P.P.

SAVANI CHAITANYA VIDYA SANKUL, CBSE

CASE STUDIES
SUBJECT: -BUSINESS STUDIES STD: -12th

1. According to the technique of Scientific management “Differential Piece Wage system” How much
more will a worker making 60 units earn as compared to a worker making 49 units? If the
standard output per day is 50 units and those who make standard output or more than standard
get Rs. 75 per unit and those below get Rs. 65 per unit.
A. Rs. 4500
B. Rs. 3185
C. Rs. 1315
D. Rs. 3250

Ans:

Worker A = 60 units × Rs. 75 per unit

= Rs.4500

Worker B = 49 units × Rs.65 per unit

= Rs. 3185

Difference = 4500 – 3185

= Rs. 1315

2. From the following information regarding Aditya Ltd. which is in the business of manufacturing
green tea, calculate the Return on Investment and Interest Coverage Ratio of the company: (Show
working)
Earning before interest and tax - Rs. 15,00,000
10% debentures - Rs. 12,00,000
Equity Share Capital (Rs.10 each) Rs. 18,00,000
Tax Rate 40%

Ans: Calculation of Return on Investment (ROI)

EBIT
ROI= × 100
TOTAL INVESTMENT

15,00,0000
ROI = × 100
30,00,000
 = 50%

Calculation of Interest Coverage Ratio (ICR)

EBIT
Interest coverage ratio =
Interest

15,00,000
ICR =
1,20,0000

=12.5 times

3. Krish limited is in the business of manufacturing and exporting carpets and other home décor
products. It has a share capital of Rs. 70 lacs at the face value of Rs. 100 each. Company is
considering a major expansion of its production facilities and wants to raise Rs. 50 lacs. The finance
manager of the company Mr. Prabhakar has recommended that the company can raise funds of the
same amount by issuing 7% debentures. Given that earning per share of the company after
expansion is Rs. 35 and tax rate is 30%, did Mr. Prabhakar give a justified recommendation? Show
the working

Ans:
- Earnings per share = Rs. 35
Earning After Tax
EPS =
No.Of Shares
Earning After Tax
35 =
70,0000

Earning after tax = 35 × 70,000

Earning after tax = Rs. 24,50,000
7
Interest= 50,00,000 x
100
= Rs.. 3,50,0000
Let the Earning before tax (EBT) = x
EBT- Tax = EAT
X-0.30 x = 24,50,000
0.70 x = 24,50,000
24,50,000
X=
0.70
X = Rs.35,00,000

Earning before tax = Rs. 35,00,000

EBIT = Earning before tax + Interest

 = 35,00,000 + 3,50,000
= Rs.. 38,50,000

EBIT
ROI = × 100
TOTAL INVESTMENT
38,50,000
= × 100
1,20,00000
= 32.08%
As ROI (32.08%) > Rate of interest (7%).
The company can choose to use trading on equity to increase its EPS.
The finance manager was justified in making this recommendation.

4. Vedansh Limited has a share capital of Rs.10,00,000 divided into shares of Rs.100 each .For
expansion purpose ,the company requires additional funds of Rs. 5,00,000 .
The management is considering the following alternatives for raising funds :

Alternative 1: Issue of 5000 Equity shares of Rs.100 each

Alternative 2: Issue of 10% Debentures of Rs. 5,00,000

The company’s present Earnings Before Interest and Tax ( EBIT) is Rs.4,00,000 p.a.
Assuming that the rate of Return of Investment remains the same after expansion, which
alternative should be used by the company in order to maximise the returns to the equity
shareholders. The Tax rate is 50%.
Show the working.

Answer :
4,00,000
Rate of Return of Investment is = × 100 = 40%
10,00,000

EBIT after expansion = 40% × 15,00,000 = Rs.6,00,000

Calculation of EPS
Particular Plan -1 Plan -2
 EBIT 6,00,000 6,00,000
Less : Interest 40% ---- - 50,000

EBT 6,00,000 5,50,000

Less: Tax 50 % -3,00,000 -2,75,000

EAT 3,00,000 2,75,000

No. Of shares 15,000 shares 10,000 shares

𝐄𝐀𝐓 Rs. 20 Rs.27.5

EPS =
𝐍𝐨.𝐨𝐟 𝐬𝐡𝐚𝐫𝐞𝐬

The company should use Plan 2 in order to increase the return to the equity shareholders.

