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Capital Structure

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Akash Kamath
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272 views7 pages

Capital Structure

FM

Uploaded by

Akash Kamath
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF or read online on Scribd
oaeerer CAPITAL STRUCTURE PER) The Net Sales oF Apex Co. are 1S erares, EBIT of the company as a percentage of Net Sales is [2% The eapital emplayed comprises © 5 crores of equity, @ | crore af Cumulative Redeemable Preference Shares bearing 13% rate of dividend aind Debt Capital of ® 3 ceores at an anual interest rate of 13% and eamporate income tax rate is 40%, Required : (1) Calculate Return on Equity (ROE) for the company and indicate is segments due to the presence of reference Share Capital and Debt Capival (2) Calculate the Operating Leverage of the Company given that its combined leverage is 3. (a) The existing capital structure of XYZ Ltd. is as under Equity Shares of & 100 each % 40.00.004) Retained Earnings ® 10,00,000 Prefecence Shares 2. 25,00,000 7% Debentures 2 25.00,000 The existing rate of retu¢n on the corkpsny's capital is 12% and the ineome tax rate is 50%. The company pequines 4 sum of 25,000,008t0 finance its expansion programme for} which ft is considering the following alternatives (1) Issue of 20,000; Equity Shares at'a premilim oft 25 per share, (2) _ Issue af 10% Prefererlee Shares. GB) _ Issue of 8% Debentures. — It is’ estimated thal the Price Eating, Ratio in the cases of equity, preference and| Debenivre financing would be-20; ITand T6 respectively Wiich of the above alternatives would you consider to be the best? (b} Give reasons for your choice in (4) above EE) x¥ Led. pro cs you with the following figures + Profit | ena00 Less: Interest on Debentures (@) 12% | 60,000} 200,000 Less : Income Tax @ 50% 1.000400 Profit afer tmx [1.00.00 | Number of Equity Shares (of @ 10 exch) 40,000 EPS (Eaming Per Share) 2.50 Ruling Peice in Market 25 PE Rat Price/EPS) 10 The company has undistributed reserves of Z 600,000. The company needs @ 2.00.000 for expansion. This amount will earn at the same rate as finds already employes, You are informed that [Capital Structure 7 . Debi deat equity rao | PHL Sa Tae | ee + Equity interest rate on additional amount borrowed to: 14%. You are required to ascertain the probable price of the share ci) iF the additional tiands are raised ws debt; tif) ifthe amount is raised by issuing Equity Shares, higher than 35% will push the P/E Ratio down te 8 and raise the PER) the capital structiine of JCPL Ltd. is as follows : | z Equity Share Capital of 10 each 800,000 3% Preference Shares of 10-each 625.000 10% Debentures of & 100-exch __4.60,000 | - 18,25,000 | Additional Information : Profit after tay (tax rate 30%) 1,82,000, Operating expenses (including depreciation € 90.000) being Equity Share dividend paid 15%. Market price per equity share = 20, Require to calculate: (i) Operating and financial leverage (ii) Cover far the prefédrencd anil equity share of dividends (iii) the earning yield and preg eacing fatio (iv) “The net find flav ) times of EBIT EXE Limited is considering three|financing plans, The key information is as foliows: ia) Total investment ro be ralsed % 2,00,000, | tb) Plons of Financing Peopoction-+ — Plans Equity T Debt | Preference Shares _| 4 100% | = B 50% z “ Sh 50% | Kc) Cosi of Debt 8% Cast of Preference Shares 8% (a) Tax Rote 50% ie) Equity Shares of the face value of & 10 each will be issued ai a premium of & 10 per share. (f) Expected PUT is @ 80.000. Determine for cach plan Ji) Earning Per Share (EPS) and (ji) ‘The finanetal break even poi. (iii) Indicate if any of the plans dominate and compute the PRIT range amerg the plans for y P 2 pl indifference, B riypothetieal Lid. is in need of % 1,00,000 to Finance its increased net working capital requirements, The finance manager of the company believes thar its various finsncial costs and share! price will be unaffecied by the selection of « particular plan, sin a small sum is involved, Capital Structure 8 Debentures will cost 10 per cent, Preference Shares 1 per cent and Equity Shares can be sole! for € 25 er share, The tax rate {5 35 per cent Sources of Funds Financial Plans (per cent) 1 2 3 Equity Shares 100 30 30 Preference Shares. a 0 0 Debentures o 60 30 i) Determine the financial break even paint. fii) Which plan has greater risk? Assume EBIT level of & 50.000, EEL. new project consideration by your company requires 4 eapital investment of & 150 