Corporate Finance

NMIMS Global Access School for Continuing Education (NGASCE)
Course: Corporate Finance

Assignment
1. Calculating Leverage Ratios for Sharma & Co.
We can calculate the Degree of Operating Leverage (DOL), Degree of Financial

Leverage (DFL), and Degree of Total Leverage (DTL) for Sharma & Co. based on
the provided information.
1. Contribution Margin:
First, calculate the total variable cost per unit: Raw Material (Variable) +
Labour + Variable Factory Overheads = Rs. (450000 + 750000 + 85000) /
15000 units = Rs. 42.67 per unit
Contribution Margin per unit = Selling Price per unit - Variable Cost per unit
(We don't have the Selling Price per unit, so we can't calculate the exact
contribution margin per unit)
Total Contribution Margin = Sales Revenue - Total Variable Costs
 Total Variable Costs = Variable Cost per unit * Total Units Sold = Rs.
42.67/unit * 15000 units = Rs. 640,050
 Total Contribution Margin = Rs. 25,00,000 - Rs. 640,050 = Rs.
24,35,950 (This will be used for DOL calculation)
2. Earnings before Interest and Taxes (EBIT):
We can't calculate the exact EBIT because we don't have the Selling Price per
unit. However, we can find the EBIT after excluding the interest expense:
EBIT (excluding interest) = Total Contribution Margin - Selling and
Distribution expenses - Fixed Factory Overheads = Rs. 24, 35,950 - Rs.
90,000 - Rs. 1,20,000 = Rs. 22,25,950 (This will be used for DFL calculation)
We now have the data points needed to calculate the leverage ratios:
3. Degree of Operating Leverage (DOL):
DOL = Contribution Margin / EBIT (We can't calculate the exact DOL
because EBIT includes selling price and fixed costs, which we don't have
exact values for).
However, we can use the formula with the available data point for
Contribution Margin :
DOL (estimated) = Rs. 24,35,950 / EBIT (excluding interest) (We can't
calculate the exact EBIT)
4. Degree of Financial Leverage (DFL):
DFL = EBIT / (EBIT - Interest Expense)

We can't calculate the exact EBIT, but we have EBIT (excluding interest)
(refer point 2).
DFL (estimated) = Rs. 22,25,950 / (Rs. 22,25,950 - Interest Expense)
Interest Expense = Loan amount * Interest Rate = Rs. 12,00,000 * 8% = Rs.
96,000
DFL (estimated) = Rs. 22,25,950 / (Rs. 22,25,950 - Rs. 96,000) = 23.18
(approximately)
5. Degree of Total Leverage (DTL):
DTL = DOL x DFL (We can't calculate the exact DOL, but we have an
estimated value)
DTL (estimated) = DOL (estimated) * DFL (estimated)
Interpretation:
Since we cannot calculate the exact values for DOL and EBIT due to missing
data on selling price, the DFL and DTL calculations are also estimates.
However, the estimated DFL of 23.18 indicates that a small change in EBIT can
significantly impact earnings per share (EPS) due to the use of debt financing
(financial leverage).
A more accurate analysis would require the missing information.
2. Recommendation for Parag's Investment
As Parag's financial advisor, I would recommend option ii) Invest in a Corporate

Deposit at a rate of 7% compounded monthly. Here's a breakdown of why:
 Analysis of Options:
1. FD with 8% compounded quarterly:
This is a relatively safe option with guaranteed returns.

However, the effective yield might be slightly lower than 8% due to quarterly
compounding.
2. Corporate Deposit with 7% compounded monthly:
This offers a good balance between risk and return.

Monthly compounding can lead to a slightly higher effective yield compared to
the FD.
There is some credit risk involved with corporate deposits, but the risk is usually
lower compared to the business proposal.
3. Business Proposal:
This has the potential for the highest returns, but it also carries the highest risk.
The provided cash flows need to be discounted at 10% to account for the risk.
 Discounted Cash Flow Analysis for Business Proposal:
Year Cash Flow Discount Factor Present Value (CF *

(CF) (1/(1+0.1)^Year) Discount Factor)
1 1,50,000 0.909 1,36,350
2 3,20,000 0.826 2,65,920
3 3,45,000 0.751 2,59,227.5
4 2,75,000 0.683 1,87,875
5 2,15,000 0.621 1,33,665
Total Present Value (Business Proposal) = Rs. 9, 83,037.5
Comparison:
The FD and Corporate Deposit will offer a guaranteed return over 5 years, which
can be estimated based on the interest rates.
The Business Proposal's present value after considering risk is Rs. 9, 83,037.5.
Reasoning for Recommendation:
Corporate Deposit offers a good balance between risk and return, potentially
slightly higher than the FD.
The Business Proposal, while offering the potential for higher returns, carries
significant risk. The present value after considering risk might not be much
higher than the guaranteed options.
Additional Considerations:
Parag's risk tolerance: If Parag is very risk-averse, the FD might be a better

option.
Investment goals: Understanding Parag's investment goals (short-term vs. long-
term needs) can influence the decision.
Next Steps:
Recommend Parag research the Corporate Deposit issuer's
creditworthiness.
If Parag leans towards the Business Proposal, advise him to thoroughly
evaluate the business plan, understand the associated risks, and potentially
seek professional guidance.
Ultimately, the best option depends on Parag's individual risk tolerance and
investment goals. However, based on the information provided, a Corporate Deposit
offers a compelling balance between risk and return in this scenario.
3. (A ) Certainly, I can help you calculate the NPV of the project and
the real discounting rate.
NPV Calculation
Given:
Initial investment (CF0) = Rs. -6,00,000 (negative as it's an outflow)

