NET INCOME APPROACH- Practice Question and Answer

 

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)

                              


                                =Rs.15,00,000

2.Value of the Firm = Market Value of  Equity+ Market Value of Debt

V=15,00,000+2,00,000

V=17,00,000

3. Calculation of Value of Overall cost of Capital (Ko)

                           


                                                Ko=11.76%

Case 2 : Calculation of Value of the Firm when it borrows Rs.2,00,000  to pay off equity capital

Earnings available to equity Shareholder (NI)

 

 

Earnings Before Interest and Taxes(EBIT)

2,00,000

Less: Interest (2,00,000x10/100)

40,000

Earnings available to equity shareholders

1,60,000

 

1.Market Value of Equity = Earnings available to Equity Shareholders/Cost of Equity (ke)

                               


                                                    =Rs.13,33,333

2.Value of the Firm = Market Value of  Equity+ Market Value of Debt

Value of the Firm(V)=13,33,333+4,00,000

Value of the Firm =17,33,333

3. Calculation of Value of Overall cost of Capital (Ko)

                            


                                                    Ko=11.54%

 

               


Comments

Post a Comment

Popular posts from this blog

PART A UNIVERSITY QUESTION PAPER AND ANSWERS

Image
  SHORT ANSWER QUESTIONS AND ANSWERS 1. Define Cost Accounting. Cost accounting is a systematic process of recording, classifying, analyzing, and reporting costs associated with a business's operations. Its primary goal is to help management in planning, controlling, and decision-making regarding cost efficiency and profitability.   2. What is meant by cost centre? A cost centre is a segment of an organization to which costs can be attributed. It can be a department, a production line, or an activity. Managers of cost centres are responsible for the costs incurred within their area but do not directly generate revenue . 3. Define EOQ. EOQ is an inventory management formula that determines the optimal order quantity to minimize the total inventory costs, including ordering costs and holding costs. It aims to strike a balance between frequent small orders and infrequent large orders. 4. Explain ABC analysis. s :  ABC analysis is an inventory categorization tec...
Read more
. TATA MOTORS SET TO BEGIN THEIR MANUFACTURING UNIT IN RANIPET, TAMIL NADU Today , an important milestone for Tamil Nadu in General and Manufacturing industry N CM MK Stalin laid the foundation stone for Tata Motors Rs 9000 crore manufacturing plant in in Panapakkam, Ranipet district. It has an economic mileage for the Tamil Nadu. Just after six months of signing of MOUs with Tata Motor Groups, Tata Motor set to begin their manufacturing whch would fetch 5,000 jobs. MOU was signed in March,2024 for envisaging an investment woth Rs.9,000 crores over the period of 5 years which will provide direct and indirect employment opportunities for unemployed youths of Tamil Nadu. he plant will manufacture vehicles of flagship models of luxurious Jaguar and Land Rover, apart from four-wheelers of the Tata Motors portfolio. About Tata Motors Tata Motors is a leading global automobile manufacturer of cars, utility vehicles, pick-ups, trucks, and buses, offering an extensive range of inte...
Read more

UNIT 2 & 3 QUESTION BANK

  UNIT 2 & 3 QUESTION BANK Course Code UCM23602J Course Name INCOME TAX LAW AND PRACTICE– II                         Courser Teacher- G.VINCENT QUESTION BANK –SHORTANSWER QUESTION TYPE UNIT 2 INCOME FROM OTHER SOURCES SHORT ANSWER QUESTIONS AND ANSWER 1. Give examples of “Income from Other Sources.” Income from Other Sources is a residual head that includes all income not taxable under the other four heads (Salaries, House Property, Income from Business or Profession, and Capital Gains). It includes earnings from investments, gifts, and unexpected windfalls that are not part of a regular business. Examples:   Dividends from shares, Interest on bank deposits, Family pension, and Winnings from lotteries. 2. What is casual income? Casual income refers to any income that is non-recurring, unexpected, and arises from a source tha...
Read more