Corporate finance : Second Int Q 2 N 4 - Solution

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Q. No. 2:

a) Amount of capital budget = Rs 60 million – Rs 30 million = Rs 30 million

(b) Equity financing = 50% of Rs 30 million = Rs 15 million

(c) Internal equity = Rs 3 million

    External equity = Rs 15 million – Rs 3 million = Rs 12 million

(d)  Cost of debt after tax (kd_t )= 10 (1 – 0.40)

                                             = 6%

Cost of preferred stock (k_p) = 11%

Cost of internal equity (K_r) = 12%

Cost of external equity (k_e) =( 4.8/114) + 0.08 = 12.21%

(e) WACC using cost of internal equity = 6 x 0.40 + 11 x 0.10 + 12 x 0.50 = 9.5%

 (f) WACC using cost of external equity = 6 x 0.40 + 11 x 0.10 + 12.21 x 0.50 = 9.61%

Q.No.4

(a)    Balance Sheet (common stock financing)

Assets	Rs	Liabilities and equity	Rs
		Current liabilities (315,000-175,000)	140,000
		Common stock, par Rs 1	140,000
		Additional paid in capital	300,000
		Retained earnings	45,000
Total assets	625,000	Total liabilities and equity	625,000

Working note:

Common stock financing:

No. of new share = 350,000/7= 50,000; Total no of share = No of existing share + no of new share

                                                                                                     = 90,000 + 50,000

                                                                                                             = 140,000

 Par value = 140,000 x 1= Rs 140,000

Additional paid in capital = (7 – 1) x 50,000 = Rs 300,000

Assets	Rs	Liabilities and equity	Rs
		Current liabilities (315,000-175,000)	140,000
		Common stock, par Rs 1	133,750
		Additional paid in capital	306,250
		Retained earnings	45,000
Total assets	625,000	Total liabilities and equity	625,000

                                                         Balance Sheet (after conversion of convertible bond)

Working note:

No of new share = no of debenture x conversion ratio

Conversion ratio =1000/8 =125

No of debenture = 350,000/1000= 350

No of new share = 350 x 125 = 43,750

Total no. of share= 90,000 + 43,750 = 133,750

Par value = 133,750 x 1 = Rs 133,750

Additional paid in capital = 43,750 x  (8 – 1) = Rs 306250

Assets	Rs	Liabilities and equity	Rs
		Current liabilities (315,000-175,000)	140,000
		7% Debenture	350,000
		Common stock, par Rs 1	133,750
		Additional paid in capital	306,250
		Retained earnings	45,000
Total assets	975,000	Total liabilities and equity	975,000

                                            Balance Sheet (after exercise of warrants)

Working note:

No of new share = no of debenture x exercise ratio

Exercise ratio = 125

No of debenture = 350,000/1000= 350

No of new share = 350 x 125 = 43,750

Total no. of share= 90,000 + 43,750 = 133,750

Par value = 133,750 x 1 = Rs 133,750

Additional paid in capital = 43,750 x  (8 – 1) = Rs 306250

(b)

                                  Income statement

	All equity financing	After conversion	After exercise
EBIT	Rs 125,000	Rs 125,000	Rs 195,000
less: interest	-	-	24,500
EBT	125,000	125,000	170,500
less; taxes (40%)	50,000	50,000	68,200
EAT	75,000	75,000	102,300
No of share	140,000	133,750	133,750
EPS = EAT/No of share	Rs 0.54	Rs 0.56	Rs 0.76

(c) Mr. Harry should choose the debenture with warrant because this alternative has the highest EPS than other alternatives.