Question Paper Investment Banking & Financial ServicesII (262): January 2006Section 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 Read the case carefully and answer the following questions:1. Appraise the various alternatives available to Discovery Engineering Systems. (20 marks) < Answer > 2. Represent your appraisal in the form of a decision tree with explanatory notes. (6 marks) < Answer >

3.4.

Discuss the various lease related risks that HP Financial Services would need to bear.(8 marks) < Answer > How mature is IT leasing in India and what are the emerging trends in IT leasing in India? (8 marks) < Answer >

5.

What competition does IT leasing companies face from banks that also offer leasing options?

(8 marks) < Answer > Discovery Engineering Systems (P) Limited is a Noida based venture capital funded manufacturing company in the Small and Medium Enterprise (SME) sector. The company is having a very good track record for the past 3 years With an outstanding growth rate Having its own sprawly premises in Nodia Having enough working capital and provisions for contingency.

Discovery Engineering has quality management, aggressive in nature. The management team comprises of professionals having extensive knowledge and related experience both in India and abroad. Goal of the company is to work on untested projects and develop new products and hence get the pioneering advantage of earning higher than normal returns. For achieving its goal the management is also planning to develop strong marketing, sales and distribution network in India and abroad. For achieving its goals and increasing its productivity, Discovery Engineering wants to use some high cost Computer Numerical Control (CNC) machines costing Rs.200 lakhs for complete automation of all its services. This automation would help the company to achieve 100% capacity utilization from the current 80% level. Given the uncertainties associated with the CNC machine market, the Vice President (Technical) believes that the useful life of the CNC machines is a stochastic (random) variable with the following probability distribution: Useful Life (in years) Probability 3.0 0.4 4.0 0.2 5.0 0.2 6.0 0.2

After reviewing the above probability distribution, the Vice President (Finance) is not very keen on purchasing the equipment. He believes that taking the equipment on lease, preferably under a flexible arrangement will

make more commercial sense. HP Financial Services is leasing company with offerings ranging from leasing of CNC machines to various automation equipments. Under this segment the company has provided CNC machines and automation equipment to approximately 750 customers. HP has also started IT equipment leasing, which includes hardware, software and other services for HP customers. Their financial service portfolio includes operating and finance leases, variety of acquisition strategies for multi-vendor/ multi-technology solutions, utility structures and lifecycle asset management. There is also a range of re-marketing services to maximize value of older equipment, add-ons and upgrades for corporate accounts and financing for printing and imaging services. In India they have approximately 100 customers. HP Financial Services leverage their relationship to reach the different verticals that their customers target, which includes telecom companies, banking, finance, manufacturing and the government sector. Their offerings can cut across any vertical. The financial and telecom segments are emerging in nature and have a very huge growth potential, therefore HP has included these in its portfolio to increase the volume of business. HP Financial Services have come up with two lease proposals for Discovery Engineering Systems. Proposal I : A finance lease under which the lessee will have to pay a rental of Rs.350/Rs.1000 a year for a non-cancelable period of five years. After 5 years, the lease can be renewed for another three years on a yearly basis at a rental of Rs.15/Rs.1000 per year. The lease rentals are payable annually in arrears. Proposal II: This involves a Back-to Back Short-Term Lease arrangement. Under this arrangement two short term leases, each for a duration of three years will be structured. The lease rentals payable annually in arrears for the first short-term lease will be as follows: Year 1 2 3 Lease Rental (Rs. in lakhs) 45 45 45

On expiry of the lease period, the lease can be renewed for another three years on the basis of the prevailing lease rate for the equipment of that vintage. The following information is provided by the VP Finance of Discovery Engineering Systems: The capital costs of similar high technology CNC machines have been escalating at the rate of 15% over the last 3 years 3 years The ratio of cost of used CNC machine to cost of new CNC machine is expected to be 0.20 after The net realizable value of the CNC machines by the end of year 4 will be negligible The lease rentals for the second lease term should be projected assuming a pre-tax return of 25%

The cash flow projections reveal that the investment in the new CNC machines will result in an incremental EBDIT of Rs.75 lakh in year 1, Rs.90 lakh in year 2 and Rs.105 p.a. in years 3 to 6 The tax relevant rate of depreciation is 25% Marginal rate of tax (including surcharge) is 35% Post tax required rate of return is 13% p.a. Incremental cost of debt is 16% p.a.

END OF SECTION D

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 1Read the caselet carefully and answer the following questions: 6. In recent times Individual Credit Rating is taking pace. Explain how the lenders are benefited through Individual Credit Rating and also state the disadvantages associated with it. (9 marks) < Answer > 7. What kind of credit information does the credit information bureau store and what happens lender provides the incorrect information to the bureau? when the

(8 marks) < Answer > As the number of companies borrowing directly from the capital market increases, and as the industrial environment becomes more and more competitive and demanding, investors find that the borrowers net worth or the name are no longer sufficient to ensure successful raising of funds from the market. In such a scenario to enable the investor to take informed decision, credit rating has emerged as one of the most critical factor in choosing. Offering this service is a Credit Rating Agency, which provides an impartial and objective opinion on the credit quality of debt obligations of different companies and assists investors, individuals and institutions in making investment decision. This was the discussion requirement of credit rating for companies but now a days credit rating of the individual is also taking pace. With liberalization in full swing, loans for cars and white goods are freely available at the right price for Indias 200 million strong middle class. Today there is no stigma attached to the loan for acquisition of goods for status. The consumer finance market is on boom and with it, the need to rate or assess an individual in order to avoid the risk of default, is all the more necessary. The presence of so many consumer finance companies like Country Wide, is an indication of growing need for consumer finance and with it the individual rating. In developed financial markets, there are specialized financial institutions that maintain records of credit histories of individuals and business entities. Lenders mostly banks and credit card companies, usually setup these institutions, called credit information bureaus. Whenever an individual seeks a loan from a bank or finance company, the lender before extending the loan checks his credit profile with the bureau to find out whether the borrower has defaulted with any other lender and whether he is capable of settling the loan. The question which arises in every ones mind is that why there was no credit information bureau in India until now. Until now, if any borrower failed to repay his loan to the bank in time, the bank could not share his loan details with anyone else. Laws relating to banking secrecy prevented a lender from sharing information pertaining to their customer with any third party. The only time information of a default would come in public domain was when the bank filed a suit for recovery of the loan. The bureau largely provides information on retail borrowers. This information is available to banks that contribute information in respect of their own borrowers. Lenders are provided a credit information report based on which they can take an informed decision on whether to lend or not.

Caselet 2Read the caselet carefully and answer the following questions: 8. What according to you are the possible costs the SSI units are expected to bear, if they dont opt for factoring? (8 marks) < Answer > Explain the difference between credit insurance and factoring. (8 marks) < Answer >

9.

There are many ways to generate cash flow. However, not all may be right for you. If your

business is smaller one or you are new, you may not qualify for a traditional working capital loan. Or you may need cash flow support above and beyond such a loan. In such circumstance one attractive alternative you have is to hire a factor. A factor is a company that purchases receivables, giving your business an advance payment up front. It is a mode of financing that can help free businesses from the cash-flow squeeze caused by slow-paying customers. Companies in the services industry are particularly well-suited to factoring as a financing tool. Smaller companies requires cash frequently while a large client or customer takes long time to pay the dues. These imbalances the financial position of the company. In such situation factoring comes to rescue the companies. Similar problems are faced by the SSI units. They have been facing constrains in their operations on account of inadequacy caused by delays in receiving payments for their supplies. A large number of SSI units are managed by their promoters and/or persons with technical orientation who are unable to pay continuous attention to the areas of debt collection, accounting and working capital management. By and large, such units do not have an organizational set up for recovery of dues from the buyers. The potential demand for factoring services from SSI sector is estimated to be sizable; it would take some time before this demand could crystallize. In this connection, it is considered that the question of reservation of a specific percentage of total business of factoring organizations for SSI sector, to give an initial boost to factoring for this sector. In its view this may not be desirable, especially in the initial stages as it could endanger the factoring organizations commercial viability. Moreover, as factoring develops, such reservation may not be necessary at all. Some experts are of the view that factoring for SSI units could prove to be mutually beneficial to both factors and SSI units and factor should make every effort to orient their strategy to crystallize the potential demand from this sector. Caselet 3 Read the caselet carefully and answer the following questions:10. What does Clause 49 of listing agreement state with respect to appointment of independent directors? Explain the rationale of SEBI behind appointment of independent directors in the company. (9 marks) < Answer > 11. Clause 49 may be a headache to the listed companies but it is a big opportunity for headhunter to make money. Explain. (8 marks) < Answer >

Clause 49 is comparable to Sarbanes-Oxley Act in US and the EU-VIII in Europe. It alters the qualification of the independent directors (IDs) in the board, besides making the CEOs and CFOs fully accountable for the financial statements that they certify. The new clause has brought in the much-needed clarity and has done away with ambiguity. In its present form, Clause 49 puts in black and white as to who qualifies for the role of an independent director and who does not. Some of the important qualifiers are Any person holding more than 2% stake in the company has been debarred from acting as an independent director. Supplier, service provider, customers cannot act as an independent director.

