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LEVERAGE, COST OF CAPITAL & CAPITAL BUDGETING TEST PAPER

Time: 80 Min

Total marks: 40

Instruction: All Questions are compulsory

Q.1 Cost of Debt is always less than cost of equity. Discuss

(3 Marks)

Q.2) G.G Ltd. has the following capital structure as on 31st March 2002.

Ordinary Shares (4,00,000 shares)

10% Preference Shares
12% Debentures

(10 Marks)

Rs.
80,00,000
20,00,000
60,00,000

The shares of the company are presently selling at Rs. 30 per share. It is expected that the
company will pay next year dividend of Rs. 3 per share which will grow @ 10% forever.
Assume tax rate of 40%. You are required to,
i) Compute the weighted average cost of capital based on existing capital structure.
ii) If the company raises an additional Rs. 80 lakhs debt by issuing 15% debentures, the expected
dividend at year end will be Rs. 3, the market price per share will fall to Rs.15 per share, the
growth rate remaining unchanged.
Calculate the new weighted average cost of capital.
Q.3 a) What is Leverage? Discuss its types and meaning in details.
b) Techniques of monitoring the debtors

5 Marks
5 Marks

Q.4 Interest Rs.1200/- DFL 3, DOL 2, PV Ratio 1/3, Interest Rate @ 10%,
Debt: Equity is 2 : 1
Tax @ 50%
(A) Prepare Income Statement
(B) Calculate RoI
(C) Is financial leverage favorable?
(D) Calculate Asset Leverage
(E) If Industry Asset leverage is 1.1, is this firm efficient?

7 Marks

Q.5 ABC Ltd. is considering relaxing its present credit policy. At present it has annual credit
sales of Rs.20 lacs and has an accounts receivable turnover ratio of 6 times a year. Bad debts at
present account to Rs.50,000. The firm is required to give a return of 30% on the investment in
accounts receivables. The companys variable costs are 60% of selling price.
Option I Option II
Credit Sales (Rs.)
40 lacs
50 lacs
Accounts Receivables Turnover Ratio (Times)
4
3
Bad Debts
70,000
1,00,000
Administrative and collection cost at present are Rs.50,000 which will increase by Rs.10,000 in
Option I and Rs.30,000 in Option II.
Which is the better option from the two options?

10 Marks

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Time: 40 Min

Total marks: 20
Chapter: Capital Structure.
Instructions: All Questions are compulsory.

Q.1) Explain any 2 theories of Capital Structure.

(6 Marks)

Q.2) Explain any 4 determinants of Capital Structure

(4 Marks)

Q.3) The existing capital structure of ABC Ltd. is as follows:

Particulars
Equity shares of Rs.100 each
Retained Earnings
9% Preference shares
7% Debentures

(10 Marks)
Rs.
4000000
1000000
2500000
2500000

Company earns a return of 20% and the tax on income is 50%.

Company wants to raise Rs. 2500000 for its expansion project for which it is considering
following alternatives:
Issue of 20000 Equity shares at a premium of Rs. 25 per share.
Issue of 10% Preference shares.
Issue of 9% Debentures.
Projected that the Price Earning ratios in the case of Equity, Preference and Debentures
financing Rs. 20, 17 and 16 respectively.
Which alternative would you consider to be the best? Give reason for your choice.

SCOrE Results for BMS SEM VI 2009 10

Renu Bajaj

Amreen Khan
Raj Shah

IF 93,
IF 96,
QMB 95,

1st in Siddharth College

S.I.E.S College
NM College