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Group 8 Division C
1. Parth Dave 178 2. Udit Dave 179 3. Ashish Bharadwaj 181 4. Krutik Dedhia 218 5. Atharva Oswal 219 6. Raj Shah 323 7. Dhruv Kalia - 324
The right capital structure planning also increases the power of company to face the losses and changes in financial markets.
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3. Idea generation of new source of fund: a. Good planning of capital structure will make versatile to finance manager for getting money from new sources. b. venture capital or private equity sources precisely understand. c. Finance managers of company are generating new and new idea for getting money from public at low risk. d. Promoters or managers do 10 minutes meeting with investors and motivate them by showing the special event which they have made in PPT.
Illustration 1.1
A firm has $200,000 of cash available for investment, ko = 10%. If the company were to invest the $200,000 in a project with a return greater than ko, then the present value of the firm would increase. Consider a project that will require all the $200,000 now and will return $30,000 per annum indefinitely. Using i = ko = .10 the present value of the income stream =$300,000 (the IRR equals 15%).
Initial assumptions of all models (1) (2) (3) (4) (5) No taxation Immediate change in gearing All earnings distributed All shareholders expect same future earnings No growth in earnings.
Illustration 2.2
Two companies have the same EBIT but different capital structures Company A: E (EBIT) = $80,000 all equity capital Company B: E (EBIT) = $80,000 DEBT = $500,000 @ 6%, remainder equity. The debt service cost (interest) = $30,000 p.a. The expected earnings of shareholders are Company A = $80,000 Company B = $50,000 ($80,000 30,000) Shareholders earnings have greater relative dispersion for Company B than for Company A (coefficient of variation).
All capital structures are optimal. The increase in ks is exactly sufficient to offset the effect of the increased importance of kd so ko is constant.
Illustration 3.1
Firm R.C. has an EBIT of $900,000. There is debt of $4 million in the capital structure. kd = 7.5% and WACC (ko) = 10%. The total value of the firm V =$9,000,000 The value of debentures = Thus equity is worth $4,000,000 $5,000,000
As employees, management will tend to put constraints on the level of gearing as they will perceive a decrease in their job security with an increase in financial risk.
Situation as of 1981
Total Debt : $ 1,69,23,23,000 Shareholders equity : $ 76,76,00,000 Total Capital : $ 2,45,99,23,000 Percentage Debt : 68.80 % Objective : Reduce debt percentage to 60 % to consistently have A rating and reduce interests payments do that dividends are not reduced Options : 90 Day commercial paper at 13.5 % 25 years debenture at 16.5 % Common stock trading at $32 per share
Suggested Solution :
1. We cannot use commercial paper as they are a kind of short-term debt and high interest payments will have to be done. That will reduce profits and dividend payouts will be impacted, which the company would not like to. Thus, lets consider the next alternative. Debentures are a part of debt capital. Borrowing capital at 16.5 % for 25 years will have a drastic impact on bottom line. Neither the above nor this alternative is preferred. Thus let us consider the next step. We issue FPO of 10 million shares at $32 per share. This will raise capital of $ 32,00,00,000. Total Capital will increase to $ 2,77,99,23,000 and debt percentage shall decrease to 60.60 %. This will serve the purpose of consistently having a A grade rating and also help raise funds at low interest rates and also company will not have to reduce dividend.
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Thank you