MFOOO8 MERCHANT BANKING AND FINANCIAL SERVICES
1. A) Who are regarded as Merchant bankers? State the depository services rendered by them.
(5 Marks)
Answer: The term “Merchant Banking” originated among the Dutch and Scottish traders and was later on developed and professionalized in Britain. It should be noted that merchant banking although a non-banking activity resembles banking function. It is said that a set of functions and services rendered by a merchant banker may be termedlvasa ‘merchant banking’.
A h t a According to Random House Dictionary, “merchant ar bank is organisations that h S underwrites securities for corporations, advise such clients by on mergers and is involved in y sit are sometimes ownership of commercial ventures. These organizations banks which are not om r c e . l v > ai i merchants and sometimes houses which are neither 9 gm nor banks.” Un 00merchants l a ip 05/2 84@ n According to Charles P Kindleberger, banking is the development of a a / “merchant M une alv m J ath banking from commerce which frequently a prolonged intermediate stage known ki < encountered r a k Si banking”. sh in England originally as merchant : l to ai d e m t it E The SEBI (Merchant Bankers) Rules 1992, states: “ A merchant banker has been m b u S who is engaged in the business of issue management either by making defined as any person arrangements regarding selling, buying or subscribing to securities or acting as managers consultant, advisor or rendering corporate advisory services in relation to such issue management”. A set of financial institutions that are engaged in providing specialist services which generally include the acceptance of bills of exchange, corporate finance, portfolio management and other banking services are known as ‘merchant bankers’. Merchant banks in India carry out the following functions and services: »
Corporate Counseling
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Project Counseling Page 1 of 11
MFOOO8 MERCHANT BANKING AND FINANCIAL SERVICES
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Pre-investment Studies
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Capital Restructuring
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Credit Syndication and Project Finance
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Issue Management and Underwriting
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Portfolio Management
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Working Capital Finance
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Acceptance Credit and Bills Discounting
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Mergers, Amalgamations and Take-over
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Venture Capital
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Lease Financing
» » » » »
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y sit om r c e . l v ni 9> mai U Fixed Deposit Banking l 00 g pa 5/2 84@ i an /0 a Mutual Funds M une alv m <J ath Relief to Sick Industries kki r ha Si s il: Project Appraisal d to a e m itt Em b Su Foreign Currency Finance
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MFOOO8 MERCHANT BANKING AND FINANCIAL SERVICES
1. B) State the tax (Sales tax and income tax) issues in case of hire purchase transactions?
(5 Marks)
Answer: In case of hire-purchase transactions, the hire-vendor pays tax on the income inherent in hire installments, not on the whole of the hire rentals. Thus, the tax is charged only on the income, and not the inflow. There are no well-defined rules on determination of income in case of hire-purchase transactions - therefore, accounting method adopted by the tax payer
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will generally be followed. Thus, either of the straight-line, sum-of-digits, or actuarial or IRR Al basis can be adopted for income allocation.
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S y b In the case of Nagarjuna Investment Trust, recently, ty the mHyderabad Tax Tribunal has i s r .cothis was a case where the tax made a detailed analysis of the straight-line method. l ve >Though i i n 9 ma U payer sought to follow different methods of l income 00 gallocation for tax purpose and for pa 5/2 84@ i accounting purposes, the case has brought a the possible interpretation of the word /0 fore an to M une alv "evenly" (not necessarily meaning im "equally") <J rathas used in the 1943 Circular relating to hirek k ha purchase tax treatment. Si s : to ail d e m Sales taxes are considered itt E-to be regressive tax; that is, low income people tend to m b spend a greater percentage of their income in taxable sales (using a cross section time-frame) Su than higher income people. However, this calculation is derived when the tax paid is divided not by the tax base (the amount spent) but by income, which is argued to create an arbitrary relationship. If all purchases are subject to the same tax rate, the tax rate itself is flat with those who consume more paying more in taxes. While the tax on spending as a percentage of gross income may be regressive, the effective tax rates can be progressive on consumption due to exemptions or rebates. If a sales tax is to be related to income, then the unspent income can be treated as tax-deferred (spending savings at a later point in time), at which time it is taxed. Sales taxes often exclude items or provide rebates in an effort to create progressive effects. In many locations, "necessary" items such as non-prepared food, clothing, or prescription drugs are exempt from sales tax to alleviate the burden on the poor. Page 3 of 11
MFOOO8 MERCHANT BANKING AND FINANCIAL SERVICES
A personal or individual income tax is levied on the total income of the individual (with some deductions permitted). It is often collected on a pay-as-you-earn basis, with small corrections made soon after the end of the tax year. These corrections take one of two forms: payments to the government, for taxpayers who have not paid enough during the tax year; and tax refunds from the government for those who have overpaid. Income tax systems will often have deductions available that lessen the total tax liability by reducing total taxable income. They may allow losses from one type of income to be counted against another. For example, a loss on the stock market may be deducted against taxes paid on wages.