lakh. The} required funds can be raised either through the sale of Equity Shares or borrowed from a financial institution. Interest on term loans is 15 per cent and tan rate is 35 per cent. If the debt-equity ratio} insisted by the financing agencies is 2 ; I, calculate the indifference point for the project. Explain its} meaning, Also prepare a verification table. GE] the Modern Chemicals Lid, requires € 25,00.000 fora new plant, This plant is expected 10} viel! carnings before interest and taxes af %5,00,000, While deciding about the financial plan the] company considers the objective of maximizing earninss per-share. It has three alternatives to finance! the project —by raising debt oft 2,50}0n0 ‘or |0,00,000 or ® 15,00,000 and the balance, in each case, | by issuing Equity Shares. The compahs"s share is currently selling at € 150, but is expeeted to deine ho 2 125 in case the funds ure lboerdwedl in excess of % 10.00.000, The funds can be borrowed at the} rate of 10% upto & 2,$0,000) at 15% over & 2.56.00, and upto 10,00,000 and at 20% aver % 10.00.00. The £24 rate applicable Eo the company is: 50%; ANALYSE, which fomdf fmahging should the company ehaose?) Ganesha Limited is settihw up & project swith 2 capital outlay Of % 60,06,009. Ht has two} alternatives in financing the project cast ‘Alternative ~ |: 10% equity finance by issuing Fquity Shares of @ 10 cack. Alitcrnative ~ II: Debt-equity ratio 2+ 1 (issuing Equity Shares of € 10 each) The rate oF interest payable on the debis is 18% pa, The corporate tax rate is 40%. Calculate the indifference point between the two alternative methods of financing ‘Yoyo Ltd, presently: has % 36,00,000 in debt outstanding bearing an interest rate of 10 per cent Ii Wishes to Finance a % 40,00,000 expansion programme and is considering tiese elternatives Jadditional debt at |2 per cent interest, Preference Shares with an | per cent dividend and the issue of| Equity Shares at % 16 per share. The company presently hus £00,000 shares outstanding and is in a 40 pet cent et. a) Weachings hefore interest andl taxes are presently % 15.00.0002, what would be earnings per share for the three alternatives, assuming no immediate increase in profitability? kb) Develop un indifference chart for these alterna What are the appronimate ind ffenence points? To check one of these points, what is the indifference point mathematically between debt and common? ic) Which alternative do you prefer? How mu altemative would be best? h would EBIT need to increase before the next Capital Structure below. ‘Sources of Funds Financing Plans 1 | 2 Equity 15,000 shares of & 100 each 30,000 shares af € 100 cach Preference Shares 12%, 25,000 shares of € 100 each = 3,00,000 at a coupon rate af 0.10 Debentures | 2 15,00,000 at a cougon rate of 0.1 | Assuming 35 per cent tax rate (i) Determine the two EBIT— EPS coordinates for sach financial plan, (ii) Determine the (a) indifference point, and (hy financial break-even point for each financing plan, (iii) Which plan has more financial risk and why? (iv) Indicate over what EBIT range, if'any, one plan is better than the othe (v) the firm is fairly certain that its EBIT will be ® 12.50.00, which plan would you recommend, and why? £0} HOME WORK [EET Calculate the level of earnings before interest and wax (EBIT) at which the EPS indifference point between the following findnding.alternatlves will oecur— i) Equity Share Capital of € 6,00,000 and 12% Debentures of € 4,00),000. iy Faquity Shave Capital of $)4100,000, 14% Preference, Shate Capital of & 2.00,000 and 12% Debentures oF F 4,00,000. \/ |) | A Assume the corporate tax rate & 45% and par value of Equity Share is) \10 im cack ease, Vi XN the| Illa = | " Plant | L x Equity Shares of 10 each sao.900 [40:00 | 12% Debentures 2,000,000 as Preference Shares of 100 each | _ 2.00,000 | n0| — 6,00,000 | 10%, Calculate The indifference point between the plans is © 2.40,(K10. Corporate Tax rate i the rate af dividend on Preference Shares. ted (hat The Adarsh Ltd, is considering methods to finance its investment proposal, It is € initially % 4,00,008 will be needed. Two altemative methods of raising funds are avai able to the firm: (a) Issue of 13% loan amounting to 2.00,000 and issue of 2,000 Equity Shares of & 100 cach, and (b} Issue of 4,000 Equity Shares of @ 100 each. The appropriate tax rate is 35 per ven. (i) Assuming operating profits (EBIT) at: (ay © 78,000 and (b) € 80,000, whieh fiiancing proposal ‘would you recommend and why? (ii) Compute the indifference point of the ewe finanial plans. Capital Structure 