Financial Management 37

Chapter

 †h me †jL‡Ki eB †_‡K AsK †bqv cÖ‡kœi aiY †h mv‡ji cixÿvq G‡m‡Q

n‡q‡Q:
 L. J. Gitman (10e) B, S, V, 𝐾𝑜 2011, 2013, 2014, 2017
 Khan & Others (2016)
EPS 2015, 2016
 Khan & Ghoshal (2017/18)
 NU Questions (up to 2017) Indifference point of EBIT 2015, 2016
Arbitrage Process --

B Market value of debt 𝐾𝑜 Overall cost of capital

EBIT Earnings Before Interest & Tax/ NOI MPS Market Price Per Share
EPS Earnings Per Share NI Net Income = EBITI
I Total Interest NS No. of Shares
𝐾𝑑 Cost of debt S Market value of equity
𝐾𝑒 Cost of equity V Value of the firm = 𝑆 + 𝐵

Formulas Formulas
𝐸𝐵𝐼𝑇−𝐼 𝑁𝐼 𝐼
1 𝑆= 𝑆= 6
𝐾𝑒 𝐾𝑒 𝐵 =
𝐾𝑑
2 𝐸𝐵𝐼𝑇 − 𝐼 7 𝐸𝐵𝐼𝑇
𝐾𝑒 = 𝐾𝑂 =
𝑆 𝑉
𝐸𝐵𝐼𝑇−𝐼 𝐵 𝑆
3 𝑉 = 𝑆+𝐵 ⇒𝑉= +𝐵 8
𝐾𝑒 𝐾𝑂 = 𝐾𝑑 ( ) + 𝐾𝑒 ( )
𝑉 𝑉
4 𝑆 = 𝑉−𝐵 9 𝑆
𝑀𝑃𝑆 =
𝑁𝑆

5 𝐸𝐵𝐼𝑇 10 𝐸𝑃𝑆 =
𝐸𝐵𝐼𝑇−𝐼
𝑉 = 𝑁𝑆
𝐾𝑂

11 Earnings Per Share (𝐸𝐵𝐼𝑇 − 𝐼)(1 − 𝑡) − 𝑃𝐷

𝐸𝑃𝑆 =
𝑁𝑆
12 Indifference point of EBIT (𝐸𝐵𝐼𝑇 − 𝐼1 )(1 − 𝑡) − 𝑃𝐷1 (𝐸𝐵𝐼𝑇 − 𝐼2 )(1 − 𝑡) − 𝑃𝐷2
=
𝑁𝑆1 𝑁𝑆2
38 Chapter  3: Capital Structure

 NI, NOI & MM Model with Tax (g~jab KvVv‡gv Z‡Ë¡i As‡K Tax rate _vK‡j mZK©Zv)
[Problem: 15, 16, 17]
Rule-1: Tax rate _vK‡j Unlevered Firm Gi †ÿ‡Î NI I NOI Dfq c×wZ‡Z dv‡g©i Value GKB n‡e|
𝐸𝐵𝐼𝑇 (1−𝑇)
A_©vr, Value of Unlevered Firm, 𝑉𝑈 =
𝐾𝑒

Rule-2: wKš‘ Levered Firm Gi †ÿ‡Î NI I NOI/MM c×wZ‡Z dv‡g©i Value wfbœ n‡e|
(𝐸𝐵𝐼𝑇−𝐼) (1−𝑇)
Rule-3: NI c×wZ‡Z (i) Value of Levered Firm, 𝑽𝑳 = 𝑺 + 𝑩 = +𝐵
𝐾𝑒

Rule-4: NOI/MM c×wZ‡Z (i) Value of Levered Firm, 𝑽𝑳 = 𝑽𝑼 + 𝑩𝑻 GLv‡b, T =

Tax rate per Taka.
(ii) Value of share, 𝑺 = 𝑽𝑳 − 𝑩 [NOI c×wZ‡Z wbY©xZ 𝑉 †_‡K 𝐵 ev` w`‡q 𝑆
wbY©q Ki‡Z n‡e]
𝐵 𝑆
(iii) 𝐾𝑂 = 𝐾𝑑 ( ) + 𝐾𝑒 ( )
𝑉 𝑉

Rule-5: GQvov cÖ‡kœ cÖ`Ë 𝐾𝑑 †K after tax 𝐾𝑑 †Z iƒcvšÍi Ki‡Z n‡e|

A_©vr after tax 𝐾𝑑 = Before tax 𝐾𝑑 (1T)
(𝐸𝐵𝐼𝑇−𝐼) (1−𝑇)
Rule-6: cÖ‡kœ cÖ`Ë 𝐾𝑒 ai‡j Pj‡e bv| 𝐾𝑒 = GB m~‡Îi mvnv‡h¨ 𝐾𝑒 Gi gvb wbY©q
𝑆
K‡i wb‡Z n‡e|
[Source: A. Hakim & B. Ghoshal, Financial Management, Dhaka: M.C. Paul & Sons (2015), pp.249, 330]

 g~jab KvVv‡gv (Capital Structure): †Kvb cÖwZôv‡bi mvaviY †kqvi, AMÖvwaKvi †kqvi,
`xN©‡gqvw` FY I Aew›UZ gybvdv †_‡K msM„nxZ Znwe‡ji AbycvZ‡K g~jab KvVv‡gv e‡j|

 Kvg¨ g~jab KvVv‡gv (Optimum Capital Structure): †h g~jab KvVv‡gv‡Z dv‡g©i g~j¨ me©vwaK Ges
g~jab e¨q me©wb¤œ nq, Zv‡K Kvg¨ g~jab KvVv‡gv e‡j|

 Levered Firm : †h dv‡g©i g~jab KvVv‡gv‡Z FYcÎ Av‡Q, Zv‡K Levered Firm e‡j|

 Unlevered Firm: †h dv‡g©i g~jab KvVv‡gv‡Z FYcÎ †bB, Zv‡K Unlevered Firm e‡j|
 Financial Management 39

 g~jab KvVv‡gv ZË¡mg~n 

 wbU Avq ZË¡ (Net Income Approach): Aa¨vcK David Durand 1952 mv‡j cÖKvwkZ GK wbe‡Ü GB
ZË¡wU e¨vL¨v K‡ib| wbU Avq Z‡Ë¡i g~j K_v n‡jv GKwU cÖwZôvb g~jab KvVv‡gv‡Z F‡Yi AbycvZ
evwo cÖwZôv‡bi g~j¨ evov‡Z cv‡i ev mgvwMÖK g~jab LiP Kgv‡Z cv‡i| GLv‡b mvgwMÖK g~jab LiP
n‡jv F‡Yi LiP (Kd) Ges BKzBwU g~jab LiP (Ke) Gi ¸iæZ¡cÖ`Ë LiP| g~jab KvVv‡gv‡Z wjfv‡i‡Ri cwigvY
evov‡j ¸iæZ¡cÖ`Ë LiP K‡g hv‡e Ges cÖwZôv‡bi g~j¨ e„w× cv‡e| Ab¨w`‡K wjfv‡i‡Ri cwigvY Kgv‡j
mvgwMÖK g~jab LiP e„w× cvq Ges cÖwZôv‡bi g~j¨ K‡g hvq|
 G ZË¡wU wb‡Pi AbywgZ kZ©¸‡jvi (Assumptions) Dci cÖwZwôZt
1 g~jab KvVv‡gv‡Z ïaygvÎ FY I mvaviY †kqvi _vK‡e|
2 cÖwZôv‡bi Av‡qi Dci †Kvb Ki w`‡Z nq bv;
3 F‡Yi LiP BKzBwU g~ja‡bi Li‡Pi †P‡q Kg, A_©vr 𝐾𝑑 < 𝐾𝑒 ;
4 wjfv‡iR e„w× cvIqv m‡Ë¡I 𝐾𝑑 I 𝐾𝑒 w¯’i _v‡K|

