PROBLEMS ON VALUE OF A RIGHT

1. A firm's share is selling for Rs.130 in the market. It has 50 lakh shares outstanding.
The firm wants to raise Rs.20 crore capital through rights issue. The subscription
price on the new share will be Rs.100 per share. Calculate (i) the number of
shares to be sold to raise the required capital and (ii) number of rights needed to
purchase one new share?
2. A firm has following information: number of outstanding shares 20 lakh; current
market price Rs.150; subscription price of new shares Rs.130; an investor needs
three rights to buy one new share. Calculate the value of one right.
3. Sunshine Industries Ltd has 900,000 shares outstanding, at current market price of
Rs.130 per share. The company needs Rs.22.50 million to finance its proposed
modernization-cum-expansion project. The board of the company has decided to
issue rights for raising the required money. The subscription price has been fixed
at Rs.75 per share. How many rights are required to purchase a new share? What
is the value of a right?
4. A firm is considering to make a rights issue to raise Rs.50 million. It has 500,000
shares outstanding and the current market price of a share is Rs.170. The
subscription price on the new share will be Rs.125 per share. Find (i) how many
shares should be sold to raise the required funds? (ii) How many rights are needed
to purchase one new share? (iii) What is the value of one right?
5. A company is considering a rights offering to raise funds to finance new projects,
which require Rs.45 million. The flotation cost will be 10% of funds raised. The
company currently has 2 million shares outstanding and the current market price
of its share is Rs.100. The subscription price has been fixed at Rs.50 per share. (i)
How many shares should be sold to raise the funds required for financing the new
projects? (ii) How many rights are required to buy one new share? (iii) What is
the value of one right? (iv) Show the impact on a shareholder's wealth who holds
the required rights to buy one new share if (a) he exercises his right, or (b) he sells
his right, or (c) he renounces his right.

*Numerical sourced from different texts and sites

 ANALYSIS
PROBLEMS ON LEVERAGE
its degree of
below. Calculate and interpret operating
1. Asimplified lncome Statement of Zenith Ltd. is given
combined leverage.
leverage, degree of financial leverage and degree ofending 31# March 2016
Income Statement for the vear
Sales 1,050,000
Variable Cost
767,000
Fixed Cost 75,000
EBIT 208,000
Interest 110,000
Taxes (30%) 29,400
Net Income 68,600

respectively. Find out the

Z. The Combined Leverage and Operating leverage of acompany are 2.5 and 1.25
nterest payable is
Financial Leverage and PVRatio given that (i) Fguity Dividend is Rs.2 per share; ( )
Rs.100,000; (ii)Sales Rs.1,000,000; and (iv) Fixedcost Rs.50,000.
S: ATrm nas sales of Rs.2,000,000: Variable costs of Rs.1.400.000 and Fixed costs of Rs.400,000 inclusive of
interest of Rs.100,000. (i) Calculate its operating. financial and combined leverages. (ii) If the firm decides
to double its EBIT, how much of a rise insales would be needed on apercentage basis?

