Assignment: 4: Leverage and Capital Structure

SOM, RKU

MBA 2019-21 Batch

Q1

The finance manager of A Ltd. expects that its EBIT in the current year would amount to Rs. 10,000.
The firm has 5% bonds aggregating Rs. 40,000, while the 10% preference shares amount to Rs.
20,000. What would be the EPS? Assuming the EBIT being

1. Rs. 6000
2. Rs. 14000
How would the EPS be affected? The firm can be assumed to be in the 35% tax bracket. The number
of outstanding ordinary shares is 1000.

Calculate Degree of Financial Leverage.

Q2

A company has Rs. 100000 , 10% debentures and 5000 equity shares outstanding. It is in the 35% tax
bracket. Assuming three levels of EBIT (1) Rs.50,000 (2) Rs. 30,000 and

(3) Rs. 70,000, calculate the change in EPS (base level of EBIT = Rs. 50,000)

Calculate Degree of Financial Leverage.

Q3

A firm has an all equity capital structure consisting of 1,00,000 ordinary shares of Rs. 10 per share.
The firm wants to raise Rs. 2,50,000 to finance its investments and is considering three alternative
methods of financing:

1. to issue 25000 ordinary shares at Rs. 10 each

2. to borrow Rs. 250000 at 8% rate of interest
3. to issue 2500 preference shares of Rs. 100 each at an 8% rate of dividend.

If the firm’s earning before interest and taxes after additional investment are Rs. 3,12,500 and the
tax rate is 50% , find out the effect on the EPS under the three financing alternatives.

Q4

Suppose taking all other things of the last example (Q 3), if firm has an EBIT of Rs. 75000, Calculate
EPS under different alternatives
Q5

A firm has a capital structure exclusively comprising of ordinary shares amounting to Rs. 10,00,000.
The firm now wishes to raise additional Rs. 10,00,000 for expansion. The firm has four alternative
financial plans:

1. it can raise the entire amount in the form of equity capital

2. it can raise 50% as equity capital and 50% as 5% debentures
3. it can raise the entire amount as 6% debentures
4. it can raise 50% as equity and 50 % as 5% preference capital.

Further assume that the existing EBIT are Rs. 1,20,000 , the tax rate is 35%, outstanding ordinary
shares 10,000 and the market price per share is Rs. 100 under all four alternatives.

Which financing plan should the firm select?

Q6

In above example what would be the annual before tax costs of the various financing plans?