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CMA Intermediate · Financial Management and Business Data Analytics · Capital Structure and Capital Stacking

Meridian Textiles Ltd needs Rs 10,00,000 of new funds. Plan A: issue 10,000 equity shares at Rs 100 each. Plan B: raise Rs 10,00,000 through 10% debentures. Existing capital: 20,000 equity shares of Rs 100 each, no debt. Tax rate is 25%. What is the EBIT indifference point between the two plans?

The indifference point is Rs 3,00,000. At this EBIT, EPS is the same under both plans: 3,00,000 over 30,000 shares equals 2,00,000 over 20,000 shares after the Rs 1,00,000 interest. Tax rate does not affect the point because it cancels from both sides.

  1. ARs 2,00,000
  2. BRs 3,00,000Correct
  3. CRs 4,00,000
  4. DRs 1,00,000

Explanation

Plan A has 30,000 shares and no interest; Plan B has 20,000 shares and interest of Rs 1,00,000. Setting EBIT/30,000 = (EBIT - 1,00,000)/20,000 gives 20,000 EBIT = 30,000 EBIT - 3,00,00,00,000/1,000... solving: 2 EBIT = 3 EBIT - 3,00,000, so EBIT = Rs 3,00,000. Rs 2,00,000 results from using the wrong share ratio. The tax rate cancels out.

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