Jakarta Ltd. is considering financing an expansion project of ₹100 lakh. The finance manager has worked out the two options by studying the macro factors of the economy, and also the operating performance of the company.

CS Professional · Financial, Treasury and Forex Management · PYQS · June 2018
Jakarta Ltd. is considering financing an expansion project of ₹100 lakh. The finance manager has worked out the two options by studying the macro factors of the economy, and also the operating performance of the company. The present tax rate applicable to company is 30%. The details of present position and different financing plans are as under. Particulars Present position and Financial plans Present 20 lakh equity shares and debentures of ₹50 lakh carrying interest rate 8% Plan A Issue of Equity shares at the rate of 12.50 The expected Price earnings Ratio: 14 Plan B Issuance of Debentures carrying interest rate 14%. The expected Price earnings Ratio: 12 From the above information, calculate the Indifference point at which EPS would be the same by both plan.

Answer & Explanation:

Indifference point is the level of EBIT at which the EPS under two or more capital structures are same. Plan A (Equity financing) Interest = Interest cost as per present position only = ₹4,00,000 Effective no. of equity shares = Present + new addition = 20,00,000 + ₹100,00,000/₹12.50 = 28,00,000 Plan B (Debt financing) Interest = Interest cost as per present position + new addition = ₹4,00,000 + ₹14,00,000 = ₹18,00,000 Effective no. of equity shares = present only = 20,00,000 Calculation of indifference point EPS Plan A = EPS Plan B {(EBIT - ₹4,00,000)(1-0.30)}/28,00,000 = {(EBIT - ₹18,00,000)(1-0.30)}/20,00,000 (0.70 EBIT - ₹2,80,000)/28 = (0.70 EBIT - ₹12,60,000)/20 14 EBIT - ₹56,00,000 = 19.6 EBIT - ₹3,52,80,000 2,96,80,000 = 5.6 EBIT EBIT = ₹53,00,000

Topics: Capital Structure

Open in Interactive Practice Hub · Full Practice Hub · Chapter Weightage · More in this subject

Related Questions in this Topic