Posts

PRACTICE QUESTIONS AND ANSWER - CAPITAL STRUCTURE

  PROBLEMS ON CAPITAL STRUCTURE Problem:1 A company needs Rs.6,00,000 for construction of a new plant. The following three financial plans are feasible. 1)       The company may issue 60,000 equity shares of Rs.10 each. 2)       The company may issue 30,000 equity shares of Rsf. 10 each and 3000 debentures of Rs. 100 each bearing 8% coupon rate of interest. 3)       The company may issue 30,000 equity shares of Rs. 10 each and 3000 preference shares of Rs. 100 each bearing 8% coupon rate of interest. Earnings before interest and taxes (EBIT) are expected to be Rs.1, 50,000. Corporate tax is 50%. Calculate the earnings per share (EPS) under three plans. Which plan would you recommend and why? Problem:2 Alpha company   Ltd., has an all equity capital structure consisting of 20,000 equity shares of Rs.100 each. The management plans to raise Rs.30 lakhs to finance a program of expansion....
Post a Comment
Read more

Net Operating Income _Problem and Solution

Image
Problem Deva Ltd., has an EBT of Rs.4,50,000. The cost of debt is 10% and outstanding debt is Rs.12,00,000.  The overall   Capitalisation rate is (Ko) is 15%. Calculate the total Value of the firm and Equity Capitalisation Rate under NOI approach. Solution           i.            1.  Calculation of the Market Value of the firm( V)                                    Value of the Firm(V)= Rs.30,00,000       ii.           2.   Calculation of Market Value of Equity(S) S=Market Value of firm (V) - Market Value of Debt S=30,00,000-12,00,000 Value of Equity=Rs.18,00,000     iii.             3. Calculation of earnings available to Equity shareholders     Earning...
Post a Comment
Read more

NET OPERATING INCOME APPROACH

Image
  NET OPERATIN INCOME APPROACH This Approach is suggested by Durand.  Net Operating Income Approach to capital structure believes that the value of a firm is not affected by the change of debt component in the capital structure. It assumes that the benefit that a firm derives by infusion of debt is negated by the simultaneous increase in the required rate of return by the equity shareholders. Assumptions of Net Operating Income Approach The overall Capitalization Rate  remains constant irrespective of the degree of leverage. At a given level of EBIT, the value of the firm would be “EBIT/Overall capitalization rate.” Value of equity is the difference between total firm value and less value of debt, i.e., Value of Equity = Total Value of the Firm – Value of Debt. WACC (Weightage Average Cost of Capital) remains constant, and with the increase in debt, the cost of equity increases. An increase in debt in the Capital Structu...
Post a Comment
Read more

NET INCOME APPROACH- Practice Question and Answer

Image
  NET INCOME APPROACH Problem:                 Johnson Ltd., is expecting an annual EBIT of Rs.2,00,000. Company has Rs.2, 00,000 in10% Debentures. The Equity capitalization rate (Ke) is 12%. You are required to ascertain the total value of the firm and overall cost of capital. What happens if the borrows Rs. 2,00,000 at 10% to repay equity capital Solution Given:   Ke=12%, EBIT=2, 00,000, D=2,00,000   Earnings available to equity Shareholder (NI)     Earnings Before Interest and Taxes(EBIT) 2,00,000 Less: Interest (2,00,000x10/100) 20,000 Earnings available to equity shareholders 1,80,000   1.Market Value of Equity = Earnings available to Equity Shareholders/Cost of Equity (ke)                            ...
Post a Comment
Read more

Case Study: Navigating the Liquidity Trap – The Case of Solaris Tech Solutions

  Case Study: Navigating the Liquidity Trap – The Case of Solaris Tech Solutions 1. Background Solaris Tech Solutions (STS) is a mid-sized firm specializing in renewable energy hardware. Founded in 2021, the company experienced a rapid "boom" due to government subsidies for green energy. Within two years, its annual revenue jumped from $1 million to $8 million. On paper, STS was a runaway success; however, by the end of 2024, the company was on the verge of bankruptcy. 2. The Problem: Growth Without Management Despite high sales figures, STS faced a severe cash flow crisis. The leadership team, primarily composed of engineers, focused exclusively on product development and market share, neglecting the core principles of financial management. Several critical issues emerged: Poor Working Capital Management: To fulfill large orders, STS purchased massive amounts of raw materials. However, they offered clients 90-day credit terms while their suppliers demanded payment within 30...
Post a Comment
Read more