Capital Structure

1) Daniel Ltd. has equity share capital of Rs.12,00,000 divided into shares of Rs.100 each. It wishes to raise
further Rs.6,00,000 for expansion-cum-modernisation scheme. The company plans the following financing
alternatives. Plan A - By issuing equity shares only.
Plan B - Rs.2,00,000 by issuing equity shares and Rs.4,00,000 through debentures @ 10 % p.a.
Plan C - Rs.2,00,000 by issuing equity shares and Rs.4,00,000 by issuing 9% preference shares.
Plan D - By raising term loan only at 10% p.a.
You are required to suggest the best alternative giving your comment assuming that the estimated EBIT after
expansion is Rs.2,25,000 and corporate tax is 40%.

Statement of showing EPS under various Financial Plans

Particulars Plan A Plan B Plan C Plan D

EBIT (Earnings before Interest & Tax) 2,25,000 2,25,000 2,25,000 2,25,000
Less: Int. on Debt (B - 4,00,000 * 10%) 40,000 60,000 (D - 6,00,000 @ 10%)
EBT ( Earnings Before Tax) 2,25,000 1,85,000 2,25,000 1,65,000
Less: Tax @ 40% 90,000 74,000 90,000 66,000
Earnings After Tax 1,35,000 1,11,000 1,35,000 99,000
Less: Preference dividend (C - 4,00,000 * 9%) 36,000
Profit for equity shareholders 1,35,000 1,11,000 99,000 99,000
No of Equity Shares 18,000 14,000 14,000 12,000
EPS = Profit for equity shareholders / No of Eq Shares 7.50 7.93 7.07 8.25

Analysis/Interpretation: EPS of Rs.8.25 is highest in the case of Plan D. Hence, it is suggested that Plan D may be
implemented i.e., raising the required funds of Rs.6,00,000 by way of borrowing term loan at 10% p.a

2) AK Ltd is considering two plans to finance a project costing Rs.50 Lakh. The details are, Workings:
Plan I Plan II
(in Rs.) (in Rs.) EBIT Year 1 - 1,20,00,000 * 15%
Equity Share Capital (Rs.100 per share) 20,00,000 25,00,000 Year 2- 1,50,00,000 * 15%
12% debentures 30,00,000 25,00,000 Year 3 - 1,80,00,000* 15%
50,00,000 50,00,000
Sales for the first three years of operations are projected at Rs.120, Rs.150 and Rs.180 lakhs respectively. EBIT is Int on
expected to 15% of sales. Corporate taxation is 35%. Calculate the EPS in each of the plans for three years. Deb Year 1, 2 & 3
30,00,000 * 12%
Statement showing EPS under Plan 1 (in Rs.)
 Particulars Year 1 Year 2 Year 3 Tax Year 1 14,40,000*35%
EBIT 18,00,000 22,50,00027,00,000 Year 2 18,90,000*35%
Less: Int on debentures 3,60,000 3,60,000 3,60,000 Year 3 23,40,000*35%
EBT 14,40,000 18,90,00023,40,000
Less: Tax @ 35% 5,04,000 6,61,500 8,19,000
EAT (Profit) 9,36,000 12,28,500 5,21,000
No.of Eq shares 20,000 20,000 20,000
EPS = (Profit / No of eq shares) 46.80 61.43 76.05

Statement showing EPS under Plan 2 (in Rs.)

Int on
Particulars Year 1 Year 2 Year 3 Deb Year 1, 2 & 3
EBIT 18,00,000 22,50,00027,00,000 25,00,000 * 12%
Less: Int on debentures 3,00,000 3,00,000 3,00,000
EBT 15,00,000 19,50,00024,00,000 Tax Year 1 15,00,000 * 35%
Less: Tax @ 35% 5,25,000 6,82,500 8,40,000 Year 2 19,50,000*35%
EAT (Profit) 9,75,000 12,67,500 5,60,000 Year 3 24,00,000*35%
No.of Eq shares 25,000 25,000 25,000
EPS = (Profit / No of eq shares) 39.00 50.70 62.40

3)
 Statement showing EPS and Market Price per Share under various Financial Plans
Equity Pref
Shares Shares Deb
Particulars Existing Pla Plan Plan Plan
(80,00,00 (98,00,00
EBIT 0 * 15%) 0 *15%) 12,00,000 14,70,00014,70,00014,70,000
Less: Interest (20,00,000 * 8%) 1,60,000 1,60,000 1,60,000 1,60,000
(18,00,000 * 10%) 1,80,000
EBT 10,40,000 3,10,000 3,10,000 1,30,000
Less : Tax @ 35% 3,64,000 4,58,500 4,58,500 3,95,500
EAT 6,76,000 8,51,500 8,51,500 7,34,500
Less: Pref Dividend (20,00,000 * 10%) 2,00,000 2,00,000 2,00,000 2,00,000
(18,00,000 * 11%) 1,98,000
Profit for equity shareholders 4,76,000 6,51,500 4,53,500 5,34,500
No of Shares 25,000 39,400 25,000 25,000

EPS: Profit/ No of Equity Shares 19.04 16.54 18.14 21.38

P/E Ratio 15 12 10
Market Price Per Share: EPS * P/E Ratio Nil 248.10 217.68 213.80

Hence, the market price per share value is maximum in Equity shares plan i.e Rs.248.10. It is Recommended to follow.

4)
Statement showing EPS under Plan 2
Particulars (in Rs.) (in Rs.) (in Rs.) (in Rs.)
EBIT 15,000 25,000 50,000 75,000
Interest 3,50,000 * 9% 31,500 31,500 31,500 31,500
EBT -16,500 -6,500 18,500 43,500
Less: Tax @ 50% -8,250 -3,250 9,250 21,750
EAT -8,250 -3,250 9,250 21,750
Less : Pref dividend Nil Nil Nil Nil
Profit for Eq Sha Holders -8,250 -3,250 9,250 21,750
No of Eq Shares 35,000 35,000 35,000 35,000
EPS: EAT (or) Profit / No of Eq Shares -0.24 -0.09 0.26 0.62
 Statement showing EPS under Plan 1 Statement showing EPS under Plan 3
Particulars (in Rs.) (in Rs.) (in Rs.) (in Rs.) Particulars (in Rs.) (in Rs.) (in Rs.) (in Rs.)
EBIT 15,000 25,000 50,000 75,000 EBIT 15,000 25,000 50,000 75,000
Interest Nil Nil Nil Nil Interest Nil Nil Nil Nil
EBT 15,000 25,000 50,000 75,000 EBT 15,000 25,000 50,000 75,000
Less: Tax @ 50% 7,500 12,500 25,000 37,500 Less: Tax @ 50% 7,500 12,500 25,000 37,500
EAT 7,500 12,500 25,000 37,500 EAT 7,500 12,500 25,000 37,500
Less : Pref dividend Nil Nil Nil Nil Less : Pref dividend(3,50,000 * 9%) 31,500 31,500 31,500 31,500
Profit for Eq Sha Holders 7,500 12,500 25,000 37,500 Profit for Eq Sha Holders -24,000 -19,000 -6,500 6,000
No of Eq Shares 70,000 70,000 70,000 70,000 No of Eq Shares 35,000 35,000 35,000 35,000
EPS: EAT (or) Profit / No of Eq Shares 0.11 0.18 0.36 0.54 EPS: EAT (or) Profit / No of Eq Shares -0.69 -0.54 -0.18 0.17

