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368 Corporate Finance BRILLIANT’S

NI ` 55,000
K =  = 27.5%
e S 2,00,000

 B   S 
K = K    K e  
o d    V 
V
K = K (1 – t) = 15% (1 – 0.5) = 7.5%
d i
 6,00,000   2,00,000 
K = 7.5 ×    27.5  
o  8,00,000   8,00,000 
3 1
= 7.5 × + 27.5 × = 5.625 + 6.875
4 4
= 12.5%

Illustration 4.2.13
ABC Manufacturing Co. has a total capitalization of ` 10,00,000 and it normally earns
` 1,00,000 (EBIT) the financial manager of the firm wants to take a decision regarding the capital
structure. After a study if the capital market, he gathers the following data:
ABC ‘¡Ý¶y’o$³M[a¨J H§$nZr H$m Hw$b < 10,00,000 H$m H¡${nQ>bmBOoeZ h¡ VWm ¶h gm‘mݶV… < 10,00,000
(B©~rAmB©Q>r) H$‘mVr h¡, g§ñWm Ho$ ’$m¶Z|{e¶b ‘¡ZoOa H¡${nQ>b ñQ´>³Ma Ho$ g§~§Y ‘| EH$ {ZU©¶ boZm MmhVo h¢& EH$ Aܶ¶Z
Ho$ níMmV² ¶{X H¡${nQ>b ‘mH}$Q> {ZåZ{b{IV S>mQ>m EH${ÌV H$aVm h¡&

Debt (`) Interest Rate % Equity Capitalization Rate % at a given level of debt
(S>oãQ>) (ã¶mO Xa) (S>oãQ> Ho$ EH$ {X¶o J¶o ñVa na B{³dQ>r H¡${nQ>bmBOoeZ aoQ> %)

0 – 10.00
1 Lakh 4.0 10.5
2 Lakh 4.0 11
3 Lakh 4.5 11.60
4 Lakh 5.0 12.40
5 Lakh 5.5 13.5
6 Lakh 6.0 16
7 Lakh 8.0 20

(a) What amount of debt should be employed by the firm if traditional approach is held
valid? / S>oãQ> H$s {H$VZr am{e g§ñWm Ûmam à¶wº$ H$s OmZm Mm{hE ¶{X nma§n[aH$ {d{Y H$mo d¡Y ‘mZm OmVm h¡?
(b) If the Modigliani- Miller approach is followed, what should be the equity capitalization
rate? Assume that corporate taxes do not exist and that the firm always maintains its
capital structure at book values.
¶{X ‘mo{X{½bEZr-{‘ba {d{Y H$m nmbZ {H$¶m OmVm h¡ Vmo B{³dQ>r H¡${nQ>bmBOoeZ aoQ> ³¶m hmoZm Mm{hE? ‘mZm
{H$ H$m°nm}aoQ> Q>¡³g {dÚ‘mZ Zht h¡ VWm {H$ g§ñWm h‘oem ~wH$ d¡ë¶y na BgHo$ H¡${nQ>b ñQ´>³Ma ~Zm¶o aIVm h¡&>