Model Question Paper

Security Analysis – II (MSF2D2)

Section D : Case Study (50 Marks)
• This section consists of questions with serial number 1 - 5.
• Answer all questions.
• Marks are indicated against each question.
• Do not spend more than 80 - 90 minutes on Section D.

*
Case Study

1.Analyze the strengths, weaknesses, opportunities and threats of Surya Cigars Ltd. (SCL). ( 6 marks)
2.a. The value of a company’s assets and liabilities listed in the balance sheet at the current market
values can be estimated through asset based valuation. It also identifies omitted assets and
assigns a market value to them. But there are some problems attached with this type of
valuation model. Discuss these problems. ( 6 marks)
b. Calculate Cash Earning Per Share (CEPS) of the Surya Cigars Ltd. (SCL) during the last five
years. Make comparative analysis of CEPS with EPS. ( 7 marks)
3.Calculate the intrinsic value of the share of SCL as per the formula given below:
P0 = 0.15 × PDDM + 0.85 × PRegression
PRegression = 441.15 + 21.35 × DP + 22.05 × GR – 0.61 β + 33.2 ROE
Where,
DP = Average dividend Payout Ratio (%)
GR = Average growth rate in earnings (%)
ROE = Average Return on Equity (%)
PDDM = Price as per the DDM
PRegression = Price as per regression equation
β = Beta of SCL stock (relevant data appears in Annexure I to the case.)
It is assumed that for the next 5 years, SCL is maintaining its growth rate based on its average growth
rate in earnings, after that it stabilizes at 13%. The risk free rate and market return are 8.5% and 18%
respectively, which are expected to remain same in the future. (17marks)
4.With an increase in the world import requirements there is every possibility of rise in the export
potential and Indian Tobacco industry is presented with significant opportunities to consolidate and
strengthen its position in the global market. Briefly discuss the various promotional activities that are
taken up by the Tobacco Board of India towards exports. ( 6 marks)
5.Valuing a company which has an inconsistent schedule of earning, or with no earning at all, requires a
judicious balancing act on part of an analyst. In such instances, Price to Earning ratio for valuing a
company is not feasible. With respect to this, explain the importance of Price to Sales ratio as an
alternative for Price to Earning ratio for valuing a company. ( 8 marks)
India is currently the world’s second largest producer of tobacco next to China and the fourth largest
exporter of unmanufactured tobacco in the world. On an average, cigarettes account for about 85% of
tobacco consumption globally. Despite being the second largest producer, India is only the ninth
largest exporter of tobacco and tobacco products in the world. Out of the total tobacco produced in
India, only one-third is flue-cured tobacco suitable for cigarette manufacturing. Of the total
production of tobacco in the country, around 48% is in the form of chewing tobacco, 38% as bidis,
and only 14% as cigarettes. Thus, bidis, snuff and chewing tobacco (such as gutka, khaini and zarda)
form the bulk of India's total tobacco production. In the rest of the world, production of cigarettes is
90% of total production of tobacco related products.
This unique tobacco consumption pattern is a combination of tradition and more importantly the tax
imposed on cigarettes over the last 2 decades. Cigarette smokers pay almost 85% of the total tax
revenues generated from tobacco. Most of the tobacco produce is suitable for the manufacture of
chewing tobacco, bidis and other cheap tobacco products, which have no demand outside the country.
In India, four major cigarette players dominate the market, out of these four major players, ITC with
72% market share, Godfrey Phillips with 12% and VST and GTC with 8% share each.

