Ritu Limited in the expansion stage and it provides you the following information: (₹) Profit (EBIT) 5,00,000 Less: Interest on Debenture @ 10%…

CA Intermediate · Financial Management and Strategic Management · RTP · January 2025
Ritu Limited in the expansion stage and it provides you the following information: (₹) Profit (EBIT) 5,00,000 Less: Interest on Debenture @ 10% (1,00,000) EBT 4,00,000 Less Income Tax @ 30% (1,20,000) 2,80,000 No. of Equity Shares (10 each) 50,000 Earnings per share (EPS) Price /EPS (PE) Ratio 5.6 10 The company has reserves and surplus of 10,00,000 and required - 5,00,000 further for modernisation. Return on Capital Employed (ROCE) is constant. Debt (Debt/ Equity) Ratio lesser than 2 will raise the P/E Ratio to 12. Interest rate on additional debts is 12%. You are required to ASCERTAIN the probable price of the share. (i) If the additional capital are raised as debt; and (ii) If the amount is raised by issuing equity shares at ruling market price.

Suggested Answer and Working Notes:

Ascertainment of probable price of shares of Akash limited Particulars Plan-I If - 5,00,000 is raised as debt (₹) Plan-II If - 5,00,000 is raised by issuing equity shares (₹) Earnings Before Interest and Tax (EBIT) {20% of new capital i.e. 20% of (₹ 25,00,000 +5,00,000)} (Refer working note1) 6,00,000 6,00,000 Less: Interest on old debentures (10% of 10,00,000) (1,00,000) (1,00,000) Less: Interest on new debt (12% of 5,00,000) (60,000) - Earnings Before Tax (EBT) 4,40,000 5,00,000 Less: Tax @ 30% (1,32,000) (1,50,000) Earnings for equity shareholders (EAT) 3,08,000 3,50,000 No. of Equity Shares (refer working note 2) 50,000 58,929 Earnings per Share (EPS) 6.16 5.94 Price/ Earnings (P/E) Ratio (refer working note 3) 12 10 Probable Price Per Share (PE Ratio × EPS) 73.92 59.40 Working Notes: 1. Calculation of existing Return of Capital Employed (ROCE): (₹) Equity Share capital (50,000 shares × ₹ 10) 5,00,000 10% Debentures (₹ 1,00,000 × 100/10) 10,00,000 Reserves and Surplus 10,00,000 Total Capital Employed 25,00,000 Earnings before interest and tax (EBIT) (given) 5,00,000 ROCE = (₹ 5,000,000 /25,00,000) × 100 = 20% 2. Number of Equity Shares to be issued in Plan-II: 5,00,000 /56 = 8,929 shares Thus, after the issue total number of shares = 50,000+ 8,929 = 58,929 shares 3. Debt/Equity Ratio if - 5,00,000 is raised as debt: 15,00,000 /15,00,000 = 1 As the debt equity ratio is less than 2 the P/E ratio will be increase to 12 in Plan-I

Topics: Part-A: Financial Management

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