Lambda Ltd. has equity of Rs. 48 lakh and no debt. It wants its financial leverage, measured as the proportion of debt in total capital, to be 0.4. How much debt should it raise?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Rs. 32 lakh
Given:
Equity = Rs. 48 lakh
Debt at present = nil
Financial leverage wanted = 0.4
Financial leverage = Debt ÷ (Debt + Equity)
Let the debt to be raised be D.
D ÷ (D + 48) = 0.4
D = 0.4D + 19.2
0.6D = 19.2
D = 19.2 ÷ 0.6 = Rs. 32 lakh
Check: 32 ÷ (32 + 48) = 32 ÷ 80 = 0.4
Option (1) Rs. 32 lakh — Correct. Debt over total capital is 32 ÷ 80 = 0.4, as worked out above.
Option (2) Rs. 19.2 lakh — Incorrect. This takes leverage as debt over equity: 0.4 × 48 = 19.2.
Option (3) Rs. 72 lakh — Incorrect. This treats equity as 0.4 of total capital: 48 ÷ 0.4 = 120, and 120 − 48 = 72.
Option (4) Rs. 80 lakh — Incorrect. This is the total capital after the debt is raised: 32 + 48 = 80.
NCERT (2026-27 Edition): “Capital Structure … Capital structure of a company, thus, affects both the profitability and the financial risk. A capital structure will be said to be optimal when the proportion of debt and equity is such that it results in an increase in the value of the equity share. In other words, all decisions relating to capital structure should emphasise on increasing the shareholders’ wealth. The proportion of debt in the overall capital is also called financial leverage. …” |