CORPORATE FINANCE ASSIGNMENT I Due date to submit November 2nd 2012

Risk and Return: Portfolio Theory and Assets Pricing Models

Task 1 An investor holds two equity shares x and y in equal proportion with the following risk and return characteristics: E(Rx) = 24%; E(Ry) = 19%; x = 28% ; y = 23% The returns of these securities have a positive correlation of 0.6. You are required to calculate the portfolio return and risk. Further, suppose that the investor wants to reduce the portfolio risk (p) to 15 percent. How much should the correlation coefficient be to bring the portfolio risk to the desired level?

Cost of Capital
Task 1 A company has earnings available to ordinary shareholders Rs. 5,00,000. It has capital Rs. 50,00,000 face value of Rs. 100 each. The companys share is selling at Rs. 200. Compute cost of equity (Assuming 100% dividend payout ratio). Task 2 P & G Companys current earnings per share is Rs. 6 and its share is currently selling at Rs. 25 per share. Compute cost of equity capital. Task 3 A company has 50,00,000 equity shares outstanding. The market price of the share is Rs. 96, which the book value is Rs. 65. The firms earnings and dividends per share is Rs. 10 and Rs. 7 respectively. The company wants to issue 10,00,000 shares with a net proceeds of Rs. 80 per share. What is the cost of capital of new issue.

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CORPORATE FINANCE ASSIGNMENT I Due date to submit November 2nd 2012 Task 4

MNC Company has paid a dividend of Rs. 6 per share for last 10 years and it is expected to continue so in the future. The companys share was sold for Rs. 50 ten years ago, and its market price is also Rs. 50. What is the cost of equity share ? Task 5 VS International is thinking of rising funds by the issuance of equity capital. The current market price of the firms share is Rs. 150. The firm is expected to pay a dividend of Rs. 3.9 next year. At present the firm can sell share for Rs. 140 each and it involves a flotation cost of Rs. 10. Calculate cost of new issue. Task 6 SSS company is currently earning Rs. 10,00,000 and its share is selling at a market price Rs. 160. The firm has 2,00,000 shares outstanding and has no debt. The earnings of the firm are expected to remain stable and it has a pay out ratio of 100 per cent. What is Ke ? If firm pay out ratio is assumed 70 per cent and that it earns 15 per cent opportunities, than what would be the firms Ke ? Task 7 Woodlands companys share is currently selling for Rs. 134. Current dividend is Rs. 3.5 per share and is expected to glow at 8 per cent next 4 years and that at a rate of 15 per cent for every year. Calculate companys cost of equity. Task 8 ABB is contemplating an issue of new equity shares. The companys equity share is currently selling at Rs. 250 per share. The dividend payment record for past 6 years is as follows : of return on its investment

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CORPORATE FINANCE ASSIGNMENT I Due date to submit November 2nd 2012 Year Dividend per share 1 2 3 26 4 27 5 28 6 29

22 25

The company is expected to spend a flotation cash at 3% of the current selling price of the share. The company is requested for (a) (b) (c) growth rate in dividends cost of equity assuming growth rate calculated under continuous for ever cost of new equity

Task 9 Karvey planning to sell equity shares. Mr. Ram who wishes to invest in Karvy company by purchasing equity shares. The companys bond have been yielding at 13 per cent. You are requested by Mr. Ram to calculate his expected rate of return on equity based on bond yield plus risk premium approach (assuming 3 per cent as risk premium). Solution. Ke = Bond yield + risk premium = 13% + 3 % = 16 per cent Task 10 Mr. Krishna who has purchased equity share at Wipro company at Rs. 10 on 01-01-1997 and after holding at for 6 years sold the share at the end of 2002 for Rs. 180. During the 6 years period he had received a dividend of Rs. 15, Rs. 15.50, Rs. 16, Rs. 17, Rs. 17.50, and Rs. 17 for the years 1997, 1998, 1999, 2000, 2001, 2002 years respectively. Calculate cost of equity share based on realised yield approach. Task 11 Calculate the required rate of return on four equity stocks with the beta values shown against them. Stock A B C D 3
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CORPORATE FINANCE ASSIGNMENT I Due date to submit November 2nd 2012 Beta 0.9 1.1 1.6 1.9