Total tobacco production in India is about 700 million Kilograms annually. Rich and varied
geographic and agro-climatic conditions foster consistent availability of wide range of tobaccos.
Tobacco occupies a prime place in the Indian economy on account of its considerable contribution to
the agricultural, industrial and exports sectors. The industry in India is essentially capital intensive in
nature. The growth of this industry both in domestic and international market represents a big revenue
opportunity for the economy. The industry continuously operates in a challenging economic
environment, particularly with respect to taxation and regulations relating to communication and
consumption. The regulations, dictated by circumstances in more developed markets, together with
prolonged punitive and discriminatory taxation have had the effect of being directed almost
exclusively at cigarettes, thereby stifling cigarette consumption in India in comparison with other
forms of tobacco consumption. The burden of Tobacco tax has increasingly shifted to cigarette with
the removal of duty on raw Tobacco, resulting in increasing rates of duty compared to other Tobacco
products.
India's share in world cigarette production has remained at around 1.7% whereas India's exports of
around 2.8 billion sticks of cigarette per year accounts for less than 1% of the world export of
cigarette. There is significant opportunity for cigarette industry to grow considerably and to
consolidate its position in international market due to some recent trends like withdrawal/reduction of
agricultural subsidy and escalating cost in the traditional cigarette exporting countries.
Regulatory Body
Market and marketing system play a dominant role in ensuring remunerative price for commercial
crop like Tobacco. The Tobacco Board was constituted under the Tobacco Act, 1975. The Tobacco
Board is responsible for regulating the cultivation, production, marketing and export of tobacco.
There has been significant improvement in the marketing with establishment of Tobacco Board. In
the area of exports, it helps in promotional activities such as, inviting officials and delegates from
aboard, providing recommendatory, advisory and other support services to the Trade and Industry etc.
Tobacco is a principal cash crop of national importance. Although the cultivation of tobacco is
restricted to 0.3% of the total cultivated area, it provides employment to large number of people.
Tobacco being a labour intensive crop provides employment to more than 60 lakhs people who are
engaged in the farming, curing, redrying, packaging, grading, distribution, export and retailing
activities. On the other hand, it makes significant contribution to National Exchequer by way of
excise revenue and foreign exchange earnings.
Although there is nation wide anti-tobacco campaign, the commercial importance of tobacco can
never be underestimated due to the revenue earning potentiality and employment generation capacity
of the crop. Presently there is a call for substitution of tobacco with other crops, but the research
findings show that there is no economically viable alternative crop which is as remunerative as
tobacco to the farmer. Presently of the total tobacco produce in India, only 50% is used in the
domestic market and of this domestic consumption of tobacco only 16% is used by cigarette industry.
The main source of raw materials for cigarettes is raw tobacco which is mainly found in the state of
Andhra Pradesh. There is no scarcity in supply of raw tobacco since the net income earned by the
farmers from cultivating tobacco has been found to be much higher than the net income earned from
other crops.
Production
Botanically, the tobacco plant belongs to the family solanacea and genus Nicotiana. The genus
embraces over 60 species of which two alone are cultivated. India grows both the cultivated species
viz. Nicotiana tabacum and Nicotiana rustica. The largest area is under Nicotiana tabacum which is
grown all over the country whereas Nicotina rustica is confined to North and North Eastern states i.e.
Uttar Pradesh, Bihar, West Bengal and Assam. About 5% to 6% of the total area under tobacco is
accounted for Nicotiana rustica varieties. The cultivation of Nicotiana tabacum has countrywide
spread and this type alone accounts for more than 80% of the exchange earnings. Specific types and
varieties of tobacco have been developed for use in cigarette, bidi, cigar, cheroot, hookah, chewing
and snuff whereas tabacum types are used for all purposes.
Types
Tobacco is consumed in two ways, either by smoking or chewing. While smoking the following
tobacco products are consumed: Cigarette, Cigar, Bidi (Hand rolled, leaf wrapped country cigarettes)
and to chew the products are: Raw tobacco, Gutkha, Pan Parag etc. Due to diverse climatic conditions
every type of tobacco is grown in India. Almost 90% of area is accounted for by Nicotine tobacem
and 10% by Nicotina Restica. Only one third of the tobacco output in the country is Flue cured
Virginia (FCV) variety, suitable for cigarette manufacturing.
Cigarette market in India is at present segmented on the basis of length and filter/nonfilter.
Length Type Size of Market
Under 60mm Non-filter 4.8%
60-70mm Non-filter 95.2%
70-75mm Filter 19.3%
75-85mm Filter 5.3%
There are seven major categories of tobacco, Viz. Flue cured Virginia tobacco (FCV), Burley,
Oriental, Bark flue cured, Sun cured, Light flue cured cigar and Dark flue cured.
Flue cured Virginia tobacco is mainly used for manufacture of cigarettes. Light air cured tobacco is
used in the manufacture of bidis.
Marketing
There has been significant improvement in the marketing of FCV Tobacco with establishment of
Tobacco Board. The production and marketing of FCV Tobacco have been statutorily regulated by
the Tobacco Board. Excluding FCV Tobacco, the method of marketing of Tobacco in India differs
from type to type and from State to State. In case of FCV Tobacco the Government of India and the
Tobacco Board are announcing Minimum Support Price (MSP) from year to year with the objective
of protecting the interest of the growers of FCV Tobacco.
Current scenerio
The growth in the tobacco industry is greatly dependent on the policies of the government (both
excise related and ban of public smoking). Higher duties result in higher prices of the product.
Contraband cigarettes have become competitively priced as compared to domestic brands given the
frequent excise (price) hikes. It has started affecting volume growth of domestic companies as the
consumers are showing resistance to price hikes.
Exports
South & South East Asia emerged as the second most important destination for Indian tobaccos with a
share of 25% in total exports and had contributed significantly for increased exports of Indian
tobaccos. Unmanufactured tobacco exports to South & South East Asia increased by about 35% in
quantity terms and 32% in value terms over last year’s exports. This increase is mainly due to large
exports of tobacco to South Korea and Philippines, which emerged as the third major market for
Indian tobaccos after Belgium and Russia. Exports to Indonesia and Vietnam increased by vast
margins, while exports to Singapore declined by 42% compared to last year. Indonesia emerged as
one of the major markets for Indian tobacco in this region.
During 2007- 08, exports of unmanufactured tobacco to Western Europe increased by 20% in
quantity terms and 19% in value terms on year on year basis. This is mainly on account of increased
exports of tobacco to Belgium (by 15% - mostly for re-export to Russia and other East European
destinations), Germany (27%), Netherlands (61%) and France (37%) in this region. Exports to UK,
Sweden, Austria and Denmark declined in quantity terms compared to last year. Western Europe
continued to be the most important destination for Indian tobaccos with 33% share in total exports.
Exports of unmanufactured tobacco to Eastern Europe declined marginally by about 1% in quantity
terms. However, in value terms, the exports to Eastern Europe had increased by 7% on year on year
basis because of general increase in export prices. The decline is on account of reduced exports to
Russia by 16% in quantity terms and by about 8% in value terms. The main reason for the decline of
tobacco exports to Russia and other CIS destinations is steep increase in the price of Indian tobacco.
Re-exports of Indian tobacco to Russia from Belgium will partly make up this short fall. Exports to
Ukraine, Kazakhstan and Romania increased, while Poland reduced its off take by 11% in quantity
terms and 3% in value terms respectively. Exports to other important markets- Bulgaria and Belarus
in this region also increased. As these markets are extremely price sensitive and import low cost / low
–end tobaccos, there is significant decline in exports. Despite this, Eastern Europe continued to be the
third most important destination for Indian tobaccos with 18% share in total exports.
Research and Development
Research on Tobacco has been playing an important role in the development of Tobacco varieties in
India. India grows different variety of Tobacco under different agro-climatic conditions. As such the
problem of improvement of different varieties of Tobacco in India are numerous and complicated.
The main research work on Tobacco is being done at Central Tobacco Research Institute (CTRI) at
Rajahmundry and its Research Stations spread throughout India. Apart from conducting research for