Interpretation: From the analysis of the above three alternatives, Plan 2 gives more EPS i.e 0.62, when the EBIT is Rs.75,000 and the
company issues 35,000 equity shares of Rs.10 per share and 3,500 debentures @ Rs.100 each @ 9 % rate of Interest

Asynchronous Problem
I II III
EBIT 55,00,000 55,00,000 55,00,000
Less :Int 6,00,000 6,00,000 6,00,000
(12% of 50,00,000) 6,00,000
EBT 49,00,000 43,00,00049,00,000
Tax @40% 19,60,000 17,20,000 9,60,000
EAT 29,40,000 25,80,00029,40,000
No of Eq Share 12,00,000 10,00,000 2,50,000
EPS 2.45 2.58 2.35

5) The relationship between PBIT and EPS under alternative financing plans, let us consider the following data for Falcon limited.
i) Existing Capital Structure: 1 Million equtiy shares of Rs.10 each
ii) Tax rate : 50 %
Falcon Ltd plans to raise additional capital of Rs.10 million for financing an expansion project. In this context, it is
evaluating two alternative financing plans.
a) Issue of equity shares ( 1 million equity shares at Rs.10 per share),
b) Issue of debentures carrying 14 %
What will be the EPS under the two alternative financing plans for two levels of PBIT, say Rs. 4 million and Rs. 2 million?

Equity ( Eq Financing) Debentures (Debt Financing)

EBIT 20,00,000 40,00,000 20,00,000 40,00,000
Less: Interest Nil Nil 14,00,000 14,00,000
PBT 20,00,000 40,00,000 6,00,000 26,00,000
Tax @ 50% 10,00,000 20,00,000 3,00,000 13,00,000
Profit 10,00,000 20,00,000 3,00,000 13,00,000
No of equity shares 20,00,000 20,00,000 10,00,000 10,00,000
EPS 0.5 1 0.3 1.3

Point of Indifference

1) A new project requires an investment of Rs.12,00,000. Two alternative methods of financing are under consideration
i) Issue of equity shares of Rs.10 each for Rs.12,00,000
ii) Issue of equity shares of Rs.10 each for Rs.8,00,000 and issue of 15% debentures for Rs.4,00,000
Find out the Indifference level of EBIT assuming a tax rate of 35%. Verify your answer.

X - EBIT =?
I 1 = Int under plan 1 = Nil
I 2 = Int under plan 2 = 4,00,000 * 15% = Rs.60,000
T = Tax rate = 35%
N1 = 1,20,000
N2 = 80,000

EBIT = Rs.1,80,000

Equity ( Eq Financing) - Plan 1 Debt Equity Mix (Plan 2)

EBIT 1,80,000 1,80,000
Less: Interest Nil 60,000
PBT (EBT) 1,80,000 1,20,000
Tax @ 35% 63,000 42,000
Profit (EAT) 1,17,000 78,000
No of equity shares 1,20,000 80,000
EPS (Profit / No of Shares) 0.975 0.975

2) Lakme Ltd, wants to raise Rs.2,50,000 as additional capital . It has two mutually exclusive alternative finanical
plans. The current EBIT is Rs.8,50,000 which is likely to remain unchanged. The relevant information is:
Present capital structure: 1,50,000 equity shares of Rs.10 each and 10% bonds of Rs.10,00,000.
Tax Rate: 50%
Current EBIT: Rs.8,50,000, Current EPS : Rs.2.50, Current marekt price : Rs.25 per share
Financial Plan I : 10,000 equity shares at Rs.25 per share
Financial Plan II : 12% debentures of Rs.2,50,000
You are reqiured to calculate:
i) Earnings per shares; ii) Financial B.E.P, iii) Indifference point between Plan I & Plan II.

Statement showing EPS for Different Financial Plans

Plan 1 (in Rs.) Plan 2 (in Rs.)

EBIT 8,50,000 8,50,000
Less: Interest (10,00,000 * 10%) 1,00,000 1,00,000
(2,50,000 * 12%) Nil 30,000
EBT 7,50,000 7,20,000
Less: Tax @ 50% 3,75,000 3,60,000
EAT 3,75,000 3,60,000
No of Shares 1,60,000 1,50,000
EPS: EAT / No of Shares 2.34 2.40

Computation of Financial BEP

Plan I = Rs.1,00,000
Plan II = Rs.1,30,000

Computation of Indifference Point between Plan I & Plan II

Plan 1 (in Rs.) Plan 2 (in Rs.)
EBIT 5,80,000 5,80,000
Less: Interest 1,00,000 1,30,000
EBT 4,80,000 4,50,000
Less: Tax @ 50% 2,40,000 2,25,000
EAT 2,40,000 2,25,000
No of Shares 1,60,000 1,50,000
EPS: EAT / No of Shares 1.50 1.50

3) Assume that you are the financial manager of a company and you have the choice for raising an additional
sum of Rs.20,00,000 either by raising a 10% debt or by issue of additional equity shares of Rs.100 each at par.
The present capital structure of the company consists of 2,00,000 equity shares of Rs.100 each and no debt.

In this case, you will get at what level of EBIT after the new funds are raised, would EPS be the same whether
new funds are raised either by raising debt or issue of equity shares?
Also determine the level of EBIT at which Uncommitted Earnings Per Share (UEPS) would be the same, if
sinking fund obligations amount to Rs.2,00,000 per year.
You may assume that tax rate is 50%.

Computation of Indifference Point between Plan I & Plan II

Alternative 1 (in Rs.) Alternative 2 (in Rs.)
EBIT
Less: Interest
EBT
Less: Tax @ 50%
EAT
Less: Sinking fund obligations
Uncommitted Earnings
No of Shares
UEPS
The expected cash inflows are as follows
Year 1 2 3 4 5
Cash Inflow (Rs.) 3,000 4,500 6,000 8,000 10,000
Discount rate @ 16%. Calculate PV of cash inflows by using PV table

Year Cash Inflow (R PVF 16% PV (in Rs.) Cash inflow PV factor PV (in Rs.)
1 3,000 0.862 2,586 5,000 0.833 4,165
2 4,500 0.743 3,344 6,800 0.694 4,719
3 6,000 0.641 3,846 7,200 0.579 4,169
4 8,000 0.552 4,416 8,900 0.482 4,290
5 10,000 0.476 4,760 10,500 0.402 4,221
Total PV of Cash inflows 18,952 21,564

PV of an annuity

SRK has entered into an agreement that will fetch him Rs.60,000 p.a for the next 4 years. He wants to know the PV of Futu

Csah inflow = Rs.60,000

60,000 0.833 49980 0.8333 60,000 49998

60,000 0.694 41640 0.6944 60,000 41664
60,000 0.579 34740 0.5787 60,000 34722
60,000 0.482 28920 0.4823 60,000 28938
1,55,280 1,55,322
Applications
Parameter Symbol Built in Formula
Present Value PV PV(rate,nper, pmt, [fv],[type])
Future Value FV FV(rate,nper, pmt, [pv],[type])
No.of continuous
succesive periods NPER NPER(rate,pmt, pv,[fv],[type])
Payment per period PMT PMT(rate, nper, pv, [fv],[type])
Interest rate RATE RATE(nper, pmt,pv, [fv],[type])

Knowing What lies in store for you

Suppose you have decided to deposit Rs.30,000 per year in your public provident fund for 30 years. What will be the
accumulated amount in your PPF account at the end of 30 years if the interest rate is 8 per cent ?