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y sit om r c e . l v ni 9> mai U l 00 g pa 5/2 84@ i an /0 a M une alv m J h ki < arat k Si sh : l to ai d e m t it E m
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MFOOO8 MERCHANT BANKING AND FINANCIAL SERVICES
2. Discuss the procedure involved in public issue of securities of a new corporate enterprise.
Answer: For private companies, the first issue of securities to the public is referred to as an Initial Public Offering (IPO). IPO's are extremely speculative and rarely do they result in
large gains for investors. However, since capital is often needed to lgrow va a private company
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h and values of companies are best determined in the marketplace,atIPO's continue to be used as a way for growing private companies.
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by y t IPO's are often one of the hottest topics in financial management. Behind the glamour om rsi c e . l v > ai i and the glitz of Initial Public Offerings (IPO's)nthere a tremendous amount of hard work U 009 isgm l a /2 of4@highly skilled professionals who must and personal sacrifice. IPO's require a core ip group 5 n a e/0 lva8 literally work around-the-clock for oneMyear. n Therefore, one of the first steps to a successful m <Ju atha i r team of professionals who will make the IPO IPO is the formation of a seasoned, kk experienced ha Si s happen. You must recruit thetobest possible il: people you can find. a d e m itt Em Once an IPO b team (Investment Banker, Legal Council, Securities Exchange Su Commission (SEC) Expert, Outside Auditor, etc.) has been formed, you can establish a plan for the IPO Process. A basic timeline for an IPO will usually consist of: Month 12: Recruit new management to run the public company - CEO, CFO, etc. Start compiling the financial information. Month 11: Start due diligence work - worthless assets are written off, inconsistencies with GAAP are resolved, etc. Month 10: Start drafting the prospectus. Coordinate the collection of data to minimize duplicative efforts. Month 9: Establish a board of directors for the newly formed public company. Page 5 of 11
MFOOO8 MERCHANT BANKING AND FINANCIAL SERVICES
Month 8: Draft three-year historical financial statements. Month 7: Circulate draft prospectus for comments. Month 6: Establish transition contracts for services and products that will now be provided to the newly formed public company. Some new contracts will be needed, such as independent audits of financial statements. Month 5: Finalize historical financial statements. Start preparing interim financial statements for current period.
a Month 4: Finalize pro forma and interim financial statements. Make lv revisions to draft prospectus.
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Month 3: Convene new board of directors. Audit of interim by financials should be complete.
y sit om r c e . l Month 2: Outside auditors opinion is issued. Membership with stock exchange is complete. v ni 9> mai U l 200 @g pa 5/Exchange 4 i Month 1: File prospectus with SEC (Securities Commission). Issue press release an e/0 lva8 M n and sell the company to investors. m <Ju atha i k r ik ha S s Before the IPO Process it is essential to implement all of the necessary to is complete, il: a d e mthat will now be required within "public life." Staff controls, procedures, and itt systems Em b new financial systems tested, functions like human resources must be changes must be made, Su managed, etc. The entire IPO process is much more involved than most people realize. A great IPO team and proper planning are the key to a smooth IPO process.
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MFOOO8 MERCHANT BANKING AND FINANCIAL SERVICES
3. A) What are the personal factors of customers that influence marketing of financial products?
(5 marks)
Answer: Consumer behavior refers to the behavior that consumers display in searching for, purchasing, using, evaluating and disposing of products and services that they expect will satisfy their needs. Consumer behavior focuses on how individuals make decisions to spend their available resources on consumption-related items.
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A consumer buying behavior is influenced by various ainternal and external factors. th Out of these, the personal factors are as follows:
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by y t si Age and Life Cycle Stages: People buy different rproducts in omdifferent stages of their life c e . l v > ai ni part cycle. The products that are purchased in the early mthe life may not be preferred in the U 09 of g l 0 a later part of their life. ip 05/2 84@ n a / a M une alv m <J developed The Family Life Cycle: This concept in the 1960s as a tool for segmenting ath ki was r a k Si It was sh based on age, marital status, number and age of the market for goods and services. : l to ai affects the consumer’s needs, wants and ability to children and work status t–edeach of-m which it E m buy. b u S Occupation: A person’s occupation affects the goods and services brought. Blue collar workers tend to buy more work clothes; whereas white collar workers buy more suits and ties. Marketers try to identify the occupational groups that have an above average interest in their products and services. Economic Circumstances: A person’s economic situation will affect the product choice. Because income changes over time, an individual’s ability to use financial services will also change. Personal economic factors such as income, savings, net worth and ability to borrow affect people’s power to buy all types of goods and services, but they are especially relevant to the purchase of financial services.
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MFOOO8 MERCHANT BANKING AND FINANCIAL SERVICES
Personality: It can be defined as the aggregate of an individualâ&#x20AC;&#x2122;s trait or characteristics that make him or her unique. Some are extroverts, some are sky, some are perfectionists other are casual minded. Some are risk takers; others are cautions. Life Style: It refers to a personâ&#x20AC;&#x2122;s pattern of living. Marketers must find the relationship between the product and life style. The measurement of life style is known as Values and Life Style (VALS). Based on the life style, we can classify the people as below: 1) Believers- conservatives, conventional and orthodox.
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2) Strivers- uncertain, try to follow successful people, ahave th limited resources and exposure.
