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344 Corporate Finance BRILLIANT’S

Solution:
Statement showing the value of company
(Amount in `)
Particulars (1) (2) (3) (4) (5) (6) (7)
Debt Nil 1,00,000 2,00,000 3,00,000 4,00,000 5,00,000 6,00,000
EBIT 2,00,000 2,00,000 2,00,000 2,00,000 2,00,000 2,00,000 2,00,000
Less: Interest Nil 10,000 21,200 33,000 48,000 70,000 1,02,000
EBT 2,00,000 1,90,000 1,78,800 1,67,000 1,52,000 1,30,000 98,000
Less: Tax (50%) 1,00,000 95,000 89,400 83,500 76,000 65,000 49,000
EAT 1,00,000 95,000 89,400 83,500 76,000 65,000 49,000
Equity Capitalization
Rate (K ) 12.0% 12.0% 12.6% 13.0% 13.5% 15.6% 20.0%
e
Market Value of Equity 1,00,000 95,000 89,400 83,500 76,000 65,000 49,000
100 100 100 100 100 100 100
× × × × × × ×
12 12 12.6 13 13.5 15.6 20
8,33,333 7,91,667 7,09,524 6,42,308 5,62,963 4,16,667 2,45,000
Add: Value of Debt Nil 1,00,000 2,00,000 3,00,000 4,00,000 5,00,000 6,00,000
Value of Firm 8,33,333 8,91,667 9,09,524 9,42,308 9,62,963 9,16,667 8,45,000

Conclusion: The company should use debt of ` 4,00,000 in its capital for its capital structure
to maximize the value of the firm.
Illustration 4.2.5
Given: (i) The EBIT of ` 2,50,000 (ii) the corporate tax rate of 50% and (iii) 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:
{X¶m J¶m h¡… (i) EBIT < 2,50,000 (ii) H$m°nm}aoQ Q>¡³g aoQ> 50% VWm (iii) {ZåZ{b{IV S>mQ>m S>oãQ> H$s am{e
H$m {ZYm©aU H$aVm h¡ {Ogo g§ñWm Ho$ ‘yë¶ H$mo A{YH$V‘ H$aZo Ho$ {bE BgHo$ 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 20.0
1,00,000 10.0 12.5
2,00,000 10.5 13.0
3,00,000 11.0 12.5
4,00,000 12.0 13.5
5,00,000 14.0 15.5
6,00,000 17.0 20.0