Amount(PMT) 30,000
NPER 30
RATE 8%
$3,398,496.33
Rs.33,98,496

How much should you save annually

You want to buy a house after 5 years when it is expected to cost Rs.20,00,000. How much should you save annually if
your savings earn a compound return of 12 percent?

Rs.20,00,000 / 6.353
Rs.3,14,812
 How much can you borrow for a Car

After reviewing your budget, you have determined that you can afford to pay Rs.12,000 p.m. for 3 years toward a new
car. You call a finance company and learn that the going rate of interest on car finance is 1.5 per cent p.m. for 36 months.
How much can you borrow?

PMT 12,000
NPER 36 $331,928.21
Rate 1.50% In the white board - We got the answer - Rs.3,31,920
Rs.3,31,928
 COST OF CAPITAL

Computation of Annual Cost before Tax

Rs.
Interest on debt p.a XXX
Add: Issue expenses p.a XXX
Add: Discount on issue p.a XXX
Add: Premium on redemption of debt p.a XXX
(In case of redemption at premium)
XXX
Less: Premium on issue of debt p.a XXX
(In case of issue at premium)
Annual cost before tax XXX

i) While calculating annual cost, the issue exps, discount, premium on redemption & premium on issue are amotized over the tenure of debt.
ii) Issue expenses ( Flotation costs ) are to be calculated at face value (or) the issue price Which ever is higher (WEH)

Flotation cost at 5% FV IP FV IP
Dis 100 90 100 105 Premium

1) A company issue 10% irredeemable debentures of Rs. 10,000. The company is in 50% tax
bracket. Calculate cost of debt capital at par, at 10% discount and at 10% premium

a) Kd = Interest / NP *( 1 - Tax rate)

2) A firm issued 100 10% debentures, each of Rs. 100 at 5% discount. The debentures are to
be redeemed at the end of 10th year. The tax rate is 50%. Calculate cost of debt capital.

Cost of Debt Capital:

interest : 1,000 100*100 10,000
Discount: 500 10%
Maturity : 10 Int 1,000
P: 10,000
NP: (10,000 - 500) 9,500
K db = Annual cost before tax/ Avg value of debt * Tax
Tax = 50% (0.50)
0.108 * .50
 1,000 + (500/10) 1,050 Annual Cost Therefore, K db = 0.0538 (or) 5.38%

(10,000 + 9,500)/2 9,750 (Avg value of Debt)

3) Suppose a company named Arts Pvt. Ltd has taken a loan from a bank of Rs.10 million for
business expansion at a rate of interest of 8%, and the tax rate is 20%. Now we will calculate
the cost of debt.

Tax rate = 20%

Loan amt = 1,00,00,000 Kd = Interest exps (1 - tax rate)
Interest = 8% 8,00,000 (1 - 0.20)
8,00,000 (.80)
Interest exps = loan amt * interest Kd = Rs.6,40,000
1,00,00,000 * 8 %
8,00,000

Cost of Redeemable Debt

Kinley Ltd, issued 50,000 10 % debentures of Rs.100 each, redeemable in 10 years times at 10% premium. The cost of issue was 2.5 %. The
company's income tax rate is 35%. Determine the cost of debt (before as well as after tax) if they were issued (a) at par, (b) at a premium of 5% and (c)
at a discount of 10%.

C) Debentures isued at discount of

a) Debentures isued at par and redeemable at b) Debentures isued at premium of 5% 10% and redeemable at a premium
a premium of 10% and redeemable at a premium of 10% of 10%

i) Calculation of Annual Cost: Rs. i) Calculation of Annual Cost: Rs. i) Calculation of Annual Cost: Rs.

Interest (50,00,000 * 10%) 5,00,000 Interest (50,00,000 * 10%) 5,00,000 Interest (50,000 * 100 = 50,00,000)
Add: Cost of issue: Add: Cost of issue: (50,00,000 * 10/100) 5,00,000
50,00,000 * 2.5% = 1,25,000 / 10 years 12,500 50,00,000 *105 % = 52,50,000 13,125 Add: Cost of Issue (p.a)
Premium on redemption 52,50,000 * 2.5% = 1,31,250/ 10 yrs (50,00,000 * 2.5 /100 = 1,25,000)
50,00,000 * 10% = 5,00,000 / 10 yrs 50,000 Premium on redemption (1,25,000 / 10 yrs) 12,500
Annual cost before tax 5,62,500 50,00,000 * 10% = 5,00,000 / 10 yrs 50,000 Add: Premium on redemption
Less: Tax (5,62,500 *35%) 1,96,875 5,63,125 (50,00,000 * 10/ 100 = 5,00,000) 50,000
Annual cost after tax 3,65,625 Less: Prem on issue (5,00,000 / 10 Yrs)
50,00,000 * 5% = 2,50,000 / 10 yrs 25,000 Add: Dis on Issue
ii) Calcualtion on Average value of debt: Annual cost before tax 5,38,125 (50,00,000 * 10% p.a) 50,000
Gross Proceeds(50,000 * 100) 50,00,000 Less: Tax (5,3,125 *35%) 1,88,344 Annual Cost before tax 6,12,500
Less: Cost of issue (50,00,000 *2.5%) 1,25,000 Annual cost after tax 3,49,781 Less: Tax @ 35%
Net Proceeds 48,75,000 ii) Calcualtion on Average value of debt: (6,12,500 * 35 /100) 2,14,375
Gross Proceeds(50,000 * 105) 52,50,000 Annual Cost after tax 3,98,125
Redeemable value = 50,00,000 * 110% : Rs.55,00,000 Less: Cost of issue (50,00,000 *2.5%) 1,31,250
Net Proceeds 51,18,750 ii) Calculation of Average value of debt
Avg value = (Net Proceeds + Redeemable value) / 2 Gross Proceeds (50,000 * 90) 45,00,000
(48,75,000 + 55,00,000 ) / 2 Redeemable value = 50,00,000 * 110% : Rs.55,00,000 Less: Cost of Issue 1,25,000
Rs.51,87,500 Net Proceeds 43,75,000
Avg value = (Net Proceeds + Redeemable value) / 2
Cost of debt before tax( K db) (51,18,750+ 55,00,000 ) / 2
(Annual Cost before tax / Avg value of debt ) * 100 Rs.53,09,375 Redeemable value = 50,00,000 * 110 %
(5,62,500 / 51,87,500 ) * 100 Rs.55,00,000
10.84% Cost of debt before tax( K db)
(Annual Cost before tax / Avg value of debt ) * 100 Average value = (Net Proceeds + Redeemable value) / 2
Cost of debt after tax( K da) (5,38,125 / 53,09,375) * 100 (43,75,000 + 55,00,000) / 2
(Annual Cost after tax / Avg value of debt ) * 100 10.14% Rs.49,37,500
(3,65,625 / 51,87,500 ) * 100
7.05% Cost of debt after tax( K da) Cost of debt before tax (K db)
(Annual Cost after tax / Avg value of debt ) * 100 (Annual cost before tax / Avg value of debt)* 100
(3,49,781/ 53,09,375 ) * 100 (6,12,500 / 49,37500) * 100
6.59% 12.41%

