Name: Duration: 30 Min Sec:

Finance II Quiz - 2 Exam 9th Feb 2016

Answer the questions in the answer booklet only. Marks will be awarded only for showing ALL
relevant steps. Put up appropriate justification for your assumptions wherever applicable.
Untidy work will be penalized. Rough work should be done at the end of answer booklet only.
Calculators are allowed. Do NOT write with pencil.
Maximum Marks 15
1. Muhindra & Muhindra Ltd. (MML) is an Indian multinational automobile manufacturing
corporation. The company currently has 5 million shares outstanding, and its shares are
trading at Rs. 20 per share. The balance sheet of the company, as of December 31, 2015, is
provided below:
Balance Sheet (All figures in INR million) MML
Current Assets 80
Fixed Assets (net) 120
Total Assets 200

Current Liabilities 80
Long Term Debt 50
Common Stock 20
Retained Earnings 50
Total Liabilities and Equity 200

(i) Assume that a comparable firm in the same industry as MML has a beta of 1.5, and
the comparable firm is completely unlevered. If the risk-free rate is 8% and equity
risk premium is 5%, can you calculate the appropriate cost of capital of MML?
Assume that the debt issued by MML is risk-free, and its marginal tax rate is 34%. (3
marks)

(ii) Assume that MML now issues additional INR 50 million worth of long term debt,
over and above its existing debt, and uses this money to buy back its own shares at
the current market price of INR 20 per share. As a result of the higher leverage, MML
now has to pay a default spread of 150 basis points over the risk-free rate on its entire
outstanding debt. Assuming that everything else remains unchanged as mentioned in
(i) above, what is the new cost of capital of MML? (3 marks)

2. A manufacturing firm is financed with INR 15 million in debt and INR 5 million in equity.
The historical covariance of the stock’s returns with that of market returns has been 25%. The
historical average variance of the stock return and the equity market return has been 20% and
15%, respectively. If the firm were to increase its leverage from INR 15 million to INR 18
million and use the cash to repurchase its own shares, what would you expect its levered
equity beta to be? (3 marks)
3. You are analysing the beta for HP-Compaq, and have collected the following information for
the company’s four different divisions:

Assets Sales
HP Compaq Divisions (INR mm) (INR mm) Equity Beta Debt/Equity
Mainframes 1,800 1,600 1.25 1.00
Personal Computers 1,900 1,650 1.10 1.50
Software 500 1,250 1.50 0.25
Printers 2,900 2,700 0.90 2.00

What is the levered beta of HP Compaq, if the market value based debt to total capital ratio is
60% for the firm as a whole? Assume that assets and sales numbers are in INR millions, debt-
to-equity ratios are based on the market values, and marginal tax rate is 34%. (6 marks)

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