ABC Ltd. has the following capital structure, which is considered to be optimum as on 31st March, 2025. Particulars Amount (₹) 14% Debentures 60,000…

CA Intermediate · Financial Management and Strategic Management · MTP · September 2025
ABC Ltd. has the following capital structure, which is considered to be optimum as on 31st March, 2025. Particulars Amount (₹) 14% Debentures 60,000 11% Preference shares 20,000 Equity Shares (10,000 shares) 3,20,000 4,00,000 The company share has a market price of 19.67. Next year dividend per share is 50% of year 2024 EPS. Following is the uniform trend of EPS for the preceding 10 years which is expected to continue in future: Year EPS (₹) Year EPS (₹) 2015 1.00 2020 1.61 2016 1.10 2021 1.77 2017 1.21 2022 1.95 2018 1.33 2023 2.15 2019 1.46 2024 2.36 The company issued new debentures carrying 16% rate of interest and the current market price of debenture is 96. Preference shares of 9.20 (with annual dividend of 1.1 per share) were also issued. The company is in 50% tax bracket. (A) CALCULATE after tax: (i) Cost of new debt (ii) Cost of new preference shares (iii) Cost of new equity share (assuming new equity from retained earnings) (B) CALCULATE marginal cost of capital when no new shares are issued. (C) DETERMINE the amount that can be spent for capital investment before new ordinary shares must be sold. Assuming that the retained earnings for next year's investment is 50 percent of 2024. (D) COMPUTE marginal cost of capital when the fund exceeds the amount calculated in (C), assuming new equity is issued at 25 per share.

Suggested Answer and Working Notes:

(c) (A) (i) Cost of new debt Kd = I (1 - t) / Po = 16 (1 - 0.5) /96 = 0.0833 (ii) Cost of new preference shares Kp = PD / Po = 1.1 / 9.2 = 0.12 (iii) Cost of new equity shares Ke = D1 / Po + g Calculation of g when there is a uniform trend (on the basis of EPS) = (EPS (2016) – EPS (2015)) / EPS (2015) = (₹ 1.10 - 1.00) /1.00 = 0.10 or 10% Calculation of D1 D1 = 50% of 2024 EPS = 50% of 2.36 = 1.18 Ke = 1.18 / 19.67 + 0.10 = 0.06 + 0.10 = 0.16 (B) Calculation of marginal cost of capital Type of Capital (1) Proportion (2) Specific Cost (3) Product (2) × (3) = (4) Debenture 0.15 0.0833 0.0125 Preference Share 0.05 0.1200 0.0060 Equity Share 0.80 0.1600 0.1280 Marginal cost of capital 0.1465 (C) The company can spend the following amount without increasing marginal cost of capital and without selling the new shares: Retained earnings = 50% of EPS of 2024 × outstanding equity shares = 0.50 × ₹ 2.36 × 10,000 shares = 11,800 The ordinary equity (Retained earnings in this case) is 80% of total capital So,11,800 = 80% of Total Capital ∴ Capital investment before issuing equity shares = 11,800 / 0.80 = 14,750 (D) If the company spends in excess of 14,750, it will have to issue new equity shares at 25 per share. ∴ The cost of new issue of equity shares will be = D1 / Po + g = 1.18 / 25 + 0.10 = 0.1472 The marginal cost of capital will be: Type of Capital (1) Proportion (2) Specific Cost (3) Product (2) × (3) = (4) Debentures 0.15 0.0833 0.0125 Preference Shares 0.05 0.1200 0.0060 Equity Shares (New) 0.80 0.1472 0.1178 0.1363

Topics: Part-A: Financial Management

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