Cost of debt after tax (K da)

(Annual cost after tax / Avg value of debt) * 100
(3,98,125 / 49,37,500 ) * 100
8.06%

Cost of Redeemable Preference Share Capital

Alex Ltd, issued 15,000 12% preference shares of Rs.100. redeemable at 10% premium after 20 years. The flotation costs were 5%. Find out the cost of prefrence capital if
shares are issued (a) at par, (b) at a premium of 5% and (c) at a discount of 10%.

Cost of Redeemable Preference Shares = (Annual Cost / Avg value of RPS) * 100

a) Preference shares isued at par and b) Preference shares isued at premium of 5% and c) Preference shares isued at discount of
redeemable at a premium of 10% redeemable at a premium of 10% 10% and redeemable at a premium of 10%
i) Computation of Annual Cost Rs. i) Computation of Annual Cost Rs. i) Computation of Annual Cost Rs.
Preference Dividend Preference Dividend Preference Dividend
(15,000 * 100 = 15,00,000 * 12%) 1,80,000 (15,000 * 100 = 15,00,000 * 12%) 1,80,000 (15,000 * 100 = 15,00,000 * 12%) 1,80,000
Add: Floatation costs Add: Floatation costs Add: Floatation costs
(15,00,000 * 5% = 75,000/20 yrs) 3,750 (15,000 * 105 = 15,75,000 * 5%) 3,937.5 (15,00,000 * 5% = 75,000/20 yrs) 3,750
Add: Premium on redemption (78,750/ 20 yrs) Add: Premium on redemption
(15,00,000 * 10% = 1,50,000 / 20 yrs) 7,500 Add: Premium on redemption (15,00,000 * 10% = 1,50,000 / 20 yrs) 7,500
Annual Cost 1,91,250 (15,00,000 * 10% = 1,50,000 / 20 yrs) 7,500 Add: Discount on issue
1,91,437.5 (15,000 * 10 = 1,50,000 / 20 yrs) 7,500
ii) Computation of Avg value of RPS Less: Premium on issue: Annual Cost 1,98,750
Issue Price (15,000 * 100) 15,00,000 (15,000 * 5 = 75,000 / 20 yrs) 3,750
Less: Floatation cost Annual Cost 1,87,687.5 ii) Computation of Avg value of RPS
(15,00,000 * 5%) 75,000 Issue Price (15,000 * 90) 13,50,000
Net Proceeds 14,25,000 ii) Computation of Avg value of RPS Less: Floatation cost
Issue Price (15,000 * 105) 15,75,000 (15,00,000 * 5%) 75,000
Redemption Value: 15,00,000 * 110% Rs.16,50,000 Less: Floatation cost Net Proceeds 12,75,000
(15,75,000 * 5%) 78,750
Avg value of RPS = (NP + RV) / 2 Net Proceeds 14,96,250 Redemption Value: 15,00,000 * 110% Rs.16,50,000
(14,25,000 + 16,50,000) / 2
Rs.15,37,500 Redemption Value: 15,00,000 * 110% Rs.16,50,000 Avg value of RPS = (NP + RV) / 2
(12,75,000 + 16,50,000) / 2
Cost of Redeemable Pref Sh Capital (Kp) = Avg value of RPS = (NP + RV) / 2 Rs.14,62,500
(1,91,250 / 15,37,500) * 100 (14,96,250 + 16,50,000) / 2
K p = 12.44% Rs.15,73,125 Cost of Redeemable Pref Sh Capital (Kp) =
(1,98,750/ 14,62,500) * 100
Cost of Redeemable Pref Sh Capital (Kp) = Kp = 13.59%
(1,87,687.5/ 15,73,125) * 100
Kp = 11.93%

Cost of Irredeemable Preference Share Capital

Hatsun Ltd issued 60,000 15% irredeemable preference shares of Rs.100 each. The issue expenses were Rs.60,000. Determine the cost of preference capital if
shares are issued (a) at par, (b) at a premium of 10% and ( c) at a discount of 5%.

Cost of Irredeemable Preference Share Capital = (Annual Pref Dividend / Net Proceeds ) * 100

i) Pref Shares issued at par value: ii) Pref Shares issued at premium of 10%: ii) Pref Shares issued at discount of 5%:

Annual Pref Dividend = 60,000 * 100 = 60,00,000 * 15% = Rs.9,00,000 Annual Pref Dividend = 60,000 * 100 = 60,00,000 * 15% = Rs.9,00,000 Annual Pref Dividend = 60,000 * 100 = 60,00,00

Gross Proceeds(60,000 * 100) 60,00,000 Gross Proceeds(60,000 * 110) 66,00,000 Gross Proceeds (60,000 * 95
57,00,000
Less: Issue Exps 60,000 Less: Issue Exps 60,000 Less: Issue Exps 60,000
Net Proceeds 59,40,000 Net Proceeds 65,40,000 Net Proceeds 56,40,000

Cost of irredeemable Pref sh cap: (9,00,000/ 59,40,000) *100 Cost of irredeemable Pref sh cap: (9,00,000/ 65,40,000) *100 Cost of irredeemable Pref sh cap: (9,00,000/ 56
Kp = 15.15% Kp = 13.76% Kp = 15.96%

Note: Preference dividend is not an allowed expense for computation of tax. Hence, Cost of preference share capital before and after tax is same.
 Cost of Equity - Dividend Yield Method
AK ltd has a stable income and stable dividned policy. The average annual dividend payout is Rs.25 per share ( face
value: Rs.100). You are required to ascertain:
a) Cost of equity capital
b) Cost of equity capital if the market price of the share is Rs.150
c) Expected market price in year 2 if cost of equity is expected to rise to 20%
d) Dividend payout in year 2 if the company were to have an expected market price of Rs.160 per share, at the existing cost of equity.

b) Cost of equity capital if the market c) Computation of market price if Ke = d) Computation of dividend per share if
a) Cost of Equity Capital: market price is Rs.160 at the existing cost
price of the share is Rs.150 20%
of equity
Ke = Cost of Equity Capital Ke = D1 / MP Ke = D1/ MP Ke = D1 / MP
D1 = Expected Dividend Per Share D1 = Rs.25 20% = 25 / MP 25% = D1 / 160
NP = Net Proceeds MP = Rs.150 0.20 = 25 / MP D1 = 160 * 25 %
MP = Market Price MP = 25/ 0.20 D1 = Rs.40
Ke = (25/150) * 100 MP = Rs.125
Ke = D1 / NP Ke = 16.67%
D1 = Rs.25 Therefore, Expected MP is Rs.125. Therefore, Expected dividend per shar
NP = 100

