Indian Institute of Management Kashipur

Post Graduate Programme

MID EXAM QUESTION PAPER

Course Name (credit): Investment Management

Term: IV

Closed/Open Book: Open Book

Use of Laptop Yes/No. (If yes then with/without Internet): Yes (with Internet)
Use of Calculator (Yes/No): Yes
Use of Notes/Book (Yes/No): Yes
Duration of Exam: 2 Hours

Instructions for students (if any):

1. Please solve all the questions and upload your answers in google classroom.
2. Attempt all the questions.
3. You may use books/notes/internet resources to solve this paper. But solve this paper,
honestly yourself and do not share with anybody. Any evidence suggesting that you
have helped other candidates in solving this paper will lead F grade for you.

Section A
There are four questions in this section. Each question carries five marks. Answer the question maximum in
two paragraphs.
1. X Ltd is working in a cyclic industry. Due to economic slowdown, the performance of the
industry is not satisfactory for the last one year, but the market is expecting that the things will
become normal during the coming months.
You calculate the EPS and P/E Ratio for this company based on the last four quarters' results.
The company has Trailing Twelve Months (TTM) EPS of Rs 2.50, and its stock is currently
selling at Rs 100, hence TTM P/E Ratio is 40. You have estimated the EPS for nest year Rs 5.00.
What price will you expect for this stock by next year:
(i) Rs 200
(ii) Less than Rs 200
(iii) More than Rs 200
 Indian Institute of Management Kashipur
Post Graduate Programme
Explain briefly giving reasons.
Ans. I expect the stock price to be trading at more than Rs. 200 by the end of next year. My
reasons for the same are as following:
 Expected growth in EPS is 100% which will give a boost to the company’s P/E ratio also
as the market will expect the growth and give a boost to stock price.
 Macro-economic conditions of the markets are stated to be improved in the upcoming
year which normally increases the P/E ratio for the companies.

2. You are an equity analyst with an investment bank. You review the growth prospects and quality
of earnings for Phoenix Enterprises, one of the companies you follow. You have developed a
stock valuation model for this firm based on its forecasted fundamentals. Phoenix's financial
statements over the past five years show strong performance, with above-average growth and
profit margins. The market is expecting (reflected in current market price) that the company will
maintain its growth and profitability in future as well. However, based on your experience, you
are of the view that successful companies tend to draw more competition, putting their high
profits under pressure. Therefore, you use a conservative estimate of growth. What rating you are
likely to issue for Phoenix Stock:
(i) Buy
(ii) Hold
(iii) Sell

Explain briefly giving reasons.

Ans. I will recommend people to hold onto the existing stock for the upcoming year and keep an
eye on new entrants in the market. Reasons being:
 If there are a few new entrants in the market the company’s profits will come under
pressure but not a whole lot, therefore we will still see a healthy return on the stock.
 As the company is expirencing above average growth, Market sentiment will keep
pushing the stock up for some time even if stock price dips at the end we will still see a
profit.

3. XYZ Limited has recorded very high growth during the last two years. Its has also improved its
profit margins and asset turnover ratio quite significantly. The market is valuing the company at a
P/E ratio which is 40% higher than the P/E ratio of comparative companies in the industry. On
closer examination of the strategy of the company, you learned that the company has recently
acquired several small companies which were selling at low P/E ratios, using its excess cash.
You also learned that XYZ Ltd has been forcing the companies it acquires to accelerate the
payment of expenses before the acquisition deals are closed. As one example, XMI asked ABC
Ltd, an acquired company, to immediately pay all pending accounts payable, whether or not they
are due.
What is the source of growth, profitability and efficiency of XYZ Ltd.? Is this growth
sustainable? Do you think the high P/E Ratio of the company is justified? Why or why not?

