Module 13 · Solutions

Warm-up

E13.01 Use only information that was public on the decision date. Hindsight leaks through (1) the choice of case itself — you know it is famous, so you look for the flaw; (2) looking up later prices or events "just to check a fact"; (3) framing — describing a signal as a "red flag" because you know it mattered, when at the time it was one of many ambiguous facts.

E13.02 (a) Interest income: I1 Satyam (decisive); G9 Wirecard. (b) Borrowing despite cash: G9 Wirecard; I1 Satyam. (c) Where the profit comes from: G9 Wirecard (three partners); G4 Enron (mark-to-market), G8 Valeant, I11 Jet (other income), I14 Vakrangee (low-margin revenue surge). (d) Auditor resignation: I14 Manpasand and Vakrangee. (e) Related- party acquisition: I1 Satyam (Maytas); G9 Wirecard (the Indian acquisition marked up ~9× within weeks).

E13.03 Variant perception: G10 Apple (a consumer franchise, not a hardware maker). Implied expectations: G3 Cisco (≈34% revenue growth for ten years). Value by subtraction: I15 Tata Motors (JLR's equity priced near zero). Liquidity vs solvency: I4 DHFL (a going concern until its funding closed) vs G6 Lehman. Re-rating: I2 Asian Paints (31× → 97.5×). Value trap: G7 Nokia (low P/E on peak earnings) — contrast I12 ITC in 2020, which was not one.

E13.04 Auditors test the accounts against records and third-party confirmations (not trading patterns or counterparties' existence beyond sampling); rating agencies test debt-service capacity, usually with a lag and relying on management information (I4, G4); regulators protect market integrity and depositors, not shareholders' returns (G9 BaFin, I5 RBI); index providers screen size and liquidity (which manipulation can inflate, I14); ESG raters score policies; institutional directors rely on board papers; strategic investors (SoftBank in G9, Etihad in I11) may be buying control, options or deals rather than paying for value.

E13.05 Rubric. (a) Right reasons: G1, G2 (1989), G10, I3 (A), I15 (A), I12 (A), I13 (A). (b) Unanticipated reasons: I3 (B — earnings outran a de-rating), I15 (B — recovery after Covid), G5 (AWS). (c) Business did well, stock did not: G3, I2 (B), I13 (B), I12 (B). (d) Business or accounts failed: I1, G4, G6, G9, I4, I5, I11, I14. Place I8, I9 and I10 with an argument; they depend on which company and decision point you take.

Core

E13.06 Satyam: 257 ÷ 4,080 = 6.3% at most (other income includes non-interest items), against 8.5–9.5%. At 8.5% on all cash, expected interest ≈ ₹347 crore — ≈ ₹90 crore a year missing, every year. Wirecard: 20.6 ÷ 3,270 = 0.63%; at 2% on all cash, €65 million expected — ≈ €45 million missing, and the €20.6 million also covered customer deposits. Wirecard's result is more damning: its escrow money was supposedly in Asian banks paying 2–6%, so the gap was a factor of three or more, whereas Satyam's could (barely) be explained by current-account balances. Both failed the same test for the same reason: fraudsters can invent a balance but not the bank's interest credit.

E13.07 (a) Asian Paints: price 12.18× (25.5% a year); EPS 3.59×; P/E 3.15×. Re-rating share of the log return = ln 3.15 ÷ ln 12.18 = 46%. (b) ITC: price 2.72×; EPS 1.35×; P/E 2.02×. ln 2.02 ÷ ln 2.72 = 70%. (c) Bajaj Finance: price 75.6×; P/B 6.85×; ln 6.85 ÷ ln 75.6 = 44%, with book value per share compounding at ~31% a year for the rest. Roughly half to two-thirds of each return was re-rating — the part that cannot repeat, and in Asian Paints' and ITC's case later reversed.

E13.08 RoE = g + P/B × (r − g). (a) 0.12 + 1.3 × 0.02 = 14.6% — below the 18–20% the company was targeting; the market did not believe the plan. (b) 0.08 + 8.9 × 0.04 = 43.6% in steady state, or a long period of 20%+ RoE with 30% growth. What happened: RoE ran at 19–24% through FY2019 and 17–24% after; AUM grew 45% a year to 2019 and 20–35% after. The 2010 price was easily beaten; the 2019 price was not beaten on multiple but was carried by earnings.

E13.09 (a) Indian business EV at 6× = ₹14,214 crore; less ₹10,000 crore debt = ₹4,214 crore of equity; implied JLR equity = 6,081 − 4,214 = ≈ ₹1,867 crore, against ₹9,870 crore paid nine months earlier. (b) Implied cigarette EV = 2,03,129 − 1,04,607 = ₹98,522 crore = 6.5× EBITDA (8.9× after-tax PBIT) for a business growing profit ~7% a year. Common thread: in both, the market's price for the troubled or unloved piece was close to a liquidation or run-off value; the healthy parts alone roughly justified the whole price, so the buyer got the controversial asset almost free.