The risk free rate 20 per cent and rate of return on the market portfolio is 32 per cent. Task 12 Weekly returns of XYZ company for the period January 2003 to July 20, 2003 containing 223 observations with the weekly returns for the same period on the Economic Times price index they obtained the beta of 1.20. The average market return (based on weekly returns) during the some period is approximately 21.3 per cent. If the risk free rates assumed to be 10 per cent. How much is XYZs cost of equity ? Task 13 An investor supplied you the following information and requested to you to calculate (a) Expected rate of returns of market portfolio (b) Expected returns in each security, using CAPM

Investment in Company A Paper Steel Chemical B GOI Bonds

Initial price 20 30 40 1000

Dividends

Year-end market price 55 65 140 1005

Beta risk factor 0.7 0.8 0.6 0.99

2 2 2 140

Risk free returns, 10 per cent Task 13 Om Sai Enterprises issued 9 per cent preference share (irredeemable) four years ago. The preference share that has a face value of Rs. 100 is currently selling for Rs. 93. What is the cost of preference share with 8 per cent tax on dividend. 4
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CORPORATE FINANCE ASSIGNMENT I Due date to submit November 2nd 2012 Task 14 A company issues 12,000, 12 per cent perpetual preference shares of Rs. 100

each. Company is expected to pay 2 per cent as flotation cost. Calculate cost of preference shares assuming issued at (i) face value of par value, (ii) at a discount of 5% and (iii) at a premium of 10%. Task 15 A company has 50,000 shares of Rs. 100 at par preference shares outstanding at 11 per cent dividend. The current market price of the share is Rs. 90. What is its cost ? Task 16 Vain & Co. issues Rs. 100 face value of preference share which carries 11 per cent dividend and is redeemable after 12 years at par value. The net amount realised per share is Rs. 95. What is the cost of preference share? Task 17 AMC Engineering Company issues 12 per cent, Rs. 100 face value of preference stock, which is repayable with 10 per cent premium at the end of 5 years. It involves a flotation cost of 5 per cent per share. What is the cost of preference share capital, with 5 per cent dividend tax. Task 18 A company issues 8 per cent preference of share of Rs. 100 face value at a

premium of 10 per cent redeemable after 6 year at par and it involves a brokerage cost of Rs. 10 per share. Calculate cost of preference share. Task 19 SSL Company has 12 per cent perpetual debenture of Rs. 1,00,000. The tax rate

is 35 per cent. Determine the cost of debenture capital (before as well as after tax), assuming debentures are issued at (i) face value / par value, (ii) 10 per cent discount and (iii) 10 per cent premium. Task 20 MTR Foods has one of series of bonds outstanding which is currently yielding

10% on bondholders. The company is in the 45% tax bracket. Compute after tax cost of bond for MTR foods. Task 21 TTK Ltd., issues 14 per cent debentures par value of Rs. 100. The issue involves

a flotation cost 2 per cent and a 3 per cent discount. The debenture is redeemable at par after 10

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CORPORATE FINANCE ASSIGNMENT I Due date to submit November 2nd 2012 years. The company tax rate is 35 per cent. What is the cost of debenture ? Also with 5 per cent premium an redemption use short cut and trial and error method. Task 22 A firm issues 12 per cent debentures on the condition that the principles

amounting Rs. 1,44,000 will be repayable in 6 equal yearly installments from the end of one year. The company required to pay a tax rate of 60 per cent. Find out cost of debt. Task 23 A company currently maintaining 6 per cent rate of growth in dividends. The last

year dividend was Rs. 4.5 per share. Equity share holders required rate of return is 15 per cent. What is the equilibrium price per share. Task 24 Your company share is quoted in the market at Rs. 20 currently. The company pays a dividend of Re. 1 per share and investors market expects a growth rate of 5 per cent per year. (a) compute the company cost of equity capital (b) if the anticipated growth rate is 6% p.a. calculate the indicated market price per share. Task 25 A paper companys raw materials availability have been declining and cost of

producing paper decreasing year by year. As a result to it, earnings and dividend of the company are declining at a rate of 5 per cent per year. Company paid Rs. 10 as dividends last year. The companys required rate of return is 15 per cent. What would be the current price of the equity share of the company ?

