NET INCOME (NI) APPROACH

FORMAT
PAGE NO.6.65 PROBLEM NO.39.

Krishna Ltd is expecting an annual EBIT of Rs. 2,00,000. The company has
Rs. 7,00,000 in 10% debentures. The Cost of equity capital or capitalization
rate is 12.5%. you are required to calculate the total value of the firm. Also
ascertain the overall cost of capital.

Value of the firm (V) = S+B

Statement showing computation of Value of the firm

Particulars
Amount
Net operating Income (EBIT) 2,00,000
Less Interest 70,000
Earnings available to equity share holder 1,30,000
Equity capitalization rate Ke 12.5%
Market Value of the firm (s) = NI/Ke 16,250
Market value of Debt (B) 7,00,000
Value of the Firm (V) = S+B 17,40,000
Overall cost of capital 11.49
WORKING NOTES
CALCULATION OF INTEREST = 7,00,000X10%=70,000
Value of the firm (V) = S+B
=10,40,000+7,00,000 = 17,40,000

Market value of the share (S) = NI/Ke

= 1,30,000/.125 =10,40,000
NI = EARNINGS AVAILABLE TO EQUITY SHAREHOLDERS
Overall cost of capital = =
2,00,000/17,40,000X100=11.49%
42. Rudra ltd is expecting annual earnings before payment of interest and
taxes of Rs. 2 lakhs. The company in its capital structure has 8 lakh 10%
debentures. The cost of equity capitalization rate is 12.5%. calculate the value
of the firm under NI approach and overall cost of capital.

Statement showing computation of Value of the firm

Particulars
Amount
Net operating Income (EBIT) 2,00,000
Less Interest 80,000
Earnings available to equity share holder 1,20,000
Equity capitalization rate Ke 12.5%
Market Value of the firm (s) = NI/Ke 9,60,000
Market value of Debt (B) 8,00,000
Value of the Firm (V) = S+B 17,60,000
Overall cost of capital 11.36%

Working Notes :
Value of the firm (V)=S+B
= 9,60,000+8,00,000=17,60,000
Market value of equity (S)= NI/ke
=1,20,000/.125= 9,60,000
NI =NET INCOME AVAILABLE TO EQUITY SHARE HOLDERS
CALCULATION OF INTEREST
8,00,000X10% =80,000
OVERALL COST OF CAPITAL = EBIT/VX100
=2,00,000/17,60,000X100=11.36%

PAGE No.6.66
40. Bharati Ltd expects an annual EBIT of Rs. 1,00,000. The company has Rs.
4,00,000 in 10% Debentures. The equity capitalization rate is 12.5%. The
company proposes to issue additional equity shares of Rs. 1,00,000 and use the
proceeds for redemption of debentures of Rs. 1,00,000. Calculate the value of
the firm (V) and the overall cost of capital (Ko).

Statement showing computation of Value of the firm

Particulars
Amount
Net operating Income (EBIT) 1,00,000
Less Interest 30,000
Earnings available to equity share holder 70,000
Equity capitalization rate Ke 12.5%
Market Value of the firm (s) = NI/Ke 5,60,000
Market value of Debt (B) 3,00,000
Value of the Firm (V) = S+B 8,60,000
Overall cost of capital 11.63%

Working Notes:
Total value of debentures 4,00,000
Less Redemption 1,00,000
---------
Value of debentures 3,00,000
----------
Debenture interest – 3,00,000x10% = 30,000
Market value of the firm = NI/Ke
= 70,000/12.5x100 = 5,60,000
Value of the firm = 5,60,000+3,00,000 = 8,60,000
Overall cost of capital = EBIT/VX100
=1,00,000/8,60,000x100=11.63%

PAGE No.6.66
41. Annapoorna steel Ltd . has employed 15% Debt of Rs.24,00,000 in its
capital structure. The net operating income of the firm is Rs.10,00,000 and has
an equity capitalization rate of 16%. Assuming that there is no tax, find out
the value of the firm under NI Appraoch.
Statement showing computation of Value of the firm

Particulars
Amount
Net operating Income (EBIT) 10,00,000
Less Interest 3,60,000
Earnings available to equity share holder 6,40,000
Equity capitalization rate Ke 16%
Market Value of the firm (s) = NI/Ke 40,00,000
Market value of Debt (B) 24,00,000
Value of the Firm (V) = S+B 64,00,000

Working Notes :
Calculation of interest – 10,00,000x15%= 3,60,000
Market Value of the firm (s) = NI/Ke
=6,40,000/16x100=40,00,000
Value of the firm = 40,00,000+24,00,000 =64,00,000