Problem1. Leonnel Co. Ltd has equity share capital of the Rs 500,000 (face value Rs 100 per share). To meet the expenditure of expansion programme, the company wishes to increase Rs 300,000 and is having the following 4 alternatives to increase the funds:
i) Plan A: To have full money from the equity shares.
ii) Plan B: To have Rs 100,000 from equity and Rs 200,000 from borrowing from Financial Institution @ 10% p.a.
iii) Plan C: Full money from borrowing @ 10% p.a.
iv) Plan D: Rs 100,000 in equity and Rs 200,000 from preference shares at 8% p.a.
The company’s earnings before interest and tax are Rs 150,000 and the corporate tax is 50%.
Required:
Question1. As a financial controller, suggest which plan you would suggest the company to adopt?
Question2. “In the world of no-tax, a firm’s cost of capital is independent of its capital structure”. Explain the above statement and give proper illustrations.