development of different varieties of Tobacco for maximising production, the CTRI, Rajahmundry
has been presently doing research for development of alternative crops to Tobacco. CTRI,
Rajahmundry has also been entrusted with the research for development of alternative uses of
Tobacco in view of anti-smoking campaign.
Earlier the Directorate of Tobacco Development was running two Non-Plan Schemes on bidi Tobacco
viz. (i) Seed and Seedlings Scheme and (ii) Farmers Training Scheme at Gujarat Agricultural
University, Anand.
Surya Cigars Ltd.
The success of Surya Cigars Ltd. (SCL) is the result of the company’s commitment to innovations,
enhanced operational efficiencies and adoption of internationally acclaimed business processes.
Driven to excel, innovate and win, the company intend to emerge as one of the most respected
Company in the tobacco industry. SGL is the market leader in the Indian Cigarette Industry. The
company’s market share in filter cigarettes is more than 70%. The company has got largest retail
networks in the country, consisting of over 2 million retailers Cigarette brands produced by SGL are
very famous and almost household name for smoking persons.
As the second largest player in the Indian cigarette industry, the SCL own some of the most popular
cigarette brands in the country like Igen, Stelar and North pole. Over the years SCL benchmarks in
innovation with revolutionary brands like Stellar, the first slim cigarette and Igen, the first euro norm
cigarette in India.
Brands
Igen– India’s 1st Euro Norm cigarette holds the promise of an advanced cigarette quality and
immense style. This progressive brand, known for its innovation, has also introduced India’s 1st King
size 5’s pack, a convenient and stylish pack format for the young adult of today.
Stelar – The first slim cigarette launched in India. It has been specially engineered to deliver low
nicotine without a compromise in taste and flavour. It is available in an elegant slim shaped 10’s and
20’s pack, aimed at the cognitive consumer who wants to be progressive and responsible in his habits
and lifestyle.
North Pole – Launched in the year 1958 North Pole is the largest selling menthol cigarette in India.
North Pole has recently the Golden Peacock commendation Award for innovation in packaging.
Their products are distributed over an extensive India wide network of more than 500 distributors and
800,000 retail outlets. With the Corporate Office in Delhi, the Company has offices all across India
in over 8 locations. Surya Cigars Ltd. empowers its entire people to think and act radically, stretch
relentlessly and generate path breaking ideas and strategies to propel the Company. This helps to
create and build powerful brands with unmatched service and world class processes. Striving towards
its vision to become a leading tobacco player in India and beyond, Surya Cigars Ltd. has forayed into
international markets with successful new business ventures.
Presently, Surya Cigars Ltd. is partnering with some of the top most players in the international
tobacco industry in marketing their products and providing various professional and expert services
which include contract manufacturing, consultancy services, cut tobacco and smoke analysis. Already
present in the Middle East, West Africa, South East Africa and South East Asia, Surya Cigars Ltd.
wishes to strengthen its position as an international player by entering new markets.
Today, Surya Cigars Ltd. can claim to be the first and only tobacco Company to organize the
fragmented cigar market in India and secure its position as the market leader in the cigar distribution.
The success can be measured by the exclusive distribution agreements Surya Cigars Ltd. has with
Altadis, USA who are the world’s largest cigar Company. The other groups are Villiger of
Switzerland, Henri Wintermann from Holland and Cibahia from Brazil. The company is planning to
diversify its business in various unrelated areas. It has an idea of diversification in hospitality and
garments industry.
Production
Andhra Pradesh, Gujarat and Karnataka account for the major portion (80%) of raw tobacco
production in India. These states produce FCV tobacco, bidi tobacco, natu tobacco, cigar tobacco,
cheroot tobacco and snuff tobacco. Other states which manufacture tobaccos are Maharashtra, Orissa,
Tamil Nadu, West Bengal, UP and Bihar. With a rich heritage of over 60 years in the industry, SCL
has incorporated the latest technology to deliver products of the finest quality in the market. Driven
by innovation and speed to market, the two manufacturing facilities in Ghaziabad (near Delhi) and
Andheri (Mumbai), are equipped with state-of-the-art equipment and incorporate best practices like
TQM, Haichi-Ban, 5S, Kaizen Teian etc.
SCL views its R&D capabilities as a vital component of its business strategy that provides a long term
edge over its competition. Located along with the production facilities, the R&D extends its
competencies and together they strive to implement the best in the market.
Empowerment and Accountability
Empowerment is an essential concomitant of SCL's first core principle of governance that
management must have the freedom to drive the enterprise forward. SCL believes that empowerment
is a process of actualizing the potential of its employees. Empowerment unleashes creativity and
innovation throughout the organization by truly vesting decision-making powers at the most
appropriate levels in the organizational hierarchy.
SCL believes that the Board of Directors is accountable to the shareholders, and the management is
accountable to the Board of Directors. They believe that empowerment, combined with
accountability, provide an impetus to performance and improve effectiveness, thereby enhancing
shareholder value. The Government of India is regularizing the norms to fight against tobacco and
banning smoking in pubic places. It is a major concern for the company.
Environment and safety
SCL is known for its commitment to environment and safety. SCL’s EHS (Environment Health and
Safety) policy recognizes the twin needs of conservation and creation of productive resources .The
unit has won many awards and accolades in the area of Environment, such as ISO 14001, OSHAS
18001, etc.
Each department of EHS conducts a monthly meeting to review the progress of the action plans and
share knowledge on developments in the field. The unit goes through stringent divisional audit and
corporate audit every year. There exists an established rating system covering the areas of Policy and
organization, Occupation Health & Hygiene, Equipment and Personal Safeguarding, Fire Prevention
and Protection, Environment and Accident Recording and Investigation. The unit has progressively
improved in the ratings over last 5 years. The unit EHS team also conducts monthly departmental
audits and hygiene inspection audits. Identified managers are sent for training programs conducted by
corporate branch of EHS.
SCL, Andheri factory, is committed to work towards continually reducing risk of injury, occupational
illness and environmental impact of its operation. As a part of this commitment SCL works towards
improving workplace safety, quality of air emission, maximizing reuse of treated water and
conservation of resources. The company complies with applicable legal and other requirements
towards health, safety and environment and strives towards elimination of incidences and prevention
of pollution. SCL, in its role as a concerned corporate citizen, has committed itself towards
responsibility towards the environment, and one of the key initiatives towards realizing this
commitment has been a drive towards reducing energy costs.
Moreover, SCL recognizes that energy conservation efforts also deliver business value through their
significant impact on the bottom-line. SCL has made its contribution towards this initiative through a
sustained focus on the energy consumption of the unit.
Profit and Loss Account of SCL as on
Rs. in crores
March 08 March 07 March 06 March 05 March 04
Income
Net sales 888.04 773.36 671.76 687.33 623.85
Expenses
Material Consumed 311.27 279.78 224.09 235.55 203.76
Manufacturing
50.98 42.89 38.50 38.01 33.34
Expenses
Personnel Expenses 80.74 66.36 59.69 56.92 41.98
Selling Expenses 171.13 142.46 138.12 125.70 133.08
Administrative
127.58 117.94 112.68 136.11 138.58
Expenses
Cost Of Sales 741.70 649.43 573.08 592.29 550.74
Operating Profit 146.34 123.93 98.68 95.04 73.11
Other Recurring
15.20 10.42 10.32 11.59 14.00
Income
PBDIT 161.54 134.35 109.00 106.63 87.12
Financial Expenses 3.68 2.92 2.78 5.72 5.68
Depreciation 19.77 19.07 18.37 16.55 9.95
PBT 138.09 112.36 87.85 84.36 71.49
Tax Charges 57.51 47.12 39.57 36.36 24.31
PAT 80.58 65.24 48.28 48.00 47.18
Equity Dividend 26.00 26.00 23.40 22.88 19.76
Balance sheet of SCL as on
Rs. in crores
March 08 March 07 March 06 March 05 March 04
SOURCES OF FUNDS
Equity Share Capital
10.40 10.40 10.40 10.40 10.40
(shares of Rs.10 each)
Reserves & Surplus 487.20 405.39 347.70 314.25 276.74
Loan Funds
Secured Loans 103.38 60.73 74.39 60.36 8.60
Unsecured Loans 0.00 0.00 0.00 1.88 12.09
Total 600.98 476.52 432.49 386.89 307.83
USES OF FUNDS
Fixed Assets
Gross Block 260.25 231.09 223.40 201.28 137.21
Less : Revaluation Reserve 2.36 2.36 2.36 2.36 2.36
Less : Accumulated
128.36 112.49 96.24 78.55 63.13
Depreciation
Net Block 129.53 116.24 124.80 120.37 71.72
Capital Work-in-progress 21.47 7.95 2.67 6.47 13.23
Investments 329.57 246.27 211.01 199.16 144.73
Net Current Assets
Current Assets, Loans &
363.93 261.26 251.42 234.82 220.38
Advances