Ke = (25 /100)* 100

Ke = 25%

Cost of Equity - Dividend Yield Method + Growth Method

RHR Ltd pays a dividend of Rs.4 per share. Its shares are quoted at Rs.40 presently and investors expect a growth rate of 10% per annum. Calculate (a)Cost of
equity capital, (b) expected market price per share if anticipated growth rate is 11% and (c) Market price if dividend is Rs.4, cost of capital is 16% and growth rate
is 10%.

a) Computation of Cost of Equity (Ke) b) if growth rate is 11% c) Computation of MP if D1 = Rs.4, Ke = 16% & g = 10%

Ke = (D1 / MP) + g MP = Rs.44.44 MP = Rs.66.67

D1 = Rs.4
MP = Rs.40
g = 10%

Ke= 20%

X buys the shares of Y Co.ltd for Rs.210 each. He expects the company to pay dividends of Rs.10.50, Rs.11.025 and Rs.11.575 in three years repsectively. He
further expects that the market price be Rs.243.10 at the end of 3 years. Determine (a) growth in rate of dividend, (b) current dividend yield and (c) cost of equity.
a) Computation of growth in rate of dividend b) Current dividend yield
The dividend of Rs.10.50 has increased to Rs.11.575 over a period of 2 yrs.
Current dividend yield = (Expected dividend / Current Price) * 100
The compound factor = 11.575/ 10.50 (10.50 / 210 ) * 100
1.102 CDY = 5%
In the compound factor table, if 1.102 for 2 years will be 5% as a growth rate

Therefore, the growth in the rate of dividend is 5%.

c) Computation of Cost of Equity (Ke)

Ke = (D1/ MP ) + g
D1 = Rs.10.50 Ke = {(10.50 / 243.10) * 100 } + 5%
MP = Rs.243.10 Ke = 4.32 + 5%
g = 5% Ke = 9.32%

Weighted Average Cost of Capital (WACC)

Following information is available with regards to the capital structure of Edwards Ltd
Amount in
Rs. After tax cost of Capital %
Debentures 12,00,000 5%
Pref Share Capital 4,00,000 10%
Equity Share Capital 8,00,000 15%
Retained Earnings 16,00,000 12%
You are required to calculate WACC.

Statement of showing Weighted Average Cost of Capital

After tax
cost of Weighte
Amount in Capital % d Cost
Source (1) Rs. (2) Weights (3) (4) (5 = 3*4)
Debentures 12,00,000 12/40 = 0.30 5 1.5
Pref Share Capital 4,00,000 4/40 = 0.10 10 1.0
Equity Share Capital 8,00,000 8/40 = 0.20 15 3.0
Retained Earnings 16,00,000 16/40 = 0.40 12 4.8
40,00,000 10.30

Hence, the capital structure of Edwards ltd shows the WACC is 10.30%
2) Pranav Industrial Ltd. has assets of Rs.1,60,000 which has been financed with Rs.52,000 of debt and Rs.90,000 of equity and a general reserve of Rs.18,000.
The firm's total profits after interest and taxes for the year ended 31st March 2017 were Rs.13,500. It pays 8% interest on borrowed funds and is in the 50% tax
bracket. It has 900 equity shares of Rs.100 each selling at a market price of Rs.120 per share. Determine the weighted average cost of capital.

a) Computation of cost of debt after tax c) Statement showing WACC

After tax
cost of
Amount Weighted Cost
Capital %
% Source (1) in Rs. (2) Weights ( (5 = 3*4)
(4)
Int on Debt 8 Eq sh Capital 90,000 0.5625 12.5 7.03
Less: Tax (50% of 8) 4 Gen Reserve 18,000 0.1125 12.5 1.41
Cost of debt after tax 4 Debt 52,000 0.325 4.0 1.30
1,60,000 9.74
b) Computation of cost of equity capital
Ke = (EPS/ MP) * 100 Note: The cost of equity capital (i.e, 12.5%) is to be taken as cost of retained earnings/ general reserve
EPS = Profit after tax / No of equity shares
13,500 / 900 Therefore, the weighted average cost of capital for Pranav Industrial Ltd is 9.74%
Rs.15 per share

MP = Rs.120

Ke = (15 /120)*100
Ke = 12.5%

3) From the following capital structure of a company, compute the overall cost of capital using (i) Book
value weights & (ii) Market value weights
Book value (Rs.) Market value (Rs.)
Eq Share Capital (Rs.10 per share) 45,000 90,000
Retained earnings 15,000 Nil
Preference share capital 10,000 10,000
Debentures 30,000 30,000
The after tax cost of different sources of finance is as follows:
Eq Share Capital 14%
Retained earnings 13%
Preference share capital 10%
Debentures 5%

Statement showing WACC ( Book Value Weights) Statement showing WACC ( Market Value Weights)
After tax
cost of Weighte After tax Weighte
Amount in Capital % d Cost Amount in cost of d Cost
Source (1) Rs. (2) Weights (3) (4) (5 = 3*4) Source (1) Rs. (2) Weights (3) Capital % (4) (5 = 3*4)
Eq Share Capital 45,000 0.45 14 6.30 Eq Share Capital 90,000 0.692 14 9.69
Retained earnings 15,000 0.15 13 1.95 Pref share capital 10,000 0.077 10 0.77
Pref share capital 10,000 0.10 10 1.00 Debentures 30,000 0.231 5 1.16
Debentures 30,000 0.30 5 1.50 1,30,000 11.62
1,00,000 10.75%

Therefore, WACC under book value weights is 10.75% Therefore, WACC under market value weights is 11.62%

4) NIVEA Ltd. wishes to raise additional finance of Rs.30 Lakh for meeting its investment plans. It has Rs.6,00,000 in the form of retained earnings
available for investment purposes. The following are the further details:
i) Debt/Equity Mix 40 % : 60 %
ii) Cost of debt: a) Determination of Pattern for raising the additional finance b) Cost of debt after tax
Upto Rs.5,00,000 12% (Before tax) Rs.
Beyond Rs.5,00,000 16% (Before tax) Debt : 30,00,000 * 40% 12,00,000 Kda = (Int after tax/ Net Proceeds) * 100
iii) EPS Rs.5 Equity: 30,00,000 * 60% 18,00,000
iv) Dividend Payout 60% of the earnings For Rs.5,00,000 = 60,000 - 24,000 (5,00,000 * 12% = Rs.60,000
v) Expected growth rate in dividend 8% Detailed Pattern: (36,000/ 5,00,000)*100 60,000 * 40% = Rs.24,000
vi) Current Market price of the share Rs.50 Debt 12% 5,00,000 Kda = 7.2 %
vii) Tax rate 40% Debt 16% 7,00,000
you are required to determine Retained earnings 6,00,000 For Rs.7,00,000 = 1,12,000 - 44,800 (7,00,000 * 16% = Rs.1,12,0
a) The pattern for raising the additional finance Equity 12,00,000 (67,200 /7,00,000) * 100 1,12,000 * 40% = Rs.44,800
b) The post - tax average cost of additional debt 30,00,000 Kda = 9.6%
c) The cost of retained earnings and cost of equity, and
d) The overall weighted average after tax cost of additional finance. Avg cost of Additional Debt = (7.2 + 9.6) / 2
8.40%

c) Determination of cost of retained earnings and cost of

equity applying the dividend growth method d) Statement showing WACC
After tax cost Weighted
Amount of Capital % Cost (5 =
Source (1) in Rs. (2) Weights (3) (4) 3*4)
Ke = (D1 / MP) + g
Equity ( including
Retained earnings) 18,00,000 18/30 = 0.6 14.48 8.688
D1= Expected dividend per share (5 * 60%) Rs.3.00 Debt 12,00,000 12/30 = 0.4 8.4 3.36
Growth in dividend ( 3 * 8%) Re.0.24 30,00,000 12.048
D1 3.24
MP 50