5. X Ltd.' issued 14% Debentures of `4,00,000 and 10,000 Equity shares of `60 each. This investment
resulted in a net profit of `2,00,000 before interest and tax. The tax rate was 50%.
a. Calculate the 'Return on Investment’ and ‘Earning per Share’ of ‘X Ltd.’
b. State with reason whether the above example is that of favourable or unfavourable financial
leverage.
Ans:
EBIT
(a) Return on Investment = TOTAL INVESTMENT × 100
2,00,000
= 10,00,000 × 100

=20%
EAT
Earning per share = No.of shares
2,00,000−56000−72,000
= 10,000

= Rs. 7.20 per share

(b) It is a case of favourable financial leverage
As the ROI > Rate of interest
20 % > 14 %
So the company can extend debt, that is, it can choose Trading on equity.

6. ‘Smart Stationery Ltd.’ wants to raise funds of Rs. 40,00,000 for its new project. The management is
considering the following mix of debt and equity to raise this amount:
 Alternatives
Capital
Structure I (Rs.) II (Rs.) III (Rs.)

Equity 40,00,000 30,00,000 10,00,000

Debt 0 10,00,000 30,00,000

Other details are as follows:

- Interest Rate on Debt 9%
- Face Value of Equity Shares Rs. 100 each
- Tax Rate 30%
- Earning Before Interest and Tax (EBIT) Rs. 8,00,000
(a) Under which of the three alternatives will the company be able to take advantage of Trading on
Equity?
(b) Does Earning Per Share always rise with increase in debt?

Ans:
a. Calculation of Earning Per Share (EPS):
Alternatives
Particulars
I (Rs.) II (Rs.) III (Rs.)

Equity 40,00,000 30,00,000 10,00,000

+ 9 % Debentures ---- 10,00,000 30,00,000

Capital employed 40,00,000 40,00,000 40,00,000

EBIT 8,00,000 8,00,000 8,00,000

Less : Interest ------- (90,000) (2,70,000)

EBT 8,00,000 7,10,000 5,30,000

Less : Tax 30% (2,40,000) (2,13,000) (1,59,000)

EAT 5,60,000 4,97,000 3,71,000

No. Of Shares 40,000 30,000 10,000

shares shares shares
EAT Rs. 14 Rs.16.57 Rs.37.10
EPS =
No.of shares

b. No, Earning Per Shares only rises with increase in debt when the rate of interest on debt is
lower than the return on investment.

7. Silk Ltd. had an EPS of Rs.1. It raised a loan of Rs.10 lakhs at an interest rate of 10% p.a. from a
bank. After one year, the results were as follows:
 Details Amount

Equity (Shareholders' Funds) (2,00,000 shares of Rs. 20 Lakh

Rs. 10 each)
10% Loan Rs. 10 Lakh

Earning Before Interest and Tax (EBIT) Rs. 6 Lakh

Earning Per Share (EPS) Rs. 2

Tax rate 20%.

(i) Why did EPS in Silk Ltd. rise with the use of debt?
(ii) If EBIT of the company would have been Rs. 3 lakh, would using debt still be favourable for
the company? Explain.
Ans:
(i) The EPS in Silk Ltd. rose with the use of debt because the cost of debt is lower than the
return that the company is earning on funds employed (ROI) which is known as Trading on
Equity/ Favourable Financial Leverage.
(ii) If EBIT of the company would have been Rs.3 lakhs, using debt would not have been
favourable for the company.
Explanation
- It is unfavourable for the company because the company’s Rate of return on
investment (ROI) is not more than the cost of debt.
- The ROI of the company is (3 lakh/ 30 lakh) x 100 i.e. 10%, and the interest rate on debt
is also 10%.
- In such a case, the EPS will be reduced to Rs.0.8. This is a situation of unfavourable
financial leverage.

Alternative explanation
EBIT 3,00,000
Less: Interest 10% -1,00,000

EBT 2,00,000
Less: Tax 20% -40,000

EAT 1,60,000

No. Of shares 20,0000

EAT Rs.0.8
EPS =
No.of shares

EPS is falling, it is unfavourable.