Task 26 Equity share of Asian Paints Company that engages no external financing is selling for Rs. 100. The total earnings of the company are Rs. 1,00,000 and its outstand shares are 10,000. The companys dividend payout ratio is 70 per cent and 30 per cent retains to invest in a project which provides 10% rate of returns. Calculate cost of equity. Task 27 Mico Industries limited has assets of Rs. 3,20,000 that have been financed with Rs.

1,04,000 of debt and Rs. 1,80,000 of equity and a general reserve of Rs. 36,000. the companys initial profits after interests and taxes for the year 31-03-2004 were Rs. 27,000. It pays 8 per 6
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CORPORATE FINANCE ASSIGNMENT I Due date to submit November 2nd 2012 cent interest on debt. The company is in the 50 per cent tax bracket. It has 1800 equity shares of Rs. 100 each selling at a market price of Rs. 120 per share. Calculate WACC. Task 28 Nilgiris companys equity beta is 1.2. The market risk premium is 7 per cent and the risk free rate is 10 per cent. The company has a debt equity rte of 2 : 3. Its pre tax cost of debt is 14 per cent. If the tax rate is 35 per cent, what is the cost of capital ? Task 29 Sam company manufactures specialty chemicals. Its debt equity ratio is 0.8. Its overall costs of capital is 15 per cent and 30 per cent tax rate. (i) (ii) Task 30 If Sams cost of equity is 20%, what is pre-tax cost of debt. If Sam can use debt at an interest rate of 13%, what is cost of equity ? A firm has the following capital structure Source of Finance Equity stock (25,000 shares Rs. 50 each) Preference stock (10,000 shares Rs. 50 each) Debentures (pre tax) Amount (Rs.) 12,50,000 5,00,000 13,00,000 Specific Cost 8 12

The firms equity stocks currently selling at Rs. 70 per share and is expected to get the dividend of Rs. 5. Shareholders anticipate that the equity stock dividend will grow at a rate of 6 per cent per annum in near future. The company has a tax rate of 60 per cent. Calculate WACC. Task 31 A company is in considering the most desirable capital structure, the following

estimates of the debt and equity capital (after tax) have been made at various levels of debt equity mix. Debt as a per centage of total capital employed

Cost of debt (%)

Cost of equity (%)

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CORPORATE FINANCE ASSIGNMENT I Due date to submit November 2nd 2012 0 10 20 30 40 50 6.0 6.0 6.0 6.5 7.0 7.5 13 13 13.5 14.0 15.0 17.0

Determining the optimal debt equity mix for the company by calculation of overall cost of capital. Task 32 From the following financial statement of BLP you are required to

a) Calculate the earnings per share, b) Calculate the per centage cost of capital to the company for the debenture funds and the equity. Particulars Earnings before interest and tax (EBIT) (-) Interest on debentures Earning before tax (-) Income tax @ 50% Earning after tax Equity share capital (share of Rs. 10 each) Reserves and surplus 15% non-convertable debentures (of Rs. 100 each) 72 72 400 200 440 8
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Rs. in lakhs 210 66 144

CORPORATE FINANCE ASSIGNMENT I Due date to submit November 2nd 2012 1040 The market price per equity share is Rs. 12 and per debenture is 94. Task 33 From the following information of Excel Ltd., determine the WACC using (a)

book value weights and (b) market value weights. How are they different ? Can you think of a situation where the WACC would be the same using either of the weights ?

Source of finance

Book Value Market Value (Rs.) (Rs.)

Costs (%) 15

Equity capital Retained earnings Preference capital Debt capital

3,00,000 6,00,000 1,00,000 50,000 2,00,000 6,50,000 60,000 1,90,000 8,50,000

13 8 6

Task 34

Zee Ltd., is foreseeing a growth rate of 13 per cent p.a in the next two years. The

growth rate is likely to fall to 10 per cent for the third year and the fourth year, after that the growth rate is expected to stabilize at 7 per cent per annum. If the last dividend was Rs. 2 per share and cost of equity capital is 15 per cent, find out intrinsic value per share of Zee Ltd., as of date. Task 35 The following information is available for your perusal.

