Capital structure (in market-value terms) of AN Ltd is given below: Company Debt Equity AN Ltd. 50% 50% The borrowing rate for the company is 10% in…

CA Intermediate · Financial Management and Strategic Management · MTP · May 2024
Capital structure (in market-value terms) of AN Ltd is given below: Company Debt Equity AN Ltd. 50% 50% The borrowing rate for the company is 10% in a no-tax world and capital markets are assumed to be perfect. Required: (i) If Mr. R, owns 8% of the equity shares of AN Ltd., DETERMINE his return if the Company has net operating income of 10,00,000 and the overall capitalization rate of the company (K o ) is 20%. (ii) CALCULATE the implied required rate of return on equity of AN Ltd.

Suggested Answer and Working Notes:

Value of AN Ltd. = NOI / K o = 10,00,000 / 20% = 50,00,000 (i) Return on Shares of Mr. R on AN Ltd. Particulars Amount (₹) Value of the company 50,00,000 Market value of debt (50% x 50,00,000) 25,00,000 Market value of shares (50% x 50,00,000) 25,00,000 Particulars Amount (₹) Net operating income 10,00,000 Interest on debt (10% x 25,00,000) 2,50,000 Earnings available to shareholders 7,50,000 Return on 8% shares (8% x 7,50,000) 60,000 (ii) Implied required rate of return on equity of AN Ltd. = 7,50,000 /25,00,000 = 30%

Topics: Part-A: Financial Management

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