Independent directors should not be related to promoters or management at the board level or at one level below the board. He should not have been an employee of the firm in the immediately preceding three financial years. He has not been, for the last three years, and should not be, a partner of the current legal and consulting firms, which is associated with the firm. India has over 6,500 listed firms, which are required to fulfill the Clause 49. SEBI has set a deadline of December 31 this year for listed companies to implement this clause. This has created a good opportunities for the recruiting agencies. In the given time available companies should identify and appoint required number of IDs. With the stringent policies in place searching for a right candidate is definitely a difficult task. The CEOs and CFOs should be properly geared up so that the pressure of certifying the statements do not hamper their day to day functioning. Proper policies and guidelines will have to be framed in accordance with Clause 49, so that there is no confusion regarding functionality, authority and accountability of different offices within the firm. This new requirement of Clause 49, will thrust more responsibility on the CEOs and CFOs of the company. This step taken by SEBI is in the right direction. This clause will make it necessary for the CEOs/CFOs to disclose proper information in the financial system. This will definitely bring some relief to the investors. This clause also increases the frequency of audit committee meetings to a minimum of four times a year with a maximum gap of four months between any two meetings, form the original three meetings a year with a maximum gap of six months between two meetings. According to experts increased frequency of meetings will lead to better governance. END OF SECTION E END OF QUESTION PAPER

Suggested Answers Investment Banking & Financial ServicesII (262): January 2006Section D : Case Study 1. We have to evaluate the NPVs of the following three alternatives: Purchase Finance Lease Back to Back Short-term Lease We shall define N as the random variable presenting the useful life of the asset. Alternative (A): Purchase the Equipment The net present value of this option will be as follows: NPV (P) = P.V. [EBDIT (1-T)] + P.V. (Tax Shield on Depreciation) + P.V. (Salvage Value) Initial Investment. The present value of EBDIT (1-T) depends upon the value of N. For N = 3, P.V. [EBDIT (1-T)] @ K=13% = [75(1-0.35)*0.8550] + [90(1-0.35)*0.7831] + [105(1 0.35)*0.6930] = Rs. 134.78 Lakh For N = 4, P.V. [EBDIT (1-T)] @ K=13% = Rs. 176.64 Lakh For N = 5, P.V. [EBDIT (1-T)] @ K=13% = Rs. 213.68 Lakh For N = 6, P.V. [EBDIT (1-T)] @ K=13% = Rs. 246.46 Lakh P.V. Tax Shield on Depreciation @ K=13% and N=3 is equal to [(50*0.8850) + (37.50*0.7831) + (28.13*0.6930)] * 0.35 = Rs. 32.59Lakh Since the salvage value of the equipment is insignificant beyond the third year, we will assume that it will be retained and the full Depreciation Tax shelter available under the Income Tax act will be claimed. Salvage value of the equipment after three years = 200(1.15) 3 * 0.2 = Rs. 60.84 Lakh P.V. of the salvage value realizable after three years = (60.84*0.6930) = Rs. 42.16 Lakh Net salvage value at the end of years four, five and six is taken to be insignificant. For different values of N, the values of NPV (P) will be as follows:

Initial Investment NPV (P) N P.V. [EBDIT P.V. Tax Shield P.V. (1-T)] (Net salvage value) on Dep. 3 134.78 32.59 42.16 200 9.53 4 176.64 37.12 0 200 13.76 5 213.68 40.13 0 200 53.81 6 246.46 42.13 0 200 88.59 Expected NPV (P) = (9.53*0.4) + (13.76*0.2) + (53.81*0.2) + (88.59*0.2) = Rs.35.04 lakh. Alternative (B): Finance Lease NPV (FL) = P.V. [EBDIT (1-T)] - P.V. (Lease Rental) + P.V. (Tax Shield on Lease Rental) - P.V. (Tax Shield on Depreciation) - P.V. (Interest tax shield on displaced debt) P.V. of lease rentals during the primary period at K=16% = (200*0.350) PVIFA (16,5) = Rs.229.20 Lakh P.V. of lease rentals during the secondary period = (200*0.015) PVIF (16,6) = Rs.1.23 Lakh P.V. of Tax Shield on Lease Rental during the primary period = (200*0.350*0.35) * PVIFA (13,5) = Rs.85.99 Lakh P.V. of Tax Shield on Lease Rental during the secondary period = (200*0.015*0.35) * PVIF (13,6) = Rs.0.50 Lakh P.V. of Interest tax shield on displaced debt = [(36.67*0.8850) + (31.34*0.7831) + (25.15*0.6930) + (17.98*0.6133) +(9.65*0.5428)]* 0.35 = 123.14 * 0.35 = Rs.43.09 Lakh P.V. Tax Shield on Depreciation @ K=13% and N=3 is equal to [(50*0.8850) + (37.50*0.7831) + (28.13*0.6930)] * 0.35 = Rs. 32.59 Lakh Since the salvage value of the equipment is insignificant beyond the third year, we will assume that it will be retained and the full Depreciation Tax shelter available under the Income Tax act will be claimed. Amortization Schedule for Debt Displaced Year Amount o/s Rate of Interest Capital Debt Service at the beginning Interest Content Component Charge 1 229.20 0.16 36.67 33.33 70

2 3 4 5

195.87 157.21 112.36 60.34

0.16 0.16 0.16 0.16

31.34 25.15 17.98 9.65

38.66 44.85 52.02 60.34

70 70 70 69.99

For different values of N, the values of NPV (FL) will be as follows: N P.V. [EBDIT P.V. P.V. (Tax P.V. P.V. NPV (Lease Shield on (Interest tax (Depreciation (FL) (1-T)] Rental) Lease shield on Tax Shield Rental) displaced forgone) debt) 3 134.78 229.20 80.22 43.09 32.59 -89.88 4 176.64 229.20 80.22 43.09 37.12 -73.19 5 213.68 229.20 80.22 43.09 40.13 -39.16 6 246.46 230.43 80.65 43.09 42.13 11.46 Expected NPV (FL) = (-89.88*0.4) + (-73.19*0.2) + (-39.16*0.2) + (11.46*0.2) = Rs. -53.13 lakh. Alternative (C): Back-to-Back Short-term Lease (BBSTL) NPV (BBSTL) = P.V. [EBDIT (1-T) - P.V. (Lease Rentals)] + P.V. (Tax Shield on Lease Rental) We have not considered the interest tax shield and depreciation tax shields on the displaced debt in the computation of NPV (BBSTL). This is because of the fact that the back-to-back short-term lease is not a finance lease. We have treated the lease rentals payable over the lease term like any other operating cash outflow and valued this out flow at the marginal cost of capital. P.V. (Lease Rentals payable during the initial lease period) = 45 * PVIFA (13,3) = 106.25 P.V. (Tax Shield on Lease Rentals payable during the initial lease period) = 106.25 * 0.35 = 54.99 The equated annual lease rental (L2) payable during the second lease term can be obtained from the equation: L2 * PVIFA (25,3) = 60.84 1.952* L2 = 60.84 therefore, L2 = Rs.31.16 lakh (approx) The discount rate of 25% represents the rate of return required by the lessor. The value of Rs.31.16 lakh is the estimated market price of the used equipment after three years and has been derived from the assumption made by the finance manager. P.V. (Lease Rental payable during the second lease period)

N 3 4 5 6

= 31.16 * PVIFA(13,3) * PVIF(13,3) = Rs.51 lakh P.V. (Tax Shield on Lease Rental payable during the second lease period) = 51 * 0.35 = Rs.17.85 lakh For different values of N, the values of NPV (BBSTL) will be as follows: P.V. [EBDIT (1P.V. (Lease P.V. (Tax Shield on Lease NPV T)] Rental) Rental) (BBSTL) 134.78 106.25 37.18 65.71 176.64 157.25 55.03 74.42 213.68 157.25 55.03 111.46 246.46 157.25 55.03 144.24 Expected NPV (BBSTL) = (65.71*0.4) + (74.42*0.2) + (111.46*0.2) + (144.24*0.2) = Rs. 92.30 lakh The expected net present values of the three alternatives are as follows: Alternatives Expected NPV (Rs. in lakh) Purchase +35.04 Finance Lease 53.13 Back-to-Back Short-Term lease + 92.30 The NPV of the Back-to-Back Short-Term lease is substantially higher than the NPVs of the Purchase and Finance Lease. Therefore, the company is advised to go for Back-toBack Short-Term lease plan. < TOP >

2.Pay offs EL = 3 p = 0.4 Purchase EL = 4 p = 0.2 C1 + 35.04 EL = 5 p = 0.2 EL = 6 p = 0.2 EL = 3 p = 0.4 EL = 4 p = 0.2 D1 Opt. for FL C2 - 53.13 EL = 5 p = 0.2 EL = 6 p = 0.2 EL = 3 p = 0.4 EL = 4 p = 0.2 Opt. for BBSTL C3 +92.30 EL = 5 p = 0.2 EL = 6 p = 0.2 9.53 13.76 53.81 88.59 -89.88 - 73.19 - 39.16 11.46 65.71 74.42 111.46 144.24

Explanatory Notes:

1. 2. 3. 4. 5.

