2. CASE STUDY :
Divya Electronics was promoted about 20 years by Dipankar Mitra, who continues to be the Executive
Chairman of the firm.
As the promoter has limited resources, the firm employed a debt- equity ratio of 1.5: 1.
The firm has performed fairly well and has been reasonably profitable.
The firm also issued bonus shares on two occasions - once before making its IPO eight years ago and once
subsequently.
Current market price per share is Rs. 115, giving a retrospective PE ratio of 16.43, the highest in its history.
Dipankar Mitra and his family holds 4.5 crore shares of Divya Electronics. The rest is held more or less
equally by institutional investors and retail investors.
3. CASE STUDY :
Expansion project of firm :
* It will require an outlay of Rs. 200 crore which will be supported by external financing.
* Expected to generate an annual revenue of Rs. 240 crore.
* Its variable cost will be 60 % of revenues and its fixed operating costs would be Rs. 50 crore.
Two options available for Divya Electronics:
* It can make a public issue of equity shares at Rs. 106. The issue expenses will be Rs. 6 per share.
* It can privately place debentures carrying an interest rates of 8 %.
4. BALANCE SHEET
SOURCES OF FUNDS Rs. In crore
1. Share holder’s fund
• Paid up equity capital (140 million shares
of Rs. 10 each)
140
• Reserves and Surplus 250
2. Loan funds 200
Total 600
APPLICATION OF FUNDS Rs . In crore
1. Net Fixed Assets 400
1. Net current Assets 200
Total 600
6. a) Compute the EPS - PBIT indifference point for the two financing
options.
EPS - Earnings per share is the portion of a company’s profit allocated to each outstanding share of
common stock. It serves as an indicator of a company’s profitability.
PBIT - The profit of a company calculated by deducting expenses from revenue , excluding the
interest and tax.
INDIFFERENCE POINT - It is that EBIT level at which EPS is same for two alternative financial plans.
Relationship between PBIT and EPS :
where I = interest ,
t = tax,
n= number of shares
EPS = (PBIT - I) (1-t)/n
7. EPS (Option 1) = ( PBIT -I ) ( 1-t )/ n
= ( PBIT - 20 ) ( 1 - 0.3 ) / 16 ………………….. ( i )
EPS (Option 2) = ( PBIT - I ) (1 - t) / n
= ( PBIT - 36 ) ( 1 - 0.3 ) / 14 …………………… ( ii )
Equating both equations (i) & (ii) we get -
PBIT = Rs. 148 crore ( approx)
148 crore is the indifference point.
Interpretations :
• When PBIT < Rs.148 crore , option 1 i.e. of equity is better.
• When PBIT > Rs.148 crore , option 2 i.e. of debt is better.
• When PBIT = Rs.148 crore , both the options are equally better.
8. b) Calculate the EPS for the following year under the two financing
options assuming that the expansion project would be fully
operational.
For calculating this, firstly we have to calculate PBIT for both the Options.
Particulars Option 1 Option 2
Revenue 1040 1040
Variable Cost 624 624
Contribution 416 416
Fixed operating cost 230 230
9. Particulars Option 1 Option 2
PBIT 186 186
Interest 20 36
PBT 166 150
Tax ( 30%) 49.8 45
PAT 116.2 105
EPS ( 116.2/16) = 7.26 (105/14) = 7.5
Since the PBIT of the firm is Rs. 186 crore which is > Rs. 148 crore. , therefore Option 2
is the best alternative.
EPS of Option 2 = 7.5
10. where DTL - Degree of total leverage
DOL - Degree of operating leverage
DFL - Degree of financial leverage
DTL (Option 1) = 416 / 166 = 2.5
DTL (Option 2) = 416 / 150 = 2.77
DTL (current) = 320 / 120 = 2.67
c) Show how the degree of total leverage will change under the two
financing options
DTL = DOL * DFL
DTL = Contribution / EBT
11. Other important issues for taking the decisions :
This ratio is used to determine how easily a company can pay interest on outstanding debt.
For Option 1 = 186/20
= 9.3:1
For Option 2 = 186/36
= 5.1:1
Interpretation: Lower the ratio, the more the company is burdened by debt expenses.
So , we conclude that option 1 is better than option 2 as its interest coverage ratio is more.
Instead of taking money of Rs. 200 crore from external financing ,the company can take money from
reserve and surplus. This will increase the earnings per share of shareholders and it will also help Mr.
Dipankar Mitra to retain its portion of shares in the company.
d) Highlight any other issues that you believe are important for taking
the decision.
Interest Coverage Ratio = PBIT / Interest on debt