Ans. Reasons for the growth, profitability and eddiciency of XYZ ltd are:
 Company is acquiring new companies rapidly which gives boost to its market
capitalization and growth.
 Indian Institute of Management Kashipur
Post Graduate Programme
 Company is efficient as it is acquiring companies after all the liabilities and expenses of
the acquired company has been paid by the company being acquired which benefits XYZ
as they do not add any new liabilities to their accounts.
This growth is not sustainable as by acquiring several companies XYZ is being seen as a
successful company by the market which is giving a boost to its stock and P/E but this growth
is not organic and cannot be sustained as each company has different business and XYZ will
have to slow down its acquiring going forward to properly streamline and maintain its
existing companies which will reduce the P/E ratio and make the company less profitable.

4. Royal is the leading manufacturer and seller of fabrics and garments in the country. You have
been asked to analyze the stock of this company. You first analyze the fabrics and garments
industry Porter's five forces framework and prepare the following chart:
Force Factors to Consider
Threat of substitutes Customer switching costs are low
Rivalry Archway holds 40% of the share of branded fabrics and apparel
market of the country market. The second nearest competitor has
20% market share. International brands are increasing their
presence through franchises.
Bargaining power of Primary inputs are considered basic commodities, and there are a
suppliers large number of suppliers
Bargaining power of Customers are ready to pay a premium for higher quality, but
buyers brand loyalty is quite low.
Threat of new entrants High fixed costs to enter the industry. However, there is excess
manufacturing capacity available with several smaller companies.
They are easily available for franchise.

The demand for branded fabrics and apparel is likely to grow at a rate of 12% per annual with the
country's economic growth and increasing income of the middle class.
Answer the following questions based on the above:
(i) In your valuation model, will you use a revenue growth rate for Royal Ltd higher (or
lower) than the expected industry growth rate of 12%? Explain giving reasons.
Ans. I am making the assumption that Archway is same company as Royal, Royal is leading
manufacturer so it is expected that it will have most market share. As Royal is the leader in the
market its growth rate will either hold at the industry average or will be higher as compared to
the industry.
(ii) Company's operating profit margin is currently 15%. Do you expect an improvement (or
deterioration) in profit margin based on the above analysis?
Ans. I expect a deterioration in the OPM of the company as due to new due to following reasons
 As the market is becoming crowded company will spend more on the marketing and
advertising.
 As supplier demand increased so will the price of raw material which will eat into the
operating profit of the company.
 Indian Institute of Management Kashipur
Post Graduate Programme

Section B
This section has one question carrying ten marks (2×5).

5. You are analyzing different companies and constructing financial models for their valuation.
How will you consider the following news items in your model?

(i) The US treasury yield curve has turned inverted. The treasury bond with ten years
maturity has a lower yield than the yield of a treasury bond with 1-year maturity.
Ans. The inverted yield curve is an indicator for a pending recession. It indicates that in the
upcoming time there will be a recession in the market which lowers the yield of the long term
debt instruments compared to short term debt instruments. If the yield curve has inverted the
growth rate for the valuation will be impacted and we will consider lower growth rate going
forward.
(ii) The credit spread has become wide (credit spread is defined as the difference between
yields of AAA-rated and BBB rated corporate bonds).
Ans. The credit spreads indicate the health of the economy. The widening of the credit spread
indicates that the economy is going to have very bad time going forward which will impact
valuation as the growth rate will be lower and the company’s stock price will decrease.
(iii) RBI has reduced the repo rate by 50 basis points.
Ans. When RBI reduces the repo rate it basically means that bank can borrow money from the
bank at a lower rate of interest, which will lead to increase in liquidity in the market as banks will
provide more loans at a lower rate of interest keeping in mind the MCLR rate of the banks.
Incresae in liquidity will give a boost to the economy and increase in growth rate of the company.
(iv) In Godrej Industries the promotors have recently increased their stake. Godrej Industries
is one of the companies you are following.
Ans. If the promoters decide to increase their stake in Godrej Industries, this indicates that
promoters are optimistic about the company’s growth prospects going forward which will lead to
an increase in the stock price and P/E ratio for the company.
(v) The Indian currency (INR) is depreciating in terms of major world currencies, including
the US Dollar (USD).
Ans. The depricaition of INR as compared to other major currencies will lead to increase in the
exports and decrease in imports by the company. Therefore if we are valuating the companies
which exports their finished product e.g Godrej as its exports its furniture it will benefit them and
lead to a higher revenue value in terms of INR.

