Unit 3

Financing Decision
1. Calculate two companies in terms of its financial operating leverages and
Combined leverages.
Firm A Firm B
Sales 20, 00,000 30, 00,000

Variable cost 40% of sales 30% of sales

Fixed cost 5, 00,000 7, 00,000

Interest 1, 00,000 1, 25,000

2. The following information is available in respect of a product:

Unit sold – 60,000
Sales price per unit – Rs 12
Fixed cost – Rs 6 per unit
10% debt capital of Rs 1, 20,000
Calculate all types of leverages

3. Calculate operating leverage and financial leverage from the following.

Units sold 10,000
Selling price per unit 10
Variable cost RS 1 per unit
Fixed cost RS 10,000
Interest expenditure RS 20,000.

4. Consider the following data of XYZ limited.

Selling price per unit 60
Variable cost per unit 10
Fixed cost 300000
Interest 100000
Calculate the leverages .if the number of units sold is 10000 units.

5. Determine three types of leverages from the following information.

Selling price per unit RS 250
Variable cost 30 %
Fixed cost RS 625000
10% debt capital RS 500000
Number of units sold 25,000.
6. Calculate the leverages (2019 QP)
Sales Rs 10,00,000, variable cost 30% of sales, fixed cost 2,00,000, 10%
debenture capital is 15,00,000 and tax rate is 50%

7. The EAT is Rs 6, 30,000, income tax rate is 38.5%, interest is Rs

2, 00,000.Find out EBIT

8. Annual sales of a company are Rs 30,00,000. Sales –to-variable cost ratio

is 150% and fixed cost other than interest is RS 2,50,000 p/a. Company
has 11% debentures of Rs 3,00,000. Calculate Leverages
 12 marks problems

1. A Company has EBIT of Rs. 4,80,000 and its capital structure consists of
the following securities:
Rs.

Equity Share Capital [Rs.10 Each] 4, 00,000

12% preference shares 6, 00,000

14% Debenture 10, 00,000

The company is facing fluctuation in its sales. What would be the change in EPS?

a) If EBIT of the company increased by 25% and

b) If EBIT of the company decreased by 25%

The corporate tax is 35%

2. The capital structure of ABC Ltd. Consists of the following securities.

10% Debentures Rs. 5, 00,000
12% preference shares Rs. 1, 00,000
Equity shares of Rs.100 each Rs. 4, 00,000
Operating profit (EBIT) of Rs. 1, 60,000 and the company is in 50% tax
bracket.
1) Determine the company’s EPS.
2) Determine the percentage changes in EPS associated with 30% increase
and 30% decrease in EBIT.
3) Determine the financial leverages.

3. X Ltd. Is capitalized with Rs.10, 00,000 divided into 1, 00,000 equity shares
of Rs.10/-. The management desires to raises another Rs.10, 00,000 to
finance a major expansion programme.

There are four possible financing plans

a) All equity shares.

b) Rs. 5 lakhs in equity and the balance in debentures carrying 10% interest.
c) All debentures carrying 8% interests.
d) Rs. 5 lakhs in equity and Rs. 5 lakhs in preference shares carrying 10%
dividend.

The existing EBIT amounts to Rs.1, 20,000 p.a.

- Calculate EPS in all the above four plans.

- Calculate EPS if EBIT is doubled due to expansion programme.
 4. Omax Auto Ltd., has an equity share capital of Rs. 5, 00,000 dividend into
shares of Rs. 100 each. It wishes to raise further Rs. 3, 00,000 for
modernization. The company plans the following financing schemes:
a) All equity shares.
b) Rs. 1, 00,000 in equity shares and Rs.2, 00,000 in 10% debentures.
c) All in 10% debentures.
d) Rs. 1, 00,000 in equity shares and Rs. 2, 00,000 in 10% preference shares.
The company’s EBIT is Rs.2, 00,000. The corporate tax is 50%. Calculate
EPS in each case. Give a comment as to which capital structure is suitable.