 wbU cwiPvjbv Avq ZË¡ (Net Operating Income Approach): wbU cwiPvjbv Avq Z‡Ë¡i cÖeZ©K n‡jb
David Durand| G ZË¡wU wbU Avq Z‡Ë¡i m¤ú~Y© wecixZ| GB Z‡Ë¡i g~j e³e¨ n‡jv cÖwZôv‡bi g~jab
KvVv‡gv msµvšÍ wm×všÍ GKwU AcÖvmw½K welq| g~jab KvVv‡gv‡Z g~jab LiP ¯^Zš¿ nIqvq wjfv‡i‡Ri
†Kvb cwieZ©b n‡j cÖwZôv‡bi g~‡j¨ I †kqv‡ii evRvi g~‡j¨i Dci †Kvb cÖfve c‡o bv|
 G ZË¡wU wb‡Pi AbywgZ kZ©¸‡jvi (Assumptions) Dci cÖwZwôZt
1 cÖwZôv‡bi Av‡qi Dci †Kvb Ki w`‡Z nq bv;
2 𝐾𝑜 I 𝐾𝑑 me mgq GKB _vK‡e|
3 wjfv‡iR e„w× †c‡j BKzBwU g~ja‡bi LiPI (𝐾𝑒 ) e„w× cvq|
wbU cwiPvjbv Avq Ges e¨emv‡qi SzuwKi Dci cÖwZôv‡bi g~j¨
4
wbf©i K‡i|
 mbvZb ZË¡ (Traditional Approach): wbU Avq ZË¡ I wbU cwiPvjbv Avq ZË¡ `ywUi ga¨¯’ZvKvix
wn‡m‡e mbvZb Z‡Ë¡i D™¢e| GB ZË¡ Abyhvqx mvaviY †kqvi g~jab Ges FY g~ja‡bi Kvg¨ wgkÖ‡Yi
gva¨‡g †Kv¤úvwbi g~jab LiP Kgv‡bv Ges †Kv¤úvwbi g~j¨ e„w× Kiv m¤¢e|
†h‡nZz ¯^vfvweKfv‡e F‡Yi LiP BKzBwU g~ja‡bi Li‡Pi †P‡q Kg _v‡K, hZÿY ch©šÍ 𝐾𝑑 I 𝐾𝑒 DfqB
AcwiewZ©Z _v‡K, ZZÿY ch©šÍ FY g~ja‡bi cwigvY evwo‡q mvgwMÖK g~jab LiP n«vm Ges †Kv¤úvwbi
g~j¨ e„w× Kiv m¤¢e| wKš‘ FY g~jab evov‡bvi d‡j Ggb GKUv mgq Avm‡e hLb 𝐾𝑑 I 𝐾𝑒 DfqB e„w× †c‡q
mvgwMÖK g~jab LiP †e‡o hv‡e| d‡j †Kv¤úvwbi g~j¨ K‡g hv‡e|
 G ZË¡wU wb‡Pi AbywgZ kZ©¸‡jvi (Assumptions) Dci cÖwZwôZt
1 cÖwZôv‡bi Av‡qi Dci †Kvb Ki w`‡Z nq bv;
F‡Yi LiP wjfv‡i‡Ri GKwU wbw`©ó gvÎv ch©šÍ w¯’i _v‡K, Ges Gi ci evo‡Z
2
_v‡K|
BKzBwU g~ja‡bi LiP wjfv‡i‡Ri GKwU wbw`©ó gvÎv ch©šÍ w¯’i _v‡K ev ax‡i
3
ax‡i e„w× cvq, Gi ci BKzBwU g~ja‡bi LiP `ªæZ e„w× cvq|
Kvg¨ g~jab KvVv‡gvi gva¨‡g †Kv¤úvwbi mvgwMÖK g~jab LiP Kgv‡bv Ges
4
†Kv¤úvwbi g~j¨ e„w× Kiv m¤¢e|

 gwWwMøqvwb I wgjvi ZË¡ ZË¡ (Modigliani & Miller Hypothesis): G Z‡Ë¡i cÖeZ©K n‡jb H.
Modigliani I Merton H. Miller| Zv‡`i g‡Z, †Kvb cÖwZôv‡bi g~j¨ Zvi g~jab KvVv‡gvi Dci wbf©i K‡i bv|
A_©vr wjfv‡i‡Ri gvÎv (Debt equity ratio) hvB †nvK bv †Kb. Zv †Kv¤úvwbi g~jab LiP Ges †Kv¤úvwbi
g~‡j¨i Dci cÖfve we¯Ívi K‡i bv| GwUi g~j e³e¨ NOI Z‡Ë¡i Abyiƒc|
 G ZË¡wU wb‡Pi AbywgZ kZ©¸‡jvi (Assumptions) Dci cÖwZwôZt
40 Chapter  3: Capital Structure

1 cÖwZôv‡bi Av‡qi Dci †Kvb Ki w`‡Z nq bv;

2 𝐾𝑜 I 𝐾𝑑 me mgq GKB _vK‡e|
GKB wk‡íi wewfbœ dvg© GKB cwigvY SuywKi AvIZvq Ges
3
Zv‡`i cÖZ¨vwkZ cwiPvjbv Av‡qi m¤¢vebv GKB iKg|
4 †Kv¤úvwbi Av‡qi m¤ú~Y© jf¨vsk wn‡m‡e eÈb Kiv nq|
[m~Î: Aa¨vcK Gg. kvnRvnvb wgbv, Avw_©K e¨e¯’vcbv (4_© ms¯‹iY), XvKv: AvwRwRqv eyK wW‡cv (2003), c„ôv 289-300|]

Chapter Exercise-1 : Part B 3

Exercise-1 [Khan & Others, p.1307] EBIT of Jaklin company is Tk 1,50,000, cost of equity capital
12%, market value of debt capital is Tk 4,00,000 at 8% interest.
Required: (using NI approach): a. Value of the firm (V) b. Overall cost of capital (Ko)

 SOL: Exe-1:
𝐸𝐵𝐼𝑇−𝐼
(a) Value of the firm, 𝑉 = +𝐵 Here,
𝐾𝑒
EBIT = 1,50,000
150000 − 32,000
= + 4,00,000 I=4000008% =32,000
0.12
= 9,83,333 + 4,00,000 Ke = 12% = 0.12
B= 4,00,000
= 13,83,333
𝐸𝐵𝐼𝑇
(b) Overall cost of capital, 𝐾𝑂 =
𝑉
150000
=
13,83,333
= .1084
= 10.84%

Exercise-2 [Khan & Others, p.1307] EBIT of Salma company is Tk 2,00,000, 9% debeture is Tk
1,50,000. Its overall cost of capital is 15%.

