1. H Ltd.

Has to make a choice between Debt issue and Equity issue for its
expansion programme. Its current position is as follows:

5% Debt 20,000
Equity Capital (Rs. 10 per share) 50,000
Surpluses 30,000
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Total Capitalisation 1,00,000

Sales 3,00,000
Total Cost 2,60,000
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Interest before interest and taxes 31,000
Interest 1,000
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Earnings Before Taxes 30,000
Income Tax 10,500
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Income After Tax 19,500

The expansion programme is estimated to cost Rs. 50,000. If this is financed

through debt, the rate of interest on new debt will be 7% and the price earning
ratio will be 6. If the expansion programme is financed through equity, new
shares can be sold netting Rs. 25 per share; and the price earnings ratio will be 7.
The expansion will generate additional sales of Rs. 1,50,000 with a return of 10%
on sales before interest and taxes.

If the company is to follow a policy of maximizing the market value of its shares,
which form of financing should it choose?

2. AB Ltd. Provides you with the following information:

Profit 3,00,000
Less Interest on debentures (0.12) 60,000
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Earnings before taxes 2,40,000
Less: Taxes (0.35) 84,000
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Earnings After Taxes 1,56,000
No of Equity Shares (10 each) 40,000
Earnings Per Share 3.90
Market Price 39
PE Ratio 10
 The company has undistributed reserves, Rs. 6,00,000. It needs Rs. 2,00,000 for
expansion which will earn the same rate as funds already employed. You are
informed that a debt6 equity ratio higher than 35% will push the PE ratio down to
8 and raise the interest rate on additional amount borrowed to 14%. You are
required to ascertain the probable price of the equity share; a. If the additional
funds are raised as debt and b. If the amount is raised by raising equity share (at
current market price).

3. The evergreen company has the choice of raising an additional sum of Rs.
50,00,000 either by sale of 10% debentures or issue of additional equity shares of
Rs. 50 per share. The current capital structure of the company consists of
10,00,000 ordinary shares. At what levels of earnings before interest and tax
(EBIT) after the new capital is required, would earnings per share (EPS) be the
same whether new funds are raised by issueing ordinary shares or by issueing
debentures? Also determine the level of EBIT at which uncommitted earnings per
share(UEPS) would be the same if sinking fund obligations amount to Rs.
5,00,000 per year. Assume 35% tax rate. Discuss the relevance of the calculation.

4. The balance sheet of Smart Ltd. As on March 31st, current year is as follows:

(Rs. in lacs)

Share Capital 200 Fixed Assets 500

Reserves 140 Inventories 300
Long Term Loans 360 Receivables 240
Short term loans 200 Cash and Bank 60
Payables 120
Provisions 80

TOTAL 1100 TOTAL 1100

Sales for the current year were Rs. 600 lacs. For the next year ending on March, 31 they
are expected to increase by 20%. The next profit margin after taxes and dividend pay out
are expected to be 4 and 90 per cent respectively. You are required to quantify the
amount of external funds required.
b. determine the mode of raising the funds given the following parameters:
1. Current ratio should be 1.33
2. Ratio of fixed assets to long term loans should be 1.5
3. Long term debt to equity ratio should not exceed 1.06
4. The funds are to be raised in the order of
i. Short term bank borrowing
ii. Long term loans and
iii. Equity