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3. Cost of Capital

Problem No: 1 Introduction
a) A Share Has a Current Market Value of Rs.96 last Dividend Was Rs.12. Calculate the cost of
Equity Capital.
b) A Share Has a Current Market Value of Rs.96 last Divided Was Rs.12.If the expected annual
growth rate of divided is 4%.Calculate the cost of equity Capital.
c) AB Ltd. has in Issue 10%Debentures of a nominal Value of Rs.100. The market price is Rs.90 (ex-
interest). Calculate the cost of Debentures if (i) Irredeemable: (!l) Redeemable at par after 10
years.
d) Some 8%Convertible Debentures have a market value of Rs-106. Very recently interest was
paid.The debentures will be convertible into Equity in 3 years time, at a rate of 4 shares per
Rs.10 of Debentures. The shares are expected to have a market value of Rs.3.50 at that time and
all the debenture Holders are expected to convert their Debentures. What is the cost of capital
to the company for the convertible Debentures? Assume a corporate tax rate of 33%(including
Surcharge)

Problem No.2 Introduction
The current market price of an equity share is Rs.130 (face value Rs.10) and the amount of divided per
share is expected to be Rs.13.00 next year. Determine the cost of equity capital if the rate of divided is
expected to grow @ 6%p.a. Also compute the expected value of share after year 1 and year 2.

Problem no.3 Introduction
The Romeo Ltd. Has 1, 00,000 equity shares with ruling market price of Rs.100 per share. The company
has no debts and total earning are Rs.10 lakhs per annum. The company wants to raise additional equity
capital amounting to Rs.5 lakhs. Compute cost of equity capital assuming flotation cost are 5%.

Problem no.4 Introduction
Your companys share is quoted in the market at Rs.20 currently. the company pays as dividend of Rs.1
per share and the investor expects a growth rate of 5 per cent per year.
Compute:
The companys cost of equity capital.
a) If the anticipated growth rate is 6%p.a., calculate the indicated market price per share.
b) If the companys cost of capital is 8%and the anticipated growth rate is 5%p.a., calculate the
indicated market price of the dividend of Rs.1 per share is to be maintained.

Problem no: 5 Introductions
a) Humpty Dumpty Ltd. Has issued 14%preference shares of the face value of Rs.100 each to be
redeemed after 10 years. Floatation cost is expected to be 4%.Determine the cost of preference
shares.
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b) Equity shares of Humpty Dumpty Ltd. Are currently selling for Rs.125 per share. The company
expects to pay Rs.15 per share as divided at the end of the coming year,and the estimated
growth rate is 6%. It is expected that new equity shares can be sold at Rs.123: the company
expects to incur Rs.3 per share as flotation cost.what is the cost of equity capital?

Problem no:6 Introduction
a) A company issues Rs.10, 00,000, 16%debentures of Rs.100 each. The company is in 35%tax
bracket. you are required to calculate the cost of debt after tax. If debentures are issued at (i)
par (ii) 10%discount and (iii) 10%premium
b) If brokerage is paid at 2%What will be cost of debentures if issue is at par

Problem no: 7 Introductions
Assuming the corporate tax of 55%, compute the after tax cost of capital in the following situations:
1) Perpetual 15%debentures of Rs 1,000, sold at a premium of 10%with no flotation costs.
2) Ten-years 14%debentures of Rs 2,000, redeemable at par ,with 5% flotation costs.
3) Ten-years 14%preference shares of Rs 1,00, redeemable at premium of 5%with 5%flotation
costs.
4) An equity share selling at Rs 50 and paying a dividend of Rs 6 per share ,when is expected to be
continued indefinitely.
5) The above equity share if dividends are expected to grow at the rate of (a) 5%
6) An equity share of a company is selling at Rs 120 per share .The earning per share is Rs 20 of
which 50%is paid in dividends. The shareholders expect the company to earn a constant after
tax rate of 10%on its investment of retained earnings.

Problem no.8 Computation of cost of retained earnings
Y ltd. Retains Rs. 7, 50,000 out of its current earnings. The expected rate of return to the Shareholders, if
they had invested their had invested their funds elsewhere is 10%. Brokerage is 3%,and the
shareholders come in 30%tax bracket. Calculate cost of Retained Earnings.


