(^320) Financial Management
should be identical. Thus, on the basis of level of EBIT which ensures identical market
price for alternative financial plans, the indifference point can be symbolically computed
by following Equation.
- - -
=
-
+
&
+!) - /
&+!)^ where PEI = P/E ratio of levered plan and P/E2 = P/E ratio of unlevered plan.
Determine the indifference point at which market price of equity shares of a corporate
firm will be the same frdm the following data:- Funds required, Rs 50,000.
- Existing number of equity shares outstanding, 5,000 @ Rs 10 per share.
- Existing 10% debt, Rs 20,000
- Funds required can be raised either by (a) issue of 2,000 equity shares, netting Rs
25 per share or (b) new 15 per cent debt. - The P/E ratio will be 7 times in equity alternative and 6 times in debt alternative.
- Corporate tax rate, 35 per cent.
Solution
- - - -
=
- -
^
&+!) - ,
&+!) - , (^)
= -
-
- %
-
or (^)
-- = -
or 5(4.55x - Rs 9,100) = 7(3.9 ◊ Rs 37,050)
or 4.55x = Rs 2,13,850, i.e. ◊ = Rs 47,000
Confirmation table
15% Debt issue Equity issue
EBIT Rs 47,000 Rs 47,000
Less interest 9,500 2,000
Earning before taxes 37,500 45,000