Required:(using NOI approach): a. Value of the firm (V) b. Cost of equity capital (Ke)

 SOL: Exe-2:
𝐸𝐵𝐼𝑇 200,000
(a) Value of the firm, 𝑉 = = =13,33,333
𝐾𝑜 0.15

𝐸𝐵𝐼𝑇−𝐼
(b) Cost of equity capital, 𝐾𝑒 = Here,
𝑆
150000−13500 I =1500009% =13500
=
1183333 S = V  B = 1333333-150000
= 11.54%
= 11,83,333

Exercise-3 [Khan & Others, p.1307] Nahida company’s cost of equity capital is 12% and cost of
debt is 10%. When the company finance by using 100% equity capital, then overall cost of capital
 Financial Management 41

be 16%. If the company use 70% debt capital, what will be the overall cost of capital of the
company?

 SOL: Exe-3:
𝐵 𝑆 70 30
Overall cost of capital, 𝐾𝑂 = 𝐾𝑑 ( ) + 𝐾𝑒 ( ) = 0.10 × ( ) + 0.12 × ( ) = 10.6%.
𝑉 𝑉 100 100

Exercise-4 [Khan & Others, p.1308] There are two firms R and S -- which are identical in all
respects except that-the firm R has 10% Debenture of Tk 9,00,000. The EBIT of both firms are Tk
2,50,000. The Cost of equity capital of firm R and S are 12% and 13% respectively. Determine the
total market value (V) and overall cost of capital of two firms.

 SOL: Exe-4:
𝐸𝐵𝐼𝑇−𝐼 250000−90,000
 Total market value of R firm, 𝑉𝑅 = +𝐵 = + 9,00,000 = 22,33,333
𝐾𝑒 0.12
𝐸𝐵𝐼𝑇 250000
 Total market value of S firm, 𝑉𝑆 = = 19,23077
𝐾𝑒 0.13
𝐸𝐵𝐼𝑇 250000
 Overall cost of capital of R firm, 𝐾𝑂 = 𝑉
=
22,33,333
11.19%
𝐸𝐵𝐼𝑇 250000
 Overall cost of capital of S firm, 𝐾𝑂 = 𝑉
=
19,23,077
13%

Exercise-5 [Khan & Others, p.1308] Mabia Ltd.’s expected annual net operating income EBIT is
Tk. 90,000, 10% Debenture is Tk. 4,50,000, Cost of equity capital is 5% and Number of share of
the company is 4,000. Required: (Using NI Approach)

a. Market value of equity (S) c. Overall cost of capital (Ko) e. Earnings per share (EPS).
b. Total value of the firm (V) d. Market price per share (MPS)
 SOL: Exe-5:
𝐸𝐵𝐼𝑇−𝐼 90,000−45,000
(a) Total market value Equity, 𝑆 = = = 9,00,000
𝐾𝑒 0.05

(b) Total value of the firm, 𝑉 = 𝑆 + 𝐵 = 9,00,000 + 45,000 = 13,50,000

𝐸𝐵𝐼𝑇 90,000
(c) Overall cost of capital, 𝐾𝑂 = = 6.67%
𝑉 13,50,000
𝑆 9,00,000
225
(d) Market price per share, 𝑀𝑃𝑆 = 𝑁𝑆 = 4,000
𝐸𝐵𝐼𝑇−𝐼 90,000−45,000
11.25
(e) Earnings per share, 𝐸𝑃𝑆 = 𝑁𝑆 = 4,000

Exercise-6[Khan & Others, p.1308] From the following information of Kohinur Ltd :

10% Debenture 4,00,000

EBIT 2,50,000
Cost of equity capital 17%
42 Chapter  3: Capital Structure

Determine the total market value and overall cost of capital using NI approach.

 SOL: Exe-6:
𝐸𝐵𝐼𝑇−𝐼 250000−40,000
 Total market value, 𝑉 = +𝐵 = + 4,00,000 = 12,35,294
𝐾𝑒 0.17
𝐸𝐵𝐼𝑇 250000
 Overall cost of capital, 𝐾𝑂 = 𝑉
=
12,35,294
20.24%

Exercise-7 [Khan & Others, p.1308] The expected annual net operating income (EBIT) of
Sumaya Co is Tk. 3,00,000. The equity capitalization rate is 13%, 9% Debenture is Tk. 4,50,000
and the number of share of the company is 4,000.

Required: (Using NI Approach)

a. Market value of equity (S) c. Overall cost of capital (Ko) e. Earnings per share (EPS).
b. Total value of the firm (V) d. Market price per share (MPS)
[Ans: (a) 19,96,154; (b) 24,46,154; (c) 12.26% (d) Tk 499.04; (e) Tk 64.88]

Exercise-8 [Khan & Others, p.1308] Sharmin Company’s expected annual net operating income
(NOI) is Tk. 2,50,000. The equity capitalization rate is 13%. Rate of interest 9% on a bond
involving a total interest of Tk 90,000. The number of shares of the company is 10,000. Required:
(Using NI Approach)

a. Market value of share (S) c. Total value of the firm (V) e. Market price per share (MPS)
b. Market value of debt (B) d. Overall cost of capital (Ko) f. Earnings per share (EPS).
[Ans: (a) 12,30,769; (b) 10,00,000; (c) 22,30,769; (d) 11.21%; (e) Tk 123.08; (f) Tk 26]
 Financial Management 43

Chapter Exercise-2 : Part B 3

CE-1 EBIT of Labony company is Tk 2,00,000, cost of equity capital 10%, market value of debt
capital is Tk 5,00,000 at 12% interest.

Required: (using NI approach): a. Value of the firm (V) b. Overall cost of capital (Ko)
[Ans: (a) 19,00,000; (b) 10.53%]

CE-2 EBIT of Rupna company is Tk 1,00,000, 10% debenture is Tk 2,00,000. Its overall cost of
capital is 16%.