Section B
This section has one question of twenty marks (10+10).
 Indian Institute of Management Kashipur
Post Graduate Programme
6. In a valuation contest, three teams representing three reputed management institutes of the
country were shortlisted for the final round. In the final round, they were asked to value Dr Lal
Path Lab Ltd and issue an investment recommendation (buy, sell or hold). They were given five
years income statement for reference.
Comparative Income Statement of Dr Lal Path Lab for the last Five Years
Year (Ending on 31 March of) 2016 2017 2018 2019 2020 Average
Operating revenue 791.3 912.4 1056.9 1203.4 1330.4  
Revenue Growth   15% 16% 14% 11% 14%
Operating Expenses 581.6 674.9 792.9 909.8 986.8  
EBITDA 209.7 237.5 264 293.6 343.6  
EBITDA Margin 27% 26% 25% 24% 26% 26%
Depreciation 28 28 33 38 73  
EBIT/Operating Profit 181.7 209.5 231 255.6 270.6  
Operating Profit Margin 23% 23% 22% 21% 20% 22%
Interest 0 1 1 1 15  
Other Income 20 27.5 31.2 45.9 55 35.92
PBT 201.7 236 261.2 300.5 310.6  
Tax 67.5 81.2 89.6 100.1 82.9  
Effective Tax Rate 33% 34% 34% 33% 27% 32%
PAT 134.2 154.8 171.6 200.4
  227.7
EPS 16.13 18.61 20.63 24.09
  27.37
             
Price on 31st March 920 968 876 1052 1410  
P/E Ratio 57.04 52.03 42.47 43.68 51.52 49.35

Dr Lal Path Lab is currently trading at Rs 1850. Its Trailing Twelve Month (TTM) EPS is Rs
23.72 based on recent quarterly results (Rs 9.77, Rs 6.56, Rs 3.94 and Rs 3.45 respectively for
last four quarters). Therefore, the current TTM P/E is 78.

The contesting teams developed their models based on the following assumptions:

Team A General Approach Current data may not be reflecting the true view. Therefore, we should rely more
on average over five years.
Revenue Growth Assumed to be equal to average growth over five years.
Operating Profit
Margins Assumed to be equal to average OPM over five years.
Interest Negligible, hence ignored
Other Income Assumed to be equal to the average figure over five years
Tax Rate Assumed to be equal to the average tax rate over five years
P/E Ratio Assumed to be equal to the average P/E Ratio over five years

Team B General Approach Look at the trends

Revenue Growth It is declining every year for the last three consecutive years. Next two years
forecast is 10% and 9%
Operating Profit Operating margins are shrinking. 2020 seems an exceptional year. Next two years
Margins forecast 19% and 18%.
Interest Assumed equal to the level of 2020.
Other Income Forecasted Rs 60 and 65 crores for next two years.
 Indian Institute of Management Kashipur
Post Graduate Programme
Tax Rate Coming down every year for the last three years. Assumed to be 26% for the next
two years
P/E Ratio Showing down a declining trend. Assumed to be 45 for next two years.

Team C General Approach Use past data as a reference point. Make suitable adjustments based on economy,
industry and company analysis.
Revenue Growth The year 2020-21 will remain depressed due to lockdown effect. Turnover
assumed to grow at the rate of 8% in 202-21. Post-Covid, people will become
more health-conscious. Expected growth in 2021-22 is 25%. In long term industry
growth will remain high with increasing health consciousness and income level of
people, but the company's revenue growth will slow down with increasing
competition. Long term forecast is 10%.
Operating Profit Will come down due to competitive pressure in the long run. But the company will
Margins able to maintain it in the near future. Assumed to be 25% for the next two years.
Interest Interest charges in 2019-20 are related to leased assets and are the reflections of
change in accounting treatment (Ind AS 116). The amount is likely to remain the
same for the next two years.
Other Income Mainly comprised of income from investments. Likely to remain at the level of
2019-20.
Tax Rate Assumed to be equal to the current effective rate of corporate tax 35%
P/E Ratio Due to changes in accounting for lease, the upward revision is required in P/E of
years 2016-19 to make them comparable with P/E ratio of 2019-20. Company has
maintained P/E Ratio higher than the market average due to high expected growth.
P/E Ratio may remain higher in 2020-21 due to depressed income but high
expected growth in future; assumed to be 60. It will come down to its average by
2021-22, assumed to be 50. In the long run, the P/E ratio will gradually come
down to the market average.