Less : Current Liabilities & 243.52 155.20 157.41 173.93 142.23

 Provisions
Total Net Current Assets 120.41 106.06 94.01 60.89 78.15
Total 600.98 476.52 432.49 386.89 307.83

Annexure - I
Share price of SCL and Nifty Values
Share price of SCL Nifty
End of Month
(Rs.) Values
January 2008 174.65 5274.30
February 2008 154.50 5322.55
March 2008 187.05 4971.12
April 2008 189.05 5739.55
May 2008 188.55 4701.11
June 2008 186.00 3176.95
July 2008 218.00 5162.20
August 2008 219.90 4517.55
September 2008 204.20 5400.25
October 2008 99.80 5187.00
November 2008 295.20 5982.55
December 2008 182.60 3855.12

END OF SECTION D

Security Analysis – II (MSF2D2)

Section E : Caselets (50 Marks)
This section consists of questions with serial number 6 - 11.
Answer all questions.
Marks are indicated against each question.
Do not spend more than 80 - 90 minutes on Section E.

Caselet 1
Read the caselet carefully and answer the following questions:
6. Foreign Direct Investment (FDI) plays an important role in the long-term economic
development of a country. Briefly discuss the various advantages that FDI enjoyed in
India. ( 8 marks)
7. The FDI is not an unmixed blessing. Elucidate the various problems that may arise from
FDI inflow into India. ( 8 marks)
Globalization entails the opening of our own economy towards the world economy
where the barriers and restrictions of trade are eliminated and the governments are
encouraging private investment. The rapid growth of Asian economy is the result of
globalization where Foreign Direct Investment (FDI) is playing an important role. The
developing countries, particularly in Asia have removed restrictions and implemented
policies to attract FDI inflows to benefit from the investments and potential spillover
effects. The governments of various countries are taking appropriate steps to encourage
FDI that will maximize the significance for their economies. FDI has enough potential to
generate employment, enhance exports and contribute to the long-term economic
 development.
FDI, according to IMF, is defined as "the investment that is made to acquire a lasting
interest in an enterprise operating in an economy other than that of the investor. The
investor's purpose being to have an effective will in the management of the enterprise".
FDI plays a pivotal role in the development of Indian economy. It is an integral part of
the global economic system. Significance of FDI can be enjoyed to full extent through
various national policies and international investment architecture. Both the factors
contribute enormously to the maximum FDI inflows into India, which stimulates the
economic development of the country. Attracting FDI has become an integral part of the
economic development strategies for India. The FDI ensures production and generates
varied employment opportunities in the developing countries, which is a major step
towards the economic growth of the country. The FDI has been a booming factor that
has bolstered the economic life of India, but, on the other hand, it is also being blamed
for ousting domestic inflows. The FDI is also claimed to have lowered a few regulatory
standards in terms of investment patterns. The effects of FDI are by and large
transformative. The incorporation of a range of well-composed and relevant policies will
boost the profit ratio from FDI.
The FDI is not an unmixed blessing. The Governments of Less Developed Countries
(LDCs) have to be very careful while deciding the magnitude, pattern and conditions of
private foreign investment that includes financial Instability, net job loss etc. Raising the
inflows of FDI substantially was considered one of the key objectives of industrial and
trade reforms. The reforms were accompanied by a rapid increase in inflows of FDI into
the Indian economy.
It can be concluded that the first and second generation reforms have created a
conducive environment for foreign investments in India. Market-oriented policies are
boosting economic activity, all-round development and economic growth rate. As the
Indian economy gears up for competition in the international market, overseas investors
clearly see the potential for attractive returns from investments in India, which is also
evident from the already-achieved FDI success stories.
END OF
CASELET 1

