AVS Limited is planning to diversify its cotton manufacturing business. The Chief Financial Officer (CFO) intends to raise fund of 22,00,000 for…

CA Intermediate · Financial Management and Strategic Management · PYQS · September 2025
AVS Limited is planning to diversify its cotton manufacturing business. The Chief Financial Officer (CFO) intends to raise fund of 22,00,000 for this project. The current estimates of Earnings Before Interest and Taxes (EBIT) from the new project are - 5,00,000 per annum. The company's share is currently selling at 120 and is expected to decline to 110, in case the funds are borrowed more than - 10,00,000. It is stated that the cost of debt will be 14% up to 8,00,000, 16% for additional amount of 2,00,000 above - 8,00,000 and 18% for additional amount above - 10,00,000. The tax rate applicable to the company is 30%. the following options are in consideration of the company. Option Debt Equity I 60% 40% II 50% 50% III 40% 60% Considering the objective of maximising Earning Per Share (EPS), which option of financing should the company choose?

Suggested Answer and Working Notes:

Calculation of EPS for different financing options: Total Funds required = 22,00,000 Particulars Option-I: 60% Debt Option-II: 50% Debt Option-III: 40% Debt Debt 13,20,000 11,00,000 8,80,000 Equity 8,80,000 11,00,000 13,20,000 EBIT 5,00,000 5,00,000 5,00,000 Interest on Debts: - on debt upto 8 lacs @14% (1,12,000) (1,12,000) (1,12,000) - on debt above 8 lacs and upto 10 lacs @ 16% (32,000) (32,000) (12,800) - on debt above 10 lacs @ 18% (57,600) (18,000) - Total Interest (2,01,600) (1,62,000) (1,24,800) EBT 2,98,400 3,38,000 3,75,200 Less: Tax @ 30% (89,520) (1,01,400) (1,12,560) PAT 2,08,880 2,36,600 2,62,640 Number of shares (Equity / 110) 8,000 10,000 12,000 EPS 26.11 23.66 21.89 Since Option I i.e 60% debt provide the maximum EPS, company should choose Option I (60% debt and 40% equity) for financing.

Topics: Part-A: Financial Management

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