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Capital Structure Theories

1. A company provides you with the following information:
Capital structure:
10,000 equity shares of Rs. each 1,00,000
Debenture
EBIT 2,00,000
Tax Rate 50%
Change in EBIT (+-)20%
Show the effect of proposed change in EBIT on EPS and comment on it.

2. One-third of total market value of Vishnu limited consists of loan stock, which has a cost
of 10%. Another company ,Shiva Ltd. is identical in every respect to Vishnu Ltd., except
that its capital structure is all – equity , and its cost of equity is 16%. According to
Modigliani and Miller, if we ignored taxation and tax relief on debt capital, what would
be the cost of equity of Vishnu Limited?

3. KFC Ltd. is an all equity finance company with a market value of RS. 25,00,000 and cost
of equity, K€ = 21%.the company wants to buy-back Equity Shares worth RS. 5,00,000
by issuing and raising 15% Perpetual Debt of the same amount. Rate of tax may be
taken as 30%. After the re-structuring and applying MM Model (with taxes, you are
required to calculate-
a. Market value of KFC Ltd.
b. Cost of equity K(e)
c. Weighted average cost of capital and comment on it.

4. There are two firms U and L having same NOI of Rs. 20,000. Firm L is a levered firm
having Debt of Rs. 1,00,000 @ 7% and cost of equity of U and L are 10% and 18%
respectively. Showhow arbitrage process will work in this case.

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