Caselet 2
Read the caselet carefully and answer the following questions:
8. Uncertainty about long-run value of securities for investors can lead to disturbances in
the markets. Discuss the various factors contributing to market instability. ( 9 marks)
9. For surviving from future market crashes, a strategic perspective on investing is
necessary. Briefly discuss the various strategies the investors should adopt towards
managing the market instability. ( 9 marks)
The stock markets exhibit tendencies that make the `stability issue' more and more
complicated. The sudden booms and bursts, the intensity of market sentiments, the
skyrocketing expectations from the markets, the impacts of the flow of FII, government
policy and global market impacts can either jeopardize the scenario or catapult the
fortunes of many investors. One of the most abominable developments is the market
crash or market instability. Such a market slide can be detrimental to the interests of
investors, needless to mention the potential damage to economy as well as the market's
reputation.
The market crash is usually perceived as detrimental and is held in negative light by the
majority of investors. Instead, a positive perspective can be more enriching even during
crisis, when it offers immense opportunity to buy the stocks with optimal potential fair
value in long-term strategic investment, as the market will eventually bounce back and
such buyers will reap long-term results.
The stock markets have a general tendency to experience myriad booms and bursts; a
stock market may take off and rise rapidly over a period of time. Market crash is a
decline in the indices and deterioration in the value of stocks and securities on a
monumental scale. On an optimistic note, a crash is an excellent time to buy stock with
 promising future returns. During the period of crash, holding on to stocks without selling
is considered to be good; the panic selling by other investors causes the market prices to
drop below fair value and one should be able to pick up some lucrative bargains. As the
price falls, buyers will pour in and buy, thus eventually leading the market to regain its
valid position. This is how the market mechanisms operate.
The securities markets provide liquidity by facilitating trading and helping investors to
sell their securities to other investors for cash. A security market should ideally absorb
liquidity-driven sales without any change in security price. The price in an ideal security
market changes only as per the new information about the future cash flows, whether
positive returns or uncertainty of returns. As far as liquidity sales and purchases are not
related at all, they tend to off set one another with very less effect on price. The larger
and more concentrated the market, the better the pooling, the less the market price is
affected by liquidity trading. This will result in occasional imbalance of desired liquidity
sales and purchases. In dealer market, the market-makers absorb liquidity imbalances by
trading for their own account. In the auction markets, the specialized traders jump in to
buy and sell rapidly, so sometimes the mechanism which provides the market with
liquidity can be swamped by the rush of selling which results in a crash. The
mechanisms which provide liquidity to the market are not in a position to handle such a
great rush of selling. The major cause is volume. The market-makers provide liquidity
by buying up securities when there is an excess of sell orders and for this they need
credit to finance the purchases, which is not easily available in abundance.
Uncertainty about long-run value of securities for investors can lead to disturbances in
the markets. The investors need to understand and educate themselves about the
mechanisms of the market and how the long-term value of a security can be a wiser
investment rather than speculating for short-term instant benefits. The factors
responsible for market crash includes Influence of noise traders, Influence of quality
cycles etc.
For surviving from future market crashes, a strategic perspective on investing is
necessary. A well-planned and long-term value-based investment by investors is the key,
rather than prompt, short-term gains. One of the survival strategies include that the
investors should constantly track their portfolio, the non-performing shares and
securities should be replaced with better performers.
The markets and the investors have witnessed good times and bad times in history. The
series of market crashes have, in one way, weakened the stock markets and, in another,
strengthened to undertake the challenges and avail opportunities for better future. The
optimism for future growth in both developed as well as emerging markets shall set new
pathways to fortune hopefully avoiding the pitfalls on both micro and macro levels. The
compliances and regulations shall pave a safer haven for the stock markets to evolve.
END OF
CASELET 2

Caselet 3
Read the caselet carefully and answer the following questions:
10. PE is essential to fuel the economy and nurture the budding entrepreneurs/technocrats.
Discuss why companies should go for private equity. ( 8 marks)
11. The critical aspect either in VC or PE is exit route, because the exit route can decide the
fate of both the investee and the investor. Discuss the various exit routes available for
Private Equity investors. ( 8 marks)
Venture capital (VC) has been catering to the financial needs of the budding technocrats
and entrepreneurs all over the world for the growth and betterment of the economy. In
the recent past, the same has also turned into a new shape as Private Equity (PE).
Private Equity (PE) is the ownership of shares or other equity or equity-like interests in
companies that do not trade publicly on a stock exchange, or over-the-counter, among
investment dealers. As there is no instantaneous market for trading, these investments
are appropriate only for patient investors with a long-term view. PE opportunities are
generally more appropriate for large institutional investors with the time and resources
to evaluate the potential risks and returns, and the patience to wait for 10 years or longer
to maximize investment returns, because the investments often involve the acquisition of
a controlling interest or significant influence, costing several millions of dollars.
PE is essential to fuel the economy and nurture the budding entrepreneurs/technocrats.
Not only that, PE can even work very well in making India excel in the total
entrepreneurship that can contribute a lot for its development. The main reasons for the
need of PE includes bringing required expertise in multiple functions.
There are basically three types of PE investments. Venture capital, Buyout and
Acquisition financing and Expansion or Merchant Banking capital. Venture capital
principally meant for early-stage companies that are still developing their products or
services, but have the prospect of generating revenue in a few years; and later-stage
firms generating revenue with the expectation of profits within a year or two. Buyout
and acquisition financing usually accompanied by a new business plan, and occasionally
with new management, to improve a company's financial performance. Expansion or
merchant banking capital is for established companies looking to enter new markets or
to achieve a larger scale of operations.
PE fund managers raise money from investors with the aim of investing it in a long-term
portfolio of potentially high growth private companies. The criterion for choosing such
companies depends on the following factors such as superior business or idea, quality
and depth of management, modern and robust corporate governance, appropriate way to
invest in the company, and strategy for exiting the investment. PE strategies vary widely
with a focus on fund maturity as it is not a fancy proposition for promoters for various
reasons such as fear of losing the confidentiality and control over the company, high
cost option, and participation of outsiders. Hence, there are so many steps involved in
the PE process.
The Indian PE market has been getting more active day by day. During the last year or
so, almost all the major global VC and PE firms have either established an on-ground
presence in India or raised significant India-dedicated funds. Several key sectors of the
Indian economy, viz., IT, BPO, telecom, pharma/healthcare, financial services, retail and
automotive components that are investment targets, are experiencing even higher growth
than the said levels of growth rate. The other reasons for the growth is the well-
positioned economy that can utilize the opportunities of globalization and increase an
appetite for innovation and entrepreneurship.
The critical aspect either in VC or PE is exit route, because the exit route can decide the
fate of both the investee and investor. There are different exit routes, namely listing of
shares, offer for sale, sale to strategic investors, etc.
Thus PE is known as investing in securities through a negotiated process. The majority
of PE investments are in unquoted companies. The PE investment is typically a
transformational, value-added, active investment strategy. It calls for a specialized skill
set. Hence, the PE has become the means of financing the new and innovative projects
and to boost the entrepreneurial spirit all over the world. There is a need for PE molded
as a great weapon that works a lot in the development process of entrepreneurs in the
country, which can lead the country to acquire the development status.
END OF CASELET 3

