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CA Intermediate · Financial Management and Strategic Management · Financing Decisions - Capital Structure

Kaveri Plastics Ltd has 1,00,000 equity shares of ₹10 each and no debt. It needs ₹10,00,000 for expansion and can raise it either by issuing 1,00,000 new equity shares at ₹10 each or by issuing 12% debentures. The tax rate is 30%. At what level of EBIT will the EPS under both plans be equal?

The indifference EBIT is ₹2,40,000. Equating EPS of the all-equity plan on 2,00,000 shares with the debenture plan on 1,00,000 shares after ₹1,20,000 interest gives EBIT equal to twice EBIT minus 2.4 lakh, so EBIT is 2.4 lakh; EPS is ₹0.84 in both plans.

  1. A₹2,40,000Correct
  2. B₹1,20,000
  3. C₹3,60,000
  4. D₹1,80,000

Explanation

Equity plan has 2,00,000 shares and no interest; debt plan has 1,00,000 shares and interest of ₹1,20,000. Equate: (EBIT)(0.7)/2,00,000 = (EBIT − 1,20,000)(0.7)/1,00,000, giving EBIT = 2(EBIT − 1,20,000), so EBIT = ₹2,40,000. Check: EPS = 1,68,000/2,00,000 = 0.84 and 84,000... precisely (1,20,000×0.7)/1,00,000 = 0.84 under both. ₹1,20,000 is wrong because it is just the interest amount.

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