The capital structure of Fin Ltd. purely consists of Equity Share Capital of ₹20,00,000 consisting of share of 10 each. Its EBIT for the previous year was ₹3,00,000. Now it is planning to expands its business operations for which additional fund of ₹10,00,000 for replacement of old machines with modern machinery was needed. The company plans to raise the funds by issuing 10% Debentures of ₹100 each. Assuming the return on investment of the company remain unchanged, what will be the EPS if 10% Debentures of ₹10,00,000 are issued and tax rate is 40%.
Answer & explanation
Correct answer: option 2
The correct answer is option (2)- ₹1.05.
Initial Total Capital = Equity Share Capital = ₹20,00,000
Initial EBIT = ₹3,00,000
Return on Investment (ROI) before expansion = EBIT/Total Capital x 100
ROI = 3,00,000/20,00,000 x 100
= 15%
The ROI remains unchanged, the new EBIT will be based on the increased total capital. New EBIT after expansion:
New Total Capital = Initial Equity Share Capital + Debentures
= ₹20,00,000 + ₹10,00,000
= ₹30,00,000
ROI remains unchanged means it will be 15%.
New EBIT = New Total Capital x ROI
= ₹30,00,000 X (15/100)
= ₹4,50,000
Debentures = ₹10,00,000
Interest Rate = 10%
Interest = ₹10,00,000 X10/100
= ₹1,00,000
Earnings Before Tax (EBT) = New EBIT - Interest Expense
= ₹4,50,000 - ₹1,00,000
= ₹3,50,000
Tax Rate = 40%
Tax Expense = ₹3,50,000 X 40%
= ₹1,40,000
Earnings After Tax (EAT) = EBT - Tax Expense
= ₹3,50,000 - ₹1,40,000
= ₹2,10,000
No of equity shares = 20,00,000/10
= 2,00,000
EPS = EAT/No of shares
= 2,10,000/2,00,000
= 1.05