D1 denotes the first decision node. C1, C2 and C3 denote the chance forks. EL stands for Economics Life in years. p stands for the probability associated with a given economic life. The pay offs are denominated in lakh of rupees. < TOP >

3.

The total risk of a lease portfolio consists of the following types of risks: Default risk: The risk of not receiving the lease rentals on schedule. The default risk can arise on account of certain economy wide factors like unanticipated cost push inflation which affects the financial performance of almost all lessees or on account of industry/company specific factors which affect only a few lease accounts in the portfolio3. Residual value risk: The possibility of a decline in the estimated residual value of the equipment. This risk is particularly relevant in operating leases of hi-tech equipments and is caused by factors like technological obsolescence and uncertainty with regard to the product market life of the equipment. Interest rate risk: The interest rate risk refers to the changes in the market rate of interest, which adversely affects the cost of funds to the lessor. Purchasing power risk: This refers to the reduction in the value of lease rentals in real terms caused by unanticipated inflation. This risk is particularly relevant for real estate leases or leases with a long duration. Political risk: The political risk refers to the changes in the governmental policies in general, and the fiscal policy in particular, which have significant implications for the economic viability of lease investments. An example is the withdrawal of the investment allowance scheme, which as we noted earlier has a favorable implication for the economies of leasing. Currency and Crossborder risk: These risks are relevant only for cross-border lease transactions. The currency risk refers to the fluctuations in the exchange rate of the rupee vis--vis the currency in which the lease payments are structured. The cross-border risk refers to the unfavorable changes in the political and economic environment of the country where the lessee is located. < TOP > The total leasing industry itself is very large, of which IT leasing forms a part. The IT industry slowdown has positively impacted IT leasing, as companies generally tend to go for leasing and financing options now. Though leasing has been three for a long time, the market in India is not that mature for leasing IT equipment. This is because of tax law amendment that have been affected over a period of time and also the way a typical company looks at IT as different kind of capital investment as compared to investments in an aircraft or a truck. Today banks in India are looking at extending IT solutions to all their branches and there is also a lot of activity happening on the government front. These facts assisted by mindset change are

4.

leading to a shift from buying to leasing of IT assets. In fact, India has been outlined as a high focus and growth engine for the company in the future. Utility services and pay-per-use is an emerging trend in IT leasing. The offering allows customers to buy computing power on a pay-per-use basis. Metered billing capability allows paying for actual usage. The service provider tracks usage, bills customers and collects the billing. < TOP > 5. IT leasing companies face tough competition from banks in this regard because they have the ability to access funds at lower rates. They can also finance everything without restricting themselves to IT, which gives them the ability to handle different kinds of portfolios. So, they might be able to take more risks in certain cases than we would ever do. But the advantage It leasing companies bring is that we are dedicated only towards IT leasing and they understand the IT business better than anyone else. IT leasing companies understand when technology is to be refreshed (replacing older equipment) and offer end-of-term solutions, under which they take responsibility for replacing and the customer is not paying for it. The IT leasing companies offer residual value, which banks are not providing. They take up residual value of risk involved, typically ranging from 10 to 25 percent of total contract. This gives the IT leasing companies a definite edge over banks. There are also other value adds like an asset management offering, which allows for Web-enable tracking and management, helping the customer understand where the equipment is, details of the equipment, how much is paid for it and other such information.< TOP >

Section E: Caselets Caselet 1 6. Advantages of Individual Credit Rating 1. One of the main problems associated with consumer finance is that of bad debts. More than 20 percent of the sales become bad debts due to customer default. Unlike automobile finance, the recoveries for consumer durables are possible only after prolonged civil suits. Besides, dealers are unwilling to take any financial risk on the clients they recommend. In such a situation, the credit rating of individuals provides scope to minimize risk of default. This can, in turn, provide buoyancy to consumer finance companies. 2. Determining the willingness and ability of the borrower to pay can be assessed properly. 3. Getting durables or any other products on loans/ installments becomes easy to borrowers, especially the middle class families. 4. Rating of individuals by an outside agency, like ONICRA would be less expensive than employing a team of personnel by banks to get each credit appraisal. Today, a finance company is engaged in a variety of activities and one of them is consumer finance. By utilizing the services of independent and specialized credit rating

agencies, finance firms can concentrate on other areas of business activities and maximize their returns. Disadvantages of Individual Credit Rating 1. It is not clear how the entire process will evolve. Unlike corporate ratings, which are directly sought by a corporate before a public issue of debt, individuals cannot approach ONICRA directly to obtain a rating. Also, it is relatively easy to rate corporates owing to the availability of audited balance sheets, market data about suppliers and customers, the industry scenario and the quality of management. Individual credit rating requires a different approach. 2. The crucial issue in India is how much information individuals will voluntarily disclose. The Indian laws do not allow access to information needed for accurate rating. Obtaining information even from government authorities such as the tax department will be difficult. < TOP > 7. The credit information bureau has information on loans advanced by member banking companies, financial institutions, non-banking financial companies, housing finance companies and credit card companies. In India there is no provision for a borrower to acquire his own credit information from the bureau. In some countries it is possible for a borrower to obtain his own credit report to ascertain whether a borrower has fed the bureau with incorrect information. The only way that a borrower can correct inaccuracies in his own credit report are by approaching the lender who had fed the information in the first place. < TOP > Caselet 2 8. The high cost associated if the firm does not go for factoring are as follows:

Devaluation of your money due to inflation while waiting for payment. Inability to take advantage of net and volume discounts and other purchasing opportunities. Worsened customer relations due to collection efforts and phone calls. Inability to expand. Cash flow planning and control skewed due to uncertainty of payment dates. Inability to increase inventory. Bad debt losses. Continuous cost of ongoing credit and collection efforts. Continuous cost of accounts receivable maintenance. Inability to implement marketing and sales plans. Lowered financial statement and bank balances. Loss of working capital. Restrictions on action due to credit line and other borrowing limits.

Cost of executive and staff time fixed on non-income producing activities. < TOP >

9.

In countries where credit insurance is in popular in use, a firm can insure its receivables against credit risk. While the insurance company does not help in the collection of receivables, it settles the claims arising on account of insured accounts which have turned delinquent.( An account is considered to be delinquent not only if the customer actually becomes insolvent, but also if an account has reached a particular in being overdue.). Thereafter it takes over the delinquent account and makes vigorous efforts to collect. To ensure the insured does not throw caution to the winds by adopting liberal credit standard, the insurance company specifies the maximum amount it will cover for account with a particular credit rating. Where as the factor is a financial intermediary which pays for the debts as and when they are collected. Usually factors makes part payment immediately after the debts are purchased thereby provides immediate liquidity to the client. For rendering the services for collection and maintenance of sales ledger, the factor charges commission. < TOP > Caselet 3

10. Clause 49 of the listing agreement states that all listed entities with executive chairman to have at least 50 per cent of independent directors in the board. SEBI has set a deadline of December 31 this year for listed companies to increase the number of independent directors as per the revised clause 59 of the listing agreement, which also says that companies with non-executive chairman can have at least one-third of the board as independent directors. The companies require the independent directors to have the basic knowledge of the duties to be performed in the public company. The firms should also cooperate with the independent directors so that they can discharge their duties properly. The motive of SEBI behind this clause is very clear. Independent directors are one of the most important pillars of good board governance, and by extension it will lead to good corporate governance. Having the director who does not have the linear relations management, company, etc., is not the end reason. What is desirable is that he strives through his actions for the maximization of shareholders wealth, bringing corporate democracy and ensuring maximum transparency and disclosures by corporate houses. This reaffirms the shareholders faith, trust and confidence in accepting him as an independent director of the company. < TOP > 11. Clause 49 may be a pain to the listed companies but it is a big opportunity for headhunter to make money. The new guidelines by the market regulator have opened a huge new market for the headhunters. India has over 6,500 listed firms and on an average each should have a minimum of 3-4 independent directors. Under the new guidelines, past practices of appointing the company lawyer or the auditor on the board are not allowed any more. This has again narrowed the choice for the companies.

