--- title: "Capital structure; best option by EPS, three options" subject: "Project Engineering" chapter: 6 key: "semester_7/project_engineering:best-option-eps-three-options-c70" source: https://www.bctengineer.com/q/semester_7/project_engineering/best-option-eps-three-options-c70 site: BCT Engineering --- # Capital structure; best option by EPS, three options Project Engineering · Chapter 6: Introduction to Project Financing - Asked in: 2070 Chaitra, 1+6 marks - Video: [Financial management under BU// chapter 3// calculation of EPS when 2 different EBIT amt// part 6](https://www.youtube.com/watch?v=jlRm2qOwlWs) — study circle - Answer checked by Claude Opus 5.5 (high effort) on 2026-10-14 - Page: https://www.bctengineer.com/q/semester_7/project_engineering/best-option-eps-three-options-c70 - Whole chapter: https://www.bctengineer.com/md/semester_7/project_engineering/chapter-6 ## Question Define capital structure. XYZ company has total capital of Rs 10,00,000 which consists of 40% share and 60% loan issued @ 12% interest. It requires Rs 20,00,000 more to invest in a project and is considering the following three options: (i) Rs 8,00,000 share and Rs 12,00,000 loan @ 14% interest; (ii) Rs 5,00,000 share, Rs 7,00,000 preference share @ 15% interest and Rs 8,00,000 loan @ 14% interest; and (iii) Rs 10,00,000 share and Rs 10,00,000 preference share @ 15% interest. Which is the best option based on Earning Per Share calculation if the earning before interest and tax in a year is Rs 5,00,000 and tax applicable is 30%? ## Short answer Compute interest, EAT, and earnings for equity for each option, then divide by number of shares. Option (i) EPS = Rs 15.17, (ii) = Rs 12.91, (iii) = Rs 10.69. Option (i) is best. ## Answer #### Capital structure **Capital structure** is the mix of long-term sources of funds (equity shares, preference shares, retained earnings and long-term debt) used by a firm to finance its total capital. **Capital structure planning** is the process of deciding the best proportion of these sources so that the cost of capital is lowest and the value of the firm and return to shareholders are highest. #### Data and assumptions - Existing capital Rs 10,00,000: share (40%) = Rs 4,00,000 and loan (60%) = Rs 6,00,000 at 12% (interest Rs 72,000). - Face value of a share is taken as Rs 100. EBIT of Rs 5,00,000 is the same for all options; tax = 30%. - All three options raise Rs 20,00,000 (the amounts add up in each case). #### EPS for each option Interest = 72,000 + interest on new loan. EAT = (EBIT - interest) x 0.70. Earnings for equity = EAT - preference dividend. | Option | Shares | Interest | EBT | EAT | Pref. dividend | Earnings for equity | EPS (Rs) | |---|---|---|---|---|---|---|---| | (i) | 12,000 | 240,000 | 260,000 | 182,000 | 0 | 182,000 | 15.17 | | (ii) | 9,000 | 184,000 | 316,000 | 221,200 | 105,000 | 116,200 | 12.91 | | (iii) | 14,000 | 72,000 | 428,000 | 299,600 | 150,000 | 149,600 | 10.69 | Working for option (i): shares = (4,00,000 + 8,00,000)/100 = 12,000; interest = 72,000 + 12,00,000 x 14% = 2,40,000; EBT = 2,60,000; EAT = 1,82,000; EPS = 1,82,000/12,000 = 15.17. **Answer: EPS is Rs 15.17 for (i), Rs 12.91 for (ii) and Rs 10.69 for (iii). Option (i) gives the highest EPS and is the best option.** ## Check yourself The answer's key points as multiple-choice questions, with the correct option and why. 1. What is capital structure? A. The mix of long-term sources of funds (equity, preference, retained earnings, long-term debt) used to finance total capital B. The physical structure of a project's assets C. The yearly profit after tax D. The list of a firm's short-term creditors Answer: A. Capital structure is the proportion of long-term sources of funds financing total capital. (Key point: Capital structure definition) 2. What does capital structure planning aim at? A. Maximum debt regardless of cost B. Lowest cost of capital and highest value of firm and return to shareholders C. Eliminating all shares D. Maximising tax paid Answer: B. The best proportion of sources lowers cost of capital and raises firm value and shareholder return. (Key point: Goal of capital structure planning) 3. Why is interest in option (i) Rs 2,40,000? A. Existing loan interest 72,000 plus new loan 12,00,000 x 14% = 1,68,000 B. Only new loan interest 12,00,000 x 14% C. 20,00,000 x 12% D. Existing loan of 6,00,000 x 14% Answer: A. Total interest includes the existing Rs 72,000 (6,00,000 at 12%) plus Rs 1,68,000 on the new loan. (Key point: Interest in option (i)) 4. In option (ii), how is the preference dividend of Rs 1,05,000 treated? A. Deducted from EBIT before tax B. Deducted from EAT to get earnings for equity C. Added to interest D. Ignored since it is a share Answer: B. 7,00,000 x 15% = 1,05,000 is paid after tax: 2,21,200 - 1,05,000 = 1,16,200. (Key point: Preference dividend in option (ii)) 5. Which option is best and why? A. Option (iii), because it has no loan B. Option (ii), because it has three sources C. Option (i), because it gives the highest EPS of Rs 15.17 D. All equal, since EBIT is the same Answer: C. EPS is 15.17, 12.91 and 10.69 for (i), (ii), (iii); the highest EPS (option i) is chosen. 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