Capital Structure
QUESTION FOR PRACTICE

Q.1. The expected EBIT of a firm is Rs.2,00,000. It has issued equity share capital with ke @ 10% and 6% debt. Of Rs.5,00,000. Find out the value of the firm and the overall cost of capital , WACC .

Ans. V is 22,00,000 and KO is 9%.

Q.2. A firm has an E B I T of Rs.2,00,000 and belongs to a risk class of 10% . what is the value of cost of equity capital if it employees 6% debt. To the extent of 30% , 40% or 50% of the total capital fund of Rs.10,00,000.

Ans. Cost of equity is 10.7%, 11% and 11.33%.

Q.3. ABC ltd. Is an unlevered firm having total assets of Rs.50,00,000( all represented by share capital of Rs.50,00,000) and equity captitalization rate , Ke , (which is also, Ko, for the unlevered firm) of 10% . In has EBIT of Rs.10,00,000 subject to corporate tax @ 40%. Find out value of firm.

Ans. 60,00,000.

Q.4. XYZ ltd. Having total assets of Rs.50,00,000 and have 5% Debt. Of Rs.20,00,000 . EBIT is Rs.10,00,000 and tax rate is 40%. Find out value of firm.

Ans. 68,00,000.

Q.5. Four firms, Ulev , Levl 1, Levl2 ,levl3, are alike in all respects the percentage of 10% - Debt present in their capital structure . the EBIT of all these firms is Rs.1,50,000 and corporate tax is 30%. interest income to investors is taxable@ 20% and corporate Dividend tax Rate is 20% . Analyze the income position of the investors of different firms .
(Assume total capital of the firm is 10,00,000 and Lev.1 hold 10% debt, lev2 hold 30% debt and lev. 3 hold 50% debt)

Ans. Total income after tax is 87,500, 89,667 , 94,000, 98,333.

Q.6. S. Ltd. And T. Ltd. Are in the same risk class and are identical in all respects. Except that company S uses debt while company T does not use debt . the levered firm has Rs.9,00,000 debentures carrying 10% rate of interest. Both the firm earn 20% opening profit on their total assets of Rs. 15 lacs . the company is in the tax bracket of 35% and capitalisation rate of 15% on all equity share .You are required to company the value of S Ltd. And T Ltd. Using net income approach. Consider after tax risk.

Ans. Value of S is 18,10,000 and T is 13,00,000.

Q.7. NOI Ltd. Belongs to class of 10% and expects EBIT of Rs.4,00,000 . it employs 8% debt in the capital structure . find out the value of the firm and cost of equity capital Ke, if it employs debt to the extent of 20% ,35% and 50% of the total financial requirement of Rs.20,00,000.

Ans. 10.22%, 10.42% 10.67%.

Q.8. Aparna steel Ltd . has employed 15% debt of Rs.12,00,000 in its capital structure. The net operating income of the firm is Rs.5,00,000 and has an equity capitalization ratio of 16% .assuming that there is no tax ,find out the value of the under the NI Approach.

Ans. 32,00,000.

Q.9. The net operating profit of a firm is Rs.2,10,000 and the total market value of its 12% debt is Rs.3,00,000. The equity capitalization rate of an unlevered firm of the same risk class is 16% . find out the value of the levered firm give that the tax rate is 30% for both the firms.

Ans. U Firm 9,18,750 and L Firm 10,08,750.

Q.10. The following is the data regarding two companies X and Y belonging to the same risk class:

 Company X Company Y Number of ordinary 90,000 1,50,000 Market price per share (Rs) 1.20 1.00 6% Debentures (Rs) 60,000 --- Profit before interest (Rs) 18,000 18,000

All profit after debenture interest are distributed as dividends .
Explain how under Modigliani & miller approach ,an investor holding 10% of share in company X will be better off in switching his holding to company Y.

Ans. Net income is 1440.

Q.11. From the following selected data, determine the value of the firm, P and Q belonging to the homogeneous risk class under (a) Net Income , and (b) net operating income approach

 Firm P Firm Q EBIT 2,25,000 2,25,000 Interest At 15% 75,000 Ke 20% Tax rate 50%

Which of the two firms has an optimal capital structure under the (i) N I approach and (ii) NOI approach ?

Ans. Ans. 8,75,000, 5,62,500.

Q.12. Company U and L are identical in every respect except that the former does not use debt in its capital structure , while the latter employs Rs.6,00,000 of 15% debt . Assuming that (a) all the MM assumptions are met ,(b) the corporate tax rate is 50% (c) the EBIT is Rs.2,00,000 and (d) the equity capitalization of the unlevered company is 20% , what will be the value of the firm , U and L ? also determine the weighted average cost of capital for both the firms.

Ans. VU : Rs.5,00,000, VL : Rs.8,00,000 Ko of UF is 20% and Ko of LF is 12.5%.

Q.13. Firm A and B are similar except that A is unlevered. While B has Rs.2,00,000 of 5% debentures outstanding. Assume that the tax rate is 40%; NOI is Rs.40,000 and the cost of equity is 10%. (i) Calculate the value of the firm, if the MM assumptions are met. (ii) if the value of the firm B is Rs.3,60,000 then do these values represent equilibrium values. If not , how will equilibrium be set ? explain

Ans. VA is 2,40,000 and VB 3,20,000.

Q.14. Khandan ltd has 10,00,000 equity shares of Rs.10 each and 10% Debentures of Rs.14,00,000. The equity shares are being traded at Rs.24 per share and the debenture at par value. The return on equity shares is 20%. Find out the equity rate of return applying the MM Model (without taxes)

Ans. Ko 16.31%.

Q.15. ABC Ltd. having an EBIT of Rs. 1,50,000 is contemplating to redeem a part of the capital introducing debt financing debt financing. Presently, it is a 100% equity firm with equity capitalization rate, ke’ of 16%. The firm is to redeem the capital by introducing debt financing up to Rs. 3,00,0000 i.e. 30% of total funds or up to Rs. 5,00,000 i.e., 50% 505 of total funds. It is expected that for the debt financing up to 30%, the rate of interest will be 10% and the ke will be 20%. Find out the value of the firm and its WACC under different levels of debt financing.

Ans. 0% Deb: V- 9,37,500 / 30% Debt: 10,05,882 50% -9,50,000.