CAPITAL STRUCTURE

Q1. A Ltd. is considering a new project with a capital investment of Rs. 300 lakhs. The required funds can be raised either
through the sale of equity shares or from financial institutions. Interest on loan is 30% and the tax rate is 50%. If the debt
equity ratio insisted by the financial institution is 2:1, calculate the point of indifference for the project?

Q2. M/s Orbit Technologies Ltd. has the following capital structure.

Equity share capital (4 lac shares) Rs. 1,00,00,000

10% Preference share capital Rs. 20,00,000
15% Debentures Rs. 60,00,000

The shares of the company are presently traded at Rs. 25 per share. It is expected that the company will earn post ta
profits of Rs. 20 lacs (income tax rate assumed to be 40%)
The company wishes to raise further funds of Rs. 50 lacs and has the following options:
1. Issue new debentures and preference shares in equal proportion.
2. Issue of preference shares to the extent of 25%, balance by way of debentures.
3. Issue new debentures carrying 14% interest rate.

As a financial manager, which of the above proposal would you recommend?

Q3. Ravi Ltd. has a capital structure exclusively of ordinary share of Rs. 10 each, amounting to Rs. 5,00,000. The company
desires to raise additional funds of Rs. 5,00,000 for financing its extension programme. The company can raise 50% as
equity capital at par and balance in 5% debentures. The existing EBIT is Rs. 60,000 which will rise by 75% on expansion.
The market price per share is Rs. 100 and tax rate is 30%. Calculate EPS after expansion.

Q4. P Chemical ltd. requires Rs. 25,00,000 for a new plant. This plant is expected to yield earnings before interest and tax
of 20% on investment. While deciding about the financial plan, the company considers the objective of maximising earning
per share. It has three alternatives to finance the project by raising debt of Rs. 2,50,000 or Rs. 10,00,000 or Rs. 15,00,000
and the balance, in each case, by issuing equity shares. The company’s share is currently selling at Rs. 150, but it is expected
to decline to Rs. 125 in case the funds are borrowed in excess of Rs. 10,00,000.

The funds can be borrowed at the rate of 10% upto Rs. 2,50,000, at 15% over Rs. 2,50,000 and upto Rs. 10,00,000 and at
20% over Rs. 10,00,000. The tax rate applicable to the company is 30%. Equity shares are issued at market price.

Which form of financing should the company choose?

Q5. LNT’s capital structure consists of the following:

Equity shares of Rs. 100 each Rs. 20,00,000

Retained earnings Rs. 10,00,000
9% Preference share capital Rs. 12,00,000
7% Debenture capital Rs. 8,00,000
Total Rs. 50,00,000

The company earns 12% on capital. The income tax rate is 50%. The company requires a sum of Rs. 25,00,000 lacs to
finance expansion programme for which the following alternatives are available to it.

1. Issue of 20,000 equity shares at a premium of Rs. 25 per share.

2. Issue of 10% preference share
3. Issue of 8% debentures.
 It is estimated that the P/E Ratio in the cases of equity, preference and debenture financing would be 21.4, 17 and
15.7 respectively.

Which of the three financing alternatives would you recommend and why?

Q6. CNH Ltd. has equity shares of Rs. 1000 each for Rs. 5 crores. It wishes to raise further Rs. 3 crores for expansion
scheme. The company plans the following alternative;
a. By issuing equity shares only.
b. By issuing equity shares of Rs. 1 crore and Rs. 2 crores through 10% debentures.
c. By raising a term loan at 20% p.a.
d. By issuing equity shares of Rs. 1 crore and Rs. 2 crores worth of preference shares of 10%.

You are required to suggest the best alternative giving your comment assuming EBIT after expansion will be Rs. 1.5 crores
and corporate tax at 35%.

Q7. The existing capital structure of JP Ltd. is as follows:

Equity shares of Rs. 100 each Rs. 40,00,000

Retained earnings Rs. 10,00,000
9% Preference shares Rs. 25,00,000
7% Debentures Rs. 25,00,000

Company earns a return on capital employed of 20% and the tax on income is 35%. Company wants to raise Rs. 50,00,000
for its expansion project for which it is considering following alternatives:
1. Issue of 40,000 equity shares at premium of Rs. 25 per share.
2. Issue of 10% preference shares
3. Issue of 9% debentures

It is expected that the return on capital employed would remain same after expansion. Which alternative would you
consider best and why?