Leading search firms are use to charge very high for an independent director depending on the size of the company and its expectations from the prospective director. Lesser known agencies however charge one-third of the first-year remuneration of the director for recruiting them. Since the time SEBI made it mandatory for listed companies to fill half the board with independent directors (Clause 49 of the listing agreement) with strict deadlines, headhunters are setting up new teams to search around for potential independent directors (IDs). The new practice is expected to be a cash machine for headhunters < TOP > < TOP OF THE DOCUMENT >

Question Paper Investment Banking & Financial Services - II (262) : April 2006Section 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 Read the case carefully and answer the following questions:1. Delineate the risk factors inherent in the issue; clearly distinguishing between internal and external factors. (10 marks) < Answer > 2. As an Investment Banker, before doing the valuation of Bartronics India Limited, perform a SWOT analysis of the company. (12 marks) < Answer > A leading investment banking firm has decided to use price/earning multiple approach to value the stock of Bartronics India Limited (BIL) in view of the difficulties in applying other methods. As no comparable stock is available in India, it has decided to use international average P/E multiple of 21.7. The earnings of the company are expected to grow at the sustainable rate. The new equity is expected to earn a return of 10% p.a. The investment banking firm is contemplating to appraise the issue price of the share based on the earning per share of BIL as on 31st March 2006. You are required to find the intrinsic worth of the share using the above method assuming that the company comes with an IPO on 30th December 2005. Based on the same give your advice to an investor if, the price range of the issue is Rs.70-Rs.75. (10 marks) < Answer > It was often said that Fixed Price IPO suffered from wrong valuation and price was forced upon the investors in the Indian primary equity market. Book Building came as a ready solution and is regarded as a vehicle for price discovery. Does Book Building give 100% true price discovery in Indian equity market when compared to US market? What is the rationale of giving a floor price or a price band in IPO? (10 marks) < Answer > Some of the widely used terms we come across in context of IPO are Offer Document, Red Herring Prospectus, Abridged Prospectus, Draft Offer Document etc. What is the difference between an offer document, RHP, a prospectus and an abridged prospectus? What does it mean when someone says Draft Offer Document?

3.

4.

5.

(8 marks) < Answer > Bartronics India Limited (BIL) Public issue of 65,00,000 equity shares of face value of Rs. 10/- each per share at a price of Rs. [] for cash at a premium aggregating Rs.[]lakh (hereinafter referred to as the issue) including Promoters reservation of 5,00,000 equity shares of face value or Rs. 10/- each per share at a price of Rs. [] for cash aggregating Rs. [] and net issue to the public of 54,00,000 equity shares of face value or Rs. 10/- each per share at a price of Rs. [] for cash aggregating Rs. [] (herein after referred to as the net issue) and the net issue would constitute 37.07% of the fully diluted post issue paid-up capital of the company. The Issue is being made under clause 2.2.1 of SEBI (DIP) GUIDELINES, 2000 through a 100% Book Building Process wherein up to 50% of the net issue will be allocated on a proportionate basis to Qualified Institutional Buyers (QIBs). Further, not less than 15% of the net offer will be available for allocation on a proportionate basis to Non-Institutional Bidders and not less than 35% of the net offer will be available for allocation on a

proportionate basis to Retail Individual Bidders, subject to valid bids being received at or above the Offer Price. Authority for the Issue The Issue has been authorized pursuant to a resolution of the Board of Directors of the company adopted at its meeting held on April 25, 2005 and by a special resolution adopted pursuant to Section 81(1A) of the Companies Act, 1956, at the Extra Ordinary General Meeting of the company held on May 2, 2005 Listing The Equity Shares are proposed to be listed on Bombay Stock Exchange Limited (BSE) (the Designated Stock Exchange) and The National Stock Exchange of India Limited (NSE). The in-principle approvals of the Stock Exchanges for listing Equity Shares have been received pursuant to their letters dated [_] and [_] respectively.Capital Structure of the Company Share capital as on the date of filing of Draft Red Herring Prospectus with SEBI is set forth below: Particulars A. AUTHORISED CAPITAL 1,70,00,000 Equity shares of Rs.10/- each. B. C. ISSUED SUBSCRIBED AND PAID-UP CAPITAL 80,68,950 Equity Shares of Rs. 10/- each. PRESENT ISSUE THROUGH THIS DRAFT RED HERRING PROSPECTUS 65,00,000 Equity shares of Rs.10/- each at a price of [] Out of which 5,00,000 Equity shares of Rs. 10/- each are reserved for promoters, their friends, relatives and associates at a price of []. 6,00,000 Equity Shares of Rs. 10/- each reserved for Employees at a price of Rs. [] NET OFFER TO PUBLIC 54,00,000 Equity shares of Rs.10/- each at a price of Rs. [] EQUITY CAPITAL AFTER THE ISSUE 1,45,68,950 Equity Shares of Rs.10 Each SHARE PREMIUM ACCOUNT Before the Issue After the Issue Nominal Value 1700.00 806.89 Aggregate Value

650.00

[]

50.00

[] []

0.00

D.

540.00

[]

E. F.

1456.89 705.91 []

[] []

[] THE FIGURES WILL BE FINALIZED AFTER THE BOOK BUILDING PROCESS Ranking of Equity Shares The Equity Shares being offered shall be subject to the provisions of Memorandum and Articles and shall rank pari passu in all respects with the other existing Equity Shares of the company including rights in respect of dividend. The Allottees will be entitled to dividend or any other corporate benefits (including dividend), if any, declared by the company after the date of allotment. Face Value and Issue Price The Equity Shares with a face value of Rs.10 each are being offered in terms of this Draft Red Herring Prospectus at a price band of Rs. [] Rs. [] per Equity Share. At any given point of time, there shall be only one denomination for the Equity Shares of the company, subject to applicable laws. History of the company:

The company has been incorporated on 10.09.1990 as Super Bartronics Private Limited; it became a Public Limited Company in 1995. The company got its current name Bartronics India Limited on 1st January 1996. The company started its business in the field of Bar Coding and Smart Card Technology. Subsequent to that, the company started experimenting with new Automatic Identification & Data Capture (AIDC) solutions and today the company is in a strong position to capture the new opportunities in AIDC market The company is involved mainly with the manufacturing sector and has implemented a number of projects across companies in their manufacturing set-ups. The projects primarily involved inventory & logistics management, time & attendance and asset tracking systems. AIDC is seen as an enhancing technology as it automates the data collection for the main systems. Presently the company offers diverse range of AIDC technologies Barcode, Biometrics, Radio Frequency Identification (RFID), Radio Frequency Data Communications (RFDC) and Electronic Article Surveillance (EAS). Management The company is currently managed by the Board of Directors comprising 6 directors. The day-to-day affairs of the company are being managed by Mr. Sudhir Rao, Managing Director. Mr. Sudhir Rao- to function as CEO and to be responsible for the operational activities such as product design and development, marketing and positioning of the brand in all its channels, human resources management, financial and treasury operations, sales and marketing, import and export related activities and general administration and ultimately for optimizing shareholders value by ensuring legal and fiscal compliance. Main and Other Objects of the Company The main and other objects of the company as stated in the Memorandum of Association are: 1) 2) To manufacture, sell, deal in all types of Bar Code Equipments, Systems Accessories, Attachments, Label Materials, Label Printers, Label Verifiers and Allied Products. To enter into Technical and/or Financial collaborations with foreign companies to manufacture Bar Code Equipments, Systems. Accessories, Attachments, Label Materials, Label Printers, Label Verifiers and Allied Products. To carry on business of other automatic identifications, Equipments, Systems. Accessories, Attachments and Allied Products. To establish and run data processing / computer centers and to offer consultancy and data processing and other computer related services that are normally offered by data processing/computer centers to industrial, business and other type of customers and to impart training on electronic data processing and others and to provide IT enabled solutions in India and abroad to implement internet technologies with web based applications for e-commerce, e-business, e-trade, multimedia, call center services and networking worldwide. To acquire and take over all or any part of business, property, plant and machinery and any other assets and liabilities of any person, firm or company carrying on any business which this Company is authorized to carry on or possessed of any property suitable for the purposes of this company. To expand the companys activities by opening branches and /or in appointing agents in India and in any foreign country. The main objects and objects incidental to the main objects permit the company to undertake the present and proposed activities.