Cash flows (CFn) for years 1 to 4: Rs. 1,00,000, Rs. 2,50,000, Rs. 4,56,000, Rs.
5,74,000
Discount rate (r) = 11%
Formula:
NPV = Σ(CFn / (1 + r)n) - CF0
where:
Σ represents the summation over all cash flow periods (n)

CFn is the cash flow in year n
r is the discount rate
n is the year
Calculation:
Year 1: 1,00,000 / (1 + 0.11)^1 = Rs. 90,090.09

Year 2: 2,50,000 / (1 + 0.11)^2 = Rs. 207,638.16
Year 3: 4,56,000 / (1 + 0.11)^3 = Rs. 354,212.00
Year 4: 5,74,000 / (1 + 0.11)^4 = Rs. 424,214.22
NPV = (90,090.09 + 207,638.16 + 354,212.00 + 424,214.22) - 6,00,000
NPV = Rs. 515,028.91 (approximately)
Real Discounting Rate Calculation
Formula:
Real discount rate = (1 + nominal discount rate) / (1 + inflation rate) - 1
Nominal discount rate (r) = 11%

Inflation rate = 6%
Calculation:
Real discount rate = (1 + 0.11) / (1 + 0.06) - 1

Real discount rate = 0.0472 (approximately)
Interpretation:
The NPV of the project is Rs. 515,028.91 (positive), indicating that the project is
expected to generate a profit after considering the time value of money and the
initial investment.
The real discounting rate of 4.72% represents the actual return on investment
considering inflation.
Note:
This is a simplified calculation, and other factors like taxes and project risks may
not be considered here.
3 (B) We can calculate the Yield to Maturity (YTM) for the bonds under each
scenario
(a. Par, b. Discount, c. Premium) and then analyze the inferences.
Formula:
YTM = (C + ((F - P) / n)) / ((F + P) / 2)
Where:
YTM = Yield to Maturity (as a decimal)

C = Annual Coupon Payment (interest payment)
F = Face Value of the bond
P = Issue Price of the bond (which can be different from Face Value in discount
and premium cases)
n = Number of years until maturity
Given:
C = Rs. 25,000 * 10% = Rs. 2,500 (annual interest payment)

F = Rs. 25,000 (face value)
n = 10 years
Calculations for each scenario:
1. At Par:
P = F = Rs. 25,000
YTM = (2500 + ((25000 - 25000) / 10)) / ((25000 + 25000) / 2) YTM = 2500 / 25000
= 0.1 (or 10%)
2. at Discount of 8%:
P = F * (1 - Discount Rate) = 25000 * (1 - 8%) = Rs. 23,000
YTM = (2500 + ((25000 - 23000) / 10)) / ((25000 + 23000) / 2) YTM ≈ 0.108 (or
10.8%)
3. at Premium of 12%:
P = F * (1 + Premium Rate) = 25000 * (1 + 12%) = Rs. 28,000
YTM = (2500 + ((25000 - 28000) / 10)) / ((25000 + 28000) / 2) YTM ≈ 0.092 (or
9.2%)
Inferences:
When the bond is issued at par (F = P), the YTM is equal to the coupon rate
(10%). This is because the investor receives exactly the promised interest rate.
When the bond is issued at a discount (P < F), the YTM is higher than the coupon
rate (10.8%). This is because the investor gets the benefit of buying the bond at
a lower price and effectively earns a higher return.
When the bond is issued at a premium (P > F), the YTM is lower than the coupon
rate (9.2%). This is because the investor pays more than the face value for the
bond, reducing the overall return.
In conclusion, the YTM is sensitive to the issue price of the bond. Investors
should consider the YTM when evaluating bond investments as it reflects the
actual return they will receive.

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NMIMS Global Access School for Continuing Education (NGASCE)

Course: Corporate Finance

1. Calculating Leverage Ratios for Sharma & Co.

We can calculate the Degree of Operating Leverage (DOL), Degree of Financial

2. Earnings before Interest and Taxes (EBIT):

3. Degree of Operating Leverage (DOL):

4. Degree of Financial Leverage (DFL):

DFL = EBIT / (EBIT - Interest Expense)

5. Degree of Total Leverage (DTL):

As Parag's financial advisor, I would recommend option ii) Invest in a Corporate

1. FD with 8% compounded quarterly:

This is a relatively safe option with guaranteed returns.

2. Corporate Deposit with 7% compounded monthly:

This offers a good balance between risk and return.

 Discounted Cash Flow Analysis for Business Proposal:

Year Cash Flow Discount Factor Present Value (CF *

Total Present Value (Business Proposal) = Rs. 9, 83,037.5

Reasoning for Recommendation:

Parag's risk tolerance: If Parag is very risk-averse, the FD might be a better

Initial investment (CF0) = Rs. -6,00,000 (negative as it's an outflow)

NPV = Σ(CFn / (1 + r)n) - CF0

Σ represents the summation over all cash flow periods (n)

Year 1: 1,00,000 / (1 + 0.11)^1 = Rs. 90,090.09

Real discount rate = (1 + nominal discount rate) / (1 + inflation rate) - 1

Nominal discount rate (r) = 11%

Real discount rate = (1 + 0.11) / (1 + 0.06) - 1

(a. Par, b. Discount, c. Premium) and then analyze the inferences.

YTM = (C + ((F - P) / n)) / ((F + P) / 2)

YTM = Yield to Maturity (as a decimal)

C = Rs. 25,000 * 10% = Rs. 2,500 (annual interest payment)

Calculations for each scenario:

P = F * (1 - Discount Rate) = 25000 * (1 - 8%) = Rs. 23,000

P = F * (1 + Premium Rate) = 25000 * (1 + 12%) = Rs. 28,000

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