Problem no. 9 Debenture Valuations
VHP company had sold Rs. 1,000 12%perpetual debenture 10years ago. Interest rates have risen since
then, so that debentures of this company are now selling at 15%yield basis.
1) Determine the current indicated/expected market price of the debentures. Would you buy the
debentures for Rs. 700?
2) Assume that the debentures of the company are selling at Rs.825. If the debentures have 8
years to turn to maturity. Compute the approximate effective yield an investor would earn on its
investment?

Problem No: 10 DGM and its application in cost of capital
A companys share is quoted in market at Rs.60 currently. A company pays a divided of Rs.5 per share
and investors expect a growth rate of 12%per year. Compute:
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1) The companys cost of equity capital.
2) If anticipated growth rate is 13%p.a. calculate the indicated market price per share.
3) If the companys cost of capital is 18%and anticipated growth rate 15%p.a., calculate the
market price per share, if dividend of Rs.5 per share is to be maintained.

Problem No:11 Identify Growth Rate
The Risk free return is 10%and the risk premium is 5%with beta of a company is 1.6. The company had
declared the latest divided @ Rs.3 (2000) whereas it had declared a dividend of Rs.2.115 in the year
1994. The companys earnings and the dividend experienced constant growth. Find out the intrinsic
value of the shares.


Problem No: 12 Computation of Growth

A Ltd, intends to issued new equity shares. Its present equity shares are being sold in the market at
Rs.125 a share. The companys past record regarding payment of dividends is as follows:
1984: 10.70: 1985: 11.45: 1986: 12.25; 1987: 13.11; 1988: 14.03;
The floatation costs are estimated at 3%of the current selling price of the shares. You are required to
calculate:
a) Growth rate in dividends.
b) Cost of funds raised by issue of equity shares assuming that the growth rate as calculated above
will continue forever.

Problem no: 13 WACC

The serves Company has the following capital structure on June 30
th
, 1988:
Rs
Ordinary shares (2, 00,000 Shares) 40, 00,000
10%Preference Shares 10, 00,000
14%debentures 30, 00,000
TOTAL 80, 00,000
The share of company sells @ Rs.20, and it is expected that the company will pay next year a divided of
Rs.2 per share which will grow @ 7%forever. Assume a 50%tax rate. You are required to compute a
weighted average cost of capital based on the existing capital structure.

Problem no: 14 WACC

The following Information is available from the balance sheet of a company:
Equity share capital 20,000 shares of Rs.10 each : 2, 00,000
Reserve and surplus : 1, 30,000
8%Debentures : 1, 70,000
The rate of tax for the company is 50%. Current level of equity Divided is 12%. & Market price per share
is Rs 15
Calculate the weighted average cost of capital?

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Problem No: 15 WACC

Hansolcompany was recently formed to manufacture a new product. The company has the following
capital structure in market value terms:
13%Debentures of 2005 Rs. 60, 00,000
12%preferred Stock Rs. 20, 00,000
Common Stock (3, 20,000 shares) Rs. 80, 00,000
Rs. 1, 60, 00,000
The company stock sells for Rs.25 a share and the company has a marginal tax rate of 40%. A study of
publicity held companies in this line of business suggests that the required return on equity is about 17%
for a company of this sort.
a) Compute the firms present weighted average cost of capital
b) Is the figure computed an appropriate acceptance criterion for evaluating investment
proposals?

Problem no: 16 WACC

Excel industrial Ltd has assets of Rs. 1, 60,000/- which have been financed with Rs. 52,000/- of debt and
Rs. 90, 000/- of equity and a general reserve of Rs, 18, 000/-. The firms total profits after interest and
taxes for the year ended 31
st
March, 1988 were Rs 13, 500/- . It pays 8%interest on borrowed funds and
is in the 50%tax bracket. It has 900 equity shares of Rs.100 each selling at a market price of Rs. 120 per
share. What is the weighted average cost of capital?

Problem No: 17 WACC

Three companies A, B& C are in the same type of business and hence have similar operating risks.
However, the capital structure of each of them is different and the following are the details:
A B C
Equity Share Capital
Face value Rs.10 per share
Rs.4, 00,000 2, 50,000 5, 00,000
Market Value per share Rs.15 20 12
Dividend per share 2.70 4 2.88
Debentures
Face value per debenture Rs.100
Nill 1, 00,000 2, 50,000
Market Value per debenture -- 125 80
Interest rate -- 10% 8%
Assume that the current levels of dividends are generally expected to continue indefinitely and the
income tax rate at 50%.
You are required to compute the weighted average cost of capital of each company.