3) 4)

5)

6)

Subsidiaries of the Company The company does not have any subsidiary. Objects of the Issue The net proceeds from the issue after deducting underwriting commission and management fees, brokerage; fees to various advisors and all other Issue related expenses are estimated at Rs [] lakh. The proceeds from the issue of shares are intended to be deployed for:

Setting up of R&D Technology Center, Establishing branches in India and abroad Meeting the issue expenses

Repaying the loan Making acquisitions Meeting the working capital requirements Meeting marketing expenses The main objects clause and objects incidental or ancillary to the main objects clause of the Memorandum of Association of the company enables the company to undertake the existing activities and the activities for which the company, through the issue, is raising the funds. The Industry Bartronics is in the Automatic Identification and Data Capture (A.I.D.C) business. A.I.D.C. is the industry term used to describe the identification, and/or direct collection of data into a microprocessor controlled device such as a computer system or a programmable logic controller (PLC), without the use of a keyboard. The technology supports two fundamental requirements v.i.z. eliminating errors associated with identification and/or data collection and accelerating the throughput process. The key application of the technologies is in tracking and traciablity of products/articles, product and item identification and sortation, information and data processing, security and access control and inventory management. The A.I.D.C. technology covers six distinct groups of technologies and services. They are: Card Technologies, Data Communications Technologies, Bar Code Technologies, Radio Frequency Identification Technologies, Emerging Technologies, and the support and supplies which serve the industry. This technology can be applied to virtually every sector of industry, commerce and services where data is handled and needs to track and trace individuals, materials & equipment. The A.I.D.C. Boom: In some quarters it is being talked of as the next Killer Application, which will drive the future of Supply Chain Management. The fact that it can leverage past IT investments better through automated data collection and input, has made it receive unprecedented attention. The RFID market is expected to jump from $1.4 billion annually this year to as much as $6.1 billion in 2010, according to a study by research firm Data Monitor. The U.S. Governments growing reliance on R.F.I.D., the acceptance and use of technology by retailers like WalMart proves its success. The Indian Scenario: The Indian market is estimated to be about Rs 100 crore in FY 2005. The market has been growing at an estimated CAGR of over 50% over the past few years and is poised to grow rapidly due to the retail and manufacturing growth in the country. Additionally a majority of the larger companies have already invested in ERP and SCM software that need to be leveraged further. The use of barcode has been made mandatory in several areas of manufacture, retail and exports. For example, the Canteen Stores Department of the Ministry of Defense has embarked upon an ambitious program of automating its depots and retail outlets across the country to monitor and control stocks and sales of an estimated 4,000 different products it supplies and an inventory of over 200,000 items to the Indian armed forces. The International Scenario: Countries like Bangladesh, Sri Lanka, Dubai, Mauritius etc have a thriving Industrial sector, which contributes a significant portion to the G.D.P of their respective countries. With a good number of large, medium and midsize Industries in both the public and private sector these countries are important vendor bases that export a wide variety of goods and services to many developed nations. The AIDC potential is expected to develop strongly in the emerging markets as mentioned above. (Source: AMR Research, A Boston Based Technology Research Company and www.aidcindia.org) 1. Industry Review Automatic Identification and Data Capture (AIDC) is the industry term, which describes the identification, and/or direct collection of data into a microprocessor controlled device such as a computer system or a programmable logic controller (PLC), without the use of a keyboard. At their core, all AIDC technologies support two common goals: To eliminate errors associated with identification and/or data collection To accelerate the through-put process ( the through-put process is the input to output process ) As an industry composite, AIDC covers six distinct groups of technologies and services. They are: Card

Technologies, Data Communications Technologies, Bar Code Technologies, Radio Frequency Identification Technologies, Emerging Technologies, and the support and supplies which serve the industry. AIDC is now being seen as a radical and revolutionary data carrier and identifier discipline with principles and practices that can be applied virtually to every sector of industry, commerce and services where data is handled and needs to track and trace individuals, materials and equipment. The majority of applications are based on a few generic foundations, as listed below : Tracking and traceability Escort Information Product and item Transaction and services support Access control Sortation Automation support Booming AIDC Industry Following the successes of the ERP, CRM and SCM industries over the past few years, AIDC is receiving a good amount of attention as it can leverage past IT investments better through automated data collection and input. In fact a recent AMR research study concluded that Dwarfing Y2K and the Internet in the scope and scale of changes it will ring in, RFID is the killer application driving the next ten years of supply chain investment. While smart card and bar code technologies continue to find applications, the AIDC industry is moving rapidly towards the use of RFID in a number of high-value and high-volume market segments. The RFID market is expected to jump from $1.4 billion annually this year to as much as $6.1 billion in 2010, according to a recent study by research firm Data Monitor. It is still in a nascent stage but there are several factors, in addition to dropping chip prices, which are driving the growth of RFID as an enabling technology. These include (but are not limited to):

The US Governments use of RFID to track military shipments (to and from the Persian Gulf, for example) & Wal-Marts mandate that has asked 138 of its retail suppliers to be RFID enabled at the case- and pallet- level by January 2005 The development of standards and standards bodies such as EPC (Electronic Product Code), ISO (International Standards Organization) and ongoing work by the Auto ID Center (www.autoidcenter.org) a joint collaboration between the Uniform Code Council and EAN International) Dramatic benefits being achieved by leading consumer packaged goods, retail, manufacturing, logistics, and transportation and healthcare companies Improvements in RFID technology Indian Scenario The Indian market as specifically catered to by Bartronics, estimated at about Rs 100 crore in FY 2005, largely comprises of smart card and bar code solutions. This segment is expected to grow at 20-30% per annum. RFID and biometric solutions are making their presence felt in the current year. The market has been growing at an estimated CAGR of over 50% over the past few years and is poised to grow rapidly due to the retail and manufacturing growth in the country. Additionally a majority of the larger companies have already invested in ERP and SCM software that need to be leveraged further. Barcode Segment, the AIDC Technologies Association of India (www.aidcindia.org) has done a lot of work in the field of bar code technology, which is the precursor to RFID solutions. India is already a signatory to the EAN UCC System that enables automatic capture of vital data across the supply chain from raw material to warehousing to distribution to final retailing. The industry expects that the Walmart mandate combined with a number of other chains (Metro, Tesco, etc) will force Indian suppliers to set up confirming systems. In India, the use of barcode has been mandatory in several areas of manufacture, retail and exports. For example, the Canteen Stores Department of the Ministry of Defence has embarked upon an ambitious program of automating its depots and retail outlets across the country to monitor and control stocks and sales of an estimated 4,000 different products it supplies and an inventory of over 200,000 items to the

Indian armed forces. Source:www.aidcindia.org Smart Card segment Over the last few years, the awareness of smart cards and its applications have gradually increased among the potential users in India. Significant growth has taken place in wireless cellular applications, retail loyalty applications, healthcare applications and vehicle registration applications. Several pilot projects have also been implemented for multi-application campus cards, banking, ID, automatic fare collection, toll, healthcare, etc. Though the SIM card market has driven the growth in the last 5 years, the rate of growth in banking and retail sector is expected to be larger in the coming years. The usage in transport and health care sectors is also expected to increase. However, the industry is looking at the government usage and the much-touted national ID project for a spiraling growth in the next few years. Biometrics As both the private and Government sector organizations search for more secure authentication methods, they have increasingly become aware of biometrics as the killer technology for near foolproof security. It may not be long before all password and card based systems currently in vogue get replaced with biometric devices. While there is a growing demand for both physiological and behavioral biometrics devices, fingerprint recognition is the current hot favorite. However, lack of infrastructure and standardization in the industry, high costs and duties are the impediments in the growth of the industry. Most of the biometrics hardware is being imported from USA, Germany, Israel and in recent times from China. Indian manufacturers are also getting into the act with some fingerprint scanners now being made available in the market. Competitive Landscape The competitive landscape for Bartronics solutions is largely marked by players who are either trading in Hardware or software system integrators. Large players in the industry include Essae Technology, Great Eastern Impex, Intellicon and Stallion. Bartronics differentiates itself by being a total solution provider and hence has a list of impressive clientele in the Indian Market. This is the reason why every major company in India like ITC, HLL, TISCO, TELCO, ISPAT etc. has been served by Bartronics during the past few years. The second differentiating factor is the nation-wide sales and service network. The branches and sales offices of the company ensure that the Bartronics engineers are always on-hand to provide solutions in case there are problems at customer locations. Probably the most important differentiating factor in favour of Bartronics is its skilled service engineers. Apart from being technically qualified, the company has ensured through a structured training program that its engineers are continuously updated on the latest developments in the relevant technologies. Many of the engineers are specially trained by the companys principals. In fact, Intermec Corporation, USA awarded Bartronics with a Gold Medallion Program Certificate which certifies Bartronics engineers to service and repair any product supplied by Intermec Corporation. Apart from this recognition, Bartronics After Sales Service Function has been certified for ISO 9002 which in turn means that the companys processes have been standardized and are capable of delivering quality results consistently. Awards and Recognitions

The company has received ISO accreditation in 2002 from Det Norske Veritas (DNV). Intermec Technologies Corp., USA awarded the company with Intermec Global Medallion PartnerAward in the year 2003, appreciating the efforts of the company in the embedded hardware component with Bar Code Technology. Statements of Profits & Losses (Rs. in Lakhs) Period ended on Income Sales: Of Products manufactured by the Company Of products traded by the Company 2000-01 Apr-Mar 0 841.51 2001-02 Apr-Mar 0 820.48 2002-03 Apr-Mar 0 831.29 2003-04 Apr-Mar 0 1257.64 2004-05 Apr-Mar 0 1805.52

Other Income Increase (decrease) in inventory Total Income Period ended on Expenditure Raw materials & goods consumed Staff Costs Other Admn. expenses Selling & distribution expenses Interest Depreciation Miscellaneous expenditure written off Total expenditure Net profit before tax and extraordinary items Provision for taxation Net profit after tax & before extraordinary items Extraordinary items (net of tax) Net profit after extraordinary items Earlier year adjustments Appropriations Transfer to general reserve Proposed dividend Tax on proposed dividend Balance carried to Balance sheet

