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BRILLIANT’S Capital Structure Theories 369

Solution:
(a) Traditional Approach

Particulars Plan 1 Plan 2 Plan 3 Plan 4 Plan 5 Plan 6 Plan 7 Plan 8

EBIT 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000
Less: Interest 0 4,000 8,000 13,500 20,000 27,500 36,000 56,000
NI 1,00,000 96,000 92,000 86,500 80,000 72,500 64,000 44,000
1,00,000 96,000 92,000 86,500 80,000 72,500 64,000 44,000
S = NI/Ke
0.10 0.105 0.11 0.1160 0.124 0.135 0.16 0.20
S 10,00,000 9,14,286 8,36,364 7,45,690 6,45,161 5,37,037 4,00,000 2,20,000
Add: B 0 1,00,000 2,00,000 3,00,000 4,00,000 5,00,000 6,00,000 7,00,000
V 10,00,000 10,14,286 10,36,364 10,45,690 10,45,161 10,37,037 10,00,000 9,20,000
Ko = EBIT/V 10% 9.86% 9.65% 9.56% 9.57% 9.64% 10% 10.87%

Conclusion: Value of the firm is highest (` 10,45,690) in plan 4. Hence, company should
employ ` 3,00,000 as debt. K at this level is obviously lowest.
o
EBIT (1 t)
(b) M-M Approach V 
U
ke
V  V  Bt (There is no tax in given question)
U
L
1,00,000
Plan 1: Zero Debt V   ` 10,00,000
U
0.10
Since there is no debt, value of the firm will also be `10,00,000.
1,00,000
Plan 2: ` 1,00,000 debt V   ` 9,52,381
U
0.105
V  9,52,381 1,00,000  ` 10,52,381
L
1,00,000
Plan 3: ` 2,00,000 debt V   ` 9,09,091
U
0.11
V  9,09,091 2,00,000  ` 11,09,091
L
1,00,000
Plan 4: ` 3,00,000 debt V   ` 8,62,069
U
0.116
V = 8,62,069 + 3,00,000 = ` 11,62,069
L
1,00,000
Plan 5: ` 4,00,000 debt V   ` 8,06,452
U
0.124
V = 8,06,452 + 4,00,000 = ` 12,06,452
L