Q. 3 Indus engineering company has gross sales of Rs.375 million and profit after tax of Rs.715 million in the year 2019. The company is considering expanding its capacity by adding 30% more to its existing fixed assets. Sales are likely to increase by Rs.550 million. For the proposed expansion earnings before interest and taxes to sales ratio is 18%. The company has never borrowed in the past. The finance director has recommended that the company should raise 15% interest bearing debt for financing the expansion. In his opinion, given 35% income tax rate, the effective cost of debt will be 9.75% and considering the current net worth (balance sheet given below) debt equity ratio will be only 0.22 which is quite low for an engineering firm. Indus is a highly capital-intensive company its fixed costs are 70% of the total costs. It is notable that the performance of engineering industry is quite susceptible to economic changes. Assets Liabilities Rs. (millions) 1,000 Rs. (millions) 400 Fixed Assets Share Capital (Face value Rs.10) Reserve 950 Current Assets: Debtors Inventory Cash Net worth Current Liabilities 1,350 355 200 300 205 1,705 1,705 Required: Should the company borrow? Give your analysis by making appropriate assumptions. (Marks 10) Q. 3 Indus engineering company has gross sales of Rs.375 million and profit after tax of Rs.715 million in the year 2019. The company is considering expanding its capacity by adding 30% more to its existing fixed assets. Sales are likely to increase by Rs.550 million. For the proposed expansion earnings before interest and taxes to sales ratio is 18%. The company has never borrowed in the past. The finance director has recommended that the company should raise 15% interest bearing debt for financing the expansion. In his opinion, given 35% income tax rate, the effective cost of debt will be 9.75% and considering the current net worth (balance sheet given below) debt equity ratio will be only 0.22 which is quite low for an engineering firm. Indus is a highly capital-intensive company its fixed costs are 70% of the total costs. It is notable that the performance of engineering industry is quite susceptible to economic changes. Assets Liabilities Rs. (millions) 1,000 Rs. (millions) 400 Fixed Assets Share Capital (Face value Rs.10) Reserve 950 Current Assets: Debtors Inventory Cash Net worth Current Liabilities 1,350 355 200 300 205 1,705 1,705 Required: Should the company borrow? Give your analysis by making appropriate assumptions. (Marks 10)