Therefore, the overall weighted average after tax cost of additional finance is 12.048 %
Ke = ((3.24 / 50)) * 100) + 8%
14.48
Ke = 14.48%
 LEVERAGE

1) A firm sells its only product at Rs.12 per unit. Its variable cost is Rs.8 per unit. Present sales are
1,000 units. Calculate the operating leverage in each of the following situations:
a) When fixed cost is Rs.1,000
b) When fixed cost is Rs.1,200
c) When fixed cost is Rs.1,500

Profitability Statement
Situation Situation II Situation
Particulars I (Rs.) (Rs.) III (Rs.)
Sales (1000 * 12) 12,000 12,000 12,000
Less: Variable cost
(1000 *8) 8,000 8,000 8,000
Contribution 4,000 4,000 4,000
Less:Fixed Cost 1,000 1,200 1,500
Operating Profit (EBIT 3,000 2,800 2,500
Operating Leverage:
Contribution / EBIT 1.33 times 1.43 times 1.6 times

Interpretation: From this analysis, it is clearly evident that the operating

leverage is increasing with the every increase in the fixed cost

2) From the following information, calculate operating leverage:

No of units produced and sold: 30,000 Profitability Statement (Rs.) Profitability Statement (Rs.)
Selling price per unit: Rs.20 Particulars Particulars
Variable cost per unit: Rs.10 Sales (30,000 * 20) 6,00,000 Sales (30,000 * 20) 6,00,000
Fixed cost per unit at current level of sales is Rs.5. What will be the Less: Variable cost Less: Variable cost
new operating leverage if the variable cost is Rs.12 (30,000 * 10) 3,00,000 (30,000 * 12) 3,60,000
Contribution 3,00,000 Contribution 2,40,000
Less:Fixed Cost (30,000 * 5) 1,50,000 Less:Fixed Cost (30,000 * 5 1,50,000
Operating Profit (EBIT) 1,50,000 Operating Profit (EBIT) 90,000
Operating Leverage: Operating Leverage:
Contribution / EBIT 2 times Contribution / EBIT 2.66 times
3) The capital structure of Tom Gilbert Ltd. consists of the following securities:
Rs.
45,000 10% Preference shares of Rs.100 each 45,00,000
5,00,000 Equity shares of Rs.10 each 50,00,000
The company's operating profit is Rs.12,00,000. The company is in 40% tax bracket.
You are required to find out the financial leverage of the company. What would be the
new financial leverage if the operating profit increases to Rs.18,00,000 and interpret
your results

Statement showing Earnings before tax Statement showing Earnings before tax
Rs. (If the Operating profit is Rs.18,00,000)
EBIT 12,00,000 Rs.
Less: Preference dividend 7,50,000 EBIT 18,00,000
(Pre tax basis) Less: Preference dividend 7,50,000
(45,00,000 * 10% = Rs.4,50,000 * 100/60) (Pre tax basis)
EBT 4,50,000 (45,00,000 * 10% = Rs.4,50,000 * 100/60)
EBT 10,50,000
Fin. Leverage = EBIT / EBT : 2.67 times
(12,00,000 / 4,50,000) Fin. Leverage = EBIT / EBT : 1.71 times (18,00,000 / 10,50,000)

Interpretation: The present financial leverage is 2.67 times. It means 1% change in EBIT will cause 2.67% change in EBT in the same direction.
For example, in the present case EBIT has increased by 50% (i.e.,Rs.12 Lakhs to Rs.18 Lakhs). In the case of EBT, it has resulted in 75% increased
(i.e., from Rs.4.5 lakhs to Rs.10.5 lakhs)

4) Ascertain financial leverage from the information given below:

Networth = Rs.20,00,000
Debt/Equity ratio = 3:1
Interest rate = 10%
Operating Profit = Rs.18,00,000

Financial Leverage = EBIT / EBT

i) Calculation of amount of debt: ii) Calculation of EBT

 Debt/ Equity = 3/1 EBIT 18,00,000
Less: Int on debt 6,00,000 FL = 18,00,000/12,00,000
Therefore, Equity =1 = Rs.20,00,00 (60,00,000 * 10%) FL = 1.5 times
EBT 12,00,000
Debt =(20,00,000 / 1 )*3
: Rs.60,00,000

5) Pierre Blondin Ltd has sales of Rs.12 Lakh. The variable cost is 50% of sales, while the fixed cost amounts to Rs.
3,60,000. The amount of interest on long term debt is Rs.1,20,000.
You are required to calculate the combined leverage and illustrate its impact if sales increases by 10%.

Profitabilty Statement rofitabilty Statement ( if sales increase by 10%

Rs. Rs.
Sales 12,00,000 Sales (12,00,000 * 110%) 13,20,000
Less: variable cost 6,00,000 Less: variable cost (13,20,000 * 50 6,60,000
Contribution 6,00,000 Contribution 6,60,000
Less: Fixed cost 3,60,000 Less: Fixed cost 3,60,000
EBIT 2,40,000 EBIT 3,00,000
Less: Int on debt 1,20,000 Less: Int on debt 1,20,000
EBT 1,20,000 EBT 1,80,000

Combined Leverage = Contribution / EBT It is evident that on account of increase in sales by 10%, the EBT has increased by 50%.
6,00,000 / 1,20,000 This can be verified as given below,
CL = 5 times
Percentage of Increase in Profit = (Inc in Profit / Base Profit)* 100
The combined leverage of 5 times indicates that with (60,000 / 1,20,000)* 100
every increase Re.1 in sales, the EBT will increase by Rs.5 : 50%

6) The following figures relate to two companies. You are required to (a) calculate the operating,
financial and combined leverages of the two companies and (b) comment on their relative risk position.
X Ltd (in R Y Ltd (in Rs.)
Sales 4,00,000 8,00,000
Less: Variable cost 1,60,000 2,40,000
Contribution 2,40,000 5,60,000
Less: Fixed cost 1,28,000 2,80,000
Operating Profit (EBIT 1,12,000 2,80,000
Less: Interest 48,000 1,20,000
Profit before tax 64,000 1,60,000

i) Operating Leverage: Contribution / EBIT

For X Ltd: 2,40,000 / 1,12,000

2.14 times

For Y Ltd: 5,60,000 / 2,80,000

2 times

Analysis: The Operating Leverage is higher for X Ltd, compared to the Y ltd. Hence, X Ltd has a greater degree of business risk

ii) Financial Leverage: EBIT / EBT

For X Ltd: 1,12,000 / 64,000

1.75 times

For Y Ltd: 2,80,000/1,60,000

1.75 times

Analysis: Both companies have the same degree of financial risk. It means the tendency of residual net income (EBT) to vary
disproportionately with the net income (EBIT) is the same in case of both the companies.

iii) Combined Leverage: Contribution / EBT

For X Ltd: 2,40,000 / 64,000

3.75 times
For Y Ltd: 5,60,000/ 1,60,000
3.50 times

Analysis: Overall business risk is slightly high for X ltd. due to high degree of operating leverage even if degree of financial leverage is the same.
 Capital Budgeting
Payback Period Method

1) Project CD has an initial investment of Rs.5,00,000. Its cash flows for 5 years are Rs.
1,50,000, Rs.1,80,000, Rs.1,50,000, Rs.1,32,000 and Rs.1,20,000.
Determine the payback period.