Required:(using NOI approach): a. Value of the firm (V) b. Cost of equity capital (Ke)
[Ans: (a) 6,25,000; (b) 18.82%]

CE-3 Dipa Company’s cost of equity capital is 14% and cost of debt is 11%. When the company
finance by using 100% equity capital, then overall cost of capital be 14%. If the company use 60%
debt capital, what will be the overall cost of capital of the company? [Ans: 12.2%]

CE-4 There are two firms A and B -- which are identical in all respects except that-the firm A has
12% Debenture of Tk 5,00,000. The EBIT of both firms are Tk 2,00,000. The Cost of equity capital
of firm A and B are 14% and 16% respectively. Determine the total market value (V) and overall
cost of capital of two firms.
[Ans: 𝑉𝐴 = 15,00,000; 𝑉𝐵 = 12,50,000; 𝐾𝑂 of A =13.33%; 𝐾𝑂 of B =16%]

CE-5 Mira Ltd.’s expected annual net operating income EBIT is Tk. 2,50,000, 8% Debenture is Tk.
10,00,000, Cost of equity capital is 10% and Number of share of the company is 5,000.
Required: (Using NI Approach)
a. Market value of equity (S) c. Overall cost of capital (Ko) e. Earnings per share (EPS).
b. Total value of the firm (V) d. Market price per share (MPS)
[Ans: (a) 17,00,000; (b) 27,00,000; (c) 9.26% (d) Tk 340; (e) Tk 34]
44 Chapter  3: Capital Structure

CE-6 From the following information of Rozina Ltd :

11% Debenture 10,00,000
EBIT 4,00,000
Cost of equity capital 15%
Determine the total market value and overall cost of capital by NI approach.[Ans: V = 29,33,333; Ko =
13.64%]

CE-7 The expected annual net operating income (EBIT) of Akhi Co is Tk. 5,00,000. The equity
capitalization rate is 12%. The company has 10% Debenture of Tk. 8,00,000. The number of
shares of the company is 10,000. Required: (Using NI Approach)

a. Market value of equity (S) c. Overall cost of capital (Ko) e. Earnings per share (EPS).
b. Total value of the firm (V) d. Market price per share (MPS)
[Ans: (a) 35,00,000; (b) 43,00,000; (c) 11.63% (d) Tk 350; (e) Tk 42]

CE-8 Tisti Company’s expected annual net operating income (NOI) is Tk. 1,40,000. The equity
capitalization rate is 12%. Rate of interest is 10% on a bond involving a total interest of Tk 40,000.
The number of shares of the company is 5,000. Required: (Using NI Approach)

a. Market value of share (S) c. Total value of the firm (V) e. Market price per share (MPS)
b. Market value of debt (B) d. Overall cost of capital (Ko) f. Earnings per share (EPS).
[Ans: (a) 8,33,333; (b) 4,00,000; (c) 12,33,333 ; (d) 11.35%; (e) Tk 166.67; (f) Tk 20]
 Financial Management 45

Chapter Exercise-3 : Part B and C 3

Problem-1 [NU 3rd year 2016 (F&B)] Rima Company’s expected annual net operating income
(EBIT) is Tk. 50,000. The company has 10% debt Tk. 2,00,000. The equity capitalization rate (Ke)
of the company is 12.50%. The number of shares of the company is 2,400. Calculate market price
of the share using NI approach. [Ans: S= 2,40,000]

Problem-2 [NU 3rd year 2017 F/M (Acc)] Trisha Ltd has Tk. 10,00,000 debt in its present capital
structure. Expected net operating income is Tk. 6,00,000. Interest rate 6%. Cost of equity capital is
12%. Compute:

(a) Market value of the Company. (b). Overall cost of capital (using NI approach).

Problem-3 [A. Hakim, p-249 modified] Polash Company’s expected annual earnings before
interest and taxes (EBIT) is Tk. 50,000. The capital structure includes a debt of Tk. 2,00,000 at an
interest rate of 10%. The cost of capital (Ke) is 12.5%. The number of shares of the company is
2,400. Determine the following [using Net Income (NI) approach]:

a. Market value of equity (S) d. Market price per share (MPS)

b. Total value of the firm (V) e. Earnings per share (EPS).
c. Overall cost of capital (Ko)
[Ans: S= 2,40,000; V= 4,40,000; Ko=11.36%; MPS= 100; EPS =12.5 ]

Problem-4 [A. Hakim, p-249 modified] Kohil Company’s expected annual net operating income
(EBIT) is Tk. 50,000. The capital structure includes a debt of Tk. 2,00,000 at an interest of 10%.
The overall cost of capital (Ko) is 12.5%. Calculate the following using Net Operating Income
(NOI) approach:

a. Total value of the firm (V) b. Market value of equity (S) c. Cost of equity (Ke)
[Ans: V= 4,00,000; S= 2,00,000; Ke=15%]
46 Chapter  3: Capital Structure

Problem-5 [Khan & Jain, p.15.7] If operating income [EBIT] of a firm is Tk 50,000; cost of debt is
10%; outstanding debt is Tk 2,00,000; and the overall capitalization rate [Ko] is 12.5%. What
would be the total value of the firm (V) and the equity capitalization rate [Ke]? [Ans: V= 4,00,000;
Ke=15%]

Problem-6 [BBA (Hon's) 3rd year - 2012] The Arif Company’s expected earnings before interest and
taxes (EBIT) is Tk. 50,000. The Co. has 10% debt of Tk. 2,00,000. The equity capitalization rate
(Ke) of the company is 12.50%. The number of common stock of the company is 2000.
Required:
(i) Find out the total value of the firm.
(ii) Find out the overall cost of capital of the firm.
(iii) Determine the market value per share.
(iv) Determine the EPS.

Problem-7 [NU 4th year 2017 (F/M)] Taj Co. Ltd. has Tk. 15,00,000 debt capital in its capital
structure. Their expected Net Operating Income is Tk. 5,00,000. Rate of interest is 6%, overall cost
of capital is 12%. The company has 5,000 equity shares.
Determine:
(i) Market value of the firm.
(ii) Market value of the equity.
(iii) Market price per share.

Problem-8 [BBA Hons 3rd year (Acc) - 2016] Market value of a firm is Tk. 17,00,000 including of
Tk. 5,00,000 Debt. The pretax interest rate of debt is 10%. The company is in 34% tax bracket. The
company expects Tk. 3,06,000 EBIT every year.
Required:
(a) What would the value of the firm be if it were financed entirely with equity?
(b) What is the amount of annual earnings available for stockholders?

Problem-9 [NU 2011] You are supplied the following information of Azad Ltd:
Cost of Equity 15%
Cost of Debt 10%
 Financial Management 47

Fixed Financial cost (interest) Tk 20,000;

Earning for the year Tk 2,20,000
Required:
a. Market value of share (S) c. Total value of the firm (V)
b. Market value of debt (B) d. Overall cost of capital (Ko)
[Ans: S= 13,33,333; B= 2,00,000; V= 15,33,333; Ko=14.35% ]

Problem-10 Consider the financial details of two companies- unlevered firm and levered firm:
Details Unlevered Firm (U) Levered Firm (L)
EBIT 50,000 50,000
10% Bond nil 2,00,000
Cost of Capital (Ko) 12.5% 12.5%

Determine the following (using M-M approach):

a. Total value of the firm (V) b. Market value of equity (S) c. Cost of equity (Ke)

Solution: P-10
Calculation of V, S and Ke (under M-M Hypothesis)
Details Unlevered Firm (U) Levered Firm (L)
10% Bond 0 2,00,000
EBIT 50,000 50,000
Cost of capital (Ko) 12.5% 12.5%
Total Interest 0 20,000
𝐸𝐵𝐼𝑇 4,00,000 4,00,000
(a) Total value of the firm, 𝑉𝑈 = ; 𝑉𝐿 = 𝑉𝑈
𝐾𝑂

(b) Market value of equity, 𝑆 = 𝑉 − 𝐵 4,00,000 2,00,000

𝐸𝐵𝐼𝑇−𝐼 12.5% 15%
(c) Cost of equity, 𝐾𝑒 =
𝑆

Problem-11
[NU 4th year 2017 (F/M)] The following is the data regarding two companies SUN and MOON
belonging to the same risk class:-
Details SUN MOON
48 Chapter  3: Capital Structure

EBIT/ NOI Tk. 3,00,000 Tk. 3,00,000

6% Debt --- Tk. 10,00,000
Cost of Equity 10% 15%
Requirement:
(1) Value of the firm.
(2) Overall cost of capital
(3) Assume that an investor owns 10% of SUN Company’s share. Using Arbitrage
Process show that, how can he obtain same return at a lower cost.

