Namra Limited provides you with the following information – Particulars Amount (₹) Operating Profit 6,20,000 Less: Interest on Debentures @ 10%…

CA Intermediate · Financial Management and Strategic Management · RTP · May 2025
Namra Limited provides you with the following information – Particulars Amount (₹) Operating Profit 6,20,000 Less: Interest on Debentures @ 10% (80,000) EBT 5,40,000 Less: Tax @ 20% (1,08,000) PAT 4,32,000 Less: 14% Preference Dividend (1,12,000) Earnings for Equity Share Holders 3,20,000 No of Equity Shares (10 Each) 16,000 EPS 20 The Reserves & Surplus of the company is at 9,00,000 and Namra Limited requires additional funds of 15,00,000 for modernization and expansion. The current capitalization rate for the equity is 20% and company has a policy to retain 40% of its earnings. The debentures and preference shares are trading at premium of 10% & 25% to its current book value respectively. The fair value of equity shares is calculated by dividing the number of equity shares to the Overall Value of the firm. New equity shares for expansion will be issued 15% discount to the current fair value price. Return on Capital Employed (ROCE) which is based on the total value of the firm, will increase by 10% to its current rate after expansion and modernization. If the capital gearing ratio goes above 2.50 then interest rate on additional debt will increase by 200 basis points and dividend on preference shares would increase by half a percentage. You are required to ADVISE on the below two financial plan to be selected based on earnings. (i) Two-third amount is raised through debenture and remaining by preference share. (ii) Issue of equity shares only.

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Particulars Additional Funds : Debentures = 15,00,000 x 2/3 Pref = 15,00,000 x 1/3 Additional Funds : 100% Equity Operating Profit Wn - 1 9,55,776 9,55,776 Less: Interest Exp Current (80,000) (80,000) Additional (10,00,000 X 12%) Wn - 2 (1,20,000) - EBT 7,55,776 8,75,776 Less: Tax @ 20% (1,51,155) (1,75,155) EAT 6,04,621 7,00,621 Less: Preference Dividend Current (1,12,000) (1,12,000) Additional (5,00,000 X 14.5%) Wn - 2 (72,500) - Earnings for Equity Shareholders 4,20,121 5,88,621 No of Equity Shares Current 16,000 16,000 Additional Wn - 3 - 7,550 EPS 26.26 25.00 WN 1 - Calculation of EBIT after expansion As given in the question, ROCE is based on the total value of firm, so first step would be to calculate the total value of the firm Value of Firm = Value of Debt + Value of Pref shares + Value of Equity + Value of R/S Value of Debt (Vd) = Interest (₹) / Interest % + 10% premium = 80,000 / 0.10 + 10% premium = 8,80,000 Value of Preference (Vp) = Pref Div (₹) / Pref Div % + 25% premium = 1,12,000 / 0.14 + 25% premium = 10,00,000 Value of Equity share capital (Ve) = Dividend / Ke = (3,20,000 x 0.6) / 0.20 = 9,60,000 Value of R/S = 9,00,000 Therefore, Value of Firm (Vf) = 8,80,000 + 10,00,000 + 9,60,000 + 9,00,000 = 37,40,000 ROCE (Before expansion) = EBIT / Total value of the firm = 6,20,000 / 37,40,000 = 16.58% ROCE (After expansion) = 16.58 + 1.658 (i.e 16.58 + 10%) = 18.24% EBIT (After expansion) = (37,40,000 + 15,00,000) x 18.24% = 9,55,776 WN 2 - Calculation of Interest on additional debt and Preference dividend on additional Preference share capital Condition – If the capital gearing ratio goes above 2.50, then additional debt raised would be at higher rate of interest and additional Preference shares would also be raised at higher preference dividend rate Capital gearing ratio when Additional funds are raised through additional debt and preference share capital. Capital gearing ratio = (8,00,000 + 8,00,000 + 15,00,000) / (1,60,000 + 9,00,000) = 2.92 Since it is greater than 2.50, Interest on Debt = 10% + 2% (200 basis points) = 12% Preference Dividend = 14% + 0.5% = 14.5% WN 3 - Calculation of Additional No of Equity shares when funds are raised through equity Fair value of equity shares before issuing new equity share = Total Value of the firm / No of existing equity shares = 37,40,000 / 16,000 = 233.75 Issue Price = 233.75 - 15% Discount = 198.69 Therefore, No of New Equity shares to be issued = Additional Funds to be raised / Fair value = 15,00,000 / 198.69 = 7549.45 shares approx. 7550 shares Comment - It is advisable for Namra Limited to raise the additional funds through a mix of debentures and preference as EPS is maximum

Topics: Part-A: Financial Management

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