X Ltd is willing to raise funds for its New Project which requires an investment of 84 Lakhs. The Company has two options: Option I: To issue Equity…

Let the EBIT at the Indifference Point level be E Particulars Alternative 1 Alternative 2 Description Fully Equity of 84 Lakhs Debt = 56 Lakhs, Equity = 28 Lakhs EBIT E E Less: Interest at 12% of 56Lakhs Nil 6.72 EBT E E – 6.72 Less: Tax at 30% 0.3 E 0.3 Е – 2.016 EAT 0.7 E 0.7 Е – 4.704 Less: Preference Dividend Nil Nil Residual Earnings 0.7 E 0.7 Е – 4.704 No. of Equity Shares (Face Value - 10) 8.4 Lakh Shares 2.8 Lakh Shares EPS = Residual Earnings / No. of Equity Shares 0.7 E / 8.4 Lakh Shares 0.7 E – 4.704 / 2.8 Lakh Shares For indifference between the above alternatives, EPS should be equal. So, 0.7 E / 8.4 Lakh Shares = (0.7 E – 4.704) / 2.8 Lakh Shares On cross multiplication and simplification, 2.1 Е – 14.112 = 0.7 E. So, 1.4 E = 14.112 So, E = 14.112 / 1.4 = 10.08 So, for same EPS, required EBIT = 10.08 Lakhs. EPS at that level = 0.84 Note: Presentation of solution may differ.