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BRILLIANT’S Capital Structure Theories 353

(i) Determine the current value of the firm using the Traditional Valuation Approach.
nma§n[aH$ d¡ë¶yEeZ EàmoM H$m Cn¶moJ H$aHo$ g§ñWm Ho$ dV©‘mZ ‘yë¶ H$m {ZYm©aU H$s{OE&
(ii) Determine the firm’s overall capitalization rate, K .
o
g§ñWm Ho$ g§nyU© H¡${nQ>bmBOoeZ aoQ> K H$m {ZYm©aU H$s{OE&
o
(iii) The firm is considering to issue capital of ` 5,00,000 in order to redeem ` 5,00,000 debt.
The cost of debt is expected to be unaffected. However, the firm’s cost of equity capital is
to be reduced to 14% as a result of decrease in leverage. Would you recommend the
proposed action?
g§ñWm <5,00,000 S>oãQ> [aS>r‘ H$aZo Ho$ {bE < 5,00,000 H$m H¡${nQ>b Bí¶y H$aZo H$m {dMma H$a ahr h¡&
S>oãQ> H$s H$m°ñQ> An«^m{dV ahZo H$s Anojm h¡& ¶Ú{n g§ñWm H$s B{³dQ>r H¡${nQ>b H$s H$m°ñQ> brdaoO ‘| H$‘r Ho$
n[aUm‘ñdê$n 14% VH$ KQ>Zm h¡& ³¶m Amn àñVm{dV H$m¶©dmhr H$m gwPmd X|Jo?

Solution:
(i) Value of the firm under Traditional Valuation Approach
(`)
EBIT 4,00,000
Less: Interest @ 10% 1,50,000
NI 2,50,000
NI 2,50,000
S = i.e. = 15,62,500
K e 0.16
B (Value of Debts) 15,00,000
Market value of firm (V) 30,62,500
(ii) Calculation of overall Cost of Capital
EBIT 4,00,000
K = (As the tax rate is not given) = = 0.1306 or 13.06%
o V 30,62,500
(iii) If share capital of ` 5,00,000 is issued to redeem debts of ` 5,00,000 the resultant value
of the firm and K will be as under:
o
(`)
EBIT 4,00,000
Less: Interest @ 10% (on ` 10,00,000) 1,00,000
NI 3,00,000

NI 3,00,000
S = , i.e. = ` 21,42,857
K
e 0.14
B (Market value of debts) 10,00,000
V = 31,42,857