4
The capital structure of the Progressive Corporation consists of Ordinary share capital of Rs.1,000,000
(shares of Rs. 100each) and Rs.1,000,000 of 10% debentures. The selling price is Rs. 10 per unit; variable
costs amount to Rs.6 per unit and fixed expenses amount to Rs.200,000. The income tax rate is assumed to
be 50%. The sales level is expected to increase from 100,000 units to 120,000 units.
Youare required to calculate:
i. The percentage increase in earnings per share
ii. The degree of Financial leverage at both levels of sales
iii. The degree of Operating leverage at both levels of sales
b. Comment on the behavior of Operating and
Financial leverages in relation to increase in production
from 100,000 units to 120,000 units.
5. Afirm has sales of
Rs.7,500,000; Variable cost of Rs.4,200,000; and Fixed cost of Rs.600,000. It has a debt
of Rs.4,500,000 at 9% and equity of
What is the firm's ROI?
Rs.5,500,000.
b. Does it have favorable financial
C If the firm
leverage?
belongs to an industry whose asset turnover is 3,
d. What are the does it have high or low asset
Operating, Financial and Combined leverages the firm?
of leverage?
e If the sales drop to
f. At what level, the EBT Rs.5,000,000, what will be the new EBIT?
of the firm will be equal to zero?
6. ABC Industries, a
well-established
manufacturing companies.
firm in plastics, is
The financial manager of Considering the purchase of one of the
the two
information about the two companies each having total company has developed the following
assets of Rs.1500.000.
Sales Revenues Company P(Rs.)
-Cost of goods sold 3000,000 Company Q(Rs.)
-Selling expenses 2250,000 3000,000
-Administrative expenses 240,000 2250,000
-Depreciation 90,000 240,000
120,000 150,000
90,000
 EBIT 300,000 270,000
Variable cost break-up:
Cost of goods sold 1800,000
900,000
Selling expenses 150,000 150,000
Total variable costs 1050,000 1950,000
a.
Prepare operating statements for both the companies, assuming that sales increase by 20%.The
total fixed costs are likely to remain unchanged and the variable costs are a linear function of
sales.
b Calculate the degree of operating leverage.
C. If ABC industries wishes to buy a company which has a lower degree of business risk, which
company would be purchased by it?
7 Following are the Balance Sheet and Income
Statement of ABC Ltd.
Balance Sheet
Liabilities Rs. Assets Rs.
Equity capital (Rs.10 per share) 800,000 Fixed assets 1000,000
Retained earnings 350,000 Current assets 900,000
10% Debt
600,000
Current liabilities
150,000
Income Statemnent
Sales
Rs. 340,000
-Operating Expenses (including Depreciation) 120,000
EBIT
220,000
-Interest 60,000
PBT
160,000
-Tax @ 50% 80,000
PAT
80,000
(i) Determine the DOL, DFL and DCL at the current sales level given that all
operating expenses
(excluding depreciation of Rs.52,000) are variable; and
(iü) If total assets remaining at the same level but (a) sales increasing by 20% and (b)sales
decreasing
by 10%, what will be the EPS?

8. From the following information available for 4 firms, calculate the EBIT, EPS, DOL and DFL.
Firm P Firm Q Firm R Firm S
Sales (in Units) 20,000 25,000 30,000 40,000
Selling price per unit (Rs.) 15 20 25 30
Variable cost per unit (Rs.) 10 15 20 25
Fixed costs (Rs.) 30,000 40,000 50,000 60,000
Interest (Rs.) 15,000 25,000 35,000 40,000
Tax (%) 40 40 40 40
Number of equity shares 5,000 9,000 10,000 12,000
9. MCLtd. is planning an expansion program which will require Rs.30crores and can be funded through
one of the following 3 options:
1. Issue further equity shares of Rs.100 each at par
2. Raise a 15% loan
3. Issue 12% preference shares.
The present paid up capital is 60crores and the annual EBIT is
Rs.12 crores. The tax rate is 50%. After
the expansion plan is adopted, the EBIT is expected to be Rs.15 crores.
highest
share
costs
are
variable 28.
4345
/.
10% (incc
)
equity (b)
the 90,000
150,000
Assets;
giving
the 5.6845
Rs.
between
alternative (Rs.)
Ltd.
Sound 100,000,
on
return 10,000,000
5,000,000
5,000,000
5%.
point 50%. Rs.
Tax by
the Current are
assets increase
indifference
indicating Before of
above). rate Fixed
assets costs
data:
20% tax Assets operating to
2 following
(Rs.)
Solid
Ltd. assumingSheet
Balance Fc
EBIT+
expected
options
theoption(a) 10,000,000
10,000,000 Rs.3;
determineassuming Ltd.
Co.
and
financing the firm Equipment
fixed (b)
Rs.1; &
EBT
60,00080,000
20,00080,000 ABC are
1 of the
optionLtd.basis the sales
Also Rs. (a) for
of 4, firm; Rs.1120,000
three Sound MA of is available Rs.700,000
Rs.320,000
the
shareholders.the each) Leverage
(i.e. share)
out: EPS
turnover
the
of Financial
break-even
level. if
the financing and
on
ASsets:
10 Sheet
Find the
for EPS EpS
all Rs. per if
Leverages is
under Ltd. Financial 50%.
Assets EBIT in
(FV Balance (Rs.10 information change
EPS
debt Solid
equity on
return
Capital Retained
earnings
Current of
liabilities
Fixed
of
level Cont
EBT
of
thethethe EPS
the
the capital rate
Different Tax percent
Profit
before in
and Share on tax Likely
Calculate Tax Total
Assets is Liabilities 10%
Debt had following
to Calculate
capital Before Equity
return DebtComment
12% FollowingEquity a
firmand Fixed
costs
Calculate .chang
The40%
10. (i) (i) (ii) TheEBIT
11.
12.
EBT
 PROBLEMS ON CAPITAL STRUCTURE AND FIRM VALUE