2.92 844.43 2000-01 583.50 82.15 79.60 28.00 13.63 22.73 16.69 826.30 18.13 1.65 16.48 0.00 16.48

4.15 824.63 2001-02 540.90 74.51 115.36 38.00 10.85 32.7 6.14 818.46 6.17 0.50 5.67 0.00 5.67

0.29 0 831.58 2002-03 539.94 83.81 46.08 45.00 45.68 35.65 9.29 805.45 26.13 12.54 13.59 0.00 13.59

0.54 0 1258.18 2003-04 735.05 88.71 64.10 45.00 86.51 25.14 0.19 1044.70 213.48 78.29 135.19 0.00 135.19

11.66 0 1817.18 2004-05 1117.65 115.43 71.19 45.00 107.92 83.88 0.89 1541.96 275.22 35.50 239.72 0.00 239.72

0.00 0.00 0.00 16.48

0.00 0.00 0.00 5.67

0.00 0.00 0.00 13.59

0.00 0.00 0.00 135.19

0.00 0.00 0.00 239.72

(Rs. in Lacs) A. As at Assets Fixed Assets- gross block Less: Depreciation Net Block Less: Revaluation Reserve Net Block after adjustment for Revaluation Reserve Investments/CWIP Current assets, loans and advances Inventories Receivables Cash and bank balances Other current assets Loans and advances Total assets Liabilities and provisions Loan funds Secured loans Unsecured loans Current liabilities and provisions Sundry liability 2000-01 128.88 48.68 80.20 0 80.20 361.11 63.5 258.71 87.88 0 19.57 870.97 2001-02 232.39 81.37 151.02 0 151.02 536.93 74.55 285.82 0.79 44.33 1,093.44 2002-03 802.01 117.02 684.99 0 684.99 0.00 60.98 418.72 0.82 0 54.27 1,219.78 2003-04 817.35 142.16 675.19 0 675.19 0.00 2004-05 983.57 226.04 757.53 0 757.53 0.00

B. C.

170.15 303.22 706.56 976.95 0.70 0.50 0 0 29.02 68.77 1,581.62 2,106.97

D.

262.83 10.32 100.84

478.39 10.32 91.43

536.12 10.32 128.44

604.55 0.00 178.68

740.08 0.00 310.39

E.

Provisions Total Liabilities Net worth Represented by: Shareholders funds Share capital Reserves and surplus Less: Revaluation Reserve Reserves (Net of Revaluation Reserve) Less: miscellaneous expenditure not written off Total

10.00 383.99 486.98

15.00 595.14 498.30

15.00 689.88 529.90

15.00 798.23 783.39

15.00 1,065.47 1,041.50

432.51 70.26 0 70.26 15.79 486.98

407.93 100.52 0 100.52 10.15 498.30

407.93 122.82 0 122.82 0.86 529.90

437.93 346.12 0 346.12 0.67 783.39

437.93 606.84 0 606.84 3.28 1,041.50

END OF SECTION D

Section E : Caselets (50 Marks)This section consists of questions with serial number 6 - 12. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section E.

Caselet 1Read the caselet carefully and answer the following questions: 6. To be a developed country by 2010, India requires a jump start in each sector and needs to emphasize on the development of rural areas. The retail sector is linked to the rural sector and it needs focused attention. Discuss the keys and constraints for the growth of the retail sector in India. (6 marks) < Answer > 7. What is the need of FDI in the development of retail sector in India? Discus the benefits associated with the entry of FDI in the retail sector of India. (9 marks) < Answer > 8. Explain the causes of concern of allowing FDI in the retail sector.

(5 marks) < Answer > In the early part of the 17 century the East India Company, a group of British merchants, arrived in India to seek permission to establish their business in India. They stayed back in India and ruled India for almost 150 years. Though every trader is not a comparison for the traders of the East India Company, our parliamentarians and officials are of the notion that India would be a colony again if they allowed FDI in its retail sector. Globalization brings the entire world onto a single stage. The worlds largest retail enterprises seek globalization in the retail industry and are continuously striving to make their presence global. FDI, as in other sectors, brings advanced marketing models, management skill and technical know-how along with the capital to the host country to promote their operating efficiency and business modernization. Hence, globalization of retail sector is necessary for the development of that sector. Many countries including China, Brazil, Thailand and Singapore have opened their retail sector to foreign players and are reaping of it. This sector accounts for 10% of GDP in most countries. The global retail game is changing fast. Big international players are focusing on rebalancing their position, and they are knocking at the door of India. Being the second largest populated country in the world with 110 crore people coupled with a highly developed IT sector, the Indian retail sector is hailed as one of the sunrise sectors of the economy. According to a survey conducted by A. T. Kearney management consulting firm, India is the second most attractive retail destination among 30 emerging markets after China. Indian retail sector is contributing 14% of GDP and employing more than 7% of the total workforce. Therefore, the retail sector in India is one of the strong pillars in the growth of employment and GDP. Presently, the total size of the Indian retail industry is around $200 bn and could touch $300 bn by 2010. The growth of modern retailing and economic development will go hand in hand and India cannot afford to lag behind. The Indian retail sector can be broadly divided into two categories: Organized and unorganized. The organized sector refers to business employing more than ten persons, which includes hypermarkets and retail chains like Big Bazaar. This organized sector is only about 2% of the total retail sector and employs just 5 lakh persons. The remaining 98% of the total retail trade is in the unorganized sector. They are in the traditional form; low-cost building, kirana shops run by family members, pan-beedi shops and roadside vendors. Over 4 crore people are engaged in these unorganized retail sector. About 12 million outlets are operating in India, out of which only 4% are having an area of more than 500 sq.ft. The sector is basically labor-intensive. In 2002-03, according to the government estimation figure the retail trade in India amounted to Rs. 3,82,000 cr, whereas, A. T. Kearney estimate says that it was around Rs. 400,000 cr. On the other hand, the total size of the corporate-owned retail business was around Rs. 15,000 cr in 1999 and in 2005 it grew up to Rs. 35,000 cr at a rate of 40% per annum in the last three years. It is estimated that by 2010, the organized retail trade may touch Rs. 70,000 cr. From employment point of view, four to five crore people are engaged by the retail sector directly or indirectly.th

Caselet 2Read the caselet carefully and answer the following questions: 9. Farmers are provided credit cards to support their credit needs. Discuss how it will be beneficial to the farmers and to the issuing banks. (6 marks) < Answer > Explain the features of the Kisan Credit Card (KCC) scheme.

10.

(6 marks) < Answer > The emphasis in agricultural credit has continued to be on progressive institutionalization for providing timely and adequate credit support to farmers with particular focus on small and marginal farmers and weaker sections of society to enable them to adopt modern technology and improved agricultural practices

for increasing agricultural production and productivity. The policy essentially lays emphasis on augmenting credit flow at the ground level through credit planning, adoption of region-specific strategies and rationalization of lending policies and procedures. Agricultural credit is disbursed through a multiagency network consisting of Commercial Banks (CBs), Regional Rural Banks (RRBs) and Cooperatives. With their vast network covering almost all the villages in the country, wider coverage and outreach extending to the remotest part of the country, the cooperative credit institutions have remained the primary institutional agency for dispensation of agricultural credit. The significant contribution made by the Cooperatives can be gauged from the fact that its share in total agricultural credit flow and total rural deposits is around 43 percent and 31 percent respectively and the small farmers constitute 44 percent of their total membership. For several reasons, the Cooperative Credit Structure is facing severe problems which have restricted its ability to function viably and perform effectively the task of reaching out to all segments of the farming community and meet in full their requirements of credit. The cooperative structure is facing many structural deficiencies viz. operationally small in size (especially PACS/PCARDBs) to be economical and viable, dependent mostly on the finance provided by the higher tiers, lack of diversification in business portfolio, high transaction costs, a large percentage of non-borrowing members, involvement in non-credit function like PDS work giving negative net margin to the PACS, poor recovery and limited growth rate in issue of fresh loans. The other problems faced by the cooperatives are: Overall weak financial health, duality of control, lack of autonomy, close identification with the State, absence of professional management, inadequate internal controls/supervision, arrears in audit, and existence of imbalances. Though a number of measures have been initiated to improve the viability and functioning of Cooperatives, yet these institutions remain in moribund state requiring urgent initiation of steps for their rehabilitation. Some of the policy initiatives are namely (i) Revamping of Cooperative Credit Structure: Pursuant to the announcement made in the Union Budget for the year 2004-05, Ministry of Finance has constituted a Task Force under the Chairmanship of Prof. A. Vaidyanathan for suggesting measures required for improving the efficiency and viability of Rural Cooperative Credit Institutions and to suggest an appropriate regulatory framework. The Task Force is expected to submit its recommendations very soon. (ii) Kisan Credit Card Scheme: Kisan Credit Card (KCC) Scheme which aims at providing adequate and timely credit support from the banking system to farmers for their cultivation needs in a flexible, hassle free and cost effective manner has been operationalised. The farmers may use the cards for the purchase of agricultural inputs such as seeds, fertilizers, pesticides etc. and also draw cash for their production needs. Credit limits is fixed on the basis of operational land holding, cropping pattern, scale of finance etc. and the entire credit needs for full year plus ancillary activities related to crop production such as the maintenance of agricultural machinery/implements, electricity charges etc. is reckoned for the purpose of fixing the credit limit under KCC.

