Q. 'Kiya Ltd.' is a company manufacturing textiles. It has a share capital of Rs. 60 lakhs. The earning per share in the previous year was Rs. 0.50. For diversification, the company requires additional capital of Rs. 40 lakhs. The company raised funds by issuing 10% debentures for the same. During the current year the company earned profit of Rs. 8 lakh on capital employed. It paid tax @40%.
- State whether the shareholders gained or lost , in respect of earning per share on diversification. Show your calculations clearly.
- Also, state any three factors that favour the issue of debentures by the company as part of its capital structure.
Dear Student,
(i)
By which Shareholders are loosing due to reduction in EPS.
(ii) Three Factors :
Cost Reduction
Compared to equity, debt requires lower financing cost. Thus, companies often mix debt into their capital structure to bring down the average financing cost. Using debt, companies are contractually liable to make periodic interest payments and return debt principal at maturity.
Profit Retention
while using debt may add pressure to company's ongoing operations as a result of having to meet interest payment obligations, it helps retain more profits within the company compared to using equity, which requires the sharing of company profits with equity holders. Using debt, companies need to pay only the amount of interest out of their profits.
Financial leverage
Using debt is also advantageous to existing owners because of the effect of financial leverage. When companies use debt to provide addition capital for their business operations, equity owners get to keep any extra profits generated by the debt capital , after any interest payments.
Regards
(i)
By which Shareholders are loosing due to reduction in EPS.
(ii) Three Factors :
Cost Reduction
Compared to equity, debt requires lower financing cost. Thus, companies often mix debt into their capital structure to bring down the average financing cost. Using debt, companies are contractually liable to make periodic interest payments and return debt principal at maturity.
Profit Retention
while using debt may add pressure to company's ongoing operations as a result of having to meet interest payment obligations, it helps retain more profits within the company compared to using equity, which requires the sharing of company profits with equity holders. Using debt, companies need to pay only the amount of interest out of their profits.
Financial leverage
Using debt is also advantageous to existing owners because of the effect of financial leverage. When companies use debt to provide addition capital for their business operations, equity owners get to keep any extra profits generated by the debt capital , after any interest payments.
Regards