every respect except that the Levered Company

The Levered Company and the Unlevered Company are identical in
valuation of the two firms as follows:
has 6% Rs.200,000 debt outstanding. As per the NI approach, the
Unlevered Co. (Rs.) Levered Co. (Rs.)
Net operating income, EBIT 60,000 60,000
Total cost of debt 12,000
Net earnings, NI 60,000 48,000
Equity capitalizationrate, KE 0.100 0.111
Market value of shares, E 600,000 432,000
Market value of debt, D 200,000
Totalvalue of the firm, V 600,000 632,000
Mr. X
holds Rs.2,000 worth of Leveredcompany's shares. Is it possible for Mr. Xto reduce his outlay to earn same
return through the use of arbitrage? llustrate.
2. The two companies Xand Ybelong to the same risk class. They have everything in common except that firm Yhas
10% Debentures of Rs.5 lakhs. The valuation of the two firms is assumed to be as follows:
X(Rs.) Y(Rs.)
Net operating income (EBIT) 750,000 750,000
Interest on debt (0) 50,000
Earnings to equity holders (NI) 750,000 700,000
Equity capitalization rate (Ke) 0.125 0.14
Market value of equity (E) 6000,000 5000,000
Market value of debt (D) 500,000
Total market value of the firm (V) 6000,000 oV 5500,000 U.v
Overall capitalization rate (Ko = EBIT/V) 12.5% 13.63%
An investor owns 10% equity shares of the over-valued firm. Determine his investment cost of earning the same
income so that he is at a break-even point? Will he gain by investing in the undervalued firm?
Aparna Steel Ltd. has employed 15% Debt of Rs.1200,000 in its capital structure. The net operating income of the
firm is Rs.500,000 and has an equity capitalization ratio of 16%. Assuming that there is no tax, find out the value of
the firm under the NI Approach. COECKe)
4X Ltd. and YLtd. are identical except that the former uses debt while the latter does not. The levered firm has issued
10% Debentures of Rs.900,000. Both the firms earn EBIT of 20% on total assets of Rs.1500,000.Assuming taxrate-of
SO%- and capitalization'rte of 15% for an all-equity firm, (i)Compute the value of the two firms using NI approach;
(ii) Compute thevalue of the two firms using NOlapproach; (ii) Calculate the overallcost of capital for both firms
using NOI approach.
3. A company's cùrrent operating income is Rs.400,000. The firm has Rs.1000,000 of 10% debt outstanding, Its cost of
equity capital is estimated to be 15%.
a. Determine the current value of the firm, using traditional valuation approach;
b. Calculate the firm's overall capitalization rate;
C. The firm is considering to increase its leverage by raising an additional Rs.500,000 debt and using the proceeds
to retire that amount of equity. As a result of increased financial risk, Kp, is likely to go up to 12% and K[ to 18%.
Would you recommend the plan? O yceom mndol
8. XYZ Manufacturing Co., has a total capitalization of Rs.1000,000and normally earns Rs.100,000 EBIT. The
financial
manager of the firm wants to take a decision regarding the capital structure. After a study of the capital market, he
gathers the following data:
Amount of Debt Interest Rate(%) Ke%
Rs.0 10.00
Rs.100,000 4.0 10.50
200,000 4.0 11.00
300,000 4.5 11.60
400,000 5.0 12.40
 5.5 13.50
500,000 16.00
6.0