END OF SECTION E

END OF QUESTION PAPER

 Suggested Answers
Security Analysis – II (MSF2D2)
Section D : Case Study

1. Strength :
SGL is the market leader in the Indian Cigarette Industry. Cigarette brands produced by SGL are very
famous and almost household name for smoking persons. SGL manufactures cigarettes for all kinds of
customers and caters the need for all people. The company’s market share in filter cigarettes is more than
70%. The company has got largest retail networks in the country, consisting of over 2 million retailers.
Through this huge retail network the company can reach all types of customers in metros or rural village in
the country. The management of SGL is very strong and people at the helm of main affairs are considered to
be pioneers in the Indian Corporate world.
Weakness
The company’s main weakness can be found in the vigorous diversification started by the company in almost
all fields. If any of the new ventures do not succeed the company’s profitable business will have to bear the
losses. This will definitely create a big dent in its strong financial base. Diversification in various unrelated
business may prove to be harmful to the company’s strong brand value in its core business.
Opportunities
Export market of cigarettes is an important opportunity to the company where SGL can tap lucrative
international market.
Threats
Growing health concerns and banning of several tobacco products and banning smoking in the public places
can be viewed as threat to the company. Recently, the share of cigarettes in the total consumption has been
declining in India and has gone down to 14% as against an average of 86% in the rest of the World. This
lower consumption of cigarettes in India is posing a threat to the company. Even entry of premium
international brands is a threat to the company’s core business.
2. a. Asset based valuation estimates a firm’s value by identifying the value of its assets. But there are some
problems using this model for valuation. They are as under
• Assets listed on the balance sheet may not be traded often, so market values may not be readily
available.
• Market values, if available, might not be efficient measures of intrinsic value if markets for the
assets are imperfect.
• Market values, if available, may not represent the value in the particular use to which the asset is
put in the firm. One might establish either the current replacement price for an asset or its current
selling price (its liquidation value), but neither of these may be indicative of its value in a
particular going concern. A building used in computer manufacturing may not have the same
value when used for warehousing groceries.
• The omitted assets must be identified for their market value to be determined. Assets such as
brand asset, knowledge asset, managerial asset etc. are the assets missing from the balance sheet.
These are all intangible assets and valuing them is very difficult task.
• Even if the individual assets can be valued, the sum of the market values of all identified assets
may not (and probably will not) be equal to the value of the assets in total. Assets are used jointly.
Indeed, entrepreneurs create firms to combine assets in a unique way to generate value. The value
of the synergy asset is indefinable.
• Asset based valuation is a complex way of valuation and also an expensive tool.
PAT+Depreciation
b. Cash earning per share = No.of stocks outstanding
2008 2007 2006 2005 2004

CEPS
 (80.58 + 19.77) (65.24 + 19.07) (48.28 + 18.37) (48.00 + 16.55) (47.18 + 9.95)
1.04 1.04 1.04 1.04 1.04
= 96.49 = 81.08 = 64.09 = 62.07 = 54.93
80.58 65.24 48.28 48.00 47.18
EPS
1.04 1.04 1.04 1.04 1.04
= 77.48 = 62.73 = 46.42 = 46.15 = 45.37
CEPS give a better idea of the cash available for use within a company. From the above result it is very
evident that cash earning per share of the company has increased in 2006. Earning per share has marginally
increased in 2006. This signifies that the fixed assets are gradually increased along with depreciation. The
average growth rate in CEPS is 15.35% where as for EPS it is 15.24%. This shows that the company is
maintaining a sound financial position on its assets.
3.
Share Return Return
price of Nifty from SCL from (X – (Y– Y ) (X –
(Y – Y ) (X- X )2
SCL Values (%) Nifty (%) X) X)
(Rs.) (y) (x)
174.65 5274.30
154.50 5322.55 -11.54 0.91 -23.03 0.49 0.24 -11.39
187.05 4971.12 21.07 -6.60 9.57 -7.02 49.32 -67.23
189.05 5739.55 1.07 15.46 -10.43 15.04 226.13 -156.77
188.55 4701.11 -0.26 -18.09 -11.76 -18.51 342.74 217.70
186.00 3176.95 -1.35 -32.42 -12.85 -32.84 1078.58 421.92
218.00 5162.20 17.20 62.49 5.71 62.07 3852.53 354.39
219.90 4517.55 0.87 -12.49 -10.62 -12.91 166.62 137.13
204.20 5400.25 -7.14 19.54 -18.63 19.12 365.53 -356.27
99.80 5187.00 -51.13 -3.95 -62.62 -4.37 19.09 273.61
295.20 5982.55 195.79 15.34 184.30 14.92 222.52 2749.15
182.60 3855.12 -38.14 -35.56 -49.64 -35.98 1294.63 1786.03
Total 126.44 4.62 7617.94 5348.27

ΣY 126.44
Y = n = 11 = 11.49%
ΣX 4.62
X = n = 11 = 0.42%
Σ( X − X ) 2 7617.94
σ 2x = n −1 = 10 = 761.79(%)2

Σ(X − X) (Y − Y) 5348.27
Covxy = n −1 = 10 = 534.83 (%)2
534.83
Beta = 761.79 = 0.70
Dividend Payout Ratio (%)
Year Dividend Payout Ratio
2008 25.00/77.48 = 0.323
2007 25.00/62.73 = 0.399
2006 22.50/46.42 = 0.485
2005 22.00/46.15 = 0.477
2004 19.00/45.37 = 0.419
0.323 + 0.399 + 0.485 + 0.477 + 0.419
Average Dividend Payout Ratio = 5
= 42.06%.
Growth Rate in Earnings
Year Earnings Growth %
 2008 23.51
2007 35.13
2006 0.58
2005 1.74
2004 -
23.51 + 35.13 + 0.58 + 1.74
Average Growth Rate = 4
= 15.24%.
ROE (Return on Equity)
Year ROE (%)
2008 16.19
2007 15.69
2006 13.48
2005 14.79
2004 16.43
16.19 + 15.69 + 13.48 + 14.79 + 16.43
Average ROE = 5
= 15.32%
PRegression = 441.15 + 21.35 × DP + 22.05 × GR – 0.61 β + 33.2 ROE
= 441.15 + (21.35 × 0.4206) + (22.05 × 0.1524) – (0.61 × 0.70) + (33.2 × 0.1532)
= 441.15 + 8.98 + 3.36 – 0.43 + 5.09
= 458.15
Price as per DDM
DPS for the year 2008 is: 25.00
The required rate of return
Re = Rf + (Rm – Rf) βi
= 8.5 + (18 – 8.5) 0.70
= 15.15%.
Year DPS PVIF@ 15.15% PV (DPS)
2009 25.00 (1.1524) = 28.81 0.8684 25.02
2010 28.81 (1.1524) = 33.20 0.7542 25.04
2011 33.20 (1.1524) = 38.26 0.6550 25.06
2012 38.26 (1.1524) = 44.09 0.5688 25.08
2013 44.09 (1.1524) = 50.81 0.4939 25.10
125.30
50.81(1.13)
P5 = 0.1515 − 0.13 = 2670.48
Value at the end of year 5 = 2670.48 × PVIF (15.15%, 5)
= 1319.08
Price as per DDM = 1319.08 + 125.30 = 1444.38
P0 = 0.15 × PDDM + 0.85 × PRegression
= 0.15 × 1444.38 + 0.85 × 459.00
= Rs.606.08

