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Capital Structure

The document discusses various financial scenarios for companies looking to raise capital through debt and equity, analyzing the impact on earnings per share (EPS) and determining the best financing options. It includes calculations for indifference points, present value of equity, weighted average cost of capital (WACC), and comparisons between companies based on their capital structures. Key financial metrics such as EBIT, interest rates, tax rates, and capitalization rates are utilized to evaluate the financial plans and investment decisions.

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4 views

Capital Structure

The document discusses various financial scenarios for companies looking to raise capital through debt and equity, analyzing the impact on earnings per share (EPS) and determining the best financing options. It includes calculations for indifference points, present value of equity, weighted average cost of capital (WACC), and comparisons between companies based on their capital structures. Key financial metrics such as EBIT, interest rates, tax rates, and capitalization rates are utilized to evaluate the financial plans and investment decisions.

Uploaded by

hdvy5vwgmq
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Capital Structure

Q1. The Modern Chemicals Ltd wants to raise Rs 25,00,000 for setting up a new factory which will
generate an EBIT of Rs 5,00,000 per annum. It has three alternatives to finance the project – by
raising debt of ₹ 2,50,000 or ₹ 10,00,000 or ₹ 15,00,000 and the balance, in each case, by issuing
equity shares. The cost of Debt will be 10% for amounts up to and including Rs 2,50,000, 15% for
amounts up to and including Rs 10,00,000 and 20% for additional amounts above Rs 10,00,000. The
equity shares ( face value of Rs.100) of the company. Calculate the EPS for each option and based on
the EPS suggest the best option. Assume tax rate to be 40%.

Q2. A Ltd. is considering a new project which requires a capital investment of ₹ 150 lakhs. The
required funds can be raised either through the sale of equity shares (FV ₹ 100 each) or borrowed
from a financial institution. Interest on term loan is 15% and tax rate is 35%. If the debt-equity ratio
insisted by the financing agency is 2:1, calculate the indifference point for the project.

Q3. A Company needs ₹ 5,00,00,000 for construction of a new plant. The following three financial
plans are feasible.
(i) The company may issue 50,00,000 ordinary shares at ₹ 10 per share.
(ii) The company may issue 25,00,000 ordinary shares at ₹ 10 per share and 2,50,000 debentures of ₹
100 per share bearing at 8% rate of interest.
(iii) The company may issue 25,00,000 ordinary shares at ₹ 10 per share and 2,50,000 preference
shares at ₹ 100 per share bearing 8% rate of dividend
If the company’s earning before interest and tax are ₹ 10,00,000; ₹ 40,00,000 and ₹ 1,00,00,000, what
are the earnings per share under each of the three financial plans. Which alternative would you
recommend and why? Determine the indifference points between:
(a) Financial plan (i) and (ii) and
(b) Financial plan (i) and (iii).
Assume corporate tax rate as 35%.

Q4. Busy Bee Ltd.’s expected annual Net operating income is ₹ 4,80,000. The company has 10%
Debt of ₹ 14,40,000. The overall capitalisation rate is 15%. Decide total present value of the equity
and equity capitalisation rate. Also decide the WACC

Q5. Makers Construction Ltd. has PBIT of ₹ 10 lakhs. The company’s capital structure includes
40,000 16% debentures of ₹ 100 each. The overall capitalisation rate of the firm is 14%. Calculate
the total value of the firm and the equity capitalisation rate.

Q6. The following is the data regarding two companies X and Y belonging to the same equivalent
risk class:
Company Company
X Y
Number of ordinary
shares 90000 150000
Market price per share ₹ 1.20 ₹1
6% Debentures 60000 -
Profit before interest 18000 18000
All profits after debenture interest are distributed as dividends.
Required: Explain how, under MM approach, an investor holding 10% of shares in company X will
be better off in switching holding to company Y.

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