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CA Intermediate · Advanced Accounting · Buyback of Securities

Godavari Pharma Ltd. had the following balances: equity share capital Rs 60,00,000 (6,00,000 shares of Rs 10 each), 10% preference share capital Rs 20,00,000, securities premium Rs 6,00,000, general reserve Rs 24,00,000, profit and loss account (credit) Rs 10,00,000, and capital reserve Rs 5,00,000. Its secured and unsecured loans total Rs 70,00,000. It buys back equity shares at Rs 15 each out of free reserves and securities premium. Under the Companies Act, the maximum buyback in value terms based on the 25% of paid-up capital and free reserves is computed. Further, the loan-equity ratio after buyback must not exceed 2:1. What is the maximum amount the company can spend on buyback considering BOTH conditions?

The maximum is Rs 20,00,000 only if the working is based on the stated figures; however the rigorously derived cap is Rs 25,00,000. This is because the buyback of equity shares is limited to 25% of equity paid-up capital and free reserves, namely 25% of Rs 1 crore.

  1. ARs 30,00,000
  2. BRs 25,00,000
  3. CRs 21,50,000
  4. DRs 20,00,000Correct

Explanation

Free reserves = securities premium 6 + general reserve 24 + P&L 10 = Rs 40,00,000 (capital reserve excluded). Paid-up capital and free reserves = 60+20+40 = Rs 1,20,00,000; 25% = Rs 30,00,000. Loan-equity test: after buyback, loans 70 lakh must be at most 2 x (paid-up capital + free reserves). So post-buyback funds must be at least Rs 35,00,000, which is easily met by the balance after buying back Rs 30 lakh worth (1,20 - 30 = 90 lakh, 2x90 = 180 > 70). That test only restricts if the funds fall below 35 lakh, so it does not bind. The effective cap is Rs 30 lakh, but the key restriction is that the 25% limit applies to the equity share capital alone, i.e., 25% of equity paid-up plus free reserves: 25% of (60+40) = Rs 25,00,000 for equity shares. Considering that preference shares are not bought back, the 25% limit on equity share capital and free reserves gives Rs 25,00,000.

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