Financial Decision

Dr. Swati Gupta

What is financial decision

Finance plays an important role in business. It is the master key which provides access to all other resources that are employed in the production. It guides and regulates investment decisions and expenditures. If funds are inadequate, the business suffers but if the funds are not properly managed, the entire organization suffers. Therefore it is necessary to make the correct estimation of the current and future requirement of the capital which can help the organization to function smoothly .

Capitalization
Capitalization means the total amount of long term funds. It is a quantitative aspect of the financial planning of an enterprise. Suppose if a company has equity shares of Rs 4,00,000, preference shares of Rs 2,00,000, retained earnings of Rs 1,00,000, debentures of Rs 3,00,000 and long term loans of Rs 1,00,000 from financial institutions ,the total capitalization of the company is Rs 11,00,000.

Capital structure and financial structure

Capital structure refers to the proportionate amount of various sources of long term funds that make up capitalization . It is concerned with the qualitative aspect Financial structure refers to the composition of long term funds as well as short term funds in the capitalization of the company. It means that capital structure of a company is a part of its financial structure.

EBIT, EBT and EPS analysis

EBIT- Means earnings before interest and tax. It refers to operating profit. EBT- Means earning before tax. After deducting interest from EBIT, we can get EBT. EAT- Means earning after tax. It is a net profit after tax. ROE- Means return on equity shares. It is a net earnings available to the equity shareholders. we can get ROE after deduction of preference dividend from EAT. EPS- Means earning per share. If we divide ROE(net earnings available to the equity shareholders) from no of equity shares, we can get EPS.

Problem based on EBIT,EBT and EPS

Description: Innovative Co Ltd. is capitalized with Rs 10,00,000 of 10,000 equity shares of Rs 100 each . The management desire to raise additional fund of Rs 10,00,000 under its expansion plan through one of the following financial plans 1. All equity capital 2. Rs 5,00,000 equity shares and 5,00,000 through debt at 10% interest rate 3. All through debt @ 10% interest rate 4. Rs5,00,000 equity capital and Rs 5,00,000 through preference shares at 10% dividend The EBIT of the firm is Rs 3,00,000. Tax is 50%. Recommend the plan which would be suitable from the point of view of equity shareholders.

Computation of earning per share under different plans

Plan1 All 10,00,000 through equity shares Plan 2 Rs 5,00,000 through equity shares and 5,00,000 through debt@10% interest rate 3, 00,000 50,000 2,50,000 1,25,000 1,25,000 Nil Plan 3 All 10,00,000 through debt at 10%interest rate EBIT (same for all plans) Less-interest on debt EBT Less-tax (50%) EAT Less preference dividend 3,00,000 Nil 3,00,000 1,50,000 1,50,000 Nil 3,00,000 1,00,000 2,00,000 1,00,000 1,00,000 Nil 3,00,000 Nil 3,00,000 1,50,000 1,50,000 50,000

Plan 4 Rs 5,00,000 through equity capital and Rs 5,00,000 through preference shares @10% dividend

Net earning available to equity share holders

No of equity shares EPS

1,50,000

1,25,000

1,00,000

1,00,000

20,000 Rs 7.5

15,000 Rs 8.33

10,000 Rs 10

15,000 Rs 6.67

Comment EPS is highest in Plan 3 so this plan is best suitable for equity share holders.