Tau Ltd. has equity of Rs. 40 lakh and debt of Rs. 40 lakh at 9% p.a. Its EBIT is Rs. 10 lakh. Consider the following statements:
(A) The return on investment (RoI) of Tau Ltd. is 12.5%.
(B) The debt-equity ratio of Tau Ltd. is 1 : 1.
(C) The financial leverage of Tau Ltd., as the proportion of debt in total capital, is 1.
(D) The interest payable by Tau Ltd. on its debt is Rs. 4 lakh a year.
Which of the statements given above are correct?
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → (A) and (B) only
Given:
Equity = Rs. 40 lakh (Rs. 40,00,000)
Debt = Rs. 40 lakh (Rs. 40,00,000) at 9% p.a.
EBIT = Rs. 10 lakh (Rs. 10,00,000)
(A) The return on investment (RoI) of Tau Ltd. is 12.5%. — Correct. RoI compares EBIT with the total funds used.
RoI = EBIT ÷ Total investment × 100
RoI = 10 ÷ (40 + 40) × 100 = 12.5%
(B) The debt-equity ratio of Tau Ltd. is 1 : 1. — Correct. The ratio compares debt with equity.
Debt-equity ratio = 40 ÷ 40 = 1 : 1
(C) The financial leverage of Tau Ltd., as the proportion of debt in total capital, is 1. — Incorrect. As a proportion, financial leverage is debt over total capital.
Debt ÷ (Debt + Equity) = 40 ÷ 80 = 0.5
The figure 1 is the debt-equity ratio, the other way of showing leverage.
(D) The interest payable by Tau Ltd. on its debt is Rs. 4 lakh a year. — Incorrect. Interest is worked at the 9% rate on the debt.
Interest = 9% of Rs. 40 lakh = Rs. 3.6 lakh
Rs. 4 lakh would need a rate of 10%.
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. …” EBIT-EPS Analysis
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