Financing Decision Practice Questions

Q.1 ABC Ltd has an EBIT of Rs. 3,20,000. The tax bracket applicable is 50%.
From the following available information calculate earnings per share.
Particulars Amount (Rs.)
Equity share of Rs.10 each 4,00,000
13% Preference Share 1,00,000
9% Debentures 2,00,000
Answer: EPS=Rs.3.45

Q.2A firm has sales of Rs.10,00,000 , variable cost Rs.7,00,000 , fixed cost
Rs.2,00,000 and Rs.5,00,000 debt at 10% interest. What are the operating, financial
and combined leverages?
Q.3 Calculate the DOL for each of the firm A,B, C and D from the following
information:
Particulars A B C D
Sales Price 20 32 50 70
(per unit)
Variable cost 6 16 20 50
(per unit)
Fixed Cost 60,000 40,000 1,00,000 Nil
What relation can you develop with respected to fixed cost and degree of operating
leverage? Assume the unit sold is 5000 units by each firm.
Answer: DOL- A: 7,B:2,C:3,D:1
Q.4 Pinnacle Ltd has the following details.
Sales (@ Rs.100 per unit) Rs.24,00,000
Variable cost 50%
Fixed Cost Rs.10,00,000
It has 10% Debentures of Rs 10,00,000 and Equity share of Rs.10,00,000 (Rs.100
each).
Calculate
a) Operating leverage, financial leverage, combined leverage and EPS
b) Operating leverage, financial leverage, combined leverage and EPS and new
EBIT if sales increases by Rs.6,00,000.

Q.5 Mehta Company Limited is expecting an annual EBIT of Rs. 2,00,000. The
company has Rs. 5,00,000 in 10% debentures. The cost of equity capital or
capitalization rate is 12.5%. Compute the value of the firm by NI Approach.
Answer: Rs. 17,00,000
Q.6 An organization expects a net income of Rs. 1,00,000. It has Rs. 1,50,000, 10
% debentures. The equity capitalization rate of the company is 12%. A)Calculate
the value of the firm and overall capitalization rate according to the Net Income
Approach (ignoring income-tax). B) If the debenture debt increased to Rs.
2,00,000, what shall be the value of the firm and the overall capitalization rate ?

Answer: a) Value of the Firm (E+D) Rs. 8,58,333 Cost of Capital (Ko) =11.65%,
b) Value of the Firm (E+D) Rs. 8,66,666,Cost of Capital (Ko) = =  11.53%
It is clearly evident that addition of debt to the capital mix has decreased the
overall cost of capital increasing the value of the firm

Q.7  A manufacturing company is expecting the Net Operating Income of is Rs.

200,000. The company has debenture lending of Rs 6,00,000 at 10% interest
payable. The overall capitalization rate is 20%.
a) Calculate the value of the firm and the equity capitalization rate as per the NOI
approach.
b) What will be the impact on value of the firm and equity capitalization firm if the
debenture amount is increased to Rs. 7,50,000?
Answer: a) Value of the firm - Rs. 10,00,000, Ke = 35% b) ) Value of the
firm - Rs. 10,00,000, Ke = 50%
Here, the value of firm is irrespective of the capital mix. The benefit of adding
the debt fund of Rs. 1,50,000 is nullified by the increase in equity
Capitalization rate from 35% to 50%.

Q.8 Compute the value of the firm, value of shares and average cost of  capital
from the following information:
Net Operating Income                                        Rs. 2,00,000
Total investment                                                  Rs. 10,00,000
Equity Capitalization Rate, If:
1. Firm uses no debt                                     10%
2. Firm uses Rs. 4,00,000 as debt               11%
3. Firm uses Rs. 6,00,000 as debt               15%
Assume that Rs. 4,00,000 debt can be raised at 5% and Rs. 6,00,000 can be raised
at 7% rate of Interest. Alternative degrees of leverage are 0%, 40% and 60%.
Answer: Value of the firm : 20,00,000: 20,36,363, 1653333,
wacc-10%:9.82%,12.09%

Q.9Company A and B are homogeneous in all respects except that Company A is

levered while Company B is unlevered. Company A has Rs. 5,00,000 . All
assumptions of MM are met and the tax rate is 50%. EBIT is Rs. 50,000 and that
equity-capitalisation rate for CompanyA and B is 12%. What would be the value
for each firm according to M— M’s approach?
Answer: Vu==Rs. 2,08,333, VL == Rs. 4,58,333

Q.10 Company A and B are engaged in the same line of activity with similar
business risk. Company A is unlevered and Company B is levered with Rs. 2,00,000
debentures carrying 5% rate of interest. Both the firms have income before
interest and taxes of Rs. 50,000. The company’s tax rate is 40% and capitalisation
rate 10% for purely equity firms. Compute the value of firm U and L using the NI
and MM approach.
Answer: NI Approach- V (A)= Rs 3,00,000: V(B)=Rs. 4,40,000
MM Approach - Vu==Rs. 3,00,000, VL == Rs. 3,80,000