Caselet 3Read the caselet carefully and answer the following questions:

11. With respect to the caselet explain the working mechanism of reverse mortgage and also state when it comes to an end? (9 marks) < Answer > 12. With reverse mortgage one can turn the value of home in to cash without having to move out of the home. Discuss the advantages and disadvantage associated with this mechanism. (9 marks) < Answer > The prime concern of the elderly people is whether their savings are sufficient to meet the unexpected future financial crisis. This worry is often faced by the middle-class, especially when retirement knocks on their door. This concern is bound to creep-in, unless their children give them financial support either fully or partially. No one plans to go broke while nearing retirement. Many senior citizens fill up their retirement gas tank and get ready to cruise. But with todays longer lifespan, the elders often need more cash to help

them lead a comfortable life post-retirement. No one can predict the financial roadblocks that may arise, such as the need for expensive prescription or medical procedures. Just one major setback can drain out a major portion of the hard-earned retirement money that one has saved. Retired people may want to consider the reverse mortgage as a way of generating cash flow. But the reverse mortgage is not for everyone. It may be a good option for those who have already retired or are looking for the same. A self-occupied house in a prime location is actually not of much worth for the elderly without adequate means of support in the case of absence of old-age security. Until recently, there were two main ways to get cash against your homeeither you could sell your house or you could mortgage your house. But selling the house and moving elsewhere are options that generally are not very appealing to most elderly people. Again in case of borrowing against your home, you borrow money and make payments to build equity in a house. As you make payments, your equity (the home value minus mortgage debt) increases and your debt (loan balance) shrinks. If you fail to make regular payments, you could lose the ownership of your house. Now reverse mortgage gives you a third way of getting money against your home. With a reverse mortgage, you can turn the value of your home into cash without having to move out or repay the loan each month. The reverse mortgage is aptly named so because the payment stream is reversed. This financial instrument was first introduced in the late 1980s in the US and Canada to help the homeowners who were house-rich-but-cash-poor remain in their house and still meet their financial obligations. In the US and Canada some guidelines have been laid down for the eligibility of reverse mortgage. All senior homeowners aged 62 years or above can apply for reverse mortgage. Owners must occupy the home as principal residents. Single family, one unit dwelling is eligible property for all reverse mortgages. Some programs also accept 2-4 units owner occupied dwelling along with some condominiums, planned unit developments and manufactured homes. Almost all of the eligible people asked one common question, How much money can I get for my home? The shortest answer to this question is It depends. In general, to the amount one can receive depends on six different aspects like the mortgage program and the program option one select, the age of the youngest borrower when he takes the loan, the appraised value of the house, current interest rate, the amount of equity in the home and the location of the home. END OF SECTION E END OF QUESTION PAPER

Suggested Answers Investment Banking and Financial Services-II (262): April 2006Section D : Case Study1. RISK FACTORS An investment in Equity Shares involves a high degree of risk. You should carefully consider all of the information in this Draft Red Herring Prospectus, including the risks and uncertainties described below, before making an investment in the Equity Shares of the Company. If any of the following risks actually occur, the business, results of operations and financial condition could suffer, the trading price of the Equity Shares of the Company could decline, and the investor may lose all or part of his investment. Materiality The Risk factors have been determined on the basis of their materiality. The following factors have been considered for determining the materiality: a) Some events may not be material individually but may be found material collectively. b) Some events may have material impact qualitatively instead of quantitatively. c) Some events may not be material at present but may be having material impacts in future. The risk factors are as envisaged by the management along with the proposals to address the risk if any. Wherever possible, the financial impact of the risk factors has been quantified.A. INTERNAL TO THE COMPANY

1.

2.

4.

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The Company is promoted by first generation entrepreneurs and the investments will be subjected to all consequential risk associated with such ventures. The company was promoted by first generation entrepreneurs 15 years back. The companys business was the brain-child of these entrepreneurs and the sourcing of solutions provided by the company was the result of their efforts and understanding. Consequently, the relationships that the company has established with various stakeholders are a product of the efforts of the erstwhile promoters and carry inherent consequential risk. Currently, a team consisting of qualified professionals is managing the company on a day-to-day basis. Dependence on key management Team The company has a team of professionals who are responsible for the day-to-day operations. The company may lose the key management team to the competitors. If one or more members of the management team are unable or unwilling to continue with the company, Bartronics may find it difficult to replace such people and the business may be adversely affected. The proposed expansion project is mainly funded by the Public Issue. Any delay in raising the funds from IPO may have an adverse impact on the future performance of the Company. Delays in raising funds are likely to have an impact in the growth plans of the company in the short run due to delayed deployment of funds. Due to delays, it is likely that the company may have to renegotiate with some of the suppliers and in some cases even settle for alternate suppliers for key equipment. Such processes can delay the project thereby affecting the future performance of the company. The performance projections are prepared based on timely rising of funds and hence the delay in IPO can affect future performance of the company. The promoters and the promoters group are expected to hold 36.94 % of the post-issue paid up capital of the company. The promoters and their group will hold relatively less equity in the company postissue. To this extent, the control of the companys operations shall rest on its board of directors appointed from time to time. Due to broad-based shareholding pattern, the company shall be subjected to the risk of being run by an independent professional team. The Company has not made any definitive arrangements for the procurement of some of the equipment/machinery/fixed assets for the project, which may cause delay in implementation of the project. The process of issuing confirmation to the suppliers for the supply of equipments have been held up due to the company not having released any advances to the suppliers. Because of delay in payment of advances to suppliers, the delivery of the equipment/materials may get delayed in turn causing further delay in project implementation. By not finalizing terms with some of the vendors, the

company may also be faced with situation of seeking new vendors/suppliers where negotiations and discussions need to be started afresh. As a result, the project implementation may be significantly effected in terms of delays. 7. 8. 9. 10. 11. If the Company is unable to implement its growth strategies in a timely manner, its business and results of operations could be adversely affected. Expanding Companys market outside of India could increase costs and may decrease profits. The Company is dependent on external suppliers for key materials and components. The Companys geographically diverse business operations and its rapid growth have placed constraints on the Companys ability to generate financial information in a timely manner. The Company may, in the future, enter into strategic alliances, investments, partnerships and acquisitions. These may harm the Companys business, dilute your ownership interest and cause the Company to incur debt. The Company has significant planned capital expenditures; its capital expenditure plans may not yield the benefits intended. The capital expenditure mentioned in the Objects of the Issue has not been appraised by any bank or financial institution. The Company has not entered into any definitive agreements to utilize the proceeds of the Issue. Further, the management of the Company will have significant flexibility in applying the proceeds of the Issue. Technology Risk Automated Identification and Data Collection (AIDC) systems can be extremely difficult to specify, quantify, or justify. There are performance and security issues to address in wireless networking. Privacy Concerns of Individuals It is apprehended that the technology carries the potential for serious privacy and security violations - particularly when used on individual consumer items. Key security issues include protecting the confidentiality, integrity and availability of the data and information systems. The privacy issues include notifying consumers; tracking an individual's movements; profiling an individual's habits, tastes and predilections; and allowing for secondary uses of information. High costs become a major inhibitor to the uptake of the RFID technology. All the hardware for RFID is imported which means that costs are high. RFID tags cost between 5 and 20 US cents each at bulk rates. Given such high price levels, the tags may not be used for low value items or perishable goods. Inadequate assessment of market need The market in India is at a very nascent stage. The market potential is tremendously high considering the wide array of applications the technology would enable. However, Bartronics has not based its projections on valid research of demand. The projections have been considered using past trend and pertinent industry growth. Inadequate confirmed orders Bartronics has planned the capital outlay considering the perceived growth in demand for AIDC technologies. However, no confirmed orders of substantial amount have been placed on the Company as of date.EXTERNAL RISK FACTORS

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Competition from unorganized Sector. The company may face competition from unorganized sector, other established companies and new entrants into the industry; which may affect the profitability of the company. Changes in Laws Changes if any in the Government policies, Laws, governing business policies in general taxation laws, etc., may affect the profitability of the Company. Business with SAARC countries The Company is entering into the business in SAARC countries as well. It has been a general

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perception that business in SAARC countries except India is not secured with lot of risk involved in it. Economic downturn may affect operating performance In case of an economic downturn caused by political instability, acts of violence, terrorist attack or any other reason whatsoever, the company may not be in a position to attract maximum value for the content provided by it and hence this may affect the operating performance. 5. High Rate of Obsolescence Rate of obsolescence of the technology and equipments used in the Barcoding Industry is very high. 6. The prices of Equity Shares may fluctuate after this issue The prices of the Equity Shares may fluctuate after the issue as a result of several factors, including volatility in the Indian and Global securities market; the Companys results of operations and performance; performance of the Companys competitors, performance of the Barcoding Industry as a whole and the perception in the market about investments in the Barcoding Industry ; adverse media reports on the Company or the Barcoding Industry; changes in the estimates of the Companys performance or recommendations by financial analysts; significant developments in Indias economic liberalization and deregulation policies. There can be no assurance that an active trading market for the Equity Shares will develop or be sustained after this issue, or that the prices at which the Equity Shares are initially traded will correspond to the prices at which the Equity Shares will trade in the market subsequent to this issue. < TOP > SWOT Analysis Strengths 4.

