(^288) Financial Management
APV =
+ + +
+ + +
= = =
= 48.93 + [3.18 + 0.21 + 0.09] + [4.54 + 0.3P + 0.13]
= 48.93 3- 3.48 + 4.97 - 57.38
The projectís ANPV is:
ANPV = 57.38 - 64
The project, in spite of the benefit of interest subsidy, is still unattractive.Illustrative Problems
Problem 1: Kelley Manufacturing Co. has a total capitalisation of Rs 10,00.000, and
it normally earns Rs 1,00,000 (before interest and taxes). The Financial manager of the
firm wants to take a decision regarding the capital structure. After a study of the
capital market, he gathers the following data:
Amount of Debt Interest Rate Equity Capitalisation Rate
Rs. % (at given level of debt) %
0 - 10.00
1,00,000 4.0 10.50
2,00,000 4.0 11.00
3,00,000 4.5 11.60
4,00,000 5.0 12.40
5,00,000 5.5 13.50
6,00,000 6.0 16.00
7,00,000 8.0 20.00(a) What amount of debt should be employed by the firm if the traditional approach
is held valid?
(b) If the Modigliani-Miller approach is followed, what should be the equity
capitalisation rate?
Assume that corporate taxes do not exist, and that the firm always maintains its capital
structure at book values.
Solution
(a) As per the traditional approach, optimum capital structure exists when the
weighted average cost of capital is minimum. The weighted average cost of
capital calculations at book value weighs are as follows: