Consider the followinginformation related to two companies of the same industry
ID: 2662263 • Letter: C
Question
Consider the followinginformation related to two companies of the same industry as onDec. 31, 2009.
XYZ Company
ABC Company
Share Capital (Rs.10 each)
Rs. 850,000
Rs. 1,400,000
Reserves
Rs. 320,000
Rs. 500,000
Retained Earnings
Rs. 200,000
Rs. 250,000
Current Year Dividend
20 % (Rs. 2.0)
16 % (Rs. 1.60)
Dividend Growth Rate
10%
5%
Market Price of Common Stock
Rs. 15
Rs. 12
Required:
Which company’s capital structure is more efficient?
Note: (Calculations are not required. Do your calculations inrough work and support your answer in just one line.)
[Hint: Compare Cost of Equities of both companies.]
XYZ Company
ABC Company
Share Capital (Rs.10 each)
Rs. 850,000
Rs. 1,400,000
Reserves
Rs. 320,000
Rs. 500,000
Retained Earnings
Rs. 200,000
Rs. 250,000
Current Year Dividend
20 % (Rs. 2.0)
16 % (Rs. 1.60)
Dividend Growth Rate
10%
5%
Market Price of Common Stock
Rs. 15
Rs. 12
Explanation / Answer
Market value of a firm is determined by below ratios. Bycalculating them we can see that XYZ's capital strcuture is moreefficient that that of ABC 1. Earnings per share of XYZ is = EPS=Retained earnings/No ofShares = 200,000/85,000 = Rs 2.35 Earnings per share of ABC is =EPS = Retained earnings/No ofShares = 250,000/140,000 = Rs 1.78 2. Book Value per share = Common equity/shares outstanding XYZ BV= (850,000+320,000+200,000)/85000= Rs 16.11 ABC BV = (1400,000+500,000+250,000)/140,000=Rs 15.35 3. Market price to Book value Ratio = Market value per share/BV pershare XYZ M/B = 15/16.11= 0.93 ABC M/B = 12/15.35 = 0.78