Required:
(i) Calculate the expected stock price in 2022 based on the assumptions of each team. What will be the capital
appreciation/loss in each case, if the stock is purchased today?

Ans. Team A.
Year (Ending on 31 March of) 2016 2017 2018 2019 2020 Average 2021 2022
Operating revenue 791.3 912.4 1056.9 1203.4 1330.4   1516.656 1728.988
Revenue Growth   15% 16% 14% 11% 14%    
Operating Expenses 581.6 674.9 792.9 909.8 986.8   1122.325 1279.451
EBITDA 209.7 237.5 264 293.6 343.6   394.3306 449.5368
EBITDA Margin 27% 26% 25% 24% 26% 26%    
Depreciation 28 28 33 38 73   60.66624 69.15951
EBIT/Operating Profit 181.7 209.5 231 255.6 270.6   333.6643 380.3773
Operating Profit Margin 23% 23% 22% 21% 20% 22%    
Interest 0 1 1 1 15      
Other Income 20 27.5 31.2 45.9 55 35.92 35.92 35.92
PBT 201.7 236 261.2 300.5 310.6   369.5843 416.2973
Tax 67.5 81.2 89.6 100.1 82.9   118.267 133.2151
Effective Tax Rate 33% 34% 34% 33% 27% 32%    
PAT 134.2 154.8 171.6 200.4 227.7   251.3173 283.0822
EPS 16.13 18.61 20.63 24.09 27.37   30.20885 34.02705
Price on 31st March 920 968 876 1052 1410   1490.807 1679.235
P/E Ratio 57.04 52.03 42.47 43.68 51.52 49.35 49.35 49.35

Price of share as of Mar 1679.235 No. of 8.319328

 Indian Institute of Management Kashipur
Post Graduate Programme
31,2022 shares

Team B:
Year (Ending on 31 March of) 2016 2017 2018 2019 2020 Average 2021 2022
Operating revenue 791.3 912.4 1056.9 1203.4 1330.4   1463.44 1595.15
Revenue Growth   15% 16% 14% 11% 14% 10% 9%
Operating Expenses 581.6 674.9 792.9 909.8 986.8      
EBITDA 209.7 237.5 264 293.6 343.6      
EBITDA Margin 27% 26% 25% 24% 26% 26%    
Depreciation 28 28 33 38 73      
EBIT/Operating Profit 181.7 209.5 231 255.6 270.6   278.0536 287.1269
Operating Profit Margin 23% 23% 22% 21% 20% 22% 19% 18%
Interest 0 1 1 1 15   15 15
Other Income 20 27.5 31.2 45.9 55 35.92 60 65
PBT 201.7 236 261.2 300.5 310.6   323.0536 337.1269
Tax 67.5 81.2 89.6 100.1 82.9   83.99394 87.653
Effective Tax Rate 33% 34% 34% 33% 27% 32% 26% 26%
PAT 134.2 154.8 171.6 200.4 227.7
  239.0597 249.4739
EPS 16.13 18.61 20.63 24.09 27.37
  28.73545 29.98727
                 
Price on 31st March 920 968 876 1052 1410   1293.095 1349.427
P/E Ratio 57.04 52.03 42.47 43.68 51.52 49.35 45 45

