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Corporate Finance
Dec 2025 Examination
Q1. A large Indian conglomerate is considering increasing its leverage by issuing more long-term debt to finance a new business unit. The management is attracted by the lower after-tax cost of debt and the potential to enhance returns to equity holders. However, some board members are concerned about the risk of financial distress and the impact on the company’s credit rating. The finance manager is required to analyze the situation and advise on the optimal level of debt in the capital structure. Given the scenario, how should the finance manager apply the trade-off theory of capital structure to balance the benefits of debt (such as tax shields) against the increased financial risk and potential costs of financial distress? (10 Marks)
Q2. A firm is considering restructuring its capital structure to minimize its Weighted Average Cost of Capital (WACC). The current structure is as follows:
| Source | Market Value (Rs. lakhs) | Cost (%) |
| Equity | 800 | 15 |
| Preference Shares | 200 | 11 |
| Debt | 500 | 8 (pre-tax) |
The firm is considering increasing its debt to Rs.700 lakhs by redeeming Rs.200 lakhs of equity, keeping the total capital constant. The cost of equity will rise to 17% due to increased financial risk, and the cost of debt will increase to 9% (pre-tax). The tax rate is 35%. Calculate the WACC before and after restructuring. Critically evaluate whether the restructuring achieves the objective of minimizing WACC, and discuss the implications for the firm’s risk profile. (10 Marks)
Q3(A). A firm is considering restructuring its capital by redeeming Rs.50,00,000 of 12% debentures (trading at 95% of face value) and replacing them with new 10% debentures to be issued at 98% of face value. The company’s tax rate is 30%. The flotation cost for the new issue is 2% of the face value. The existing debentures have
5 years to maturity. Calculate the net annual after-tax interest savings (or cost) for the company over the next 5 years, considering the premium/discount on redemption and issue, flotation costs, and tax shield. Assume straight-line amortization of all premiums/discounts and flotation costs over 5 years. (5 Marks)
Q3 (B). A company is evaluating a project that requires an initial investment of Rs.2,50,00,000. The project is expected to generate the following after-tax cash flows (in Rs.) over 4 years:
| Year | Cash Flow |
| 1 | 70,00,000 |
| 2 | 90,00,000 |
| 3 | 1,10,00,000 |
| 4 | 1,30,00,000 |
The project is financed with 60% debt (interest rate: 10%, perpetual, tax-deductible) and 40% equity (cost: 16%). The corporate tax rate is 30%. Calculate the Adjusted Present Value (APV) of the project, clearly showing the base case NPV (all-equity financed), the present value of the interest tax shield, and the final APV. Interpret the result in terms of project acceptability. (5 Marks)
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