Problem-12 [BBA Hons 4th year - 2015 (Investment Mgt)] There is no taxes and given the EBIT,
interest at 10% and Ke below,find the total market value and WACC [Ko] of each firm.
Firm EBIT (in Tk.) Interest Ke
A 2,00,000 20,000 10%
B 3,00,000 60,000 12%

C 5,00,000 2,00,000 15%

Problem-13 [BBA Hons 3rd year (Acc) - 2016] The following information are given to you:
Details Firm U Firm L
EBIT 2,50,000 2,50,000
10% Debt -- 7,50,000
𝐾𝑒𝑢 15% --
Corporate tax rate 40% 40%
Personal tax rate 10% 10%

Required:
(a) Value of Unlevered firm (𝑉𝑢 )
(b) Value of Levered firm (𝑉𝐿 )
(c) Gain from leverage
(d) Cost of equity of unlevered firm (𝐾𝑒𝑢 )
(e) Cost of equity of unlevered firm (𝐾𝑒𝑙 )

Problem-14 [BBA Hons 3rd year – 2016 (Special)] There are two companies U and L where L is
levered firm and U is unlevered firm which has no debt. The firm has Tk. 10,00,000 debt of 5%.
Assume that there is no corporate tax and personal tax. The expected EBIT is Tk. 2,00,000 and cost
of equity is 12%.
 Financial Management 49

(a) Value of U firm (𝑉𝑢 );

(b) Value of L firm (𝑉𝐿 );
(c) Cost of equity of U firm;
(d) Market value of share of L firm.
Problem-15 [NU 4th year 2017 (F/M)] [CAPM]
Ananda Corporation wishes to calculate its cost of common stock using CAPM. Its investment
manager’s analysis indicates that the risk free rate of return equals 7%, the corporation’s beta
equals 1.5 and market return equals 11%. Calculate the market risk premium and cost of equity
capital. [ Hints: Risk Premium= 𝑅𝑀 − 𝑅𝐹 ; 𝐾𝑒 = 𝑅𝐹 + (𝑅𝑀 − 𝑅𝐹 ) × 𝛽]

Problem-16 [NU 3rd year- 2014] Arafat Limited with operating earnings (EBIT) of Tk. 4,00,000
is attempting to evaluate a number of possible capital structures given below. Which of the capital
structure will you recommend and why (according to net income approach)?
Capital Structure Level of debt Cost of debt Cost of equity
1 2,00,000 11% 13.0%
2 3,00,000 11% 14.5%
3 4,00,000 12% 15.5%
4 5,00,000 13% 17.0%.

Problem-17 [NU 2014] Putul company with net earnings (EBIT) of Tk 3,00,000 is attempting to
evaluate a number of capital structure given below. Which of the capital structure will you
recommend and why?
Capital Structure Debt in capital structure Kd Ke

1 3,00,000 10% 12%

2 4,00,000 10% 12.5%
3 5,00,000 11% 13.5%
4 6,00,000 12% 15%
5 7,00,000 14% 16%
Solution: P-17
Calculation of V and Ko
Details 1 2 3 4 5
EBIT 3,00,000 3,00,000 3,00,000 3,00,000 3,00,000
Less: Interest 30,000 40,000 55,000 72,000 98,000
EBT/ Net Income 2,70,000 2,60,000 2,45,000 2,28,000 2,02,000
Cost of equity (Ke) 12% 12.5% 13.5% 15% 16%
𝐸𝐵𝐼𝑇−𝐼 22,50,000 20,80,000 18,14,815 15,20,000 12,62,000
Market value of share, 𝑆 =
𝐾𝑒
50 Chapter  3: Capital Structure

Market value of debt 3,00,000 4,00,000 5,00,000 6,00,000 7,00,000

Total value of the firm, 𝑉 = 𝑆 + 𝐵 25,50,000 24,80,000 23,14,815 21,20,000 19,62,000
𝐸𝐵𝐼𝑇 11.76% 12.10% 12.96% 14.15% 15.29%
Overall cost of capital, 𝐾𝑂 =
𝑉

Comment: I will recommend the 1st capital structure because the value of the firm is the highest and overall
cost of capital is the lowest in this capital structure.

Problem-18 [NU 3rd year 2016 (F&B)] Bithy company with net operating earnings (EBIT) of Tk
30,000 is attempting to evaluate a number of capital structure given below. Which of the capital
structure will you recommend and why?
Capital Structure Debt in capital structure Kd (%) Ke (%)

1 30,000 10.00 12.00

2 40,000 10.00 12.50
3 50,000 11.00 13.50
4 60,000 12.00 15.00
5 70,000 14.00 16.00

Problem-19 [Gitman (10e) p.545] Nazmul Company has collected the following data with respect
to its capital structure, expected earnings per share, and required return.
Capital Structure Expected EPS Required Return
Debt Ratio
0% Tk 3.12 13%
10 3.90 15
20 4.80 16
30 5.44 17
40 5.51 19
50 5.00 20
60 4.40 22
(a) Compute the estimated share value associated with each of the capital structures.
(b) Determine the optimal capital structure on the basis of (1) maximization of expected
earnings per share and (2) maximization of share value.
(c) Which capital structure do you recommend? Why?
 Financial Management 51

SOLUTION: P-19 (a)

Capital Structure Expected EPS Required Estimated
Debt Ratio Return Share Value
(a) (b) c = (ab)
0% 3.12 0.13 24
10% 3.90 0.15 26
20% 4.80 0.16 30
30% 5.44 0.17 32
40% 5.51 0.19 29
50% 5.00 0.20 25
60% 4.40 0.22 20

SOLUTION: P-19(b)
 Optimal capital structure on the basis of maximization of expected earnings per share is 40% debt ratio,
where EPS is Tk 5.51.
 Optimal capital structure on the basis of maximization of share value is 30% debt ratio, where share value
is Tk 32.
SOLUTION: P-19 (c) We recommend 30% debt ratio because it results in the maximum share value.

