Financial Decision
Sunrises Ltd. dealing in ready-made garments, is planning to expand its business operations in order to cater to the international market. To prepare for the future operations, the financial manager estimates that the raw materials will get costlier in the next year and the market will grow in the next 18 months. As the new orders will be placed by the international buyers, the earnings of the company will become more stable. He also suggested that it is advisable to increase production by investing in new machinery. For this purpose the company needs an additional rupees 80,00,000 to replace machines with modern machinery of higher production capacity. The company wishes to raise the required funds by issuing debentures. The debt can be issued at an estimated cost of 10%. The EBIT for the previous year of the company was rupees 8,00,000 and total capital investment was rupees 1,00,00,000.
Calculate the Return on Investment and Cost of Debt.
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → 8%, 10%
Return on investment (ROI) shows how much the company earns on the total capital it has invested. It is found from the earnings before interest and tax (EBIT).
\( \displaystyle \text{ROI} = \frac{\text{EBIT}}{\text{Total capital investment}} \times 100 \)
\( \displaystyle \text{ROI} = \frac{8{,}00{,}000}{1{,}00{,}00{,}000} \times 100 = 8\% \)
The cost of debt is the rate the company must pay on the debentures. The passage gives it directly: the debt can be issued at an estimated cost of 10%.
Option (1) 8%, 10% — Correct. ROI 8% and cost of debt 10%, as worked out above.
Option (2) 10%, 8% — Incorrect. The two figures are swapped.
Option (3) 8%, 7% — Incorrect. The ROI is right, but the passage puts the cost of debt at 10%.
Option (4) 8%, 7.2% — Incorrect. 7.2% would be a cost of debt after tax, but the passage gives no tax rate. The cost stated is 10%.
Note: The passage is built on an NCERT exercise question on Sunrises Ltd. in the chapter ‘Financial Management’, which has been reproduced by NTA in the exam.
NCERT (2026-27 Edition): “Factors affecting the Choice of Capital Structure … 4. Return on Investment (RoI): If the RoI of the company is higher, it can choose to use trading on equity to increase its EPS, i.e., its ability to use debt is greater. …”
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