Healthcare Ltd. is a company engaged in production of organic food. Presently it sells its
products through indirect channels of distribution. The company is planning to start its own
show rooms and online portals. The financial manager suggested to use debt to invest in own
showrooms and online portals.
Company plans to raise debt capital of 40 lakhs through a loan from ICICI bank at 10% Interest.
The present capital base of the company is 9 lakhs equity shares of 10 each. The rate of tax is
30%
in the context of above case -
Assuming expected rate of return same as current year, i.e., 15%, do you think the decision to
use debt is justified.
Show your working clearly.
Answers
Answer:
yes the decision to raise is justified
Yes, the decision to use the debt is justified as the earnings per share is increased after the issue of debt.
Step-by-step explanation:
Bases Before issue After issue
(in ₹) (in ₹)
Equity shares of 9 lakh 90,00,000 90,00,000
debt capital/loan 10% NIL 40,00,000
Total capital
(equity + debt) 90,00,000 1,30,00,000
Earnings before interest
and taxes 13,50,000 19,50,000
minus: interest ------ -(4,00,000)
Earnings before tax 13,50,000 15,50,000
minus: 30% tax -(4,05,000) -(4,65,000)
Earnings after tax 9,45,000 10,85,000
No. of shares
(Rs. 10 each) 9,00,000 9,00,000
Earnings per share:-
Before issue = 9,45,000/9,00,000 = 105
After issue = 10,85,000/9,00,000 =121
Since the Earnings per share is higher after the issue of debt, the company would be able to achieve its goals, and the issue of debt is justified.