Module 4: Capital Structure

1.
(i) Calculate the level of EBIT at which the EPS is indifferent among the following alternatives:
 Equity share capital of Rs. 6 lakhs and 12% debentures of Rs. 4 lakhs;
Or
 Equity share capital of Rs. 4 lakhs, 14% preference share capital of Rs. 2 lakhs and 12%
debentures of Rs. 4 lakhs
Assume tax rate is 35% and equity share face value is Rs. 10 per share.
(ii) Also Calculate Financial Break Even Point.

2.
A new project is under consideration in Zip Ltd. which requires a capital investment of Rs 4.50 Cr.
Interest on term loan is 12% and corporate tax rate is 50%. If the debt-equity ratio insisted by the
financing agencies is 2:1, Calculate the point of indifference for the project. Assume shares of Rs. 10
each. Also calculate Financial BEP.

3.
Paramount Ltd wants to raise Rs. 100 lakhs for a diversification project which would give EBIT of
Rs.22 lakhs p.a. Cost of debt is 15% for amounts up to and including 40 lakhs; 16% for additional
amounts up to and including Rs. 50 lakhs and 18% for additional amounts above 50 lakhs. The equity
shares (face value of Rs. 10 each) currently has market price of Rs. 40 each. The market price will fall
to Rs, 32 each if debts exceeding Rs. 50 lakhs are raised. Tax rate is 50%. With the use of EPS decide
which alternative is better. The following are the different alternatives:

Option Equity Debt

I 50% 50%
II 60% 40%
III 40% 60%

4.
Govinda Enterprises Ltd. Has 10,00,000 shares of Rs 10 each with market price of Rs 50 per share. It
has also issued bonds for Rs 4 Crores @12% p.a. It is considering an expansion plan and needs to
mobilize Rs 5 Crores.
The alternatives being considered are:
(i) Issue Equity at Rs 40 per share.
(ii) Issue Bonds at 10% p.a.
(iii) Issue Preference Shares @12% p.a.
(iv) Finance 50% with Equity at Rs 40 per share and 50% with bonds @ 10% p.a.
The Company is in the tax bracket of 35%.
If the company is hopeful of generating an EBIT of Rs 2.5 Crores after expansion, which method of
financing is the best from the shareholder’s view point?
What more information is required if the market price of the share is the criterion for decision
making?
 5.
One-up Ltd has equity share capital of Rs. 500000 (face value Rs. 100). To meet the expenditure of
an expansion program, the company wishes to raise Rs. 300000 and is having the following four
alternative sources to raise the funds:
1. To have full money from the issue of equity shares
2. To have Rs. 100000 from equity shares and Rs. 200000 from borrowings from financial
institution at 10% interest per annum
3. To have full money from borrowings @ 10% pa
4. To have Rs. 100000 in equity & Rs. 200000 in 8% preference shares.
The company’s expected EBIT is Rs. 150000. The corporate tax rate is 50%. Select a suitable plan out
of the above.

6.
Super Ltd. is considering the following three financing alternatives:

Financial Plan Equity Shares Debt Preference Shares

A 100% - -
B 50% 50% -
C 50% - 50%

Total funds to be raised: Rs. 200 crores

Rate of interest on debt: 12%
Corporate Tax rate: 35%
Dividend on preference shares: 9%
Face value of equity shares Rs. 10 each issued at a premium of Rs. 10 per share.
Expected EBIT: Rs. 80 Crores
Determine: 1) EPS and financial breakeven point for each plan;
2) Indifference points for the financial plans A & B and A & C.

7.

The ZBB limited needs Rs. 5 lakhs for construction of a new plant. The following three financial plans
are feasible:
 The company may issue 50,000 equity shares of Rs. 10 each
 The company may issue 25000 equity shares of R.s 10 each and 2,500 debentures of Rs. 100 each
with an interest rate of 8%.
 The company may issue 25,000 equity shares of R.s 10 each and 2,500 preference share of Rs. 100
each with a dividend rate of 8%
If the EBIT probabilities are Rs. 10,000; Rs. 20,000; Rs.40,000; Rs. 60,000; and Rs. 1,00,000. What are
the earnings per share under each of the three plans?
Which alternative would you recommend and why?
Assume corporate tax rate to be 50%.
8.

The existing capital structure of Zenith Enterprises is as follows:

Equity share capital (Rs.10 each) Rs. 10 Crores
Reserves & Surplus Rs. 15 Crores
14%, Debentures Rs. 15 Crores
The company is considering an expansion programme costing Rs, 20 Crores and promises an
increase of Rs 6 Crores in the EBIT from its existing level of Rs 8 Crores.
Three financing alternatives for obtaining the requisite amount of Rs 20 Crores are under
consideration:
The first alternative is to issue Equity shares of Rs. 10 each at premium of Rs. 40 each.
Due to Share issue expenses the net proceeds from the shares will be only Rs. 40.
The second alternative is to borrow the requisite amount at 15% rate of interest per year.
The third alternative is a combination of the first and second, under which Rs 10 Crores will be
borrowed at 15% rate of interest per year and the balance amount obtained by share issue as per
the terms indicated in the first alternative.
Tax rate is 40%.
Required:
a) The expansion program is to be considered only if the EPS increases from the existing level,
indicate whether the program qualifies for consideration.
b) At what level of EBIT will the EPS be equal to zero under each of the financing alternatives?
c) Determine the points of indifference among the three financing alternatives and the
corresponding EPS.
d) If the chances of a more than 20% decline in EBIT after expansion program are extremely remote,
which financing alternative would you recommend and why?

9.
A Company earns a profit of Rs.3,00,000 per annum after meeting its Interest liability of Rs. 1,20,000
on 12% debentures. The Tax rate is 50%. The number of Equity Shares of Rs.10 each are 80,000 and
the retained earnings amount to Rs.12,00,000. The company proposes to take up an expansion
scheme for which a sum of Rs.4,00,000 is required. It is anticipated that after expansion, the company
will be able to achieve the same return on investment as at present. The funds required for expansion
can be raised either through debt at the rate of 12% or by issuing Equity Shares at par. Compute the
Earnings per Share and suggest the better alternative.

10.
Delta Company is contemplating conversion of 500, 14% convertible bonds of Rs. 1,000 each. Market
price of bond is Rs. 1,080. Bond indenture provides that one bond will be exchanged for 10 shares.
Price earnings ratio before redemption is 20:1 and anticipated price earnings ratio after redemption
is 25:1. Number of shares outstanding prior to redemption are 10,000. EBIT amounts to Rs 2,00,000.
The company is in the 35% tax bracket. Should the company convert bonds into shares? Give reasons.