Problem-20 Biplob Company has collected the following data with respect to its capital structure,
expected earnings per share, and required return.
Capital Structure Expected EPS Required Return
Debt Ratio
0% Tk 20 10%
20 21 12
30 22 14
40 23 16
50 24 18
60 20 20
70 18 22

(a) Compute the estimated share value associated with each of the capital structures.
(b) Determine the optimal capital structure on the basis of (1) maximization of expected
earnings per share and (2) maximization of share value.
(c) Which capital structure do you recommend? Why?
52 Chapter  3: Capital Structure

Extra Problem: Capital Structure with Tax

Problem-21 [NU 3rd year- 2013 (F/M)] Suzan is an all equity firm, expects perpetual earnings
before interest and taxes (EBIT) of Tk. 20,00,000 per year. After-tax all equity discount rate is 18
percent. The firm is subject to a 35 percent corporate tax rate. What is the value of the firm?
𝐸𝐵𝐼𝑇 (1−𝑇) (20,00,000−0) (1−.35)
 SOL: P-21: Value of the firm, 𝑉 = 𝐾𝑒
= 0.18
= 𝑇𝑘 72,22,222.

 g~jab KvVv‡gvi As‡K Tax rate D‡jøL _vK‡j EBIT Gi cwie‡Z© EAT Gi wfwˇZ V wbY©q
Ki‡Z nq| cÖwZôvbwU Unlevered nIqvq Ko = Ke| ZvB Ko Gi cwie‡Z© Ke †jLv n‡q‡Q|

Problem-22 Bithy is an all equity firm, expects perpetual earnings before interest and taxes
(EBIT) of Tk. 5,00,000 per year. After-tax all equity discount rate is 15 percent. The firm is
subject to a 40 percent corporate tax rate. What is the value of the firm?

Problem-23 [NU 3rd year- 2014 (F/M)] Rubina company presently is an unlevered firm. The
company expects to generate Tk. 2,00,000 in earnings before interest and taxes (EBIT) in
perpetuity. The corporate tax rate is 35%. All earnings after taxes are paid as dividends. The firm is
considering a capital structure to allow Tk 1,00,000 of debt. Its cost of debt is 12%. Unlevered
firms in the same industry have a cost of equity capital of 18%. What will be the new value of
Rubina company? [A: 8,22,222]

Problem-24 Mahzabin company presently is an unlevered firm. The company expects to generate
Tk. 5,00,000 in earnings before interest and taxes (EBIT) in perpetuity. The corporate tax rate is
50%. All earnings after taxes are paid as dividends. The firm is considering a capital structure to
allow Tk 2,00,000 of debt. Its cost of debt is 10%. Unlevered firms in the same industry have a cost
of equity capital of 15%. What will be the new value of Mahzabin company?

Problem-25 [A. Hakim, p. 249]] Company X and Company Y are identical in all respects
including risk factors except for debt equity. X having issued 10% debenture of Tk 18,00,000 while
Y has issued only equity shares. EBIT for both company is Tk 6,00,000. Assuming tax rate of 50%
and capitalization rate of 15% for all-equity Company.
(i) Compute the value of the Company X and Y using (a) NI Approach (b) NOI
Approach.
[Ans: (a) VU = 20,00,000; VL = 32,00,000; (b) VU = 20,00,000; VL = 29,00,000]
Calculate the Ko for both firms using NOI Approach. [Ans: X = 10.34%; Y= 15%]
 Financial Management 53

Chapter Exercise-4 : Part B and C 3

Problem-26 [BBA (Hon's) 1st year- 2014 (Acc)] Suppose that present capital structure of Habiba
Ltd is as follows:
Common stock capital (Tk 100 per share) 10,00,000
12% Debt Capital 5,00,000
Total Capital 15,00,000

The company is planning to expand its capacity that will require additional capital of Tk 6 lakh.
There are four alternative method of financing:
1. Issuing 10% debenture;
2. Issuing 11% preferred share;
3. Issuing common stock at Tk 100 per share;
4. 50% by issuing 10% debenture and 50% by issuing common stock at Tk 100 per share.
The expected earnings before interest and tax (EBIT) is Tk 4,00,000 and corporate tax rate
is 40%. You are required to calculate the earnings per share (EPS) under different methods
of financing.
Which alternative should be selected?

SOLUTION: P-26
Workings:
i). Calculation of Total Interest:
Alternative-1: (5,00,00012% )+(6,00,00010%) = 60,000+60,000= 1,20,000
Alternative-2: (5,00,00012% ) = 60,000
Alternative-3: (5,00,00012% ) = 60,000
Alternative-4: (5,00,00012% ) + (6,00,00050%)10% = 60,000+30,000= 90,000

ii). Calculation of Preference Dividend:

Alternative-2: (6,00,00011% ) = 66,000

ii). Calculation of No. of Shares:

Alternative-1: (10,00,000  100) = 10,000 shares
Alternative-2: (10,00,000  100) = 10,000 shares
Alternative-3: (10,00,000  100) + (6,00,000  100) = (10,000+6,000) = 16,000 shares
Alternative-4: (10,00,000  100) + (6,00,00050%)  100 = (10,000+3,000) = 13,000 shares
54 Chapter  3: Capital Structure

Calculation of EPS

Details Alternative-1 Alternative-2 Alternative-3 Alternative-3

 EBIT 4,00,000 4,00,000 4,00,000 4,00,000
Less: Interest expense [working-(i)] 120,000 60,000 60,000 90,000
 Earnings before taxes (EBT) 280,000 340,000 340,000 3,10,000
Less: Tax (40%) 112,000 1,36,000 1,36,000 1,24,000
 Earnings after taxes (EAT) 168,000 2,04,000 2,04,000 1,86,000
Less: Preference dividend [working-(ii)] -------- 66,000 -------- --------
 Earnings available for common
stockholders (EACS) 168,000 1,38,000 2,04,000 1,86,000
 No. of shares (NS) [working-(iii)] 10,000 10,000 16,000 13,000
 EPS (EACS  NS) 16.8 13.8 12.75 14.31

Decision: Alternative -1 should be selected since it gives the highest EPS.

Problem-27 [BBA (Hon's) 3rd year- 2016 (Special)] Suppose that present capital structure of
Liza Ltd is as follows:
Sources Taka
Common stock (Tk 100 per share) 30,00,000
12% Debt 20,00,000
Total Capital 50,00,000

The company is planning to expand its capacity that will require additional capital of Tk 22 lakh.
There are four alternative method of financing:
1. Issuing 10% debenture;
2. Issuing 11% preferred share;
3. Issuing common stock at Tk 100 per share;
4. 50% by issuing 10% debenture and 50% by issuing common stock at Tk 100 per share.
The expected earnings before interest and tax (EBIT) is Tk 15,00,000 and corporate tax rate is
40%.
You are required to calculate the earnings per share (EPS) under different methods of financing.
Which alternative Liza Ltd should select?
 Financial Management 55

Problem-28 [BBA (Hon's) 1st year- 2013] Gobinda Food Ltd. is in 40% tax bracket. Currently it
has 20,000 shares of common stock outstanding. In the current year, the company needs Tk
10,00,000 for an expansion program. There are three alternative methods of financing:
(i) Issuing common stock of Tk 100 per share;
(ii) Issuing 10% Debenture;
(iii) 70% by issuing share of common stock for Tk 100 each and remaining 30% by issuing
10% debenture.
Requirements:
(a) Find out the EPS under each of the three methods if EBIT is Tk 10,00,000. [EPS Tk 20, Tk 27,
Tk 21.56]
(b) Find out the level of EBIT at which the financial manager would be indifferent between
method-I and method-II.

