Capital structure of Sun Ltd., as at 31.3.2023 was as under: (in lakhs) Equity share capital (100 each) 600 6% Preference share capital 300 9%…

CA Final · Advanced Financial Management · RTP · May 2025
Capital structure of Sun Ltd., as at 31.3.2023 was as under: (in lakhs) Equity share capital (100 each) 600 6% Preference share capital 300 9% Debentures 480 Reserves 240 Sun Ltd., earns a profit of 240 lakhs annually on an average before deduction of income-tax, which works out to 30%, and interest on debentures. Normal return on equity shares of companies similarly placed is 7.2% provided: (a) Profit after tax covers fixed interest and fixed dividends at least 3 times.* (b) Capital gearing ratio is 0.5625. (c) Yield on equity shares capital is calculated at 50% of profits distributed and at 5% on undistributed profits. Sun Ltd., has been regularly paying equity dividend of 6%. Compute the value per equity share of the company assuming that adjustment for risk premium in comparison of similarly placed company shall be made as follows: (i) 1% for every one time of difference for Interest and Fixed Dividend Coverage. (ii) 2% for every one time of difference for Capital Gearing Ratio. * PAT + Debenture Interest / Debenture Interest + Preference Dividend

Suggested Answer and Working Notes:

(a) Calculation of Profit after tax (PAT) ₹ Profit before interest and tax (PBIT) 2,40,00,000 Less: Debenture interest (₹ 4,80,00,000 × 9/100) 43,20,000 Profit before tax (PBT) 1,96,80,000 Less: Tax @ 30% 59,04,000 Profit after tax (PAT) 1,37,76,000 Less: Preference Dividend (₹ 3,00,00,000 × 6/100) 18,00,000 Equity Dividend (₹ 6,00,00,000 × 6/100) 36,00,000 54,00,000 Retained earnings (Undistributed profit) 83,76,000 Calculation of Interest and Fixed Dividend Coverage = (PAT + Debenture interest) / (Debenture interest + Preference dividend) = (1,37,76,000 + 43,20,000) / (43,20,000 + 18,00,000) = 1,80,96,000 / 61,20,000 = 2.96 times (b) Calculation of Capital Gearing Ratio Capital Gearing Ratio = Fixed charges bearing funds / Equity shareholders' funds = (Preference Share Capital + Debentures) / (Equity Share Capital + Reserves) = (3,00,00,000 + 4,80,00,000) / (6,00,00,000 + 2,40,00,000) = 7,80,00,000 / 8,40,00,000 = 0.93 (c) Calculation of Yield on Equity Shares: Yield on equity shares is calculated at 50% of profits distributed and 5% on undistributed profits: (₹) 50% on distributed profits (₹ 36,00,000 × 50/100) 18,00,000 5% on undistributed profits (₹ 83,76,000 × 5/100) 4,18,800 Yield on equity shares 22,18,800 Yield on equity shares % = (Yield on shares / Equity share capital) × 100 = (22,18,800 / 6,00,00,000) × 100 = 3.70% Calculation of Expected Yield on Equity shares (a) Interest and fixed dividend coverage of Sun Ltd. is 2.96 times but the industry average is 3 times. Therefore, risk premium is added to Sun Ltd. Shares @ 1% for every 1 time of difference. Risk Premium = 3.00 – 2.96 (1%) = 0.04 (1%) = 0.04% (b) Capital Gearing ratio of Sun Ltd. is 0.93 but the industry average is 0.5625 times. Therefore, risk premium is added to Sun Ltd. shares @ 2% for every 1 time of difference. Risk Premium = (0.5625 – 0.93) (2%) = 0.37 (2%) = 0.74% (%) Normal return expected 7.20 Add: Risk premium for low interest and fixed dividend coverage 0.04 Add: Risk premium for high interest gearing ratio 0.74 7.98 Value of Equity Share = (Actual yield / Expected yield) × Paid-up value of share = (3.70 / 7.98) × 100 = 46.37

Topics: Security Valuation

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