E13.10 Jet: 1,360 ÷ 12,847 = 10.6% cash cover — an airline eleven months short of cash. DHFL: funding gap 17,876 − 16,290 = ₹1,586 crore (met from its liquidity buffer); sell-downs were 11,873 ÷ 16,290 = 73% of new money and CP only 3.5%. DHFL could no longer borrow short-term in the market; it was funding redemptions by selling assets — the classic sign that a lender's liability franchise has closed, whatever its asset quality.

E13.11 (a) Wirecard: EV = 0.7 × 40% − 0.3 × 100% = −2%; Kelly = (0.7 × 0.4 − 0.3)/0.4 = −5% → do not own. (b) Small cap: EV = 0.8 × 30% − 0.2 × 90% = +6%; Kelly with b = 1/3 → 20%; the max-loss rule (2% ÷ 90%) caps it at 2.2%. (c) Satyam: upside +39.7%, downside −55.3%; at p = 0.42, EV ≈ −0.2%, Kelly ≈ −0.5% → no edge at the market's own odds; the tests in the case argued for a higher p. In all three, a small change in the fraud probability flips the answer — which is why sizing, not conviction, is the right response to Amber evidence.

E13.12 Tata Motors: fixed costs = 30% × 93.3 = 28.0 per 100 of revenue; contribution margin 34.7%; break-even at 28.0 ÷ 0.347 = 80.7 → a 19.3% revenue decline. Kingfisher: break-even requires passenger revenue per head up 42.7% (₹2,010 crore ÷ ₹4,711 crore). Both businesses have high fixed costs relative to contribution, so a normal cyclical downturn (−20 to −35% in volume) produces operating losses; the balance sheet must carry the business through the trough. Tata Motors had a controlling shareholder willing to inject equity; Kingfisher's lenders converted debt instead, which bought time without changing the unit economics.

E13.13 Kingfisher: 45.70 ÷ 64.48 − 1 = −29%. Jet: 295.45 ÷ 754.74 − 1 = −61%. ITC Hotels: 171.85 ÷ 260 − 1 = −34%. The banks' ₹64.48 was a formula price (an average of past prices); Etihad's ₹754.74 bought control rights and a loyalty-programme deal five years earlier; the ₹260 was a thin pre-open auction dominated by index and arbitrage flows. None measured the value of the business; each anchored investors who treated it as if it did.

E13.14 Tata Motors (B): 65.30 ÷ 152.65 − 1 = −57%, then 4.9× the purchase price by 2026 — rewarded. ITC from peak: −48% — not yet rewarded (below the 2023 buy price). Asian Paints: 2,116 ÷ 3,590 − 1 = −41% — not rewarded by 2026. Jet: −88% to the last trade, then zero — not rewarded. Drawdowns in themselves do not distinguish good from bad decisions; what distinguished Tata Motors was a balance sheet that survived and a business whose earnings recovered.

E13.15 Vakrangee: −80% by 30-Apr-2018 when PwC resigned, −94% by 31-May. Selling on the resignation would have saved only the last 14 points of a 94% fall — most of the damage happened before the auditor left, when price and volume were the signal. Manpasand: −48% by 31-May-2018 (after Deloitte's resignation on 26 May) and −66% by 29-Jun; selling on the first trading day after the resignation (at about −20%) would have avoided most of the eventual 99% loss. The rule helps most when the resignation comes first; it is a backstop, not a substitute for earlier signals.

E13.16 Cisco: ≈34% revenue growth for ten years to justify $80 — impossible (a $273 billion revenue company). Asian Paints at ₹3,079: ≈28% profit growth for a decade — implausible for a business growing 9–12%. Vakrangee at ₹505: ≈35% profit growth for ten years from a network of kiosks — implausible, and the revenue quality was doubtful. ITC at ₹165.25: ≈4.6% perpetual dividend growth at r = 11% — undemanding for a business growing profit 7–9%. The ranking matches the outcomes: the first three lost heavily; ITC nearly tripled in three years.

E13.17 Rubric. Satyam: cash yield below deposit rates (verifiable); borrowing and pledging despite cash (verifiable); Maytas related-party deal (inferential). Wirecard: interest income on cash (verifiable); borrowing and a convertible while "cash-rich" (verifiable); profits from unnamed partners (inferential from disclosure gaps). Manpasand: negative FCF every year (verifiable); ₹900 crore raised in two years (verifiable); 62× earnings (verifiable, but not a fraud signal). Vakrangee: margin falling as revenue surged (verifiable); 5.7× price rise on heavy volume (verifiable but inferential as to cause); treasury money in another hot small cap (verifiable). Note how many verifiable flags were available in each case — and how few were acted on.

Stretch

E13.18–E13.20 Rubric: a table with each case's decision-date return vs index (from section 4) and a clear classification rule; honest discussion of survivorship (the cases were chosen because they were instructive); a rule for "expensive quality" that uses RoE/ROCE durability, reinvestment runway, balance-sheet strength and the implied growth from a reverse DCF, tested on live companies with numbers; a luck-vs-skill argument that uses only decision-date information on both sides.

Real-world task

E13.21–E13.23 Rubric: yields computed from treasury income ÷ average (cash + investments) with sources; named monitoring metrics with publication dates and thresholds; a case draft that follows the eight-section format and keeps sections 1–3 free of hindsight.