Ques-1 Discuss the Advantages and disadvantages of each of the financing schemes.

Ans-1 All Equity Option Scheme:

Advantages
(1)    The interest expense remains low for the company.
(2)    Company will have low burden of loans.
(3)    Since company is running on all equity option there is less change that company become bankrupt.
Disadvantages
(1)    Since more shares are issued so company control will be diluted.
(2)    Company cannot take advantage of financial leverage with all equity option.
(3)    Company cannot take advantage of tax shield on interest.

Equal Equity and Debt Option

Advantages
(1)    Company will give more return to their shareholders than if it had adopted all equity option.
(2)    Company can take advantage of financial leverage in this scenario.
(3)    Company is less risky than the company which has high debt.

Disadvantages
(1)    The returns are lower for shareholders than all debt option.
(2)    If business has lower return than the cost of debt than income of shareholders decreases drastically.
All Debt Option
Advantages
(1)    If company has higher return than cost of debt than it can increase the income of owners very much.
(2)    The advantage of tax shield is high in this case.
(3)    The stake of owner does not get diluted in this case.
Disadvantages
(1)    This case can be very risky if there are losses to company. Company can become bankrupt in this case very easily.
(2)    There is constant pressure to pay timely interest and principal of debt for company.
EBIT-EPS analysis of the three financing alternatives

EBIT
Interest
EBT
Taxes
EAT
No. of shares(lakh)
EPS (Rs./share)
March 2007(Estimated) all equity option March 2007(Estimated) equal equity and debt option
3500 3500
1000 1500
2500 2000
900 720
1600 1280
205 152.63
7.8 8.4
(Rs. Lakh)
March 2007(Estimated) all debt option
3500
2000
1500
540
960
100
9.6
Ques-3 Discuss the features of an appropriate capital structure .
An appropriate capital structure should incorporate the following features:

1. Flexibility:
The consideration of flexibility gives the finance manager the ability to alter the firm’s capital structure with a minim
2. Profitability:
A sound capital structure should permit the maximum use of leverage at a minimum cost so as to provide better pro
3. Solvency:
Extensive debt threatens the solvency and credit rating of the company. The debt financing should be only to the ex
4. Conservatism:
No company should exceed its debt capacity. As already explained that the interest is to be paid on debt and the pri
5. Control:
The capital structure should not lead to loss of control in the company. The stake of owners should not get reduced
pital structure with a minimum cost and delay, if warranted by the changed environment. It should also be possible for the com

t so as to provide better profitability and thus maximizing earnings per share.

ing should be only to the extent that it can be serviced fully and also be paid back (if required).

be paid on debt and the principal sum is also to be paid. These payments depend on future cash flows. If future cash flows are

ers should not get reduced very much it must remains intact so that control can be maintained.
also be possible for the company to provide funds whenever needed to finance its profitable activities.

ws. If future cash flows are not sufficient then the cash insolvency can lead to legal insolvency.