1) Divya Electronics is planning a Rs. 2000 million expansion project that will generate annual revenue of Rs. 2400 million. They are considering equity financing through a public issue or debt financing through debentures.
2) The indifference point between the two options is an EBIT of Rs. 1480 million - below this, equity is better, and above it, debt is better.
3) Given the projected EBIT of Rs. 1860 million after expansion, debt financing through debentures is the better option as it provides a higher EPS of Rs. 7.5.
4) Debt financing results in higher financial risk as evidenced by a higher degree of total leverage of 2.733 compared to
2. Case Study:
Introduction:
Divya Electronics was Promoted by Dipankar Mitra 20 Year Ago
Initially the firm employed the debt/equity ratio as 1.5:1
Issued Bonus share on two occasion
The current Market Price of share is Rs 115 and PE Ratio is 19.17
Firm is planning for Expansion of Project at Rs 2000 Million which
will generate annual revenue of Rs 2400 Million .It will variable cost
will be 60% and Fixed Cost will be Rs 500 Million
3. Case Study:
Balance Sheet
Sno Source of Fund Rs. In Million
1 Share Funds
Paid up Equity Capital(140 million
shares at Rs 10) 1400
Reserve and surplus 2600
2 Loan 2000
6000
Application Of Funds
1 Net Fixed Assets 4000
2 Net Current Assets 2000
6000
Total No of
Equity share:140
Million
Share Hold By
Dipankar and his
family is 45 Million
Eman Consultant had proposed two ways to raised the fund
4. Case Study:
Total No of
Equity share:140
Million
Share Hold By
Dipankar and his
family is 45 Million
Profit and Lost Account
Rs . In Million
Revenue 8000
Variable cost 4800
Contribution Margin 3200
Fixe Operataing Cost 1800
Profit Before Intrest and Tax 1400
Interest 200
Profit Before Tax 1200
Tax 360
Profit After Tax 840
5. Case Study:
Two Option available for financing the project
1. Public Issue of Equity shares at Rs 106 .The
issue expense will be Rs 6 Per Shares.
2. Privately carrying Debenture at 8% interest.
In Case1:
Number of Share
issued=2000million/Rs(106-6)
=20 Million
So total sahre:140+20=160 Million
Interest Cost Remain the same: 200 Million
In case2:
Number of share:140Million
Interest Paid to Debenture:
=2000*8%=160 Million
Total
Intrest:200+160=360Million
6. Case Study:
a. Compute the EPS –PBIT(EBIT) indifference point for the two
financing option.
EPS(1)=(EBIT-I1)(1-T)/N1…Equation no 1
EPS(2)= (EBIT-I2)(1-T)/N2….Equation no2
Now for indifference point
EPS(1)=EPS(2)
Given :
N1:160 Million
N2 :140Million
T: 30%
I1=200Million
I2=360Million
(EBIT-I1)/N1=(EBIT-I2)/N2
(EBIT-200)/160=(EBIT-360)/140
EBIT=1480Million
7. Case Study:
Interpretation:
1.When EBIT is less than<14800
equity finance is ok.
2.When EBIT is greater than
>1480 Debt finance is ok.
3. When EBIT=1480 it can opt for
any one
8. Case Study:
B. Calculate the EPS for the following year Under the two financing option
assuming that the expansion project would be fully operational
Rs . In
Million
Profit and Lost Account
Finacing
with Equity
Finacing with
Debenture
Revenue 8000 10400 10400
Variable cost 4800 6240 6240
Contribution Margin 3200 4160 4160
Fixe Operataing Cost 1800 2300 2300
Profit Before Intrest
and Tax 1400 1860 1860
Interest 200 200 360
Profit Before Tax 1200 1660 1500
Tax 360 498 450
Profit After Tax 840 1162 1050
No Share 140 160 140
EPS 6 7.2625 7.5
Additional Revenue from
Expansion 2400
Additional variable cost of
cost is 60% of Revenue after
expansion 1440
Additional fixed Operating
Cost after expansion 500
Intrest for Option 1 200
Intrest for option 2 is
200+8%2000 360
9. Case Study
Interpretation: Since EBIT is 1860 Million greater than 1480 million the
second option is good that is financing from debt. We can see that EPS
is 7.5 also high among two.
10. Case Study
C. Show the degree of total Leverage will change under the two
financing option
DTL: Degree of Total Leverage
CM :Contribution margin
EBT: Earning Before tax
DTL DTL(1) DTL(2)
2.66 2.5 2.733
So we can observe that in second case
DTL is high i.e High risk and EPS is also
high so High reward.
11. Case Study
D. Highlight how the any other issue that you believe are more
important in taking decision
Huge reserve and surplus can be used for financing the project
Interest Coverage ratio is getting lower in case of second
ICR ICR1 ICR2
7 9.3 5.1
Editor's Notes
Introduction of debt lead to risk . Issue of Debenture is rsiky because the balance is disturb on fulcrum
Intrset coverage ratio lower means company is burden bu Debt under this condition the option 1 is better