SOLUTION: P-28
Req-(b): Indifference point of EBIT between Method I and II:
(𝐸𝐵𝐼𝑇−𝐼1 )(1−𝑡)−𝑃𝐷1 (𝐸𝐵𝐼𝑇−𝐼2 )(1−𝑡)−𝑃𝐷2
Indifference point of EBIT = =
𝑁𝑆1 𝑁𝑆2
(𝐸𝐵𝐼𝑇−0)(1−.4)−0 (𝐸𝐵𝐼𝑇−1,00,000)(1−.4)−0
⇒ =
30,000 20,000
0.6 𝐸𝐵𝐼𝑇 .6 𝐸𝐵𝐼𝑇−60,000
⇒ = ⇒1.8 EBIT 1,80,0000 = 1.2 EBIT
3 2
1,80,000
⇒ 0.6 EBIT = 1,80,000 ⇒ 𝐸𝐵𝐼𝑇 = ∴ 𝐸𝐵𝐼𝑇 =
0.6
3,00,000.

Problem-29 [BBA (Hon's) 1st year- 2011, 2016 (Acc)] Capital structure of Sharmin Ltd is as
follows:
Common stock 40,00,000
10% Debt Capital 20,00,000
Total Capital 60,00,000

The company needs additional financing of Tk 20,00,000. This can be financed by the following
three alternatives:
(a) Fully equity stock of Tk 100 each.
(b) Fully 12% Preferred Stock.
(c) Fully 10% Debenture.
56 Chapter  3: Capital Structure

If the company expected EBIT Tk 10,00,000 and tax rate 50%, calculate:
(i) EPS; [EPS Tk 6.67, Tk 4, Tk 7.5]
(ii) Indifference point of EBIT of alternative A and C. [Ans: 8,00,000]
Problem-30 [BBA (Hon's) 1st year- 2012] Currently Shohan Ltd. has a total capital of Tk 40 lakh
, consisting of 40% debt capital at 10% interest and 60% share capital of Tk 100 per share. Now the
company is planning to expand capital by 50%.
The company had four alternative plans:
(i) 50% by 12% debt capital and 50% by common stock capital;
(ii) Fully by 11% preferred stock capital;
(iii) Fully by common stock capital;
(iv) Fully by 12% debt capital.

The expected rate of return (EBIT) on total assets is 25% and tax rate is 40%.
(a) Find out the EPS under each of the alternative method of financing.
(EBIT= (40,00,000+20,00,000)25% = 15,00,000; EPS Tk 21.53, Tk 24.33, Tk 18.27, Tk 27.5]
(b) Which alternative should be selected by the company? Why?

Problem-31 [NU 2009] The capital structure of Saikat Ltd. is given below:
Taka
10% Debenture 10,00,000
12% Preferred stock 10,00,000
Common stock 30,00,000
Total Capital 50,00,000

The company needs additional financing of Tk 20,00,000. This can be financed by the following
ways:
(a) Fully equity stock of Tk 100 each.
(b) Fully 10% Debenture.
(c) Fully 12% Preferred Stock.

If the company expected EBIT is Tk 10,00,000 and tax rate 50%, which alternative is best and
why? Also calculate the Indifference point of EBIT of alternative (a) and (b). [EPS Tk 7, Tk 8.33, Tk
3.67]
 Financial Management 57

Problem-32 [NU BBA Hons 1st year 2017 (Acc)] The capital structure of IDLC Ltd. is given
below:
Taka
12% Debenture 12,00,000
10% Preferred stock 10,00,000
Common stock (Tk. 100 per) 8,00,000
Total Capital 30,00,000

The company needs additional financing of Tk 12,00,000. This can be financed by the following
ways:
(i) Fully common stock of Tk 100 each.
(ii) Fully 12% Debenture.
(iii) Fully 13% Preferred Stock.

If the company expected EBIT is Tk 8,00,000 and corporate tax rate 25%:
(a) which alternative method of financing should be selected and why?
(b) Calculate the Indifference point of EBIT of alternative method (i) and (ii).

Problem-33 [BBA (Hon's) 2nd year- 2016 (Mgt)] Following is the capital structure of Anamika
company:
12% Debt Capital 30 Lakh
Common Stock Capital (80,000 shares) 128 "
Total Capital 158 "

To finance in an expansion program, the company needs additional capital of Tk 40 lakhs. There
are three alternative methods of financing:
(i) Through 14% debt financing.
(ii) Through 12% preferred stock financing.
(iii) Selling common stock shares of Tk 160 per share.
Assuming 40 percent corporate tax and expected EBIT of Tk 15 Lakh, find out:
(a) Earnings per share under each alternative methods of financing.
58 Chapter  3: Capital Structure

(b) Indifference point of EBIT under methods (i) and (iii).

You are also required to show the indifference point in graph.

Problem-34 [BBA (Hon's) 3rd year- 2015] Atik Ltd. has the following capital structure:
Equity (Tk 100 per share) 10,00,000
12% Debt 5,00,000
Total Capital 15,00,000

The company wishes to raise Tk 5,00,000 for expansion programmes. The following alternatives
are available:
1. 100% equity.
2. 50% equity and 50% debt at 12%.
3. 100% debt at 12%.
The expected EBIT is Tk 20,00,000 the tax rate is 40%. Calculate the EPS and which one would
you prefer? Also calculate the indifference EBIT between alternatives (i) and (ii).

Problem-35 [BBA (Hon's) 4th year- 2015 (Investment Mgt) modified] Anurag Co. Ltd. has
presented capital structure as follows:
Equity share capital (1,000 shares) 10,00,000
10% Debt capital 5,00,000
15,00,000

The firm is thinking to raise additional capital at Tk. 5,00,000 for its expansion. It has two
alternative financial methods:
(i) Issue of 12% preference share capital of Tk. 2,00,000 and equity capital of Tk.
3,00,000.
(ii) Issue of equity capital of Tk. 5,00,000.

Determine-

(a) Earnings per share under each alternative methods of financing.

(b) Indifference point of EBIT between two financial methods. Tax rate is 30%.
 Financial Management 59

Arbitrage Process - Aviwe‡UªR cÖwµqv

(gybvdv AR©bKvix fvimvg¨g~jK †jb‡`b cÖwµqv)

Problem-36 [Arbitrage Process] [NU 2008; Khan & Jain (7e), p. 19.38] The two companies, U and L
belong to an equivalent risk class. These two firms are identical in every respect except that U company is
unlevered while company L has 10 percent debentures of Tk. 30 lakh. The other relevant information
regarding their valuation and capitalisation rates are as follows:
Particulars Firm U Firm L
Net operating Income (EBIT) Tk. 7,50,000 Tk. 7,50,000
Less: Interest on debt (I) --- 3,00,000
Earnings to equity holders (NI) 7,50,000 4,50,000
Equity capitalisation rate (Ke) 0.15 0.20
Market value of share (S) 50,00,000 22,50,000
Market value of debt (B) --- 30,00,000
Total value of the firm, 𝑉 = 𝑆 + 𝐵 50,00,000 42,50,000
Overall cost of capital ( 𝐾𝑂 ) 0.15 0.143
60 Chapter  3: Capital Structure

Debt-equity ratio (B/S) 0 1.33

(a) An investor owns 10 percent equity shares of company L. Show the arbitrage process and the
amount which he could reduce his outlay through the use of leverage.
(b) According to Modigliani and Miller, when will this arbitrage process come to an end?