Companys present BV capital structure is as follows Rs. 9

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CORPORATE FINANCE ASSIGNMENT I Due date to submit November 2nd 2012 Debentures (Rs. 100 per debenture Preference shares (Rs. 100 per share) Equity shares (Rs. 10 each) 7,00,000 3,00,000 10,00,000 20,00,000 All these securities are traded in the capital market and their recent prices are : Debentures Rs. 110 per debenture Preference stock Rs. 120 per share Equity share Rs. 22 per share Anticipated external financing opportunities are : a) Rs. 100, redeemable debenture at face value after 8 years, 13 per cent interest rate, 4 per cent flotation cost. b) 14 per cent redeemable preference shares (5 years), it involve a flotation cost of 5 per cent and the sales price Rs. 100. c) Equity share : Rs. 2 per share brokerage, Rs. 22 sales price. In addition, the dividend expected as the equity share at the end of the year Rs. 2 per share. The anticipated growth rate in dividends is 6 per cent and the firm has the practice of paying all its earnings in the form of dividends. The corporate tax rate is 35 per cent . Task 36 A company has the following capital structure on 31-12-2003 Rs. Equity shares (20,000 shares) 10% preference shares 14% debentures
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10,00,000 2,50,000 7,50,000 10

CORPORATE FINANCE ASSIGNMENT I Due date to submit November 2nd 2012 20,00,000 The companys share is currently selling at Rs. 20. Next year expected dividend is Rs. 2 per share that will grow at 6 per cent forever. The company is in the tax bracket of 50 per cent. You are required to calculate : a) WACC based on the existing capital structure b) New WACC if the company raises an additional Rs. 5,00,000 debt by issuing 15 per cent debenture. This will increase the existing dividend by Re. 1 and leave growth rate unchanged, but the price of share will fall to Rs. 15. Task 37 A company issues 5,000 12% debentures of Rs. 100 each at a discount of 5%. The commission payable to underwriters and brokers is Rs. 25,000. The debentures are redeemable after 5 year. Compute the after tax cost of debt assuming a tax rate of 50 % Solution: I (1-t) + (f +d+Pr-Pi)/ N 60,000 (1-0.5) +(25,000+25,000+0-0)/ 5

Kd = --------------------------------- = -------------------------------------------------- = 8.42 per cent (RV +SC) / 2 (5,00,000 +4,50,000) / 2

Task 38 An electric equipment manufacturing company wishes to determine the weighted average cost of capital budgeting projects. You have been supplied with the following information. Balance Sheet Capital and Liabilities Amount (Rs.) Equity share capital Preference Share Capital Debentures 12,00,000 4,50,000 9,00,000 11
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Assets

Amount (Rs.)

Fixed Assets Current Assets

25,00,000 15,00,000

CORPORATE FINANCE ASSIGNMENT I Due date to submit November 2nd 2012 Retained Earnings Current Liabilities 4,50,000 10,00,000

40,00,000 Anticipated external financing information:

40,00,000

1. 20 years 14% debentures of Rs.2,500 face value redeemable at 5 % premium sold at par 2 % flotation costs. 2. 15% preference shares: sales price Rs. 100 per share 2% flotation cost 3. Equity share: sales price Rs. 115 per share. Flotation cost Rs. 5 per share The corporate tax rate is 55 % and expected growth in equity dividend is 8 % per year. The expected dividend at the end of the future financial year is Rs. 11 per share. Assume that the company is satisfied with its present capital structure and intends to maintain it. Task 39 A Ltd. Company with net operating earnings of Rs. 6,00,000 wants you to evaluate possible capital structures, shown below. Which capital structure will you select? Why? Capital Structure Debt in Capital Structure (Rs.) 6,00,000 8,00,000 10,00,000 Cost of Debt (%) Cost of Equity (%)

1 2 3

10 10 11

12 13 15

Task 40 PES has the following capital structure, which is considered to be optimal. The components of capital proportions are: Equity 60%, Debt 25%, Preference stock 15%. PESs expected net income this year is 30%, and its tax rate is 40%. In future the dividends are expected to grow at a constant rate of 9%. Rs.36 paid as dividends in the last year. The 12
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CORPORATE FINANCE ASSIGNMENT I Due date to submit November 2nd 2012 companys share is selling at (currently) Rs.54 per share. PES can obtain new capital in the following ways: 1. Preferred New preferred stock with a dividend of Rs.11 and it can be sold at Rs. 95 per share. 2. Debt - at 12% a. Determine specific cost of components of capital structure b. Calculate WACC.

