1. Whether floating rate of interest is a fixed charge source of fund or not?discuss Presented by NehaAgarwal (7BS2460)

3. Causing a deeper effect on the EPS of the share holder

5. Spread of interest rate Margin over the base rate. Floating interest rate ={ base rate +spread ; if interest rate rises base rate -spread ; if interest rate falls } Consider eg. A 5 yr. loan is priced at 6month LIBOR + 2.5%. at the end of each 6month period, the rate for the following period= LIBOR at that point + (/- ) spread

8. production units

10. What is financial leverage? Is the leverage that occurs due to the presence of fixed financial charges in a firm. Due to interest rates to bonds ,debentures and preference dividends. Here,Fixed charges do not vary with EBIT. Quantitatively, DFL= % change in EPS/%changeinEBIT

11. Relationship between financial leverage and interest rate Rise in interest rate implies rise in fixed cost and hence rise in financial leverage. DFL rises ,EPS falls

12. Have you ever thought what will happen to financial leverage if interest rate is floating ? Remember before coming to ICFAI hyderabad, we had to take a loan … Hardly, 9 months …. Interest rates in banks was floating with full vigor……..what could be the leverage then………

15. bond value increases with rising interest rate

17. …contd. A company worth Rs. 10,00,000 shares Rs. 8,00,000 bonds Rs. 2,00,000 bonds interest rate ---- floating EBIT (expected value) 50,000 tax @35% on PBT No preference shares issued no. of outstanding shares 5000

19. Inference from scenario 1 Interest rate changes monthly from 5.75% to 8.4%. Interest rises from 11,500 to 16,800 EBIT level kept same Investors will be more interested to invest in debts than in shares debt- equity proportion rises As the company now pays more money as returns to the financial institutions or bond/debenture holders, hence less money is left with the company to pay to the shareholders. Hence , EPS declines from 5.005 to 4.316 Rate of fall of EPS is 13.76%

20. scenario2 company issues more bonds than share bonds Rs. 6,00,000 shares Rs. 4,00,000 EBIT(expected value) RS.1,50,000 (rising in the same proportion as bond value)

22. Inference of scenario2 Interest rate rises from 8.56% to 10.5% Interest rises from 51,360 to 63,000 EPS falls from 12.8232 to 11.31 Rate of fall of EPS is 11.8%

23. Inference of Scenarios 1 &2 Debt-equity proprtion changes from 1:4 to 3:2 Firm’s expected earnings increase in same proportion. Highly floating rate- rises from 5.75% to 10.5% Interest- fixed cost rises from 11,500 to 87,000 EPS falls with a rate of 13.76% in scn.1 while falls with a rate of 11.8% in scn.2 Hence, as interest rate rises, EPS falls with a falls with a falling rate.

25. …contd. Case 1 % change in EBIT =+ 40% % change in EPS = +39.7052% DFL = % change in EPS/%change in EBIT = 39.7/40 = 0.9925

26. case 2 % change in EBIT= -40% % change in EPS = -39.87% DFL = % change in EPS/ % change in EBIT 39.87/40 = 0.9965 …contd.

28. Interest rate is also increased or decreased by 40% to both sides.

29. % change in EPS from base is not the same.

30. However ,if fixed interest rate is taken it remains same

31. DFL increases with increasing interest rate

32. DFL decreases with decreasing interest rate

34. DFL affected by a larger amount by change in rate.

35. % change in DFL =(0.9965-0.9925)/0.9925 = 0.403%

36. Whether you increase or decrease the EBIT by the same proportion ,if a floating rate exists then DFL in both cases doesnot remains same.

37. 0.403% is highly significant.