Question

1. X Ltd. presents the following particulars.:

EBIT (i.e., Net Operating income) is Sh. 30,000,000

The equity capitalisation ratio (i.e., cost of equity) is 15% (K.)

Cost of debt is 10% (K_d)

Total Capital amounted to Sh. 2,00,000,000

Leverage (Debt to total Capital) 0%, 20%, 50%. and 100%

Calculate the cost of capital and the value of the firm for each of the following alternative leverage after applying the net income (NI) approach

Answer 1

Composition of Debt and Equity:

		Case 1: Eq-100%	Case 2 Debt:20%,Equity-80 %	Case 3 Debt-50%,Equity-50%	Case 4 Debt:100%
S.No	Particulars	Amount(Sh)	Amount(Sh)	Amount(Sh)	Amount(Sh)
A	Total Capital	30,000,000	30,000,000	30,000,000	30,000,000
B	Debt to Total capital	0%	20%	50%	100%
C	Value of the Debt( A*B)	0	6000000	15000000	30000000
D	Equity Share Capital( A-C)	30,000,000	24,000,000	15,000,000	0

Computation of Overall Cost of Capital :

S.No	Particulars	Amount(Sh.)	Amount(Sh.)	Amount(Sh.)
		Case 1: Eq-100%	Case 2 Debt:20%,Equity-80%	Case 3 Debt-50%,Equity-50%
A	EBIT( Net Operating income)	30,000,000	30,000,000	30,000,000
B	Debt	0	6000000	15000000
C	Less: Cost of Debt@ 10%	0	600000	1500000
D	Earnings available for Shareholders ( NI)	30,000,000	29,400,000	28,500,000
E	Equity Capitalization rate( ke)	15%	15%	15%
F	Market value of Equity( NI/Cost of Equity)[D/E]	200,000,000	196,000,000	190,000,000
G	Market value of the Debt	0	6000000	15000000
H	Total value of the firm( F+G)	200,000,000.00	202,000,000	205,000,000
I	Overall Cost of Capital ( A/H)( %)*	15.00	14.85	14.63

*We know that Overall Cost of Capital = EBIT/Total value of the firm

Case 4: 100% Debt

Total value of the Form= Market value of Debt+Market value of the Equity

= sh 2000,00000+0

= sh 2000,00000

Overall cost of capital=EBIT/Totall value of the firm

=300,00000/sh 2000,00000

= 15%