CAPITAL STRUCTURE
Q.1 The EBIT of ABC Ltd is Rs. 8, 00,000. The company has 10% Debentures of Rs. 20, 00,000. The
equity capitalization rate is 15%. Calculate the value of the firm and overall capitalization rate
according to the Net Income Approach.
Q.2 A company earned a profit of Rs. 10 lakhs before providing for interest and tax (PBIT). Its market
capitalization rate is 14% and it has 15,000 -12% secured redeemable debentures of Rs. 100 each.
You are required to calculate the value of the firm under Net Income Approach. Also calculate the
overall cost of capital of the firm.
Q.3 XYZ expects a net operating income of Rs. 2, 00,000. It has Rs.8, 00,000, 6% debentures. The
overall capitalization rate is 10%. Calculate the value of the firm and the equity capitalization rate
(Cost of Equity) according to the net operating income approach.
Q.4 The Operating Income of ‘PQ’ Ltd is Rs. 6, 00,000. The firms cost of debt is 10%. The amount of
Debt is Rs. 15, 00,000. The overall cost of capital of the firm is 15%.
You are required to determine:
a. Total value of the firm
b. Cost of equity
Q.5 The following data relate to A Ltd. and B Ltd. of same risk class.
Particulars A Ltd. B Ltd.
Earnings Before Interest and Tax Rs. 100,000 Rs. 100,000
10% Debentures Rs. 500,000
Equity Capitalization Rate 16.00% 12.50%
You are required to calculate the total market value of each of the firms. Using MM
Approach.
Q.6 The two companies X Ltd and Y Ltd are having same earnings before interest and taxes of Rs. 2,
00,000. Y Ltd is levered company having a debt of Rs. 10, 00,000 @ 9% rate of interest. The cost
of equity of X Ltd is 10% and that of Y Ltd is 11.50%. You are required to calculate the total
value of each company.
Q.7 Aman Ltd. wants to raise Rs. 1, 00,000 as capital. The company expects earnings before interest
and taxes (EBIT) Rs. 40,000 per annum. The management is considering the following
alternatives for raising the capital:
a. Issue 10,000 equity shares of Rs. 10 each.
b. Issue 5000 equity shares of Rs. 10 each and 500, 12% preference shares of Rs. 100 each.
c. Issue 5000 equity shares of Rs. 10 each and 10 % Debentures of Rs. 50,000.
You are required to calculate earnings per share and advise the alternative to be used for
raising capital, assuming tax rate of 30%.
Q.8 A company’s capital structure consists of the following:
Rs.
Equity Shares of Rs. 100 each 40,00,000
Retained Earnings 10,00,000
9% Preference Share 25,00,000
7% Debentures 25,00,000
The company earns 12% on capital. The income tax rate is 50%.
The company requires a sum of Rs. 25, 00,000 to finance expansion programme for which following
alternatives are available to it.
a. Issue of 20,000 Equity Shares at a premium of Rs. 25 per share.
b. Issue of 10% Preference Shares.
c. Issue of 9% Debentures.
It is estimated that the P/E ratio in the cases of equity, preference and debenture financing would be 20,
17 and 16 respectively. Which of the three financing alterative would you recommend and why?
FORMULAS
Market Value of Equity (S) = Earnings available to Equity shareholders
Ke
Value of the Company/firm (V) = Value of Equity (S) + Value of Debt (D)
Value of the Company/firm (V) = EBIT
Ko
Overall Cost of Capital (Ko) = EBIT x 100
Value of the firm
