Question Bank

1. A company has earnings of Rs 1,00,000. The capital structure of the company contains
debt as well as equity in which debt is of Rs 4,00,000 borrowed at the rate of 10%.
Presently, the cost of equity capital of the company is 12.50%. Find the total value of
the firm and overall cost of capital using Net Income Approach. Also illustrate the Net
Income Approach assuming debt is first increased by Rs 1,00,000 and thereafter
reduced by Rs 1,00,000.

2. A company has earnings of Rs 1,00,000 and overall cost of capital 12.50%. The
company presently has debt of Rs 4,00,000 borrowed at the rate of 10%. Find the value
of company using Net Operating Income Approach. Also illustrate using NOI
Approach, how change in debt by Rs 1,00,000 have bearing on cost of equity capital of
the company.

3. Given the financial data of two companies A ltd and B ltd. Calculate the value of two
firms using NOI Approach.
A B
EBIT 120000 120000
Debt 300000 0
Rate of Debt 6%
Equity Capitalization Rate 10%

4. Given the financial data of two companies A ltd and B ltd. Calculate the value of two
firms using NOI Approach.
A B
EBIT 150000 150000
Debt 400000 0
Rate of Debt 10%
Equity Capitalization Rate 15%

5. There are two companies X Ltd and Y ltd. Both the companies have earning of 25% on
their total assets worth Rs 20,00,000. Further X Ltd has debt of Rs 10,00,000 borrowed
at rate of 12%. Both the companies are subject to tax rate of 50% and have equity
capitalization rate of 15%. Calculate the value of both the firms using Net Income (NI)
and Net Operating Income (NOI) Approach.

6. There are two companies L Ltd and U Ltd. Both the companies are identical in all respects
except that company L Ltd has a debt of Rs 30,00,000 raised at the interest rate of 10%. Both
the companies have earning of Rs 750,000. Further L Ltd is having capitalization rate of 20%
whereas U Ltd has capitalization rate of 15%. Illustrate using Modgilliani Miller Approach that
how an investor X holding 10% shares of L Ltd will be better off by switching over to U Ltd.
7. A company has earnings of Rs 1,00,000. The capital structure of the company contains debt
as well as equity in which debt is Rs 4,00,000 borrowed at the rate of 10%. Presently, the cost
of equity capital of the company is 12.50%. Calculate the total value of the firm and overall
cost of capital using Net Income Approach. Also calculate the value of firm and overall cost of
capital if debt is first increased and thereafter reduced by Rs 1,00,000.

8. There are two firms which are identical in all respects except in terms of their capital as
can be observed from the details given below:
Given L Ltd U Ltd
Levered Unlevered
EBIT 1,00,000 1,00,000
Debt 5,00,000 0
Rate 12% 0
Ke 20% 16%

Calculate the values of the two firms and illustrate using Modigliani Miller Approach how an
investor holding 10% shares of L Ltd will be benefitted by switching over his investment from
L. Ltd to U. Ltd.

9. Diamond Engineering Ltd with EBIT OF Rs 3,00,000 is evaluating a number of possible

capital structures, given below. Which of the capital structure will you recommend and why?
Capital Structure Debt Cost of Debt Cost of Equity
I 3,00,000 10% 12%
II 4,00,000 10% 12.5%
III 5,00,000 11% 13.5%
IV 6,00,000 12% 15%
V 7,00,000 14% 18%

10. The following is the data regarding two companies X and Y belonging to same risk class:
Company X Company Y
Number of Ordinary Shares 90,000 1,50,000
Market Price per share (Rs) 1.20 1.00
6% Debentures (Rs) 60,000 0
Profit before Interest (Rs) 18,000 18,000

All profits after debenture interest are distributed as dividends. Explain how under Modgilliani
Miller Approach, an investor holding 10% shares in Company X will be better off in switching
his holding to Company Y?