Deepa Limited has Earnings Before Interest and Taxes (EBIT) amounting to 60,00,000. The company is considering the introduction of debt into its…

CA Intermediate · Financial Management and Strategic Management · MTP · January 2026
Deepa Limited has Earnings Before Interest and Taxes (EBIT) amounting to 60,00,000. The company is considering the introduction of debt into its capital structure and is evaluating different levels of debt financing. The details of the alternative debt options, along with the corresponding cost of debt and cost of equity, are given below: Option Debt in Capital Structure Cost of Debt (Kd) Cost of Equity (Ke) 1 60,00,000 10% 12% 2 75,00,000 13% 15% 3 90,00,000 14% 16% 4 1,05,00,000 14% 16% Assuming that the company operates in zero tax regime. WHICH option of debt financing in the capital structure would you recommend as per Traditional Approach of the capital structure theory?

Suggested Answer and Working Notes:

Particulars 1 2 3 4 EBIT 60,00,000 60,00,000 60,00,000 60,00,000 Less: Interest 6,00,000 9,75,000 12,60,000 14,70,000 Earning available for equity holders [A] 54,00,000 50,25,000 47,40,000 45,30,000 Equity capitalization rate [B] 12% 15% 16% 16% Market Value of equity [A]/[B] 4,50,00,000 3,35,00,000 2,96,25,000 2,83,12,500 Market value of debt (given) 60,00,000 75,00,000 90,00,000 105,00,000 Total Market Value 5,10,00,000 4,10,00,000 3,86,25,000 3,88,12,500 Overall cost of capital (EBIT x 100 / Total market value) 11.76% 14.63% 15.53% 15.46% The capital structure having debt of 60,00,000 is recommended as overall cost of capital is minimum at 11.76%.

Topics: Part-A: Financial Management

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