Computation of Payback period( Differntial CFAT) 1,50,000 1,80,000 1,50,000 1,32,000 1,20,000
Since the cash inflows are not uniform, cumulative cash inflows have
to be ascertained to calculate payback period

Statement showing cumulative cash flows

Year CFAT (Rs.) Cumulative CFAT (Rs.)
1 1,50,000 1,50,000
2 1,80,000 3,30,000
3 1,50,000 4,80,000
4 1,32,000 6,12,000
5 1,20,000 7,32,000

The initial investement id Rs.5,00,000 , Rs.4,80,000 can be recoevered in three years.

The remaining Rs.20,000 is to be recovered in the 4th year

Time required for earning Rs.1,32,000 in the fourth year = 12 months

Time required to earn Rs.20,000 in the fourth year = 12/1,32,000

1.81 months (2 Months)

Payback Period = 3 years, 2 months

2) A company has to choose one of the following two mutually exclusive projects. Investment required for each project is Rs.1,50,000. Both
the projects have to be depreciated on straight line basis. The tax rate is 50%
Profit before depreciation
Year Project X (in Rs.) Project Y (in Rs.)
1 42,000 42,000
2 48,000 45,000
3 70,000 40,000
4 70,000 50,000
5 20,000 1,00,000
Calculate Payback Period.
 Project X Project Y
Statement showing CFAT & Cumulative CFAT (in Rs.) Statement showing CFAT & Cumulative CFAT (in Rs.)
PAT CFAT Cum
Profit before Dep Depreciation (1,50,000 / PBT {3 PAT CFAT Cum CFAT Profit before Dep & Depreciation PBT (50%) {5 = CFAT
Year & Tax {1} 5) {2) = 1-2) (50%) {4} {5 = 1-4} {6} Year Tax {1} (1,50,000 / 5) {2) {3 = 1-2) {4} 1-4} {6}
1 42,000 30,000 12,000 6,000 36,000 36,000 1 42,000 30,000 12,000 6,000 36,000 36,000
2 48,000 30,000 18,000 9,000 39,000 75,000 2 45,000 30,000 15,000 7,500 37,500 73,500
3 70,000 30,000 40,000 20,000 50,000 1,25,000 3 40,000 30,000 10,000 5,000 35,000 1,08,500
4 70,000 30,000 40,000 20,000 50,000 1,75,000 4 50,000 30,000 20,000 10,000 40,000 1,48,500
5 20,000 30,000 -10,000 -10,000 20,000 1,95,000 5 1,00,000 30,000 70,000 35,000 65,000 2,13,500

The above table shows that in 3 years , Rs.1,25,000 has been recovered. Rs.25,000 is left out of the The above table reveals that Rs.1,48,500 has been recovered in 4 years. Rs.1,500 is left out of
initial investment. In the 4th year , the CFAT is Rs.50,000. It means the payback period is between third the initial investment. In the 5th year , the CFAT is Rs.65,000. It means the payback period is
and fourth years. between fourth and fifth years.

Therefore, Payback period for Project X = 3 years + (25,000 / 50,000) * 12 Therefore, Payback period for Project X = 4 years + (1,500 / 65,000) * 365 days
3 Yrs 6 Months 4 Yrs 9 days.

Net Present Value: Present Value of cash Inflows - Present value of cash outflows

Accept project if NPV is positive, else reject.

If both are positive, the project with higher NPV should be preferred.

PV of cash inflows = CFAT (Cash flows after tax) * PV factor

PV of cash outflows = Cash outflows * PV factor

Discount (PV) Factor = 1 / (1+r)n

1) An investment of Rs.10,000 (having scrap value of Rs.500) yields the following returns
Year 1 2 3 4 5
CFAT 4,000 4,000 3,000 3,000 2,500
The cost of capital is 10% , Is the investment desirable? Discuss it according to NPV method assuming the
PV factors for 1st, 2nd, 3rd, 4th and 5th Year - 0.909, 0.826, 0.751, 0.683 and 0.620 respectively.

Statement showing NPV

 PV Present
Factor value
Year CFAT (Rs.) @ 10% (Rs.)
1 4,000 0.909 3636
2 4,000 0.826 3304 Note: The scrap value is taken as an additional inflow at the end of the fifth year
3 3,000 0.751 2253
4 3,000 0.683 2049 Analysis: Since the value of NPV is Positive i.e., Rs.3,102. Hence, the investment is desirable.
5 2,500 0.620 1550
Scrap 500 0.620 310
Total PV of Cash inflows 13,102
Less: PV of cash outflows 10,000
NPV 3,102

2) Bimetal Ltd, is considering two different investment proposals D & J. The details are as under,
Proposal D Proposal J
Investment cost 1,90,000 4,00,000
CFAT Year 1 80,000 1,60,000
Year 2 80,000 1,60,000
Year 3 90,000 2,40,000
Sugeest the most attractive proposal on the basis of NPV Method considering that the future incomes
are discounted at 12%

Statement showing NPV

CFAT Present Value (Rs.)
Year D J P.V Factor D J
1 80,000 1,60,000 0.893 71440 1,42,800
2 80,000 1,60,000 0.797 63760 1,27,520
3 90,000 2,40,000 0.712 64080 1,70,880
Total PV of Cash inflows 1,99,280 4,41,280
Less: PV of cash outflows 1,90,000 4,00,000
NPV 9,280 41,280

Interpretation: NPV is more in Proposal J and therefore, it should be accepted.

Internal Rate of Return Method (IRR)

It is the rate of return at which the sum of discounted cash inflows equal the sum of discounted of cash outflows.

It is the rate at which the NPV of the investment is zero.