Help
Box
 Financial Management 61

[Source: Luvb, †Nvlvj I Rvnv½xi, wewb‡qvM e¨e¯’vcbv (2017/18), c„ôv- 934-935]

Solution: P-36
Req. (i)
Arbitrage Process
(Position of the Investor)
Before arbitrage (in Firm L) Taka After arbitrage (in Firm U) Taka
Value of Investment (22,5000010%) 2,25,000 Fund for Arbitrage:
Dividend Income (4,50,00010%) 45,000 Sales of shares of L 2,25,000
Personal loan (30,00,00010%) 3,00,000
Total amount for Arbitrage 5,25,000
Less: Investment in Firm U
(50,00,00010%) 5,00,000
Surplus Fund 25,000
Dividend Income (7,50,00010%) 75,000
Less: Interest paid (3,00,00010%) 30,000
Net Income 45,000 Net Income 45,000

Comment: Through arbitrage process, the investor will be able to reduce his outlay but ensuring the same return.
Req. (ii): Comment: According to Modigliani and Miller, this arbitrage process will come to an end when the value
of both firms are identical.

Problem-37 [Arbitrage Process] The two companies, U and L belong to an equivalent risk class.
These two firms are identical in every respect except that U company is unlevered while company
L has 12 percent debentures of Tk. 2,50,000. The other relevant information regarding their
valuation and capitalisation rates are as follows:
Particulars Firm U Firm L
Net operating Income (EBIT) Tk. 2,00,000 Tk. 2,00,000
Less: Interest on debt (I) --- 3,0,000
Earnings to equity holders (NI) 2,00,000 1,70,000
Equity capitalisation rate (Ke) 0.15 0.17
Market value of share (S) 13,33,333 10,00,000
Market value of debt (B) --- 2,50,000
Total value of the firm, 𝑉 = 𝑆 + 𝐵 13,33,333 12,50,000
62 Chapter  3: Capital Structure

Overall cost of capital ( 𝐾𝑂 ) 0.15 0.16

An investor owns 10 percent equity shares of company L. Show the arbitrage process and the
amount which he could reduce his outlay through the use of leverage.
Problem-38 [Arbitrage Process] [NU 4th year- 2017 (Inv Mgt)] There are two firms L and U
which are identical in all respect except that L has 10% Tk. 5,00,000 debentures. The earnings
before interest and taxes of both the firms are Tk. 1,00,000. The equity capitalization of the firm L
is slightly higher (15%) than that of firm U (13%). Determine the total value and overall cost of
capital of the two firms.
Miss Labony, investor, holds 10% of outstanding shares in L firm. Should she prefer switching
from the L firm to U firm?
Solution: P-38
Calculation of V and Ko
Details Levered Firm (L) Unlevered Firm (U)
EBIT 1,00,000 1,00,000
Less: Interest 50,000 ---
Net Income (NI) 50,000 50,000
Cost of equity (Ke) 15% 13%
𝑁𝐼 3,33,333 7,69,231
Market value of share, 𝑆 =
𝐾𝑒

Market value of debt, B 5,00,000 ---

Total value of the firm, 𝑉 = 𝑆 + 𝐵 8,33,333 7,69,231
𝐸𝐵𝐼𝑇 12% 13%
Overall cost of capital, 𝐾𝑂 =
𝑉

Arbitrage Process
(Position of the Investor)
Before arbitrage (in Firm L) Taka After arbitrage (in Firm U) Taka
Value of Investment (3,33,33310%) 33,333 Fund for Arbitrage:
Dividend Income (50,00010%) 5,000 Sales of shares of L 33,333
Personal loan (5,00,00010%) 50,000
Total amount for Arbitrage 83,333
Less: Investment in Firm U
(7,69,23110%) 76,923

Surplus Fund 6,410

Dividend Income (1,00,00010%) 10,000
 Financial Management 63

Less: Interest paid (50,00010%) 5,000

Net Income 5,000 Net Income 5,000
Comment: The investor should prefer switching from the L firm to U firm. Because through arbitrage process, the
investor will be able to earn same amount of income by investing less amount in firm U.

Problem-39 [Arbitrage Process] There are two firms L and U which are identical in all respect
except that L has 10% Tk. 15,00,000 debentures. The earnings before interest and taxes of both the
firms are Tk. 3,00,000. The equity capitalization of the firm L is slightly higher (15%) than that of
firm U (13%). Determine the total value and overall cost of capital of the two firms.
Mr. Umar, investor, holds 20% of outstanding shares in L firm. Should he prefer switching from
the L firm to U firm?
Solution: P-39
Calculation of V and Ko
Details Firm L Firm U
EBIT 3,00,000 3,00,000
Less: Interest 1,50,000 ---
Net Income (NI) 1,50,000 3,00,000
Cost of equity (Ke) 15% 13%
𝑁𝐼 10,00,000 23,07,692
Market value of share, 𝑆 =
𝐾𝑒

Market value of debt, B 15,00,000 ---

Total value of the firm, 𝑉 = 𝑆 + 𝐵 25,00,000 23,07,692
𝐸𝐵𝐼𝑇 12% 13%
Overall cost of capital, 𝐾𝑂 =
𝑉

Arbitrage Process
(Position of the Investor)
Before arbitrage (in Firm L) Taka After arbitrage (in Firm U) Taka
Value of Investment (1000,00020%) 2,00,000 Fund for Arbitrage:
Dividend Income (1,50,00020%) 30,000 Sales of shares of L 2,00,000
Personal loan (15,00,00020%) 300,000
Total amount for Arbitrage 5,00,000
Less: Investment in Firm U
(23,07,69220%) 4,61,538

Surplus Fund 38,462

Dividend Income (3,00,00020%) 60,000
Less: Interest paid (3,00,00010%) 30,000
64 Chapter  3: Capital Structure

Net Income 30,000 Net Income 30,000

Comment: The investor should prefer switching from the L firm to U firm. Because through arbitrage process, the
investor will be able to earn same amount of income by investing less amount in firm U.

Problem-40 [Arbitrage Process] There are two firms L and U which are identical in all respect
except that L has 11% Tk. 10,00,000 debentures. The earnings before interest and taxes of both the
firms are Tk. 1,00,000. The equity capitalization of the firm L is slightly higher (16%) than that of
firm U (14%). Determine the total value and overall cost of capital of the two firms.
Mr. Parvez, investor, holds 10% of outstanding shares in L firm. Should he prefer switching from
the L firm to U firm?

Problem-41 [Arbitrage Process] There are two firms L and U which are identical in all respect
except that L has 10% Tk. 3,00,000 debentures. The earnings before interest and taxes of both the
firms are Tk. 200,000. The equity capitalization of the firm L is slightly higher (14%) than that of
firm U (12%). Determine the total value and overall cost of capital of the two firms.
Mr. Maznu, investor, holds 15% of outstanding shares in L firm. Should he prefer switching from
the L firm to U firm?