Price of share as of Mar No. of

31,2022 1349.427 shares 8.319328
Year (Ending on 31 March of) 2016 2017 2018 2019 2020 Average 2021 2022
Operating revenue 791.3 912.4 1056.9 1203.4 1330.4   1436.832 1796.04
Revenue Growth   15% 16% 14% 11% 14% 8% 25%
Operating Expenses 581.6 674.9 792.9 909.8 986.8      
EBITDA 209.7 237.5 264 293.6 343.6      
EBITDA Margin 27% 26% 25% 24% 26% 26%    
Depreciation 28 28 33 38 73      
EBIT/Operating Profit 181.7 209.5 231 255.6 270.6   359.208 449.01
Operating Profit Margin 23% 23% 22% 21% 20% 22% 25% 25%
Interest 0 1 1 1 15   15 15
Other Income 20 27.5 31.2 45.9 55 35.92 55 55
PBT 201.7 236 261.2 300.5 310.6   399.208 489.01
Tax 67.5 81.2 89.6 100.1 82.9   139.7228 171.1535
Effective Tax Rate 33% 34% 34% 33% 27% 32% 35% 35%
PAT 134.2 154.8 171.6 200.4 227.7   259.4852 317.8565
EPS 16.13 18.61 20.63 24.09 27.37   31.19065 38.20699
                 
Price on 31st March 920 968 876 1052 1410   1871.439 1910.35
P/E Ratio 57.04 52.03 42.47 43.68 51.52 49.35 60 50
 Indian Institute of Management Kashipur
Post Graduate Programme
Price of share as of Mar No. of
31,2022 1910.35 shares 8.319328
Team C:
Capital Apprecaition
Valuating Team   A B C
Current Price   1850 1850 1850
Price on 31st March 1679.23 1349.42
2022   5 7 1910.35
- 60.3496
Capital Appreciation   -170.765 500.573 7
%age   -9.23% -27.06% 3.26%

(ii) Which sets of assumptions you find more appropriate. What assumptions will you like to make based on your
understanding of the sector and the company? Calculate the expected stock price in 2022 based on your assumptions.
Will you recommend for buying Dr Lal Path Lab stock today?

Ans. As per my recommendation we will go with the industry analysis of Team C as it takes into account a
holistic view of the market and industry.
My assumption:
 I will go with revenue projection of Team C with growth rate of 8% in FY21 taking into account
abnormal year and growth of 25% in FY22 due to rapid recovery
 I expect the company to hold its OPM at the average of previous years.
 As per Team C’s information the interest expence will not change going forward
 Other Income to be maintained at the level of previous average.
 Tax rate to be avg of previous 5 years as effective tax rate rather than standard corporate tax rate
 P/E ratio will increase in FY21 accounting to the fact that pharma sector is growing rapidly due to
pandemic and will reasonably rach to 60. And as the economy comes back to normal in FY22 the
P/E ratio will reach the previous average of 5 years i.e 50
Year (Ending on 31 March of) 2016 2017 2018 2019 2020 Average 2021 2022
Operating revenue 791.3 912.4 1056.9 1203.4 1330.4   1436.832 1796.04
Revenue Growth   15% 16% 14% 11% 14% 8% 25%
Operating Expenses 581.6 674.9 792.9 909.8 986.8      
EBITDA 209.7 237.5 264 293.6 343.6      
EBITDA Margin 27% 26% 25% 24% 26% 26%    
Depreciation 28 28 33 38 73      
EBIT/Operating Profit 181.7 209.5 231 255.6 270.6   316.103 395.1288
Operating Profit Margin 23% 23% 22% 21% 20% 22% 22% 22%
Interest 0 1 1 1 15   15 15
Other Income 20 27.5 31.2 45.9 55 35.92 35.92 35.92
PBT 201.7 236 261.2 300.5 310.6   337.023 416.0488
Tax 67.5 81.2 89.6 100.1 82.9   107.8474 133.1356
Effective Tax Rate 33% 34% 34% 33% 27% 32% 32% 32%
PAT 134.2 154.8 171.6 200.4   227.7 229.1757 282.9132
EPS 16.13 18.61 20.63 24.09   27.37 27.54738 34.00674
                 
Price on 31st March 920 968 876 1052 1410   1652.843 1700.337
P/E Ratio 57.04 52.03 42.47 43.68 51.52 49.35 60 50
 Indian Institute of Management Kashipur
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Price of share as of Mar No. of
31,2020 1700.337 shares 8.319328

My recommendation of the stock will be to sell as the stock is overpriced today due to abnormal growth in

pharma sector resulting from the pandemic which will come down in FY 22 and stock price will decrease.