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## State whether the shareholders gained or lost, in respect of earning per share on diversification. Show you calculations clearly. Also, state any three factors that favour the issue of debentures by the company as part of its capital structure. -CBSE business studies 2016 class 11

Kay Ltd. is a company manufacturing textiles. It has a share capital of Rs 60 lakhs. In the previous year its earnings per share was Rs 0.50. For diversification, the company requires additional capital of Rs 40 lakhs. The company raised funds by issuing 10% Debentures for the same. During the year the company earned profit of Rs 8 lakhs on capital employed. It paid tax @ 40%. a. State whether the shareholders gained or lost, in respect of earning per share on diversification. Show you calculations clearly. b. Also, state any three factors that favour the issue of debentures by the company as part of its capital structure.

Asked On2017-07-19 16:08:46 by:milan-ransingh

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a. Let the face value of equity share be Rs. 10 each.
Profit before interest and tax = Rs. 8,00,000
Interest on 10% debentures = Rs. 4,00,000
Profit before tax = Profit before Interest and Tax - Interest
Profit before tax = 8,00,000 - 4,00,000 = Rs. 4,00,000
Tax @ 40% = 4,00,000 × (40/100) = Rs. 1,60,000
Profit available to shareholders = 4,00,000 - 1,60,000 = Rs. 2,40,000
Earning Per Share (EPS) = Profit after tax/Number of Equity Share = 2,40,000/6,00,000 = 0.4
Thus, shareholders have incurred loss after the issue of debentures as earning per share (EPS) has fallen from Rs 0.5 to Rs 0.4.
b. The following are the three factors which favour the issue of debentures by the company as part of its capital structure.
i. Good cash flow position: If the company has a good cash flow position, then issuing debentures is more favourable as compared to issuing shares.
ii. High tax rate: It is beneficial for the company to issue debentures if the tax rate is higher. This is because interest paid by the company to its debenture holders is tax deductible.
iii. Control: If the company does not want to dilute the control of management, then issuing debentures is best for the company.

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