(a) Explain the 'Financial Indifference Point' in the context of EBIT-EPS analysis by giving suitable example. (10 marks) (b)…

(a) Financial indifference point in EBIT-EPS analysis

The financial indifference point is the level of EBIT at which earnings per share (EPS) is the same under two financing plans. Below it the plan with less fixed-cost finance gives the higher EPS; above it the plan with more debt does. It is found by equating the EPS of the two plans: [(EBIT − I₁)(1 − t) − PD₁] / N₁ = [(EBIT − I₂)(1 − t) − PD₂] / N₂.

Example: a firm needs ₹1,00,000 and the tax rate is 50%. Plan 1 issues 10,000 equity shares of ₹10. Plan 2 issues 5,000 shares of ₹10 and ₹50,000 of 10% debt (interest ₹5,000). Equating EBIT × 0.5 / 10,000 = (EBIT − 5,000) × 0.5 / 5,000 gives EBIT = ₹10,000, where EPS is ₹0.50 under both plans. If expected EBIT exceeds ₹10,000, debt raises EPS; if lower, equity is better.

(b) Capital structure and its determinants

Capital structure is the long-term mix of debt, preference and equity capital with which a firm finances its assets. Its main determinants are:

• Cost of capital and tax: interest is tax-deductible, so debt lowers the overall cost up to a limit.
• Financial and business risk: firms with volatile earnings or high operating leverage cannot carry much fixed interest.
• Control: fresh equity dilutes the promoters' control, while debt does not.
• Flexibility and floatation costs: spare borrowing capacity is kept for future needs, and debt is usually cheaper to raise.
• Market conditions and firm characteristics: size, growth, asset tangibility and the state of the capital market.

A good structure balances the tax gain from debt against the rising risk of distress.

(c) Objectives of the RBI's monetary policy

Under the RBI Act, 1934, as amended in 2016, the primary objective is price stability while keeping in mind the objective of growth. The Monetary Policy Committee targets CPI inflation of 4% with a tolerance band of ±2%, using the repo rate as the main tool.

Other objectives include economic growth through a suitable interest rate, financial stability through the CRR, SLR and liquidity operations, orderly exchange rate conditions by limiting excess volatility of the rupee, and adequate credit flow to productive sectors, including priority sectors. In practice, the RBI balances these aims, with inflation control given priority when they conflict.

(d) Capital market and economic development

The capital market is the market for long-term funds, with maturity above one year, where equity, debentures, government securities and other instruments are issued in the primary market and traded in the secondary market, for example on the NSE and BSE.

Its role in development has four sides. It mobilises household savings into productive investment through IPOs and mutual funds. It supplies long-term capital for industry and infrastructure, which raises capital formation. It allocates funds to efficient firms through prices set by the market. It also improves corporate governance through SEBI's disclosure rules and draws foreign portfolio and direct investment. A well-regulated market thus links savers with investors, though volatility and speculation need checking.

(e) Merger and its types

A merger is a combination of two or more companies into one, in which one company absorbs the other or a new company takes over both; in India it follows the scheme of arrangement provisions of Sections 230–232 of the Companies Act, 2013.

Types:

• Horizontal merger: between competitors in the same line, to gain scale and market share, for example Vodafone and Idea.
• Vertical merger: between firms at different stages of the supply chain, to secure supply or distribution.
• Conglomerate merger: between firms in unrelated businesses, to diversify risk.
• Congeneric or concentric merger: between firms in related businesses sharing markets or technology.
• Reverse merger: a healthy company is absorbed by a weaker one, often for listing or tax benefits.

The merger may be paid for in cash or by share exchange.