Case 055Capital structure decisionsCore

A metals company needs Rs 600 crore for a new plant and can issue bonds at 8.5% or shares at 20x earnings. Compare EPS in year 1 and year 3, leverage, and the rating effect, and choose.

ScotiabankLondon · 2026

The situation

Vandrisha Metals earns net income of Rs 300 crore on 100 crore shares, EPS of Rs 3.00, and its shares trade at Rs 60, a P/E of 20. EBITDA is Rs 700 crore and debt Rs 1,400 crore, so leverage is 2.0x. Tax is 25%.

It needs Rs 600 crore for a new plant. The plant earns nothing in year 1 while it is built, and from year 3 adds Rs 90 crore of EBIT and Rs 120 crore of EBITDA. Vandrisha can issue Rs 600 crore of bonds at 8.5%, or sell new shares at Rs 60. Its rating agency's guidance, for this illustration, is that leverage above 2.5x for more than a year or two would put the current rating under pressure.

Your task

Which route gives higher EPS in year 1 and year 3, what happens to leverage and the rating, and which would you choose?

Quick check

In year 3, once the plant earns, which route gives the higher EPS?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

On these numbers the shares win on EPS in both years, Rs 2.73 against Rs 2.62 in year 1 and Rs 3.34 against Rs 3.29 in year 3, and they keep leverage at 2.0x instead of 2.86x. At 20x earnings the shares cost 5.0% against 6.4% for debt after tax. Debt only wins on EPS below about 17x. Choose shares, unless the board values control above both.

Step 1How do you compare two currencies quickly?

Ask what each rupee raised costs in earnings. A share sold at a P/E of 20 gives away 1/20 of earnings per rupee raised, a 5.0% earnings yieldEarnings divided by the share price, the inverse of the P/E; the share of profit each new rupee of equity must give up to the new holders.; a bond at 8.5% costs 8.5% less the tax shield, 6.375%. Whichever costs less gives the higher EPS. It is like choosing between a friend who wants 5% of your shop's profit for every rupee lent and a bank that charges 6.4% after tax: the friend is cheaper on this year's numbers, though the friend owns a slice of the shop for ever.

Rs crore unless statedBonds, year 1Shares, year 1Bonds, year 3Shares, year 3
Existing net income300.0300.0300.0300.0
Plant EBIT of 90 after 25% tax67.567.5
Bond interest after tax, 600 x 8.5% x 0.75(38.25)(38.25)
Net income261.75300.00329.25367.50
Shares, crore100110.0100110.0
EPS, Rs2.622.733.293.34
Debt / EBITDA2.86x2.00x2.44x1.71x
New shares at Rs 60 add 10 crore shares; bonds add Rs 38.25 crore of after-tax interest. The shares give higher EPS in year 1 (Rs 2.73 against Rs 2.62) and year 3 (Rs 3.34 against Rs 3.29) and keep leverage at 2.0x rather than 2.86x.
At 20x earnings, the shares are the cheaper currency on EPSBonds at 8.5%EPS, Rs (bar = 0 to 3.50)Year 12.62Year 33.29Debt / EBITDA (bar = 0 to 3.0x)Year 12.86xYear 32.44x2.5x guideLower EPS both years, above 2.5xShares at 20x (10 crore new)EPS, Rs (bar = 0 to 3.50)Year 12.73Year 33.34Debt / EBITDA (bar = 0 to 3.0x)Year 12.00xYear 31.71x2.5x guideHigher EPS both years, lower risk
Funding the plant with shares gives Vandrisha higher EPS in both years and keeps leverage at 2.0x then 1.71x, while bonds give lower EPS and push leverage to 2.86x in year 1, above the illustrative 2.5x rating guide, before the plant's EBITDA brings it back to 2.44x.
Step 2When would the answer flip to debt?

Find the P/E at which the two EPS lines meet. In year 3 that is about 17.2x, and in year 1 about 13.7x. Below roughly 17x the shares become the dearer currency and debt starts to win on EPS; above it, equity wins. That is why metals companies, which often trade on low multiples near the top of a cycle, tend to fund with debt, and why a rich valuation is a reason to issue shares. Say this condition out loud: it turns a calculation into a view.

Step 3What does the rating side add?

On the bond route, leverage jumps to 2.86x in year 1, because the debt arrives before the plant earns anything. Agencies look at the path, not only the destination, so a borrower above its guide for a year or two needs a credible plan to get back, and even then may be placed on a negative outlook. By year 3 leverage is 2.44x, under the guide. A steel or metals downturn in year 2 would push it higher still. The limit of the EPS test is also worth a sentence: the 5.0% earnings yield is not the true cost of equity, which shareholders would put nearer 13% or 14%, so on a full cost-of-capital view debt is cheaper. EPS and ratings both point to shares here; the cost-of-capital view is the argument for a partly debt-funded mix.

Where candidates lose it

The reflex answer is that debt is cheaper than equity, so debt gives higher EPS. That is true on a cost-of-capital basis and false on EPS at a P/E of 20, where the shares cost 5.0% against 6.4% for the bonds after tax.

The other miss is ignoring timing. The debt arrives in year 1 and the plant's earnings in year 3, so leverage and EPS are worst exactly when the agency first looks.

What the interviewer asks next

  • The shares fall to 14x before the issue. Which route wins on EPS now?
  • Would a 50/50 mix keep leverage under 2.5x in year 1?
  • How would a convertible bond change this comparison?
  • Why might the board prefer debt even when EPS favours shares?

Asked at Scotiabank, Corporate Banking, London, 2026 (Wall Street Oasis): Asked about M&A and other bank functions, capital structure, debt vs equity

Company names and figures are illustrative.