Here are some of the numerical problem of Capital Structure from Net Income Approach.
Numerical 1
A company, Alexa Ltd., has an EBIT of $120,000. The total capital is $1,000,000, with 60% equity and 40% debt. The cost of debt is 8%, and the equity capitalization rate is 10%.
Calculate:
1. Net income.
2. Value of the firm according to the NI approach.
Solution:
Debt Amount = 40% of Total Capital
= 40% * $ 1,000,000
= $ 400,000
Interest = 8% of Total Debt
= 8% * $ 400,000
= $ 32,000
(Interest in levied on debt portion of capital)
Net Income
Net Income = EBIT - Interest
= $ 120,000 - 32,000
= $ 88,000
Value of the Firm
Value of the Firm = EBIT/Equity Capitalization Rate
= 120,000/10%
= $ 1,200,000
Thus:
Net Income: $ 88,000
Value of the Firm: $ 1,200,000
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Numerical 2
Ananta Manufacturing Industries has an EBIT of Rs. 150,000, with a total capital of Rs. 1,500,000 (50% debt and 50% equity). The cost of debt is 6%, and the equity capitalization rate is 9%.
Calculate the firm's value and net income if the debt proportion is increased to 60%.
Solution:
Interest with 50% Debt
Debt = 50%* Rs. 1,500,000 = .50*1500000 = Rs. 750,000
Interest = Rs. 750,000 * 6% = Rs. 45,000
Net Income with 50% Debt
Net Income = EBIT-Interest = 150,000-45,000 =Rs 105,000
Value of the Firm at 50% Debt
Value of the firm = EBIT/Equity Capitalization Rate
= 150,000/9%
= Rs. 1,666,666.67
Now, with the Debt 60%
Debt =60%* Rs. 1,500,000 = Rs. 900,000
Interest = Rs. 900,000 * 6% = Rs. 54,000
Net Income with 60% Debt
Net Income = EBIT - Interest = 150,000 - 54,000 = Rs. 96,000
New Firm Value with 60% Debt (Assuming WACC decreases with more debt)
Value of the Firm = EBIT/New Equity Capitalization Rate
= Rs. 150,000/8.5%
= Rs. 1,764,705.88
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Numerical 3
A firm has a capital of $ 2,500,000 with an EBIT of $ 300,000. It is financed by 60% by equity and 40% debt. The interest rate on debt is 6%, and the equity capitalization rate is 12%. Calculate the firm’s value and WACC under the NI approach.
Solution:
Interest Expenses
Debt = 40%*2,500,000 = $ 1,000,000
Interest = $ 1,000,000 * 6% = $ 60,000
Net Income
Net Income = EBIT - Interest = $ 300,000- $ 60,000
= $ 240,000
Firm’s Value
Value of the Firm = EBIT/Equity Capitalization Rate
= 300,000/12%
= $ 2,500,000
WACC Value remains unchanged i.e. 12% hence the value of the firm remains the same.
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Numerical 4
Aditya Exim has an EBIT of Rs. 250,000, a total capital of Rs. 1,5000,000 with 40% debt, and equity capitalization rate of 11%. The cost of debt is 5%. Suppose the company decides to increase its debt proportion to 55%.
Calculate:
1. New Debt Amount and Interest Expense at 55 % debt.
2. Net Income with the new interest expense.
3. Weighted Average Cost of Capital (WACC) if the equity capitalization rate adjusts to 13% with the increased Debt.
Solution:
Initial Debt Proportion = 40%
Debt = 40% * Rs. 1,500,000 = Rs. 600,000
Interest = Rs. 600,000 * 5% = Rs. 30,000
Revised Debt Portion = 55%
Debt = 55% * Rs. 1,500,000 = Rs. 825,000
New Interest Amount = Rs. 825,000 * 5% = Rs. 41,250
New Net Income
Net Income = EBIT - Interest
= Rs. 250,000 - 41,250
= Rs. 208,750
WACC Calculation
Equity = 45% * Total Capital = Rs. 675,000
Debt = 55% * Total Capital = Rs. 825,000
New Cost of Equity = 13%
WACC = (Equity Proportion*Cost of Equity)+(Debt Proportion*Cost of Debt)
= ( 0.45*13%) + (0.55*5%)
= 5.85%+2.75%
= 8.6%
Thus:
1. New Interest Expense = Rs. 41,250
2. New Net Income = Rs. 208,750
3. New WACC = 8.6 %
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Numerical 5
ABC Limited has an EBIT of Rs. 500,000 and Total Capital of Rs. 2,000,000 with an initial debt ratio of 30%. The cost of debt is 5%, and the equity capitalization rate is initially 10%. The firm considers increasing the debt ratio of 50% which would increase the equity capitalization rate of 12%.
Calculate:
1. New Interest Expense with 50% Debt
2. Net Income after interest expense
3.New firm value at the updated equity capitalization of 12%
Solution
Interest with Initial Debt (30%)
Debt = 30% * Rs. 2,000,000 = Rs. 600,000
Interest = Rs. 600,000 * 5% = Rs. 30,000
New Debt ( 50%)
New Debt = 50% * Rs. 2,000,000 = Rs. 1,000,000
New Interest Expenses = Rs. 1,000,000 * 5% = Rs. 50,000
New Net Income
Net Income : EBIT - Interest = Rs. 500,000-50,000 = Rs. 450,000
New Firm Value with 12% Equity Capitalization Rate:
Value of Firm = EBIT/New Equity Capitalization Rate
= 500,000/12%
= Rs. 4,166,666.67
Thus:
1. New Interest Income : Rs. 50,000
2. New Net Income: Rs. 450,000
3. New Firm Value = Rs. 4,166,666.67