Description

Business Valuation

Dec 2026 Examination

 

Q1. A company is evaluating three mutually exclusive projects, each with distinct cash flow patterns and differing levels of risk. The required rate of return is determined using CAPM, where the risk-free rate is 6%, and the market risk premium is 7%. The projects have the following betas and cash flows:

Year	Project X Cash Flows (Rs.)	Project Y Cash Flows (Rs.)	Project Z Cash Flows (Rs.)
0	-4,50,000	-3,50,000	-3,00,000
1	60,000	90,000	75,000
2	1,20,000	80,000	90,000
3	2,10,000	1,20,000	85,000
4	2,00,000	1,40,000	80,000
5	1,40,000	60,000	75,000
Project Betas	1.2	0.8	1

For each project, (a) calculate the discount rate using CAPM, (b) determine the Net Present Value (NPV), (c) rank the projects in order of feasibility. If the company faces capital rationing and can invest Rs.6,00,000 at maximum, which project or combination should be chosen to maximize NPV without exceeding the investment ceiling? (10 Marks)

Ans 1.

Introduction

This company is comparing three projects that differ in risk and cash flow pattern. Since each project carries a different level of risk, a single discount rate cannot fairly compare them. The Capital Asset Pricing Model gives each project its own risk adjusted discount rate, based on its individual beta. Once this rate is known, the Net Present Value method can measure the true value each project adds. Ranking the projects by this value tells the company which option creates the most wealth. A capital ceiling then narrows this choice further, since the company cannot fund every attractive project at once.

Concept and Application

CAPM Based Discount Rate

The Capital Asset Pricing Model links the required return on a project to its own systematic risk,

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Q2(A). Consider a target company, Alpha Ltd., which operates in an industry highly sensitive to market cycles. The following table contains smoothed historical financial metrics (average over the last 3 years) and the corresponding valuation multiples for its closest comparable:

Company	Average Net Income (Rs. crore)	Average EBITDA (Rs. crore)	P/E (Avg.)	EV/EBITD A (Avg.)	Beta ()
P	510	820	24	12.5	1.18
Q	750	1,240	21	14	1.05
R	630	1,190	29	13.5	1.31

 

Alpha Ltd. has a forecasted net income of Rs.675 crore, EBITDA of Rs.1235 crore, and an industry-average beta of 1.18. Given dynamic market conditions, analysts propose to adjust the average P/E and EV/EBITDA multiples for Alpha Ltd. based on its beta: use the average multiple if Alpha’s beta equals peer average, subtract 1.5x from each multiple for every 0.1 beta above the average, or add 1.5x for every 0.1 below. Calculate Alpha’s implied equity value (using both the adjusted P/E and adjusted EV/EBITDA, assuming net debt = Rs.1280 crore), then provide a weighted final equity valuation if EV/EBITDA is assigned 65% weight and P/E 35% weight. Present all steps. (5 Marks)

Ans 2(A).

Introduction

Alpha Ltd. operates in a cyclical industry, making its valuation sensitive to how comparable companies are currently priced. The comparable company method uses trading multiples from similar peers to estimate what Alpha might be worth. Since Alpha’s own beta can differ from the peer average, analysts propose adjusting the peer multiples before applying them, and combining two different multiples through a weighted average gives a single, balanced estimate of Alpha’s

 

 

Q2 (B) Delta Foods is preparing its annual financial statements and needs to report the value of its long-held production facility. The finance team debates whether to use book value or current market value for asset valuation, especially given recent sectoral downturns that have depressed real estate prices. Some directors value consistency and regulatory compliance, while others argue that current market value better reflects economic reality for investors. The board must choose an approach that not only meets compliance needs but also maintains credibility with shareholders. Critically analyze the implications of using book value versus market value for asset reporting in financial statements under both regulatory and stakeholder perspectives. Assess which approach would offer a more accurate and responsible representation of Delta Foods’ asset base, considering the market downturn. (5 Marks)

Ans 2(B).

Introduction

Delta Foods must decide how to report the value of its long-held production facility, especially now that a sectoral downturn has pushed real estate prices down. The finance team is split between book value, which supports consistency and compliance, and current market value,