Problem No: 18 WACC

The Capital structure of swan & Co, comprising 12%debentures, 9%preference shares and equity shares
of Rs 100 each, is in the proportion of 3:2:5.
The company is contemplating introduction of further capital to meet the expansion needs by seeking
14%term loan from financial institutions. As a result of this proposal, the proportions of debentures,
preference share and equity would get reduced by 1/10,1/15 and 1/6, respectively. In the light of above
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proposal, calculate the impact on weighted average cost of capital, assuming 50%tax rate, expected
dividend of Rs 9 per share at the end of the year, and growth rate of dividends at 5%. No change in the
dividend, dividend growth rate and market price of share is expected after availing the proposed term
loan.

Problem No. 19 WACC

Calculate the WACC using the following data by using:
a) Book value weights
b) Market value weights
The capital structure of the company is as under:

Rs.
Debentures ( Rs. 100 per debenture) 5, 00,000
Preference shares (Rs. 100 per share) 5, 00,000
Equity shares (Rs. 10 per shares) 10,00,000
Total 20,00,000
The Market prices of these securities are:
Debenture Rs. 105 per debenture
Preference Rs. 110 per preference share
Equity Rs. 24 each
Additional information
(1) Rs. 100 per debenture redeemable at par, 10%coupon rate, 4%floatation cots, 10 year
maturity.
(2) Rs .100 per preferences share redeemable at par, 5%coupon rate, 2%floatation cost and 10
years maturity.
(3) Equity shares have Rs. 4 floatation cost and market price Rs.24 per share.
The next year expected dividend is Rs.1 with annual growth of 5%. The firm has practice of paying all
earning in the form of dividend.
Corporate tax rate is 50%

Problem no 20 MWACC

The following is the capital structure of a company. The company plans to raise additional Rs.5, 00,000
for expansion of its plant. It is estimated that Rs.2, 00,000 will be available as retained earnings and the
balance funds of Rs.3, 00,000 shall be raised from issuance of additional debentures.
Source Amount Rs After tax cost
Equity share capital 3, 00,000 15%
Retained Earnings 2, 00,000 14%
Preference Share capital 3, 00,000 10%
Debentures 2, 00,000 5%
Total 10, 00,000

Problem No: 21 Marginal WACC

Alert Ltd. has the following capital structure, which it considers to be optimum:
Rs.in Lacs
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5,000 @ 9%Debentures of Rs.100 each 5
2,000 @ 10% PREF.shares of Rs.100 each 2
1, 30,000 @ Equity shares of Rs.10 each 13
Total 20

The prevailing market price is Rs.24 per share. The company pays 50%of EPS by way of dividend. The
company also expects and also consistently withstand in the past a 10%growth rate in the EPS. The
company can issue new debt at 10%interest. The current market rate of existing debenture is Rs 98 per
debenture. New preference shares can be issued @ 11%dividend getting 98 per share (net). Assume
corporate tax as 50%.
a) Calculate cost of new debt, cost of new pref.share capital, cost of retained earnings.
b) The marginal (weighted) cost of new capital assuming that no further equity capital is raised,
c) How much amount can the company spend for capital investment in 2009 before raising new
equity capital and without disturbing the existing capital,
d) What will be the marginal cost of capital of the company requires in excess of the amount
computed in (3) above assuming that the company can sell new Equity shares @ Rs 20 per share
(net) . The cost of debt and pref. shares remains unchanged.
Note: The EPS for the latest year ending 2008 was Rs, 2.83

Problem No: 22 WACC Book Value Basis and Market Value Basis

A Paper company has the following specific cost of capital along with the indicated book and market
value weights:
Type of Capital Cost Book Value Weights Market Value Weights
Equity 18% 0.50 0.58
Preference Shares 15% 0.20 0.17
Long term debt 7% 0.30 0.25
a) Calculate the weighted cost of capital, using book and market value weights,
b) Calculate the weighted average cost of capital, using marginal weights, if the company intended
to raise the needed funds using 50%long-term debt, 35%preference shares and 15%retained
earnings.

