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CS Executive · Corporate Accounting and Financial Management · Capital Structure

Gupta Foods Ltd has total long-term capital of Rs 10 crore, of which 40% is 10% debt and 60% is equity. EBIT is Rs 2 crore and the tax rate is 25%. Two alternatives for the same Rs 10 crore are considered: the present mix, or all-equity. Ignoring any change in EBIT, by what amount is the annual profit after tax under the present mix lower than under all-equity?

Profit after tax is lower by Rs 30 lakh. Debt of Rs 4 crore at 10% costs Rs 40 lakh interest, which is tax-deductible at 25%, so the after-tax burden is Rs 30 lakh. All-equity PAT is Rs 150 lakh against Rs 120 lakh.

  1. ARs 30 lakhCorrect
  2. BRs 40 lakh
  3. CRs 10 lakh
  4. DRs 20 lakh

Explanation

Debt = Rs 4 crore; interest = Rs 40 lakh. PAT all-equity = 200 x 0.75 = Rs 150 lakh. PAT present = (200 - 40) x 0.75 = Rs 120 lakh. Difference = Rs 30 lakh, the after-tax interest (40 x 0.75). Rs 40 lakh ignores the tax shield.

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