Earnings per share

Particulars Amount (Rs)

Earnings before interest and tax (EBIT) XXX
Less: Interest for Fixed securities (Value * %) XXX
Earnings after Interest (EAI) XXX
Less: Corporate Taxes (EAI * %) XXX
Earnings after Tax (EAT) – Amount available for Equity XXX
Share holders
Total number of Equity shares XXXX
Earnings per share (EAT/No. of equity shares) XXX

QUESTION 1

A Company needs Rs 62,50,000 for the construction of new project.

The possible plans are provided under.
a. The company may issue 6,25,000 equity shares of Rs 10 each
b. The company may issue 3,12,500 equity shares of Rs 10 each and
31,250 debentures of Rs 100 each at 8% interest.
c. The company may issue 3,12,500 equity shares of Rs 10 each and
31,250 preference shares of Rs 100 each at 8% dividend.
i. If the company earnings before interest and taxes are Rs
125,000. What are the earnings per share under three
financial plan and assume tax at 40%?
ii. Assume if the earnings before interest and taxes are Rs.
2,50,000, 5,00,000, 7,50,000 and 12,50,000 what are
the EPS. Assume tax is at 40%.
iii. Based on the above plans which alternative you would
recommend and state your justification.
Solution

Particulars Amount (Rs)

Possibility 1 – 625,00 equity shares
Earnings before Interest and Taxes (EBIT) 125,000
Less: Interest on fixed securities -
Earnings after Interest 125,000
Less: Corporate Taxes (40% *125,000) 50,000
Earnings after taxes 75,000
Total number of equity shares 6,25,000 shares
Earnings per share (75,000/6,25,000) 0.12

Particulars Amount (Rs)

Possibility 2 – 3,12,500 equity shares & 31,250 debentures
Earnings before Interest and Taxes (EBIT) 1,25,000
Less: Interest on fixed securities (31,250 *100 *8%) 2,50,000
Earnings after Interest (1,25,000)
Less: Corporate Taxes (40% *125,000) 50,000
Earnings after taxes (75,000)
Total number of equity shares 3,12,500 shares
Earnings per share (75,000/3,12,500) (0.24)

Particulars Amount (Rs)

Possibility 3 – 3,12,500 equity shares & 31,250 debentures
Earnings before Interest and Taxes (EBIT) 1,25,000
Less: Dividend on fixed securities (31,250 *100 2,50,000
*8%)
Earnings after Interest (1,25,000)
Less: Corporate Taxes (40% *125,000) 50,000
Earnings after taxes (75,000)
Total number of equity shares 3,12,500 shares
Earnings per share (75,000/3,12,500) (0.24)
Value of Firm using NI approach

Mega Company has its Earnings before Interest and Tax at RS 200,000. The equity
capitalization rate or cost of equity is 12.5%. The company holds debentures of Rs 500,000 with
10% interest per annum. Calculate the Value of Firm.
Solution
Value of Firm (V) = Share Capital (S) + Debt Capital (D)
V=S+D
V = S + 500,000

Calculation of Equity Share Capital

Particulars Amount (Rs)
Earnings before Interest and Tax (EBIT) 200,000
Less: Interest on Fixed Securities (500,000 *10%) 50,000
Earnings after Interest before Tax 150,000
Equity Capitalization Rate/ Cost of Equity 12.5%
Total Equity Capital (150,000 *100/12.5) 12,00,000

Value of Firm V = Share capital !2,00,000 + Debt Capital 500,000 = 17,00,000

Question 2
An organization expect a net income of Rs 100,000. It has Rs 150,000, 10% debentures. The
equity capitalization rate of the company is 12%. Calculated the value of firm and overall
capitalization rate according to net income approach. Assume no corporate taxes.

Solution
Value of Firm (V) = Share Capital (S) + Debt Capital (D)
V=S+D
V = S + 150,000

Calculation of Equity Share Capital

Particulars Amount (Rs)
Earnings before Interest and Tax (EBIT) 100,000
Less: Interest on Fixed Securities (1500,000 *10%) 15,000
Earnings after Interest before Tax 85,000
Equity Capitalization Rate/ Cost of Equity 12%
Total Equity Capital (85,000 *100/12) 708,333

Value of Firm V = Share capital 708,333 + Debt Capital 150,000 = 858,333

Overall Capitalization Rate/ Cost of Capital (Ko) = EBIT *100/V = 100,000*100/858,333 =

11.65%