600,000 20.00
8.0
700,000
be employed by the firm if the traditional approach is heldvalid? O Vor Ol COCopts
What amount of debt should
a
capitalization rate?
should be the equity
b. If the MM approach is followed, what firm always maintains its capital structure at book
values.
Assume that corporate taxes do not exist, and that the of debt (D) to
and 12% respectively. The ratio of market value
7. Phoenix Ltd. has a cost of debt and WACC of 9% returnof the equity investors, K[, given that there is
market value of equity (E) is 0.8. Find out the required rate of
no tax.
Enterprises:
8. The following information is available regarding the Mid-Air
a. Mid-Air currently has no debt
b. Expected EBIT is Rs.2400,000 (Mid-Air is in a no-growth situation)
C. There are no taxes
borrowing rate is constant and it is independent of
d. If Mid-Air begins to use debt, it can borrow at 8% rate. This
to retire common stock, so the total
the amount of debt used. Any money raised by selling debt would be used
assets of the company will remain constant
e. The rate of return on equity, Ko is12%
required to determine (a) the
Using MM Model without corporate taxes and assuming adebt of Rs.1 crore, you are
firm's total market value; (b) the firms value of equity; (c) the firm's leverage cost of equity.
9. The values for two firms Xand Y in accordance with the traditional theory are given below:
Particulars X(Rs.) Y(Rs.)
Expected operating income 50,000 50,000
Total cost of debt 10,000
Net income 50,000 40,000
Cost of equity 0.10 0.11
Market value of shares 500,000 360,000
Market value of debt 0 200,000
Total value of firm 500,000 560,000
Average cost of capital 0.10 0.09
Debt equity ratio 0.556
Compute the values for firms Xand Yas per the MM approach, assuming that (i) corporate income taxes do not
exist; and (ii) the equilibrium value, Ko is 12.5%.
10. The net operating profit ofa firm is RS.210,000 and the total market value of its 12% Debt is Rs.300,000. The equity
capitalization rate of an unlevered firm of the same risk class is 16%. Find out the value of the levered firm given that
the tax rate is 30% for both the firms.
11. From the following selected data, determine the value of the firms, Pand Qbelonging to the homogeneous risk class
under (a) NetIncome approach, (b) Net Operating Income approach using MM model with taxes.
Particulars« Firm P (Rs.) Firm Q (Rs.)
EBIT 225,000 225,000
Interest at 15% 75,000
For both the firms, Equity capitalization rate, KE, is 20%, and the corporate tax rate is 50%.
Which of the two firms has an optimal capital structure under each of the models?
12. Companies Uand Lare identical in every respect, except that U is unlevered while Lis levered. Company Lhas
Rs.2000,000 of 8% Debentures outstanding. Assume (1) that allthe MM assumptions are met, (2)that the tax rate is
50%, (3) that EBIT is Rs.600,000 and that equity capitalization rate for company U is 10%.
a. What would be the value for each firm according to MM
approach?
b. Suppose Vu=Rs.2500,000 and Vi=Rs.4500,000. According to MM, do they represent
equilibrium values? If not,
explain the process by which equilibrium will be restored.
 PROBLEMS ON EBIT-EPS ANALYSIS

