Ravi Glass Ltd., a widely held company is considering for a major expansion of its activities for which an additional investment of ₹3 Crores is required. The company has following three options/alternatives for the fina

CS Professional · Advanced Tax Laws and Practice · PYQS · June 2017
Ravi Glass Ltd., a widely held company is considering for a major expansion of its activities for which an additional investment of ₹3 Crores is required. The company has following three options/alternatives for the financing of proposed additional investment of ₹3 crores: (i) By issue of Equity shares and raise the equity share capital only. (ii) ₹2 crores from issue of Equity shares and ₹1 crore by issue of 15% debentures. (iii) ₹1 crore from issue of Equity shares, ₹1 crore from issue of 15% debentures and remaining ₹1 crore by taking a bank loan on interest payable at 15% p.a. The expected rate of return on the new investment has been worked out at 30%. The corporate rate of tax for the time being on the income is 30.9%. Company has proposed to declare the total net profits as dividend. You are required to suggest the company which is the best alternative to be undertaken for the purpose of proposed investment. Assume that no other taxes are being payable/ to be charged on the distributed profits.

Answer & Explanation:

Computation of Expected Rate of Return on Capital Employed Particulars (Proposal I) Issue of Equity Shares (Proposal II) Issue of 15% Debenture and Equity Shares (Proposal III) Bank loan 15%, Issue of 15% Debenture and Equity Shares Equity Share Capital 3,00,00,000 2,00,00,000 1,00,00,000 15% Debenture - 1,00,00,000 1,00,00,000 Bank Loan @ 15% p.a. - - 1,00,00,000 Total Capital Employed 3,00,00,000 3,00,00,000 3,00,00,000 PBIT (Expected Rate of Return @ 30% of total Capital employed) 90,00,000 90,00,000 90,00,000 Less: Interest on Debenture @15% - (15,00,000) (15,00,000) Less: Interest on Bank Loan @15% - - (15,00,000) Profit Before Tax 90,00,000 75,00,000 60,00,000 Less: Tax @ 30.90% on PBT (27,81,000) (23,17,500) (18,54,000) Net Profit After Tax 62,19,000 51,82,500 41,46,000 Expected Rate of Return to Share Holders 20.73% 25.9125% 41.46% Conclusion: The Company is paying its entire net profits as dividend and the rate of return on equity is highest in the case of third alternative. Therefore, the company should opt for the third alternative.

Topics: Income Tax Act, 1961

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