Capital Structure Test Solutions
Solution 1: (i)
P0 =
D1
Ke - g
CA – IPC TEST
CAPITAL STRUCTURE
= 3.50 (1.06)
0.15 – 0.06
= `41.22
(ii) Ke = D1 + g
P0
0.15 = 3.50 (1 + g) + g
50
7.50 = 3.50 + 3.50g + 50g g= 4
= 7.48%
53.5
Solution 2:
(i)
Determination of EPS at EBIT level of `22,00,000
Financing Plan
(a)
(b)
Equity Shares (`) Debentures (`) Pref.
EBIT
22,00,000
22,00,000
Less: Interest
(16,000)
(1,21,000)
Taxable Income
21,84,000
20,79,000
Less: Tax @ 30%
(6,55,200)
(6,23,700)
EAT
15,28,800
14,55,300
Less: Dividend on Pref. Shares
(20,000)
(20,000)
Earnings available for equity shares
15,08,800
14,35,300
Number of Equity Shares
90,000
80,000
EPS (`)
16.76
17.94
(ii)
Equivalency level of Earnings between Equity & Debt
[(X – `16,000) (1 - 0.30)] – `20,000 = (X – `16,000 – `1,05,000) (1 - 0.30) – `20,000
90,000
80,000
0.7X – `11,200 – `20,000 = 0.7X – `11,200 – `73,500 - `20,000
90,000
80,000
0.7X – `31,200 = 0.7X – `1,04,700
90,000
80,000
8(0.7X – `31,200) = 9(0.7X – `1,04,700)
5.6X – `2,49,600 = 6.3X – `9,42,300
5.6X – 6.3X = - `9,42,300 + `2,49,600
- 0.7X = - `6,92,700
X = `6,92,700 = `9,89,571
0.7
(iii)
Equivalency level between Preferred Stock and Common Stock
(X – `16,000) (1 - 0.30) – `20,000 – `98,000 = (X – `16,000) (1 – 0.30) – `20,000
80,000
90,000
0.7X – `11,200 – `1,18,000 = 0.7X – `11,200 – `20,000
80,000
90,000
9(0.7X – `1,29,200) = 8(0.7X – `31,200)
6.3X – `11,62,800 = 5.6X – `2,49,600
6.3X – 5.6X = - `2,49,600 + `11,62,800
0.7X = `9,13,200
X = `9,13,200
0.7
= `13,04,571
Solution 3:
Particulars
(`) in million
Net operating income
40
Less: Interest on debt capital (`90 million x 8%)
(7.2)
Earnings available to equity shareholders
32.8
Equity capitalization rate
16%
(c)
Shares (`)
22,00,000
(16,000)
21,84,000
(6,55,200)
15,28,800
(1,18,000)
14,10,800
80,000
17.64
Market value of equity
205
Market value of debt
90
Total value of the firm
295
Ko = `40 million/`295 million = 13.56%
Solution 4: (i) Calculation of Value of Firm (V F) under Traditional approach:
Value of Firm = Value
P0 =
D1
Ke - g
CA – IPC TEST
CAPITAL STRUCTURE
= 3.50 (1.06)
0.15 – 0.06
= `41.22
(ii) Ke = D1 + g
P0
0.15 = 3.50 (1 + g) + g
50
7.50 = 3.50 + 3.50g + 50g g= 4
= 7.48%
53.5
Solution 2:
(i)
Determination of EPS at EBIT level of `22,00,000
Financing Plan
(a)
(b)
Equity Shares (`) Debentures (`) Pref.
EBIT
22,00,000
22,00,000
Less: Interest
(16,000)
(1,21,000)
Taxable Income
21,84,000
20,79,000
Less: Tax @ 30%
(6,55,200)
(6,23,700)
EAT
15,28,800
14,55,300
Less: Dividend on Pref. Shares
(20,000)
(20,000)
Earnings available for equity shares
15,08,800
14,35,300
Number of Equity Shares
90,000
80,000
EPS (`)
16.76
17.94
(ii)
Equivalency level of Earnings between Equity & Debt
[(X – `16,000) (1 - 0.30)] – `20,000 = (X – `16,000 – `1,05,000) (1 - 0.30) – `20,000
90,000
80,000
0.7X – `11,200 – `20,000 = 0.7X – `11,200 – `73,500 - `20,000
90,000
80,000
0.7X – `31,200 = 0.7X – `1,04,700
90,000
80,000
8(0.7X – `31,200) = 9(0.7X – `1,04,700)
5.6X – `2,49,600 = 6.3X – `9,42,300
5.6X – 6.3X = - `9,42,300 + `2,49,600
- 0.7X = - `6,92,700
X = `6,92,700 = `9,89,571
0.7
(iii)
Equivalency level between Preferred Stock and Common Stock
(X – `16,000) (1 - 0.30) – `20,000 – `98,000 = (X – `16,000) (1 – 0.30) – `20,000
80,000
90,000
0.7X – `11,200 – `1,18,000 = 0.7X – `11,200 – `20,000
80,000
90,000
9(0.7X – `1,29,200) = 8(0.7X – `31,200)
6.3X – `11,62,800 = 5.6X – `2,49,600
6.3X – 5.6X = - `2,49,600 + `11,62,800
0.7X = `9,13,200
X = `9,13,200
0.7
= `13,04,571
Solution 3:
Particulars
(`) in million
Net operating income
40
Less: Interest on debt capital (`90 million x 8%)
(7.2)
Earnings available to equity shareholders
32.8
Equity capitalization rate
16%
(c)
Shares (`)
22,00,000
(16,000)
21,84,000
(6,55,200)
15,28,800
(1,18,000)
14,10,800
80,000
17.64
Market value of equity
205
Market value of debt
90
Total value of the firm
295
Ko = `40 million/`295 million = 13.56%
Solution 4: (i) Calculation of Value of Firm (V F) under Traditional approach:
Value of Firm = Value