CAPITAL STRUCTURE DECISIONS

OPTIMAL CAPITAL STRUCTURE CASE STUDY:

Kohinoor Mills Limited (KML) operates in the Textile goods sector. Kohinoor Mills Limited is

a Pakistan-based company engaged in the textiles industry. Now the proprietor wants to

restructure of their capitalization on large-scale, because Financial Leverage is an aspect of

financial planning which enable the company to enhance the return on equity shares by using

debt with lower fixed cost which is less than the overall return on investment. Current financial

highlights of electric lines company base on its equity finance, I am being hired as a financial

analyst on contractual basis to evaluate the restructure of capitalization to inclusion debt portion

of its amount of capital and find out the optimal capital structure of the company at maximization

of total market value of company with minimum cost level. KML financial highlights represent

its total equity Rs 1,575,000 ( in thousands), earnings before interest and tax Rs 315,000, portion

of debt zero percent, portion of equity 100 percent, cost of equity 13 percent, weighted average

cost of capital 13 percent on the basis of unlevered cost of equity, earning per share Rs 9.75, risk

free rate 9 percent, market risk premium 5 percent, number of shares outstanding 21,000 (in

thousand ), market price per share Rs 75, KML's is a growth rate zero percent and pays out all of

its earnings as dividend. KML's tax rate is 35 percent. Quotations for before tax cost of debt

from a local bank is given; KML's can borrow unlimited amounts from a well-known financial

institution ( Habib Metropolitan Bank) at lowest interest rates, 10 percent of debt can borrow at

cost of 7 percent, 20 percent of debt can borrow at cost of 9.5 percent, 30 percent of debt can

borrow at cost of 11 percent, 40 percent of debt can borrow 14.5 percent, 50 percent of debt can

borrow at cost of 17.3 percent and 60 percent of debt can borrow at cost of 19.5 percent. An

increase in the debt ratio also increase the risk faced by shareholders, and this has an effect on the cost of equity. This relationship is harder to quantify, but it can be estimated. The Hamada's

equation shows how increase in the debt/ equity ratio increase beta. Kohinoor Mills Limited has

unlevered beta 0.8 that is the beta it would have if it has no debt. All earnings are paid out as

dividends and growth rate remain zero percent.

Note: The written version of your group analysis will be submitted to the instructor in class, as

per the pre announced date. This write-up will be graded, based upon the reasonableness and

thoroughness of your analysis, as well as the clarity of your writing. Late cases will not be

accepted.

Based on the given information, what is the firms optimal capital structure, and what is the weighted average cost of capital at the optimal structure?

Quotations for before tax cost of debt from a local bank is given; Selected firm can borrow unlimited amounts from a well-known financial institution at lowest interest rates as per weights of debt.

An increase in the debt ratio also increase the risk faced by shareholders, and this has an effect on the cost of equity. This relationship is harder to quantify, but it can be estimated.

The Hamadas equation shows how increase in the debt / equity ratio increase beta