4. Tobacco Board undertakes the following Export Promotion Activities:

• Inviting official and business delegations from abroad. Organizing visits of official and trade
delegations abroad.
• Participation in International Trade Fairs and Exclusive world tobacco exhibitions & symposiums
abroad.
 • Publicity by undertaking an extensive advertisement campaign in the international media to promote
Indian tobacco
• Dissemination of Information and various enquiries received from overseas customers to the exporters
• Providing recommendatory, advisory and other support services to the Trade and Industry.
• Problem solving in Government Agencies and Organizations - RBI, Import/Export Procedures;
problems with Importers through Indian Missions abroad.
• Provision of inputs to the Central Government on policy matters relating to export of tobacco and
tobacco products.
5. Valuing a company with inconsistent schedule of earning, or worse, with no earning at all requires a delicate
balancing act on part of the analysts. At these instances, traditional methods of valuations befall to
helplessness. That’s where the price/sales ratio comes in. Just like its more popular alternative the P/E ratio,
PSR (Price-to-Sales Ratio) is useful to value any company. Price-to-Sales Ratio for a company can be
calculated by dividing the market capitalization of a company by its total revenue for the last four quarters.
As compared to PE ratio, Price-to-Sales Ratio is a more reliable measure because, unlike earnings, revenue
for a company is difficult to manipulate. Besides earnings is a complex figure which may include inflows
from non-recurring events also. Therefore, analysts look to both the PE ratio and PS ratio of companies
before taking any investment decision. PS ratio is useful while valuing companies even with no earnings at
all. PS ratio comes handy to value companies in today’s dynamic set-up where mergers and divestitures are a
part of the daily routine. For examples, need for economy of scale has driven companies in telecom sector
for sometime. Owing to write-offs related to merger, several such companies report negative earnings soon
after the process. However, strategically and fundamentally, the company may well be on its way to a bright
future. This can be verified by analyzing the Price-to-Sales Ratio, which may be growing immediately after
the merger, thus presenting a more realistic presentation of the prospect for the company.
Like any other ratio, a high or low PS ratio connotes different interpretations for an analyst. High or low PS
ratio depends on the profit margin of the company. Thus, PS ratio for a steel manufacturer may vary from the
PS ratio for a chip maker.
Price-to-Sales Ratio may also vary consequent to the capital structure of the company. A company with a lot
of debt component in its balance sheet may have to allocate more resources for servicing the interest burden,
and thus might see erosion in its profits. Another problem with PSR is that sales figure does not contain any
information about the debt burden of the company. Thus, it may so happen that some companies may have
no profits but only huge debt and could be on the verge of bankruptcy. Due to all these, it is advisable to
compare both the PE ratio and PS ratio for the company on a historical basis for a reliable analysis.
Mathematically, relationship between these two ratios can be established Ratio x (Profit Margin).
 Security Analysis – II (MSF2D2)
Section E: Caselets
Caselet 1
6. The various advantages FDI enjoyed in India are:
Enhancement of Export Potential
By raising the level of efficiency and the standards of product quality, FDI makes a positive
impact on the host country's export competitiveness. It provides the host country a better
access to foreign markets due to international linkages.
Economic Growth
This is one of the major sectors, which is enormously benefited from FDI. A remarkable
inflow of FDI in various industrial units in India has boosted the economic life of the
country.
Employment Generation
The FDI has also ensured a number of employment opportunities by aiding the setting up of
industrial units in various corners of India. The training obtained by the employees in the
receipt of FDI also contributes to human capital formation.
Consumer Benefits
The consumers of the host country benefit through better variety of products at competitive
prices due to the inflow of FDI.
Trade Benefits
The FDI has opened a wide spectrum of opportunities in the trading of goods and services in
India both in terms of import and export production. It provides the much needed foreign
exchange which helps bridge the balance of trade deficit which otherwise would add to the
external debt of the country.
Technology Diffusion and Knowledge Transfer
The FDI apparently helps in the outsourcing of knowledge from India, especially in the
Information Technology Sector. It helps in developing the know-how process in India in
terms of enhancing the technological advancement in India.
Benefits to the Government
Profits generated by FDI contribute to the corporate tax revenues in the host country. The
FDI is non-volatile and non-debt creating and hence avoids debt servicing (i.e., interest
payments). The macroeconomic effects of FDI is connected with issues of domestic capital
formation, balance of payments and taking advantage of external markets for achieving
faster growth. The microeconomic effects are connected with cost reduction, improvement
in the quality of the product, making changes in industrial structure and global inter-firm
linkages.
Linkages and Spillover to Domestic Firms
Various foreign firms are now occupying a position in the Indian market through joint
ventures and collaboration concerns. The maximum amount of the profits gained by the
foreign firms through these joint ventures is spent on the Indian market.
7. The problems that may arise FDI inflow into India are:
Impact on Domestic Savings and Investment
When foreign investment is competitive with home investment, the profits in domestic
industries fall, leading to a fall in domestic saving. Foreign corporations may form
monopolies in the domestic market and drive out small firms. When FDI enters in the form
of mergers and acquisitions, taking excessive control over decision-making and
management, it may not take into account the needs of domestic economy. Repatriation of
profits can lead to withdrawal of capital from the host country.
Worsen Balance of Payment
The FDI can have a negative impact on the balance of payments situation of the host
country through an increase in import of inputs and through remittances of royalties and
dividends abroad by the subsidiaries.
Inappropriate Technology
Developing countries might not have the ability to absorb high technology imparted by
 foreign firms. For example, domestic conditions such as poor infrastructure, low levels of
education, rigid labor laws and other regulations are other obstacles facing the Indian
economy. Some foreign corporations can bring in technology that is not appropriate to suit
the conditions of the host developing country.
Environmental Cost
Foreign investors can take the advantage of weak environmental regulations in developing
countries, by using technologies that are cheap but harmful to the environment.
Net Job Loss
Job creation might only take place in already well-developed urban sectors where the levels
of education, training and infrastructure are high. Small-scale and rural areas have a low
capacity to attract FDI and as a result are left out.
Financial Instability
Given the capacities and constraints of developing countries, free capital movements make
them more vulnerable to both external and internal shocks. The dependency of developing
countries on foreign finance to cover their current account deficit also makes them more
financially fragile.
Increase in Income Inequalities
Foreign firms reinforce dualistic socio-economic structure and increase income inequalities.
They create a small number of highly paid modern sector executives. They divert resources
away from priority sectors to the manufacture of sophisticated products for the consumption
of local elite. As they are located in urban areas, they create imbalance between rural and
urban opportunities, accelerating the flow of rural people to urban areas.

