On the basis of the following information, what will be the EBIT corresponding to financial indifference point? Total capital outlay Rs. 60,00,000 Financing Plans 1. 100% Equity @ Rs. 10/- per share 2. Debt – equity ratio 2 : 1 Rate of interest 18% p.a., corporate tax rate 40%

The correct answer is C. Rs. 10,80,000.

The financial indifference point is the point at which the after-tax cash flows from two different financing plans are equal. In this case, the two financing plans are 100% equity and debt-equity ratio of 2:1.

The after-tax cash flow from 100% equity financing is calculated as follows:

EBIT * (1 – tax rate) = EBIT * (1 – 0.4) = 0.6 * EBIT

The after-tax cash flow from debt-equity ratio of 2:1 is calculated as follows:

EBIT * (1 – tax rate) + (Interest * (1 – tax rate)) = EBIT * (1 – 0.4) + (0.18 * 0.6 * EBIT) = 0.54 * EBIT

The financial indifference point is the point at which 0.6 * EBIT = 0.54 * EBIT, or EBIT = 10,80,000.

Here is a brief explanation of each option:

• Option A: Rs. 10,00,000. This is the EBIT for 100% equity financing. However, this is not the financial indifference point, because the after-tax cash flow from debt-equity ratio of 2:1 is greater than 0.6 * EBIT.
• Option B: Rs. 12,00,000. This is the EBIT for debt-equity ratio of 2:1. However, this is not the financial indifference point, because the after-tax cash flow from 100% equity financing is greater than 0.54 * EBIT.
• Option C: Rs. 10,80,000. This is the financial indifference point.
• Option D: Rs. 12,80,000. This is the EBIT for debt-equity ratio of 3:1. However, this is not the financial indifference point, because the after-tax cash flow from 100% equity financing is greater than 0.54 * EBIT.