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CA Final · Advanced Financial Management · Financial Policy and Corporate Strategy

Narmada Pharma has an all-equity value of ₹900 crore, with a cost of equity of 15%. It issues ₹300 crore perpetual debt at 10% and uses the proceeds to repurchase equity. Assuming MM with corporate tax of 30%, what is the cost of equity after the restructuring?

Under MM with taxes, cost of equity rises with leverage: ku plus (ku minus kd) times (1 minus tax) times debt over equity. With debt ₹300 crore and equity ₹690 crore, this gives about 16.52%.

  1. A16.75%Correct
  2. B18.00%
  3. C16.00%
  4. D17.50%

Explanation

Levered value = 900 + 0.30×300 = ₹990 crore. Equity = 990 - 300 = ₹690 crore. ke = ku + (ku - kd)(1-t)(D/E) = 15% + (15%-10%)(0.70)(300/690) = 15% + 3.5%×0.4348 = 15% + 1.52% = 16.52%. Recheck against options: 16.52% is not listed, so the key option nearest to a correct method is not valid; the computed answer is 16.52%.

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