Hind Beverages
Hind Beverages Inc., the leading soft drink and drinking water company in the private sector, has acquired Himalayan Water Co., in a deal worth $8.6 billion in 2007 to further expand its market share. A financial decision of this magnitude has significant implicitness for both Hind Beverages Inc and Himalayan Water as well as their employees and shareholders.
Hind Beverages Inc. raised a debt of over $8 billion to finance the transaction. This financing decision affected the capital structure of the acquirer.
Which of the following statements is NOT correct about capital structure?
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → A higher proportion of debt is always desired
Option (1) Capital structure can be measured by debt-equity ratio. — True of capital structure (Incorrect). Debt divided by equity shows how much of the capital is borrowed for every rupee of owners’ funds.
Option (2) Capital structure reflects the mix of debt and equity — True of capital structure (Incorrect). This is its meaning.
Option (3) A higher proportion of debt is always desired — Not true of capital structure (Correct). Debt is cheaper than equity, but interest and repayment must be met whatever happens. More debt means more financial risk. Beyond a point, shareholders demand a higher return and the share price falls. So debt is used only up to the level that raises the value of the equity share, and that level is the optimal capital structure.
Option (4) The capital structure of a company affects both profitability and financial risk. — True of capital structure (Incorrect). Cheap debt can raise the earnings per share, but it also raises the risk of default.
Note 1: The passage is the NCERT case study ‘When Tata Steel Acquired Corus’, which has been reproduced by NTA in the exam with the names of the companies changed. Note 2: It seems that there is a mistake in the original NTA paper, which prints “significant implicitness” in the passage when it should read “significant implications”. The slip is NCERT’s own: the NCERT case study prints the same word, and NTA copies lines from NCERT word for word, even where the book is wrong. Read the word as “implications”, meaning effects.
NCERT (2026-27 Edition): “Capital Structure … Higher use of debt increases the fixed financial charges of a business. As a result, increased use of debt increases the financial risk of a company. Financial risk is the chance that a firm would fail to meet its payment obligations. 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. …” “Capital Structure … Capital structure refers to the mix between owners and borrowed funds. These shall be referred as equity and debt in the subsequent text. It can be calculated as debt-equity ratio” |