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370 Corporate Finance BRILLIANT’S

1,00,000
Plan 6: ` 5,00,000 debt V   ` 7,40,741
U
0.135
V = 7,40,741 + 5,00,000 = ` 12,40,741
L
1,00,000
Plan 7: ` 6,00,000 debt V   ` 6,25,000
U
0.16
V = 6,25,000 + 6,00,000 = ` 12,25,000
L
1,00,000
Plan 8: ` 7,00,000 debt V   ` 5,00,000
U
0.20
V = 5,00,000 + 7,00,000 = ` 12,00,000
L
Conclusion: Value of firm is highest in Plan 5. Hence, debt ` 4,00,000 is recommendable as per
MM approach.

Illustration 4.2.14
A firm finances all its investments by 40% debt and 60% equity. The estimated required rate of
return on equity is 20% after taxes and the debt is 8 percent after taxes. The firm is considering an
investment proposal costing ` 40,000 with an expected return that will last forever. What amount
in rupees must the proposal yield per year so that the market price of the share does not change?
EH$ g§ñWm BgHo$ g^r {Zdoem| H$mo 40% S>oãQ> VWm 60% B{³dQ>r Ûmam ’$m¶Z|g H$aVr h¡& B{³dQ>r na [aQ>Z© H$s
AZw‘m{ZV Amdí¶H$ aoQ> 20% h¡ VWm Q>¡³g Ho$ níMmV² S>oãQ> 8 à{VeV h¡& g§ñWm h‘oem MbZo dmbo Ano{jV [aQ>Z© Ho$ gmW
< 40,000 bmJV Ho$ EH$ {Zdoe àñVmd H$m {dMma H$a ahr h¡& àñVmd go à{V df© én¶o ‘| {H$VZr am{e CËnÝZ hmoZm
Amdí¶H$ h¡ {Oggo {H$ eo¶a H$m ~mOma ‘yë¶ Z ~Xbo?
Solution:
Computation of finance, the firm would get for its investment:
40,000 (Cost of investment)

Raised through debt (40%) Raised through equity (60%)
40 60
40,000 × = 16,000 40,000 × = 24,000
100 100
8 20
Cost of debt = 16,000 × Cost of equity = 24,000 ×
100 100
(in ) (in ) `
`
= 1,280 = 4,800

Total Cost
= 6,080 (1,280 + 4,800)`
Total Cost 6,080
% of Total Cost = × 100 = × 100 = 15.20%
Investment 40,000