5. Somu Ltd company ., has an equity share capital for Rs. 10, 00,000
dividend into shares of Rs. 100 each. It wishes to raise further Rs. 6, 00,000
for modernization. The company plans the following financing schemes:
e) All equity shares.
f) Rs. 2, 00,000 in equity shares and Rs.4, 00,000 in 10% debentures.
g) All in 10% debentures.
h) Rs. 2, 00,000 in equity shares and Rs. 4, 00,000 in 8% preference shares.
The company’s EBIT is Rs.3, 00,000. The corporate tax is 50%. Calculate
EPS in each case. Give a comment as to which capital structure is suitable.

6. A company’s capital structure consists of the following.

Equity shares of Rs.100 each 10, 00,000

Retained earnings 5, 00,000

9% Pref. shares 6, 00,000

7% debentures 4, 00,000

Total 25, 00,000

The company earns 12% on its capital. The income tax rate is 50%. The company
requires a sum, of Rs. 12, 50,000 to financeits expansion programme for which the
following alternatives are available:

I. Issue of 10,000 equity shares at a premium of Rs. 25 per share.

II. Issue of 10% preference shares.
III. Issue of 8% debentures.

It is estimated that the P/E ratios for equity, preference and debenture financing would
be 21.4,17 and 15.7 respectively.

Which of the three following alternatives would you recommend and why?
 7. The existing capital structure of ABCLtd., is as follows.

Equity shares of Rs. 100 each 40,00,000

Retained earnings 10,00,000

9% preference shares 25,00,000

7% debentures 25,00,000

The company earns 12% on its capital. The income tax rate is 50%. Company
wants to raise Rs. 25, 00,000 for its expansion project for which it is considering
following alternatives:

1) Issue of 20,000 equity shares at a premium of Rs. 25 per share.

2) Issue of 10% preference shares.
3) Issue of 9% debentures.

Projected that the price/earnings ratio in the case of equity, preference and
debentures financing would be 20, 17 and 16 respectively.

Calculate earnings per share and market price per share.

8. The existing capital structure of ABC Ltd., is as follows:

Equity shares of Rs. 100 each 60, 00,000

Retained earnings 15, 00,000

9% preference shares 37, 50,000

7% debentures 37, 50,000

The company earns 12% on its capital. The income tax rate is 30%. Company
wants to raise Rs. 37, 50,000 for its expansion project for which it is considering
following alternatives:

1) Issue of 30,000 equity shares at a premium of Rs. 25 per share.

2) Issue of 10% preference shares.
3) Issue of 9% debentures.
4) Projected that the price/earnings ratio in the case of equity, preference and
debentures financing would be 20, 17 and 16 respectively.

Calculate earnings per share and market price per share.

9. The P. Ltd. has equity share capital of Rs. 10, 00,000 in shares of Rs. 10
each and debt capital of Rs. 10, 00,000 at 20% interest rate. The output of
the company is increased by 50% 1, 00,000 units to 1, 50,000 units.
Selling price per unit Rs. 20
Variable cost per unit Rs. 10
Fixed cost Rs. 5, 00,000
Tax rate 40%
You are required to calculate:
a) Percentage increase in EPS.
b) Degree of operating leverages at 1, 00,000 units and 1, 50,000 units.
c) Degree of financial leverages at 1, 00,000 units and 1, 50,000 units.

10. The Balance sheet of a company is as follows

Liabilities Amount Assets Amount
Equity shares of 6,00,000 Fixed assets 15,00,000
Rs 10 each
10% Debentures 8,00,000 Current assets 5,00,000
P & L A/C 2,00,000
Creditors 4,00,000
20,00,000 20,00,000

The company’s total assets turnover ratio is 5 times. Its fixed operating
expenses are Rs 10, 00,000 and variable cost is 30%. Income tax rate is
50%.
1. Calculate all the leverages.
2. Show the likely level of EBIT. if EPS is
a) 5 b) 3 c) 2.