SELECT * FROM question_mgmt as q WHERE id=5260 AND status=1 SELECT id,question_no,question,chapter FROM question_mgmt as q WHERE courseId=3 AND subId=20 AND chapterId=598 and ex_no='2' AND status=1 ORDER BY CAST(question_no AS UNSIGNED) CBSE Free NCERT Solution of 12th business-studies Financial Management sunrises ltd dealing in readymade garments is pl

Question:

Sunrises Ltd. dealing in readymade garments, is planning to expand its business operations in order to cater to international market. For this purpose the company needs additional ₹ 80,00,000 for replacing machines with modern machinery of higher production capacity. The company wishes to raise the required funds by issuing debentures. The debt can be issued at an estimated cost of 10%. The EBIT for the previous year of the company was ₹ 8,00,000 and total capital investment was ₹ 1,00,00,000. Suggest whether issue of debenture would be considered a rational decision by the company. Give reason to justify your answer. (Ans. No, Cost of Debt (10%) is more than ROI which is 8%).

Answer:

If the cost of the debt is less than the cost of capital then a company can issue debenture for raising fund.

In the above case, the cost of capital is 10%, for the total capital of ₹ 80,00,000, the cost of capital is ₹ 8,00,000. The EBIT for the previous year of the company was ₹ 8,00,000 and total capital investment was ₹ 1,00,00,000. So the total ROI is 

ROI = RETURN ÷ INVESTMENT × 100

ROI= 800000 ÷ 10000000 × 100 = 8 %

It will assume that the company will operates with the same efficiency, the additional investment of ₹ 80,00,000 will have net ROI of 8% which will be ₹ 6,40,000 against the cost of debt ₹ 8,00,000.

In the above case the cost of debt is 10% which is generating ROI of 8%, so it will not be advisable for the company to issue debenture when the cost of debt is higher than the cost of capital.


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