1.

AB limited provides you the following data –

EBIT Rs.3,00,000
Less Interest@ 12% Rs.60,000
Profit before Tax Rs.2,40,000

Tax rate is 50%, company has 40,000 equity shares of 10 each. Current Market price per
equity share is 30. Company has undistributed reserves of Rs. 6,00,000. Company needs Rs.
20,00,000 for expansion, which would yield same rate of return as of now. You are informed
that the debt equity ratio (Debt / (debt + equity)) higher than 35% will push PE ratio down by
20% and also rate of interest on debt raise to 14% on the additional amount of debt if any.
You are required to estimate Market price after expansion by considering following options-

a. Additional funds raised by debt

b. Additional funds raised by issue of equity shares at current market price

Working Notes:
Capital Employed:

Current Debt = Rs. 500000.00 Lacs (i.e. Interest @12% Rs.60000*100/12)

Equity = Rs. 400000.00 Lacs (I.e. 40000 share of 10 Rs. Each)
Reserve = Rs. 600000.00 Lacs (Given)

Total Capital Employed: 500000.00 + 400000.00 + 600000.00 = Rs. 1500000.00

Return on Investment:

𝑬𝑩𝑰𝑻 𝟑𝟎𝟎𝟎𝟎𝟎
ROI = =
𝑻𝑶𝑻𝑨𝑳 𝑪𝑨𝑷𝑰𝑻𝑨𝑳 𝑬𝑴𝑷𝑳𝑶𝒀𝑬𝑫 𝟏𝟓𝟎𝟎𝟎𝟎𝟎
= 20%

Earnings Per share:

𝑷𝑨𝑻 𝟏𝟐𝟎𝟎𝟎𝟎
EPS=
𝑵𝑶.𝑶𝑭 𝑺𝑯𝑨𝑹𝑬𝑺
= 𝟒𝟎𝟎𝟎𝟎
=3

PAT = PBT – TAX (240000.00 – 50% of 240000.00 = Rs. 120000.00)

PE Ratio:

𝑴𝑨𝑹𝑲𝑬𝑻 𝑷𝑹𝑰𝑪𝑬 𝟑𝟎
PE Ratio = = = 10
𝑬𝑷𝑺 𝟑

Debt Equity Ratio under Debt Equity Option:

 𝑫𝑬𝑩𝑻 𝟓𝟎𝟎𝟎𝟎𝟎+𝟐𝟎𝟎𝟎𝟎𝟎𝟎
Debt Equity Ratio = 𝑫𝑬𝑩𝑻+𝑬𝑸𝑼𝑰𝑻𝒀
= 𝟓𝟎𝟎𝟎𝟎𝟎+𝟐𝟎𝟎𝟎𝟎𝟎𝟎+𝟏𝟎𝟎𝟎𝟎𝟎𝟎 = 71% (Approx.)

Which is 35% higher and PE is 20% down i.e. (10 - 20 % of 10 = Rs. 8)

100% Debt 100% Equity

Particular Option A Option B
Existing Capital 15,00,000 15,00,000
Funds raised by equity - 20,00,000
Funds raised by Debt @ 14% 20,00,000
Total Capital 35,00,000 35,00,000

EBIT @20% 7,00,000 7,00,000

Interest @ 12% 60,000 60,000
Interest @ 14% 2,80,000 -

Profit Before Tax 3,60,000 6,40,000

Tax @ 50% 1,80,000 3,20,000

Profit After Tax 1,80,000 3,20,000

No. Of Equity Share 40,000 1,06,667

EPS 4.50 3.00

PE 8.00 10.00

Market Price 36.00 30.00