Vyom Limited, an IT conglomerate, is planning to take over Aryayash Limited, a startup company incorporated 2 years ago but holding a lot of…

CA Intermediate · Financial Management and Strategic Management · MTP · January 2025
Vyom Limited, an IT conglomerate, is planning to take over Aryayash Limited, a startup company incorporated 2 years ago but holding a lot of prospects. To determine the buyout consideration, Vyom Limited has approached you as a Finance controller to estimate the fair value of the startup company today based on future earnings estimates. Following details of the startup company are as below - Expected Sales in the coming year are 25 lakhs with P/V ratio of 40%. The sales are expected to grow at a rate of 20% for the next 2 years, to 40% for another 2 years, 25% in the 6th year and thereafter cash flows will grow at a steady rate of 10%. Fixed cost for the upcoming year is expected to be 12 lakhs for the first two years, 10 lakhs thereafter. Loss in any year can be set-off only against the profits of the immediate next year. Corporate taxes applicable are 25% & 20% to Vyom Limited & Aryayash Limited respectively. Vyom Limited's desired rate of return is 15% & Cost of Capital of Aryayash Limited is 17%. As a finance controller, CALCULATE the Fair value of Aryayash Limited.

Suggested Answer and Working Notes:

Fair Value of Company = Present Value all future cash flows discounted at the expected Rate of return of acquiring company. WN 1 - Calculation of Cash flows (in Lakhs) YEAR 1 2 3 4 5 6 Contribution (40% on sales) 10 12 14.4 20.16 28.22 35.28 (-) Fixed Cost -12 -12 -10 -10 -10 -10 NPBT (A) -2 0 4.4 10.16 18.22 25.28 (-) Losses Set Off 0 0 -2(Setoff) 0 0 0 Taxable Income 0 0 2.4 10.16 18.22 25.28 (-) Tax @ 25% (B) 0 0 0.6 2.54 4.55 6.32 Cash Flow (A - B) -2 0 3.8 7.62 13.66 18.96 PV OF CASH FLOWS @ 15% -1.740 0 2.50 4.35 6.79 8.19 Total PV of cash flows (yr 1 to 6) = 20.08 lakhs (+) PV of cash flow at terminal value (end of Year 6) = (18.96 + 10%) / (0.15 - 0.10) = 417.12 Lakhs Therefore, PV of above = 417.12 X PV factor (15%, 6th Year) = 180.20 lakhs Total fair value of Aryayash limited = 20.08 + 180.20 = 200.28 Lakhs Note - 1. Discounting rate should be the desired rate of acquiring company i.e. of Vyom Limited 2. Terminal value of cash flows means the cash flows at that point from where it would grow at constant rate. Here it assumed that from 7th year, Cash flows/NPAT will grow at a constant rate and not sales

Topics: Part-A: Financial Management

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