Task 41 Assuming that a firm pays at a tax at a 50 percent rate, compute the after-tax cost of capital in the following cases: i. ii. iii. A 8.5 percent preference share sold at par. A perpetual bond sold at par, coupon rate of interest being 7 percent. A ten year, 8 percent, Rs 1000 par bond sold at Rs 950 less 4 percent underwriting commission. A preference share sold at Rs 100 with a 9 percent dividend and a redemption price of Rs 110 if the company redeems it I five years. An ordinary share selling at a current market price of Rs 120, and paying a current dividend of Rs 9 per share, which is expected to grow at a rate of 8 percent. An ordinary share of a company, which engages no external financing, is selling for Rs 50. The earnings per share are Rs 7.50 of which sixty percent is paid in dividends. The company reinvests retained earnings at a rate of 10 percent.

iv.

v.

vi.

Task 42 A firm finances all it investments by 40 percent debt and 60 percent equity. The estimated required rate of return on equity is 20 percent after taxes and that of the debt is 8 percent after taxes. The firm is considering an investment proposal costing Rs 40000 with an expected return that will last forever. What amount (in rupees) must the proposal yield per year so that the market price of the share does not change? Show calculations to prove your point. Task 43 The Service Company has the following capital structure on 30th June 2004: 13
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CORPORATE FINANCE ASSIGNMENT I Due date to submit November 2nd 2012 (Rs000) Ordinary shares (200000 shares) 10% Preferences shares 14% Debentures 4000 1000 3000 8000

The share of the company sells for Rs 20. It is expected that company will pay next year a dividend of Rs 2 per share, which will grow at 7 percent forever. Assume a 50 percent tax rate. a) Compute a weighted average cost of capital based on the existing capital structure. b) Compute the new weighted average cost of capital if the company raises an additional Rs 2000000 debt by issuing 15 percent debentures. This would result in increasing the expected dividend to Rs 3 and leave the growth rate unchanged, but the price of share will fall to Rs 15 per share. c) Compute the cost of capital if in (b) above growth rate increases to 10 percent. Task 44 The Kay Company has the following capital structure at 31st March 2003 which is considered to be optimum. Rs 14% Debentures 11% Preferences Equity (100000 shares) 300000 100000 1600000 2000000

The companys share has a current market price of Rs 23.60 per share. The expected dividend per share next year is 50 percent of the 2003 EPS. The following are the earnings per share figure for the company during the preceding ten years. The past trends are expected to continue. 14
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CORPORATE FINANCE ASSIGNMENT I Due date to submit November 2nd 2012 Year 1994 1995 1996 1997 1998 EPS (Rs) 1.00 1.10 1.21 1.33 1.46 Year 1999 2000 2001 2002 2003 EPS (Rs) 1.61 2000 1.95 2.15 2.36

The company can issue 16 percent new debentures. The companys debentures is currently selling at Rs 96. The new preference issue can be sold at a net price of Rs 9.20, paying a dividend of Rs 1.1 per share. The companys marginal tax rate is 50 percent. a) Calculate the after tax cost (i) of new debt, (ii) of new preference capital and (iii) of ordinary equity, assuming new equity comes from retained earnings. b) Find the marginal cost of capital, again assuming no new ordinary shares are sold. c) How much can be spent for capital investment before new ordinary shares must be sold? Assume that retained earnings available for next years investment are 50 percent of 2003 earnings. d) What is the marginal cost of capital (cost of funds raised in excess of the amount calculated in part (c) if the firm can sell new ordinary shares to net Rs 20 a share? The cost of debt and of preference capital is constant.

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