1. Half
Afirm15%requires total capital funds of Rs.25 lakhs and has two options: (a) All equity (b) Half equity and
debt. The equity share can be currently issued at Rs.100 per share. The expected EBIT of the
company is Rs.250,000with tax rate at 40%. Find out the EPS under both the financial plans.
2. AB Ltd. needs Rs.10 lakhs for expansion. The expansion is expected to yield an annual EBIT of Rs.160,000.
Inchoosing a financial plan, AB Ltd. has an objective of maximizing earningS per share. It is considering
the possibility of issuing equity shares and raising debt of Rs.100,000 or Rs.400,000 or Rs.600,000. The
current market price per share is Rs.25 and is expected to drop to Rs.20 if the funds are borrowed in
excess of Rs.500,000. Funds can be borrowed at the following rates: (a) upto Rs.100,000 at 8%; (b) over
Rs.100,000 upto Rs.500,000 at 12%; (c) over Rs.500,000 at 18%. Assume a tax rate of 50%. Determine the
EPS for the three financing alternatives.
3. The operating income of atextile firm amounts to Rs.186,000. It pays 50% tax on its income. its capital
structure consists of the following:
15% Preference shares Rs.100,000
Equity shares (Rs.100each) 400,000
14% Debentures 500,000
a. Determine the firm's EPS
b. Determine the percentage change in EPS associated with 30% change (both increase and decrease) in
EBIT
C. Determine DFL at the current levelof EBIT
d. What additional data do you need to compute DOL and DTL?
4. Three financing plans are being considered by ABCLtd. which requires Rs.1000,000 for construction of a
new plant. It wants to maximize the EPS and the current market price of the share is Rs.30. It has a tax
rate of 50% and debt financing can be arranged as: (a) upto Rs.100,000 @10%; (b) from Rs.100,000 to
Rs.500,000 @14%;(c) over Rs.500,000 @18%. Thethree financing plans and the corresponding EBIT are
as follows:
a. Plan I: Rs.100,000 debt; expectedEBIT Rs.250,000
b. Plan l: Rs.300, 000debt; expected EBIT Rs.350,000
C. Plan ll: Rs.600,000 debt;expected EBIT Rs.500,000
Find out theEPS for.all the three plans and suggest which plan is better from the point of view of the
company.
5. Acompany is considering lowering the selling price of its product. The following information is available
on the costs of producing and income from selling its product:
Number of units sold 300,000
Sale price Rs.10 p.u.
Variable costs Rs.6 p.u.
Fixed costs Rs.600,000
The management has asked you to prepare a statement indicating the percentage increase in volume
necessary to maintain a net operating income at the current level on product with decrease in price of
10% and 20% assuming other costs remaining constant.
6. The following information is available in respect of XYZ Ltd.
Number of shares issued 10,000
Market price per share Rs.20
Interest rate 12%
Tax rate 46%
Expected EBIT Rs.15,000
 debt or equity to produce
The firm needs Rs.50,000 for investment next year. Should the firm issue
is the EPS for the
higher EPS? Also find out the indifference levelof EBIT for the two alternatives. What
indifference level of EBIT?
financial plans are
7. Acompany needs Rs.500,000 for construction of a new plant. The following three
company may
feasible: (i) The company may issue 50,000 common shares at Rs.10 per share; (ii)The
8% rate of interest;
issue 25,000 equityshares at Rs.10 per share and 2,500 debentures of Rs.100 bearing
2,500 preference shares at
(ii) The company may issue 25,000 equity shares at Rs.10 per share and Rs.40,000;
Rs.100 per share bearing 8% rate of dividend. If the company's EBIT are Rs.10,000; Rs.20,000;
financial plans?
Rs.60,000; and Rs.100,000 what are the earnings per share under each of the three
a
Which alternative would you recommend and why? Determine the indifference points. Assume
corporate tax rate of 50%.
amount by.the issue
8. A company requires capital funds of Rs.5 crores and has two options: (i) To raise the
of 15% debentures, and (ii) To issue equity shares at Rs.20 per share. It already has 40 lakhs equity shares
issued and debt financing of Rs.6 crores at the rate of 12%. Find out the expected EPS under both
financing options at the given EBIT levels of Rs.2 crores and Rs.7.5 crores. What should be the choice of
the company given that the applicable tax rate is 50%.
9. ABC Ltd. is considering expansionof its plant capacity to meet the growing demand.The company would
finance the expansion either with 15% Debentur¿s or i_sueof 1000,000 shares at aprice of Rs.16 per
share. The funds requirement is Rs.16,000,000. The averagerate of taxapplicable to the company is
51.75%. The company's Income Statement before expansion is as follows
(Rs. lakhs)
Sales 1,500
Less: Costs 1,050
EBIT 450
Less: Interest 50
PBT 400
Less: Tax @ 51.75% 207
PAT 193
Number of shares (lakhs) 50
EPS (Rs. 3.86
The company's expected EBIT with associated probabilities after expansion is as follows:
EBIT (Rs. Ilakhs) Probability
250 0.10
450 0.30
540 0.50
630 0.10
You are required to calculate the company's expected EBIT and EPS for each plan.
10. PQR Enterprises has assets of Rs.20 crores financed by 1 crore equity shares of Rs.20 each. The equity
shares are currently being sold at par and the firm is considering to retire some of the shares with
borrowed funds, which it can obtain at an interest rate of 15%. The expected EBIT (tax rate 50%) for the
next year is Rs.5 crores.
a. What would be the effect on expected EPS and Return on equity and why?
b. The firm is considering two alternative leverage ratios of 25% debt and 50% debt to total assets. Find
out the expected EPS and Return on equity for both the leverage ratios.
C. In abad year, the EBIT of the firm mayfall to Rs.2 crores and in a good year it may go even up to Rs.8
crores. Find out the EPS and expected Return on equity for both the levels of EBIT and the leverate
ratio of 25% and 50%.