10) A compatiy needs € 31.25.00 for the construction of new plant. ‘The following three plans are feasible: ‘The company may issue 3,12,$00 Equity Shares at ® 10 per share. The Company may issue 1,56,250 ordinary Equity Shares at @ 10 per share and 15.625 Debentures of & 100 denomination bearing a 8% rate of innerest, The Company may issue 1,56.250 Equity Shares at % 10 per share and 15,625 Preference Shares at [00 per share bearing 4 8% rate of dividend. If the company’s earnings before interest and taxes are € 62,500, T 1,25,000, & 2.50.00, & 3.75.00 and € 6,25.000, what-are the earnings per share under cach of these financial plans?) ‘Assume a corporate Income Tax rate of 40%. Which alternative would you recommend und why? Sun Lad, is considering two financial plans : Details of which aré as under (i) Fund's requirement ~% 100 lakhs (ii) Financial Plan Puns | Equity | Debt I 100% a 25% (iii) Cost of debi— 12% pa. (iv) Tax Rate-30%| | | | (v) Equity Share ® 10 bach, issued at a premium of € #8 per ¢hare. (vi) Expected earings before interest and taxes (BIT) % 40 Fakhs, ‘You are required to compute > (i) EPS in each of the plan, (ii) The Financial Bread Even Point (iii) Indifference point between Plan 1 and IL 10 lakhs ordinaey shares. of € 10 each, Currently, it ts ear The company’s shaves are listed and are quosed in the tar to diversify production and has approved a project whieh will cost ® 50 lakhs and which is exp Best af Luck Ltd, a profit making company. has a paid up capital of @ 100 lakhs consisting af an anowal pre-tax profit of & 60 lakhs of @ 5010 % 80, The management wants do ictd a pre-tax income of & 40 lakhs per anaum. To raise this additional capital, the otlowing options are under consideration of the management : ta) To issue Fewity Share Capital for the entire additional amount, It is expected that the new shares (Face Valueof % 10) can be sold at a premium of @ 15 tb) To tssute 16% non-convertible debentures-of % [00 each for the entire amount, te) Ta issue equity capital for ¥ 23 akhs (face value of € 10) and 16% non-convertible debentures Tor the balance amount, In this ease, the company can issue shure al a premium of € 40 cach, ‘Yiu are required to advise the management as 10 how the additional capital cam be raised: keeping in mind thet the management wants 19 maximize the earnings per shere to maintain its goodwill, The company is paying Income Tax. at 5%, Capital Structure i Q.1 What is capital structure? jAns ‘Capital structure is the combination of capitals from different sources of finance. The capital of a company consists wf equity share holders’ fund, preference share capital and long term external debts, The source and quantum of capital is decided on the basis of need of the| company and the cost of the capital. While deciding optimal capital structure, the objective of 2 company is to maximise the value of the company. aT Ko Capital Structure decision refers to deciding which sources of finance w he tapped: amount to be funded and their relative proportions (mix) in total capital. Value of the firm = 19.2. Explain the principles of “Trading on Equity”. The use of long-term fixed interest bearing debt and preference share capital along with equity share copital is called financial leverage or trading on equity. ‘The use o” long-term debe increases the earnings per shore if the finm yields a return higher than the cost of debt, The] eamings per share also increase with the use of preference share capital but duc 40 the Fact thal interest is allowed to be -ceducted-while- computing’ tax, the leverage impact of debt is much! ‘can operate adversely also if the rate pf interest on lon Joan is pherefpre, it needs caution te plan the more. However, lever more than the expected)rate of earnings of the fr. capital structure ofa firm, . {ih Indifference point Earning par share @) 0 car ef) point is that level of EBIT needed te satisfy all the fixed financial lends. It denotes the level of EBIT for which the Financial break charges i.e, interest and preference div company’s EPS equals ceva, Ifthe EBIT is less thaw the financial breakeven paint, then the EPS will be m the expected level of EBIT is more than the breakeven paint, then more fixed costs f ive but if Capital Structure 12) instruments can be taken in the capital structure, otherwise, equity would be pieferred. Financial break even point is used for determining the appropriate amount of debt a comoany might carry, Indifference point: tis that Jevel of BIT at which EPS is

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