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CA Intermediate · Financial Management and Strategic Management · Scope and Objectives of Financial Management

Ramesh Industries Ltd. has 5,00,000 equity shares. It is considering a project that will increase the annual EPS from ₹12 to ₹14 but will raise risk, and the market is expected to reduce the P/E multiple from 10 to 8. Based on the wealth maximisation objective, what is the effect of the project on the market price per share, and should it be accepted?

The market price falls from ₹120 (12 x 10) to ₹112 (14 x 8), so the project reduces shareholder wealth and should be rejected. Higher EPS alone is misleading because it ignores the increased risk reflected in the lower P/E multiple.

  1. APrice rises from ₹120 to ₹112; reject
  2. BPrice falls from ₹120 to ₹112; rejectCorrect
  3. CPrice rises from ₹120 to ₹140; accept
  4. DPrice falls from ₹120 to ₹112; accept, since EPS rises

Explanation

Current price = 12 x 10 = ₹120. New price = 14 x 8 = ₹112. The price falls by ₹8 per share, so shareholder wealth falls and the project should be rejected despite the higher EPS. Accepting it based on EPS alone reflects profit maximisation, which ignores risk.

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