The company has established a Brand Value amongst its clients over a period of 16 years. The company has a reputed clientele, which include corporate houses of India like TISCO, TELCO, HLL, ITC, Ashok Leyland, TVS, CMC, Ranbaxy, Compaq, VST, Whirlpool, ITW, Dr.Reddys, and Nagarjuna etc. The company also offers services to the Devotees of Lord Balaji (Tirupati) by managing the Inflow Logistics of the Pilgrims. To promote the use of barcodes in India, the national IT task force laid down a clause, making the use of barcodes mandatory for all products within a time frame of five years. This gives a boost to the business prospects of the company. Barcode technology helps in effective inventory management and back tracking of the goods. These benefits are encouraging the business and trade houses to adopt this technology thereby enhancing the business opportunities for the company.

The Government of India is favoring Foreign Direct Investment (FDI) into the retail sector. Barcode technology plays a very important role in this sector. The hardware and software tools of this technology have become essential for retailing. The company with its experience is at an advantageous position to meet the demands of the retail sector. Weaknesses

Bar coding made its foray in the Indian business sector in the 80s and only now it is gaining momentum, because of this the company has to satisfy itself with low level of operations and subsequently a low growth rate. The adoption of man made procedures with ease and comfort and human tendency of resistance for change can be counted as the hindrances in the growth path of the company as they continue to be the de-marketing features. Companies hesitate to adopt this technology because of its service related issues. Access for trouble shooting mechanism and operational aspects act as hindrances for the growth of the industry as a whole and the company in particular.

Huge infrastructure costs associated at the implementation stage; particularly with RFID technology is an impediment, which would influence the buyers decision. Opportunities Bar coded cargo gets faster clearance worldwide by Customs, freight forwarders etc., thereby

enhancing the prospects for the bar coding technology.

The company can enjoy enhanced product / exporters image by virtue of compliance with International standards The benefits of using the technology in the retail sector and the availability of service providers across the country makes it easy for the client to adopt and implement the bar coding technology.

Biometric technologies will be used for verifying or recognizing the identity of a living person based on a physiological characteristic through fingerprint identification, voice identification, facial feature identification, etc. This could open up new avenues wherein the technology can be applied. Threats

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Technology obsolescence perceived as a threat to the industry as well as to the company. Entry of global players into the Indian market is also perceived as a threat to the company. < TOP >

g = ROE * b ROE = Net Profit / Net Worth 239.72/1041.50 g = 23% Net Profit as on 31st March 2005 = Rs.239.72 lakh. Net Profit as on 31st March 2006 = 239.72 * 1.23 = Rs.294.86 lakh. Let x be the allotment price for the shares of BIL. Return from new capital = 65 * x * 0.1* 0.25 = Rs.1.625x lakh, Therefore, the total profit on 31st March, 2006 = 294.86 + 1.625x. The EPS as on 31st march, 2006 is (294.86 + 1.625x)/145.68950. Average P/E ratio is 21.7 Now, the price as on 31st December, 2005x = 21.7 * 294.86 + 1.625x

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145.68950 145.68950x = 6398.46 + 35.2625x 110.427x = 6398.46 x = 57.94 i.e Rs.58 (approximately) The offer price of shares of BIL is higher than the value of the shares calculated above. Therefore an investor is advised to avoid investing in this company as per the valuations made above. < TOP > In a typical fixed price offer, the price of the issue is fixed by the issuer in consultation with the Investment Banker taking into consideration the companys historical performance and also the future projections. The Investment Banker does lot of qualitative and quantitative analysis and performs the valuation exercise. But here one thing, which is not considered at all, is the market perception. All the greatest of valuations become irrelevant when market does not accept. Because ultimately market is the decision maker. With the advent of the book building method in Indian IPO, market forces came into play. The onus does not lie on the issuer and the Investment Banker but it lies on the market. Who comprises of market? The only one answer is Investors. This is their investment and they have all right to decide how much they want to pay for it. What value the different set and class of investors perceive as the true value of the companys equity, they bid at that rate. Hence we can say that here price is not forced but discovered by the market. A very plausible question follows. Is Indian IPO by book building method is giving rise to 100% true price discovery like US market? The answer is not so simple. The answer can be YES or NO. Let us explain why it is yes and why it is no. Why it yes in spite of having a Floor Price or a Band. The issuer is definitely having some rationale in fixing this floor or band. Let us first focus on the rationale of fixing a floor price.

Indian investors are still not so rational and their maturity level is no where when compared with those of their US counterparts. Moreover in US the market is totally dominated by the Institutional investors. Small investors are virtually non existent. Due to this immaturity of the small investors, the issuers feel that given a free hand the investors lowest bid rate can be any thing. So they are hedging the risk of not achieving a minimum price. This minimum floor price is determined by the most savvy Investment Bankers after exercising all the valuation models. Hence the floor price here is nothing but a risk hedging mechanism. Now the main question comes they why a cap? Is not More the Merrier. But here also there lies a risk. Taking into consideration of the maturity level of the investors in a book building issue the investors can bid at a very high rate to ensure an allotment. A very high issue price once again will create a tremendous pressure to the issuer to maintain that price. Stock price is nothing but an indicator of the companys performance. So here the pressure lies on the high performance and that may be beyond the capacity of the company. Hence they prefer a price cap also to hedge this risk. If we assume that due to this diligent band given by the issuer the bids would not go haywire. In the US market, as the market is dominated by the institutional investors, the big boys are not irrational in their bids. Hence here this band is nothing but a risk management tool in the hand of the investors. So we can say that in spite of this floor price or price band, price discovery is achieved to quite an extent. But once again, the irrationality of the Indian market comes here in book building where there is a band. Most of the investors always try to bid at the cut off rate to ensure allotment and hence true price discovery is never achieved. And then, once again there are some reservations. Hence we can only say that in book building only a price discovery is tried and it is definitely much better than a fixed price offer but we have to go a long way in achieving true price discovery. < TOP > 5. Offer document means Prospectus in case of a public issue or offer for sale and Letter of Offer in case of a rights issue which is filed Registrar of Companies (ROC) and Stock Exchanges. An offer document covers all the relevant information to help an investor to make his/her investment decision. Draft Offer document means the offer document in draft stage. The draft offer documents are filed with SEBI, at least 21 days prior to the filing of the Offer Document with ROC/ SEs. SEBI may specifies changes, if any, in the draft Offer Document and the issuer or the Lead Merchant banker shall carry out such changes in the draft offer document before filing the Offer Document with ROC/ SEs. The Draft Offer document is available on the SEBI website for public comments for a period of 21 days from the filing of the Draft Offer Document with SEBI. Red Herring Prospectus is a prospectus which does not have details of either price or number of shares being offered or the amount of issue. This means that in case price is not disclosed, the number of shares and the upper and lower price bands are disclosed. On the other hand, an issuer can state the issue size and the number of shares are determined later. An RHP for and FPO can be filed with the ROC without the price band and the issuer, in such a case will notify the floor price or a price band by way of an advertisement one day prior to the opening of the issue. In the case of book-built issues, it is a process of price discovery and the price cannot be determined until the bidding process is completed. Hence, such details are not shown in the Red Herring prospectus filed with ROC in terms of the provisions of the Companies Act. Only on completion of the bidding process, the details of the final price are included in the offer document. The offer document filed thereafter with ROC is called a prospectus. Abridged Prospectus means the memorandum as prescribed in Form 2A under sub-section (3) of section 56 of the Companies Act, 1956. It contains all the salient features of a prospectus. It accompanies the application form of public issues. < TOP >

Section E: Caselets Caselet 16. The Key to the Growth of the Organized Retail Sectors in India

Increase per capita disposable income and increase of consumption Changing taste and fashions

Expansion of urban areas and availability of easy loan to the entrepreneurs. The Constraints for the Growth of Retail Sector

Easy availability of consumer credit with low interest rate Infrastructure development and availability of retail space

Neglecting the required policy Complex government regulations Inefficiency in supply chain Lack of expert management and trained staff Ban on FDI in the sector. < TOP >

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Though Indian retail sector is emerging as one of the