalized the price by looking at the market condition, now it is time to distribute
the share to the buyer.

~ 10 ~