# ABC Co. sells 10,000 units at a price of Rs. 10 per unit. ABC’s total fixed cost is Rs. 20,000, Interest expense 10,000, and variable cost is Rs. 6 per unit.

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1. ABC Co. sells 10,000 units at a price of Rs. 10 per unit. ABC’s total
fixed cost is Rs. 20,000, Interest expense 10,000, and variable cost is
Rs. 6 per unit. Find ABC’s degree of operating leverage, degree of
financial leverage and find degree of total leverage. ABC’s parent
company has Rs. 2.5 million is assets that are currently financed by
100% equity. Its EBIT is Rs.600,000 and its tax rate is 30%. If ABC’s
parent changes its capital structure to include 40% debt, what is its
ROE before and after the change? Assume interest rate on debt is 10%.
Comment why the ROE increases after adding debt. Assuming all other
things remain same, how will the ROE change if interest on debt is
suddenly increased to 20% ? Elaborate on the same (10 Marks)
2. Kuber Company has a target capital structure of 50% debt and 50%
equity, with an after tax cost of debt of 8%. Cost of retained earnings is
14%. Its profit after tax is Rs, 250,000. Kuber is considering the
following projects to invest in
Project
Size of project
IRR of project
Project A
100,000
12.0%
Project B
120,000
11.5%
Project C
120,000
11.0%
Project D
120,000
10.5%
Project E
100,000
10.0%
Find the company’s weighted average cost of capital. If the company
accepts all the projects that it could invest in just from its profit after
tax and considering their IRRs, which projects should it take up? Give
reason. What will be its total investment in these projects?
Taking into account its target capital structure, how much of equity
portion should the company invest in these projects? If the company
follows Irrelevance Approach (Modigliani and Miller) or residual
dividend policy, what will be its dividend payout ratio? (10 Marks)
3. Hi-Tech company’s partial balance sheet for 2 years is given below
Due to a new product launch, Hi-Tech’s sales grew at a faster pace in
year 2018. HiTech’s working capital bank had been assessing its
Maximum Permissible Bank Finance (MPBF) under Method 1 till 2017,
but due to a credit squeeze it suddenly changed to Method 2 in year
2018.
a) What is the change in net working capital between 2018 and 2017? (5
Marks)
b) What is the change in MPBF limit assigned by the bank from year 2017 to
2018? With this change in MPBF limit, will the working capital financing
from the bank increase or decrease? (5 Marks)
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