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प्रश्न
Sunrises Ltd. dealing in readymade garments, is planning to expand its business operations in order to cater to international market. For this purpose the company needs additional Rs. 80,00,000 for replacing machines with modern machinery of higher production capacity. The company wishes to raise the required funds by issuing debentures. The debt can be issued at an estimated cost of 10%. The EBIT for the previous year of the company was Rs. 8,00,000 and total capital investment was Rs. 1,00,00,000. Suggest whether issue of debenture would be considered a rational decision by the company. Give reason to justify your answer. (Ans. No, Cost of Debt (10%) is more than ROI which is 8%).
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उत्तर
A company can issue debenture for raising fund if the cost of the debt is less then cost of capital.
In this case, the cost of capital for sunrises limited is 10%, for the total capital of 80,00,000, cost of capital will be 8,00,000 INR.
As per the previous year earnings statement, the company had net earnings of 8,00,000 for the capital investment of 1,00,00,00 , so total ROI for that is mentioned below
`"ROI"= "RETURN" / "INVESTMENT"`
`"ROI" = 800000/10000000 = 8` Percent
Under the assumption that company will operate under the same efficiency, the additional investment of 80,00,000 will be having net ROI of 8% which will be 6,40,000 aganist the cost of debt 8,00,000.
As for the project the cost of debt is 10 % which is generating ROI of 8% , it would not be advisable decision for a company to issue debenture when cost of debt is higher than cost of capital.
संबंधित प्रश्न
Viyo Ltd.' is a company manufacturing textiles. It has a share capital of Rs 60 lakhs. The earnings per share in the previous year was Rs 0.50. For diversification, the company requires additional capital of Rs 40 lakhs. The company raised funds by issuing 10% debentures for the same. During the current year the company earned profit of Rs 8 lakhs on capital employed. It paid tax @ 40%.
a. State whether the shareholders gained or lost, in respect of earning per share on diversification. Show you calculations clearly.
b. Also, state any three factors that favour the issue of debentures by the company as part of its capital structure.
Sakshi Ltd. is a company manufacturing electronic goods. It has a share capital ofRs 120 lakhs. The earning per share in the previous year wasRs 0.5. For diversification, the company requires additional capital ofRs 80 lakhs. The company raised funds by issuing 10% debentures for the same. During the current year the company earned profit ofRs 16 lakhs on capital employed. It paid tax @ 40%.
a. State whether the shareholders gained or lost in respect of earning per share on diversification. Show your calculations clearly.
b. Also state any three factors that favour the issue of debentures by the company as part of its capital structure.
What is meant by Capital Structure?
How does cost of equity affect the choice of capital structure of a company? Explain
Explain the following as factors affecting the choice of capital structure:
Cost of equity
Explain the following as factors affecting the choice of capital structure:
Return on Investment
Explain the following as factors affecting the choice of capital structure:
Flexibility
Write the external factors influencing capital structure.
Answer the following question.
'Determining the overall cost of capital and the financial risk of the enterprise depends upon various factors.' Explain any six such factors.
Read the following text and answer the following questions on the basis of the same:
Mr. A. Bose is running a successful business. Mr. Bose is the owner of R. K. Cement Ltd. Mr. Bose decided to expand his business by acquiring a Steel Factory. This required an investment of Rs. 60 crores. To seek advice in this matter, he called his financial advisor Mr. T. Ghosh who advised him about the judicious mix of equity (40%) and Debt (60%). Employ more of cheaper debt may enhance the EPS. Mr. Ghosh also suggested him to take loan from a financial institution as the cost of raising funds from financial institutions is low. Though this will increase the financial risk but will also raise the return to equity shareholders. He also apprised him that issue of debt will not dilute the control of equity shareholders. At the same time, the interest on loan is a tax deductible expense for computation of tax liability. After due deliberations with Mr. Ghosh, Mr. Bose decided to raise funds from a financial institution.
Identify the concept of Financial Management as advised by Mr. Ghosh in the above situation.
______ refers to a situation when a company is not able to meet its fixed financial charges.
Which component of capital structure determines the overall financial risk?
Assertion (1): Higher the flotation cost, less attractive the source.
Reason (R): The choice between the payment of dividend and retaining the earnings is, to some extent, affected by the difference in the tax treatment of dividends and capital gains.
State any four factors affecting the decision that determines the overall capital and the financial risk of the enterprise.
Which of the following is not a factor affecting capital structure of a company?
The Board of directors of Medex Pharma Ltd. decided to issue debentures worth ₹ 40 lakhs in order to finance a major Research and Development project. This would increase the Debt Equity ratio from 1:1 to 2:1.However, at the same time it would increase the Earnings per share.
The reason that will justify the above situation is ______.
