Page 208 - DMGT207_MANAGEMENT_OF_FINANCES

Unit 8: Capital Structure Decision

Net Income Approach: According to this approach, the cost of debt and the cost of equity do not Notes
change with a change in the leverage ratio.
NOI Approach: According to this approach, the market value of the firm is not affected by the
capital structure changes.
Optimum Capital Structure: It is that capital structure where market value per share is maximum
and the cost of capital is minimum.
WACC Approach: It is midway between NI and NOI approaches.

8.14 Review Questions

1. Critically analyse the differences between capital structure and financial structure.
2. From the following information determine optimal capital structure by the calculation of
cost of capital.
Particulars Plan 1 Plan 2 Plan 3 Plan 4 Plan 5 Plan 6 Plan 7
Debt as a percentage of total capital 0 0.1 0.2 0.3 0.4 0.5 0.6
Debt cost (Kd %) 6 6 6 6.5 7 7.5 8.5
Equity cost (Ke %) 14 14 14.5 15 16 18 19

3. Analyse the different forms of capital structure.
4. It is proposed to start a business and so required a capital of 10 lakh and an assured return
of 15 per cent on investments. Calculate EPS if:
(a) Total capital required, by way of 100 equity
(b) If 50 per cent of equity capital and 50 per cent, 10 per cent debentures.

5. Elucidate the relationship between the leverage & cost of capital according to the NI &
NOI approach.
6. Calculate EBIT. Interest 5,0000; sales 50,000; Variable cost 25,000; Fixed cost 15,000.

7. List down the approaches available to determine the capital structure of the firm.
8. Critically analyze the different theories of capital structure.
9. From the following information calculate EPS.
Particulars Venkat Ltd ( in lakh) Sai Ltd ( in lakh)
Equity (shares of Rs. 10 each) 200 100
Debentures at 12 % - 100
Assets 100 200

Calculate EPS assume (a) 20 per cent before tax rate of return of assets, (b) 10 per cent
before tax return on assets; company is in 50 per cent tax bracket.
10. Elucidate the procedure for EBIT-EPS analysis.

11. ‘There is nothing like optimum capital structure for a firm’. Critically evaluate the statement.
12. Penta Four Ltd., has currently adopted an all equity structure, consisting of 15,000 equity
shares of 100 each. The management is planning to raise another 25 lakh to finance a
major expansion programme and is considering three alternative methods of financing.
(a) To issue 25,000 equity shares of 100 each.

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