Direction (Qs.1 to 10): Read the passage carefully and answer the questions given below it. Certain words/ phrases are given in bold to help you locate them while answering some of the questions.

Though cash is king in business, it is the simplest item to value under any method of valuation. To value cash there is no need to use complex methodologies such as discounted cash flow (DCF) or to make complex assumptions such as growth rate or discount rate. Nor do you need expert values. (like you need for valuation of fixed assets like land and buildings) The general assumption is cash is always valued at face value. The current controversy on valuation in the proposed merger of Cairn India with Vedanta Resources centres on valuation of cash and raises a doubt about the above principle of valuation of cash. Valuing cash at face value may not be valid in some exceptional circumstances. While valuing the company or shares, if the company has cash surplus of a normal magnitude the recommended method is to value the business and add the cash surplus at face value to arrive at the total value of the company.

Then the question arises what is to be done in case the cash surplus is large. Before answering this we need clarity on what the definition of large cash surplus is. When the surplus generated is held as cash in the normal course of business cycle or accumulated and held temporarily as cash to meet a large defined investment within a short period of time (say maximum of two or three years ) then such cash fall within the definition of normal cash surplus to be valued at face value.

In the case of Cairn, cash is about one third of book value, which doesn’t come under the definition of cash surplus in the normal course of operation. Hence in this case cash can be valued a face value only if it is held for a specific identified investment to be made within a few years and the business valuation factors the financial benefit flowing from such identified investment.

There is also a possible exception to this rule of valuation, i.e. valuing large cash surplus at face value without a specific investment plan. This exception applies when the price consideration of the company or share with large cash surplus is paid to the current owner in cash. In this case the seller sells cash for cash and hence it is fair to value cash at face value irrespective of the size of cash surplus and there is no need for investment plan for large surplus cash. In case of valuation for mergers, the above exemption can’t apply as the shareholders of the merging company generally get shares, and not cash. Maybe in recognition of this principle, the merger scheme of Cairn with Vedanta provides for some cash (in the form of short-term security) component in the swap ratio offered to Cairn shareholders. Despite this, some minority shareholders of Cairn object to the valuation, possibly because this portion of compensation is less than 20 percent of cash surplus of Cairn. Then comes the complex question of how to value cash, which is larger than cash surplus in the normal course of business, nor held for a specific investment and the consideration for transfer of cash is not paid in cash.

The cash in this case is to be valued based on opportunistic value for the seller and the alternative cost of raising such cash for the buyer. Both these values are extremely subjective and vaguer than well-defined methods of valuations such as DCF, Profit multiple or replacement value. Hence, they will always be subject to controversies.