3) 4) 5) 6) 7)
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by y t si loyal, Struggler- lower incomes, lowest renounces, rbrand ombuy on purpose. c e . l v ni 9> mai U l 00 g buy on purpose. Makers- practical, self-sufficient, family-oriented, pa 5/2 84@ i an /0 lva M une status-conscious. Achievers- successful, work-oriented, m <J atha i k r ik ha S s Actualizes- highest income, self-oriented, image-conscious, wide range of interests. to il: a d m tte i E- and well-educated professionals. Fulfilled- mature, responsible, m b Su
8) Experiences- outgoing, young, risk takers and youthful customers.
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MFOOO8 MERCHANT BANKING AND FINANCIAL SERVICES
3. B) Excellent Company Ltd. has an investment plan amounting to Rs.250 lakh. The tax relevant rate of depreciation of the Excellent Company is 25%; its marginal cost of capital and marginal cost of debt are 16% and 20% respectively. The company falls in the tax bracket of 33.66% of income tax. The company is considering two different alternatives for its capital expenditure. In the case of hire purchase plan, the interest is 16%; the down payment is 20% and the rest in 36 equated monthly installments. In the other plan of leasing, the rentals are payable at Rs.28 ptpm, in advance. The primary lease period can be assumed to be 5 years. Assume that the SOYD method is used to allocate total charge for credit under hire purchase plan. The net salvage value of the
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v equipment after 3 years can be assumed to be Rs.50 lakh. Which alternative -leasing or hire Al by
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purchase should the company use and why?
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(5 Marks)
y sit om r c e . l v Answer: ni 9> mai U l 00 g pa 5/2 84@ i Cost aofn Hire-purchase /0 a M une alv m J h ki < arat k Si note 1): sh 1. Down Payment (working Rs. 50 lakh l to i a ed m itt E 2. Plus: presentbm value of monthly hire-purchase installment Rs. 229.60 lakh u (working note S 2) 3. Minus: present value of depreciation tax shield (working note Rs. 45.51 lakh 3) 4. Minus: present value of net salvage value Total
Rs.
Working notes: 1. Down payment = 250 lakh X 0.20 = 50 lakh
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MFOOO8 MERCHANT BANKING AND FINANCIAL SERVICES
2. Monthly hire-purchase installment = [ Rs. 200 lakh (250 â&#x20AC;&#x201C; 20% down payment) + (Rs. 200 lakh X 0.16 X 3 years)] / 36 = Rs. 8.222 lakh Present value of monthly hire-purchase installment: = Rs. 8.222 lakh X 12 X 1/d (12) X PVIFA (20, 3) where I = 0.20 = (Rs. 8.222 lakh X 12) X 1.105 X 2.106 = 229.60 lakh 3. Present value of depreciation tax shield: = [Rs. 62.5 lakh X PVIF (16, 1) + Rs. 46.875 lakh X PVIF (16, 2) + Rs. 35.156 X PVIF (16, 3) + Rs. 26.367 X PVIF (16, 4) + Rs. 19.776 X PVIF (16, 5)] X 0.3366
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= [(62.5 X 0.862) + (46.875 X 0.743) + (35.156 X 0.641) lv + (26.367 X 0.552) A + (19.776 X 0.476)] X 0.3366 th
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= Rs. 45.51 lakh
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om c e . l v ni 9> mai Cost ofl U Leasing 00 g pa 5/2 84@ i an /0 a M une alv J h note 1) 1. Present value of lease payments m (working ki < arat k Si sh : o l t ai on lease payment (2) 2. Minus: present value d of tax shield e m t it E m b u S value of tax shield on charge of credit (3) 3. Plus: present
Rs. 92.57 lakh Rs. 96.00 lakh
Total Working note: 1. Present value of lease payments: = [(Rs. 250 lakh X 0.028 X 12) X 1/d (12) X PVIF (20, 5)], where I = 0.20 = Rs value of tax shield on lease payment = [Rs. 250 lakh X 0.028 X 12 X {PVIF (16, 5)} X 0.3366] = Rs. 92.57 lakh Page 10 of 11
MFOOO8 MERCHANT BANKING AND FINANCIAL SERVICES
2. Present value of tax shield on charge for credit: Total charge for credit = Rs. 250 lakh X0.80 X 0.16 X 3 = Rs. 96 lakh
Allocation of total charge for credit; SOYD Method
Year
SOYD factor
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36+35+34…..+25/36+35+…..+1=366/666
Annual charge(Lakh)
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22.79 lv
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th ra a 2 24+23+….+13/36+35+…..+1=222/666 Sh 13.82 by y t om4.86 rsi c 3 12+11+…..+1/36+35+….+1=366/666 e . l v ni 9> mai U l 00 g pa 5/2 84@ i an /0 a M une alv 3. Present value of tax shield:kim <J rath k ha Si s : = [(Rs. 22.79 X 0.862) X 0.743) + (Rs. 4.86 X 0.641)] X 0.3366 to + (Rs. 13.82 ail d e m itt E= Rs. 11.12 lakh m b Su Decision: Since the cost of leasing exceeds the cost of hire-purchase, the Excellent Company should acquire the equipment under the hire-purchase plan.
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