Caselet 2
8. Factors contributing to market instability are:
Influence of uncertainty and risk: The first contributing factor to market instability is the
uncertainty about the long-run value and the risks associated with it. There is no particular
standardized value or rule of thumb and opinions differ from one investor to another. Some
investors are optimistic about and favor a long-term positioning while others are skeptical or
pessimistic and always favor a short-term positioning. The market eventually favors the
optimistic investor in comparison to the pessimistic, as a result of which the prices rise.
Influence of noise traders: The volatility is aggravated by noise traders who care little
about long-term value. They are spontaneous and are always betting so that the rising trend
should continue, without giving due logical consideration to fundamental analysis. There is
always a rush of such people when the market rises. Their buying helps prices to increase
more and more, giving them capital gains for achieving their expectations and spurring
more buying. This phenomenon of rapid rise in prices followed by peak and then a sudden
crash is known as a bubble. This is detrimental to the stability and sustenance of growth in
markets.
Influence of limits on short-selling: Optimal short-selling can be seen in a positive as well
as in optimistic perspective. But there is a thin line which when crossed can potentially
contribute to a crash as the investors become illogical and oversell. This creates imbalance
and instability.
Influence of quality cycles: It relates to the quality inherent in the investments themselves.
The investors with tendencies of greed and hunger are always seeking new and innovative
investment avenues. To cater to the need of investors, the markets start offering more of
new and creative investment avenues but only at the cost of deteriorated quality in order to
cater to quantity. Thus investors face a risk of uncertainty toward future gain.
Increasing importance of institutional investors and foreign investors: The institutional
investors, who trade in large volumes, are agile, reactive and better informed than individual
investors, and their reactions have far-reaching impacts. So, there exists a bargaining power
in their hands. The institutional investors are also gaining importance in securities markets.
Instead of holding stocks for themselves, they do their dealings through intermediaries as a
preferred channel. They do not cease to influence stock markets for their volume of trading.
Besides the above discussed issues, sometimes international political issues can also
influence the markets. Experts believe that when international cooperation influences
 national policies, the new economic order of a global economy becomes fragile and equity
markets tend to decline. Thus, the intensity of factors determines the quantum of market
slide.

9. The various strategies the investors should adopt towards managing the market instability
are:
• Investors must avoid leveraging their investments to avoid the much-dreaded debt
trap.
• Investors must look into the diversification of portfolio with strategic implications.
Diversification should be done not necessarily for the heck of it but with a well-
designed objective. On the cross-border trading front, diversification can also be done
in developed as well as emerging markets, besides a number of industrial sectors..
• The investors should pay more attention to company's fundamentals and consistent
profitability rather than the stock prices.
• The investors should constantly track their portfolio, the non-performing shares and
securities should be replaced with better performers.
• Logical choice of value over price should be made.
• Financial literacy tops the list. In contrast to the international financial markets,
financial literacy among the Indian investors is comparatively low.
• Avoid extremely volatile or high risk companies as well as very small industries with
high debt burdens ranging over a long term.
• The large cap shares may not always be as lucrative as certain mid cap shares, the
choice should be made logically.
• Invest in fundamentally sound companies; the opportunity should be available when
there is massive selling due to investor sentiment, overreaction by market players on
some news and issues, followed by experts' negative remarks.
• The well-regulated intermediaries can play a constructive role in the stability of
markets. The investors (less financially literate) must channel through the
intermediaries for best results.
• Avoid short-selling up to risky proportions.
• Market instruments should be opted for on the basis of risk-return trade-offs and
compatibility should be there between what an instrument is offering and what an
investor is expecting.
• Short-selling should be optimally restricted and if the investors are financially literate
there can be a balance between market optimism and restricted short-selling. This may
curb the volatility to some extent.
• Investors can better prepare themselves for value creation and profitability on the
stock markets. Hopefully, the investors' strategies and market forces are incoherence
and lead to better market mechanisms and wiser choices, for the economies and
individuals to make fortune by exercising right choices. The investors should evolve
with the evolution in stock markets.
Caselet 3
10. • PE firms often work in conjunction with other providers of finance and may be able to
help put a total funding package together for the business.
• PE firms also bring in required expertise in multiple functions.
• The placement with reputed investor will further enhance the brand image of the
company.
• PE helps achieve ambitions of a company and provides a stable base for strategic
decision-making.
• PE firms will seek to increase a company's value to its owners, without taking day-to-
day management control.
• PE firms usually provide higher valuations in normal stock market conditions and
 lower valuations when stock market is booming.
• Investors can also help company in improving and developing its business and
strategies.
11. The various exit routes are
• Listing of shares: The listing of shares subsequently after public offer is a well-
linked route for exit as it enables free transfer of securities in the open market.
• Offer for sale: The PE investor may get out of the transition by offering his holding
to any other interested investor.
• Sale to strategic investors: The PE holder, if not restricted by the covenants of the
agreement, may sell his stake to any acquirer, who is interested in taking over the
management of the company.
• Tag along rights: It is a contractual obligation used to protect minority shareholders.
Basically, if majority shareholders sell their stake, then the minority shareholders have
the right to join the transaction and sell their minority stake in the company.
• Management buy-out: The managers and/or executives of a company can purchase
controlling interest in a company from exiting shareholders.
• Auction of shares: The PE investors may sell their stake in an open market
transaction by way of auction.
• Buyback by promoters: The holding of outsider investor is being purchased by
promoters through buy back complying with the provisions of the Companies Act,
1956.
• Merger with listed companies: The most popular way of exiting is merger or
amalgamation of investee company with any other listed company, enabling the
shareholders to freely transfer the shares in the open market.