Page 343 - Corporate Finance PDF Final new link

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BRILLIANT’S Capital Structure Theories 343

Solution:
Statement showing the value of Company and Overall Cost of Capital (in `)

Particulars Existing When debt When debt is
is increased reduced

Debt @ 10% 4,00,000 5,00,000 3,00,000
EBIT 1,00,000 1,00,000 1,00,000
Less: Interest (I) 40,000 50,000 30,000
Earnings to equity holders 60,000 50,000 70,000
Equity Capitalization Rate (K ) 12.50% 12.50% 12.50%
e
60,000 100 50,000 100 70,000 100
Market value of Equity(S)
12.5 12.5 12.5
= 4,80,000 = 4,00,000 = 5,60,000
Market Value of Debt (B) 4,00,000 5,00,000 3,00,000
(V = S + B) 8,80,000 9,00,000 8,60,000
Overall Cost of Capital

 EBIT 100  1,00,000 100 1,00,000 100 1,00,000 100
K =  
o  V  8,80,000 9,00,000 8,60,000

= 11.36% = 11.11% = 11.63%

Illustration 4.2.4
Given EBIT of ` 2,00,000 the corporate tax rate of 50% and the following data, determine the
amount of debt that should be used by the firm in its capital structure to maximize the value of
the firm:
H$m°nm}aoQ> Q>¡³g 50% na < 2,00,000 H$s EBIT VWm {ZåZ{b{IV S>mQ>m {X¶m J¶m h¡, S>oãQ> H$s am{e H$m {ZYm©aU
H$s{OE {Ogo g§ñWm Ûmam ‘yë¶ H$mo A{YH$V‘ H$aZo Ho$ {bE BgH$s H¡${nQ>b ñQ´>³Ma ‘| g§ñWm Ûmam Cn¶moJ {H$¶m OmZm
Mm{hE&

Debt (`) K (before tax) % K %
i e
Nil 10.0 12.0
1,00,000 10.0 12.0
2,00,000 10.6 12.6
3,00,000 11.0 13.0
4,00,000 12.0 13.5
5,00,000 14.0 15.6
6,00,000 17.0 20.0