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Ebit – Eps Analysis
QUESTION FOR PRACTICE

Q.1. A company’s current EBIT is Rs. 20 lakh. Its present borrowings are :

Rs.
14% Term loans 40,00,000
Working capital borrowings from Banks at 16% 33,00,000
15% Public deposits 15,00,000

The sales of the company are growing, and to support them the company proposes to obtain an additional bank loan of Rs. 25 lakh. The increase in EBIT is expected to be 20%. Calculate the change in interest coverage ratio after the additional borrowing and comment.

Ans. Interest Coverage Ratio reduces from 1.52 to 1.40

Q.2. A company is considering lowering the selling piece of its product. The following information is available on the costs of producing and income from selling its product :

Number of units sold 3,00,000
Sale price Rs. 10 per unit
Variable costs Rs. 6 per unit
Fixed costs Rs. 6,00,000

The management has asked you to prepare a statement indicating the percentage increase in volume necessary to maintain a net operating income at the current level on product with decrease in price of 10% and 20% assuming other costs remaining constant.

Ans. Desired sales are 4,00,000 units and 6,00,000 units

Q.4. A company needs Rs. 5,00,000 for construction of a new plant.

The following three financial plans are feasible:
(i) The company may issue 50,000 common shares at Rs. 10 per share,
(ii) The company may issue 25,000 equity shares at Rs. 10 per share and 2,500 debentures of Rs. 100 bearing a 8% rate of interest,
(iii) The company may issue 25,000 equity shares at Rs. 10 per share and 2,500 preference shares at Rs. 100 per share bearing at 8% rate of dividend. If the company’s earnings before interest and taxes are Rs. 10,000, Rs. 20,000, Rs. 40,000, Rs. 60,000 and Rs. 1,00,000 what are the earnings per share under each of the three financial plans? Which alternative would you recommend and why? Determine the indifference points Assume a corporate tax rate of 505.

Ans. Alternative I: EPS are Re. 0.10,0.20,0.40,0.60 and 1.00; Alternative II : EPS are Rs. – 0.20, 0, 0,40, 0.80 and Rs.1.60; Alternative III: EPS are Rs. – 0.60, -0,40,0,0.40 and Rs. 1.20. Indifferent level of EBIT between Alternative I and II is Rs. 40,000 and between Alternative I and III is Rs. 80,000

Q.5. Arvind Textile Mill currently has 10,00,000 shares of equity outstanding with a market price of Rs. 50 per share. It also has Rs. 4 crore in 12% bonds. The company is considering a Rs. 5 crore expansion programme that it can finance through:
1. All equity shares at Rs. 40 per share or
2. Straight bonds at 15% interest or
3. Half equity shares at Rs. 40 per share and half 15% bonds

You are required to do the following:
(i) For EBIT level of Rs. 2,50,00,000 after the expansion programme, calculate the earnings per share for each of the alternative modes of financing. Assume a corporate tax rate of 50%.
(ii) What are the indifference points between alternatives?
(iii) What is your interpretation of the results?

Q.6. Super Star Ltd. has decided to change its capital structure. The firm currently has one crore fully paid up shares. The share commands a price of Rs. 50 in the market and is likely to remain the same even after proposed capital restructuring. The restructuring involves increasing the firm's existing Rs. 9 crore 10% debt to Rs. 14 crore.

The proceeds will be used to retire the equity. The interest rate on debt is not expected to change as the debt investors do not perceive the firm to become more risky as a result of proposed dose of debt. Company is in 40% tax bracket. Calculate the minimum level of EBIT that the firm must earn so that EPS does not change.

Q.7. The following information is available in respect of XYZ Ltd. :

Number of shares issued 10,000
Market price per share Rs. 20
Interest rate 12%
Tax rate 46%
Expected EBIT Rs. 15,000

The firm needs Rs. 50,000 for investment next year. Should the firm issue debt or equity to produce higher EPS. Also find out the indifference level of the alternatives? What is the EPS for that EBIT?

Ans. EPS is Rs. 0.49, and 0.65; the indifference level of EBIT is Rs. 30,000 and EPS at the level is Rs. 1.30

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