Professional Documents
Culture Documents
G%
20
40
50
60
70
Ke%
Kd%
K0%
20
22
24
30
40
50
6.5
20
18.8
16.8
18.25
20.02
V000
500
532
548
495
595
20.6
485
Indifference Analysis
The indifference point, often called as a breakeven point, is highly impo
rtant in financial planning because, at EBIT amounts in excess of the E
BIT indifference level, the more heavily levered financing plan will gene
rate a higher EPS. On the other hand, at EBIT amounts below the EBIT
indifference points the financing plan involving less leverage will genera
te a higher EPS.
Example: Dhaka Builders Ltd., is planning an expansion program. It re
quires Tk. 20 lakhs of external financing for which it is considering two
alternatives. The first alternative calls for issuing 15,000 equity shares
of tk. 100 each and 5,000 10% Preference Shares of tk. 100 each; the
second alternative requires 10,000 equity shares of tk.100 each, 2,000
10% Preference Shares of tk. 100 each and tk. 8,00,000 Debentures c
arrying 9% interest. The company is in the tax bracket of 50%. You are
required to calculate the indifference point for the plans and verify your
answer by calculating the EPS.
Indifference Analysis
Capital Structure :
Plan 1 (tk.)
15,00,000
5,00,000
20,00,000
15,000
Plan 2 (tk.)
10,00,000
2,00,000
8,00,000
20,00,000
10,000
Let, at X level of EBIT, the EPS under both the plans will be the same.
EPS under 1st plan:
X (1 t ) pd
=
N1
( X I )(1 T ) Pd
N2
nd
X (1 0.5) 50,000
15,000
Indifference Analysis
Now, equalizing both the EPS, we will get:
>
>
>
X (1 0.5) 50,000
15,000
0.5 X 50,000
15,000
0.5 X 50,000
3
> 1.5X- 1,68,000
=
=
=
=
> X =
X-1,00,000
tk. 1,36,000
Financial Distress
Costs of Financial Distress: Costs arising from bankruptcy or distorted bu
siness decisions before bankruptcy.
The cost of going bankrupt:
Direct costs: Legal and other deadweight costs
Indirect costs: Costs arising because people perceive you to be in finan
cial trouble
As the company borrow more, you increase the probability of bankruptcy
and hence the expected bankruptcy costs
Market Value = all Equity Financed + PV Tax Shield - PV Costs of Fi
nancial Distress
Financial Distress
Value of
unlevered
firm
Optimal amount
of debt
Debt
Financial choices
Trade-off Theory - Theory that capital structure is based on a trade-off
between the benefits and costs of debt.
Pecking Order Theory - Theory stating that firms prefer to issue debt r
ather than equity if internal fund is insuffieient.
Dividend
Dividend is the cash/stock/buyback paid to shareholders.
Dividend policy raises a number questions, namely :
Why do companies pay dividends
When do companies pay dividends
What is the process of paying dividends
How do companies pay dividends
Dividend Payment Procedure
Types of Dividends
Cash Dividend.
Stock dividend: Bonus Share, New share
Share Repurchase: Buy shares on the market, tender off
er to shareholders.
Dividend Facts:
Dividends are sticky.
Dividends tend to follow earnings.
Dividends are different across countries.
Measures of Dividend
Dividend Payout = Dividends/ Net Income
Measures the percentage of earnings that the company pays i
n dividends.
If the net income is negative, the payout ratio cannot be comput
ed.
Dividend Yield = Dividends per share/ Stock price
Measures the return that an investor can make from dividends
alone.
Becomes part of the expected return on the investment
Dividend Theories
1)
2)
3)
4)
Middle of the roaders: Leftist theory with some reality throw in.
5)
Operating Income
Corporate tax at 35%
After Tax income (paid as div)
Income tax paid by investors at 15.0%
Cash to Shareholder
100.00
35.00
65.00
9.75
55.25