Global Ltd. is a widely-held company engaged in power generation in Assam. At present, the company is having a capital of ₹10 crore in fully paid equity shares. The company is considering a proposal to increase its power
CS Professional · Advanced Tax Laws and Practice · PYQS · December 2016
Global Ltd. is a widely-held company engaged in power generation in Assam. At present, the company is having a capital of ₹10 crore in fully paid equity shares. The company is considering a proposal to increase its power generation capacity which will require ₹5 crore. The additional capital required can be raised either by issue of fully paid equity shares or by issue of 10% debentures. Directors of the company want to raise the funds through equity shares as the company can have fully owned capital. Will you accept the proposal at 20% rate of return (pre-tax) and 30% rate of tax? Give reasons in support of your answer.
Answer & Explanation:
Computation of Expected Rate of Return on Capital Employed Particulars Amount in ₹ (Proposal I) Issue of Equity Shares Amount in ₹ (Proposal II) Issue of 10% Debenture Equity Share Capital 15,00,00,000 10,00,00,000 10% Debenture - 5,00,00,000 Total Capital Employed 15,00,00,000 15,00,00,000 PBIT (Expected Rate of Return @ 20% of total Capital employed) 3,00,00,000 3,00,00,000 Less: Interest on Debenture @ 10% - (50,00,000) Profit Before Tax 3,00,00,000 2,50,00,000 Less: Tax @ 30% on PBT (90,00,000) (75,00,000) Net Profit After Tax 2,10,00,000 1,75,00,000 Expected Rate of Return to Share Holders 14.00% 17.50% Conclusion: The proposal of deriving additional capital by issuing fully paid up equity shares is not acceptable as it will give lesser rate of return to share holders in future. Therefore, it is beneficial to raise the additional funds through the issue of 10% Debentures as it will increase the rate of return to shareholders from 14% to 17.50%.
Topics: Income Tax
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