ZED Limited is presently financed entirely by equity shares. The current market

Question

ZED Limited is presently financed entirely by equity shares. The current market value is Rs. 6, 00, 000. A dividend of Rs. 1, 20, 000 has just been paid. This level of dividend is expected to be paid indefinitely. The company is thinking of investing in a new project involving an outlay of Rs. 5, 00, 000 now and is expected to generate net cash receipts of Rs. 1, 05, 000 per annum indefinitely. The project would be financed by issuing Rs. 5, 00, 000 debentures at the market interest rate of 18%.

Explanation / Answer

Given that Initial outlay of Rs. 5,00,000 by investing in a new project and project cash flow = Rs. 1,05,000 and
given that the project would be financed by issuing Rs. 5,00,000 debentures at the market interest rate of 18%.

That means :

Net cash receipts=a Rs.1,05,000 per annum Less: debenture interest (Rs.5,00,000*18%)=b (90,000) Surplus available for dividend distribution,c = a-b Rs.15,000 Original dividend paid (given) = d Rs.1,20,000 Total dividend, e = c+d Rs.1,35,000 Value of equity = Total dividend / cost of equity Rs.1,35,000 / cost of equity

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