TUTORIALS ON CAPITAL STRUCTURE AND LEVERAGE

Question 1. The Capital Structure of Shipping Corporation consist of an ordinary share

capital of Rs.10,00,000 shares of Rs.100 and Rs.10,00,000 of 10% Debentures. The unit
sales increased by 20% from 1,00,000 units to 1,20,000 units. The selling price is Rs.10
Per unit,variable cost amount to Rs.6 per unit and fixed cost amounted to Rs.2,00,000.
The income tax rate is 35%

a) You are required to calculate the following:

(i) The percentage increase in Earning Per Share (EPS)
(ii) The degree of Financial Leverage at 100000 units & 120000 units.
(iii) The degree of Operating Leverage at 100000 units & 120000 units.
b) Comment on the behavior of Operating and Financial leverage in relation to
increase of production from 100000 units to 120000 units.

Question 2 . A firm sells its products for Rs. 100 per unit has variable operating costs of
Rs. 50 per unit and fixed operating costs of Rs. 50,000 per year. (1) Show the various
levels of EBIT that would result from the sales of (1) 1000 units, (2) 2000 units and (3)
3000 units.

Calculate the Degree of Operating leverage.

Question 3. Finmin Power Corporation has a capital structure exclusively comprising of

ordinary shares amounting to Rs. 10,00,000. The firm now wishes to raise additional
Rs. 10,00,000 for expansion. The firm has four alternative financial plans:

1.It can raise the entire amount in the form of equity capital

2.It can raise 50% as equity capital and 50% as 5% debentures.

3.It can raise the entire amount as 6% debentures.

4.It can raise 50%as equity capital and 50% as 5% preference share capital

Further assume that the existing EBIT is Rs. 1,20,000 , the tax rate is 50%, outstanding
shares 10,000 and the market price per share is Rs. 100 under all the four alternatives.

Which financing plan should be selected by the firm? Advise.