This method is also known as Marginal rate of return or Time adjusted rate of return method.
 a) when cash inflows are uniform

F = I /C
Therefore, F - Factors to be located
I-Initial invesment
C = Cash inflow per year

b) when cash inflows are not uniform

IRR = Lower rate + (Positive NPV / Diff in PV of CFAT)* Diff in rate

3) The cash flows of two mutually exclusive projects are as under

(in Rs.)
t0 t1 t2 t3 t4 t5 t6
Project P -40,000 13,000 8,000 14,000 12,000 11,000 15,000
Project J -20,000 7,000 13,000 12,000 _ _ _
Required:
i) Estimate the NPV of the project P and J using 15% as the hurdle rate
ii) Estimate the IRR of the project P and J
iii) Why there is a conflict in the project choice by using NPV and IRR criteria?
iv) Which criterion you will use in such a situation? Estimate the value at that criterion. Make a project choice.

i) Statement showing Net Present Value (NPV) ii) Computation of Internal rate of Return (IRR)
CFAT (in Rs.) Present Value (in Rs.)
Since both the projects yield a positive NPV at 15%, a higher discount should be used to get the negative NPV
which is essential for calculation of exact IRR. Alternatively, 24% & 26% discount rates are chosen for projects
Year P J PVF (15%) P J P & J respectively.
1 13,000 7,000 0.870 11310 6090
2 8,000 13,000 0.756 6048 9828 Statement showing NPV
3 14,000 12,000 0.658 9212 7896 Project P Project J
4 12,000 _ 0.572 6864 _ Year CFAT (in Rs. PVT 24% PV (in Rs.)
CFAT (in Rs.)PVT 26% PV (in Rs.)
5 11,000 _ 0.497 5467 _ 1 13,000 0.806 10478 7,000 0.794 5558
6 15,000 _ 0.432 6480 _ 2 8,000 0.650 5200 13,000 0.630 8190 PV Factor = 1 / (1 + r)
P.V of CFAT 45,381 23,814 3 14,000 0.524 7336 12,000 0.500 6000 1 / (1+0.26) 0.794
Less: PV of cash outflow 40,000 20,000 4 12,000 0.423 5076 _
(40,000 * 1) (20,000 * 1) 5 11,000 0.341 3751 _ 1 / (1+0.26) 0.630
NPV 5,381 3,814 6 15,000 0.275 4125 _
P.V of CFAT 35,966 19,748 1 / (1+0.26) 0.500
Less: PV of cash outflow 40,000 20,000
(40,000 * 1) (20,000 * 1)
NPV -4,034 -252
 IRR = Lower rate + (Positive NPV / Diff in PV of CFAT)* Diff in rate

Proj P (45,381 - 35,966 = 9,415) Project P = 15 + (5,381 / 9,415) * 9 Project J = 15 + (3,814 / 4,066) * 11
(24 - 15 = 9) 15 + (0.5715 * 9) 15 + (0.9380 * 11)
15 + 5.1438 15 + 10.3182
Proj J (23,814 - 19,748 = 4,066) IRR of Proj P = 20.14% IRR of Proj J = 25.32%
iii) Statement showing comparison of NPV & IRR (26 - 15 = 11)

Project P J iv) Resolving the conflict - Project Choice

NPV @ 15% (in Rs.) 5,381 3,814 In case of conflict between NPV & IRR, the NPV criterion should generally be preferred. Hence, Project P,
Rank based on NPV I II whose NPV is Rs.5,381 will be preferred in the above case. However, in this case, project P and J have
IRR 20.14% 25.32% differential lives and hence equivalent annual flows will be a better criterion for project ranking.
Rank based on IRR II I
Project life 6 Years 3 Years Equivalent annual flows = NPV / Annuity factor at 15% for the relevant project life
Inittial Investment 40,000 20,000
Project P = 5,381 / 3.7845
Reason for Conflict: : Rs. 1,422
The difference/ Conflict in ranking between NPV and IRR is attributed to: Project J = 3,814 / 2.2832
a) Disparity in the initial investment : Rs.1,670
b) Difference in the project lives Analysis: The annual equivalent of Project J is higher than Project P. Hence, Project J can be preferrable.
c) Non uniform cash inflows of the project.

4) A machine costs Rs.20,000 and is expected to yield the following net cash returns (estimated in current prices). Evaluate the proposal
Year 1 2 3
Cash returns (Rs.) 10,000 16,000 12,000
The firm expects inflation to be at the rate of 5% p.a., and the cost of capital is 10% p.a. (in real terms).

The future cash flows are given in current prices and the inflation rate is 5% p.a. So, the future cash flows in money term would be as follows

Computation of Money Cash Flow

Year Cash Flow (Rs.) Inflation Factor Money Cash flow (Rs.)
1 10,000 (1.05)1 10,500
2 16,000 (1.05)2 17,640
3 12,000 (1.05)3 13,892

Computation of PV factor @ 10% adjusted by the inflation factor i.e., 5%

PVF at 10%: Year 1 : 0.909, 2: 0.826, 3 : 0.751

PVF after adjusting with inflation factor

Year 1 = 0.909 / 1.05 0.866

Year 2 = 0.826 / (1.05)2 0.749
Year 3 = 0.751/ (1.05)3 0.649

Computation of Inflation adjusted NPV

Year Money Cash flow (RsPVF @ 10% PV
1 10,500 0.866 9,093
2 17,640 0.749 13,212
3 13,892 0.649 9,016
Total PV of money cash flows 31,321
Less: PV of cash outflow (20,000 * 1) 20,000
NPV 11,321

Analysis/ Interpretation: As the project have the positive NPV of Rs.11,321, Hence it is acceptable.

3) CT Ltd is considering the purchase of a new machine. Two alternative machines are available, X & Y each costing Rs.78,000. the cash inflows are expected to be as follows,
Year Cash Inflows
X Y
1 35,000 45,000
2 35,000 33,000
3 22,000 22,000
4 12,000 12,000
The company has the expected return on capital of 10%. Risk premium rates are 4% and 8% respectively for Machine X & Y. Which machine should be preferred?

Statement of Net Present Value of Machine X Statement of Net Present Value of Machine Y

PV Factor (Risk PV Factor (Risk

adjusted rate of Present adjusted rate of Present
Year CFAT (in R 14% {10% + 4%) Value Year CFAT (in Rs 18% {10% + 8%) Value
1 35,000 0.877 30695 1 45,000 0.847 38115
2 35,000 0.769 26915 2 33,000 0.718 23694
3 22,000 0.675 14850 3 22,000 0.609 13398
4 12,000 0.592 7104 4 12,000 0.516 6192
Total P.V of cash inflows 79,564 Total P.V of cash inflows 81,399
Less: P.V of cash outflow 78,000 Less: P.V of cash outflow 78,000
Net Present Value 1,564 Net Present Value 3,399
Interpretation: From the above analysis, it is revealed NPV of Machine Y is greater than Machine X, Hence Machine Y should be preferred by the Company.
The following items have been extracted from the liabilities side of the balance sheet of Nelson Ltd as on 3
Rs.
Paid up capital:
2,00,000 equity shares of Rs.10 each 20,00,000
Reserves & Surplus 30,00,000
Loans:
15% Non convertible debentures 10,00,000
14% institutional loans 30,00,000
Other information about the company as relevant is given below:
Year ended 31st DDividend Per Sha Earnings Per SharAvg MP per share(Rs.)
2016 4.00 7.50 50.00
2015 3.00 6.00 40.00
2014 4.00 4.00 30.00
Compute the WACC using book value as weights and Price/Earnings (P/E) Ratio as the basis of cost of eq