Problem No: 23. WACC Book Value Basis and Market Value Basis

A Companys after tax cost of different sources of finance is as follows:
Cost of equity capital : 14%
Cost of Retained earnings : 13%
Cost of Preference Shares : 10%
Cost of Debt : 5%
The capital structure of the company is as under:
Source Book Value Market Value
Equity Share capital 4, 00,000 10, 00,000
Retained earnings 1, 00,000 ---
Preference Share Capital 2, 00,000 2, 00,000
Debt 3, 00,000 3, 00,000
Total 10, 00,000 15, 00,000
Calculate the weighted average cost of capital using (a) Book Value Weight and (b) Market value weights
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Problem No: 24 WACC-Book Value weights and Market value weights

A Transport Company is interested in measuring its cost of specific types of capital, as well as its overall
cost. The finance department of the company indicates that the following costs would be associated
with the sale of debentures, preference shares and equity shares. The corporate tax rate is 55%. The
shareholders are in the 30%marginal tax bracket.
Debentures: The Company can sell 15 years 14%debentures of the face value of Rs 1,000 for Rs 970, In
addition, an underwriting fee of 1.5%of the face value would be incurred in this process.
Preference Shares: 15%preference shares, having a face value of Rs 100, can be sold at a premium of
10%. An underwriting fee of Rs 2 per shares is to be paid to the underwriters.
Equity Shares: The Companys equity shares are currently selling for Rs 125 per share. The firm expects
to pay Rs 15 per share at the end of the coming year. Its dividend Payments over the past 6 years per
share are given below:
Year Dividend (Rs)
1 10.60
2 11.24
3 11.91
4 12.62
5 13.38
6 14.19
It is expected that the new equity shares can be sold at Rs 123 per share. This company must also pay Rs
3 per share as underwriting fee.
Market and book values for each type of capital are as follows:
Book Value (Rs) Market Value (Rs)
Long- term bedt 18, 00,000 19, 30,000
Preference Shares 4, 50,000 5, 20,000
Equity Shares 60, 00,000 100, 00,000
Retained earnings 15, 00,000
Total 97, 50,000 124,50,000
(i) Calculate the specific cost of each sources of financing,
(ii) Determine the weighted average cost of capital using,
(iii) (a) Book value weights, and (b)market value weights.


Problem No.25 Revised WACC

XYZ & CO has following capital structure on 31
st
December
11%Debentures Rs 5, 00,000
10%Preference Shares Rs 1, 00,000
4000 Equity shares of Rs 100 each Rs 4, 00,000
Total Rs 10, 00,000
Equity shares are quoted at Rs 102, and it is expected that the company will declare a dividend of Rs 10
per share at the end of current year. The dividend is expected to grow at 10%for the next 5 years. The
companys tax rate is 50%.
a) Calculate from the foregoing data the cost of equity capital, and weighted average cost of
capital
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b) Assuming the company can rise additional debentures for Rs 3 lakhs at 12%, calculate the
revised weighted average cost of capital, if the resultant changes are:
(i) Increase in dividend rate from 10 to 12%
(ii) Reduction in growth rate from 10 to 8%
(iii) Fall in market price of shares from Rs 102 to Rs 92.

Problem No: 26 CAPM

M Ltd Share beta factor is 1.40. The risk free of interest on government securities is 9%. The expected
rate of rate of return on company equity shares is 16%. Calculate cost of equity capital?

Problem No: 27 CAPM
The following facts relate to Hypothetical Ltd.
(i) Risk-free interest in the market is 10%
(ii) The firms beta coefficient b is 1.50
Determine the firms cost of equity capital using the capital asset pricing model assuming an
expected return on the market of 14%for next year. What would be the K, if the firms b (a) rises to
2, and (b) falls to 1.


Problem No: 28 Project Evaluation Cost of Capital

M/S Efficient Corporation has a capital structure of 40%debt and 60%equity. The company is presently
considering several alternately investment proposals consisting less than Rs, 20,00,000. The corporation
always raises the required funds without diluting its present debt equity ratio. The cost od raising debt
and equity are as under.
Cost Of
Debt
Equity
Upto Rs 2,00,000 10% 12%
Above 2,00,000 and up to 5,00,000 11% 13%
Above 5,00,000 and up to 10,00,000 12% 14%
Above 10,00,000 and up to 20,00,000 13% 14.5%
Assuming the tax rate at 50%calculates:
1. Cost of capital of two projects X and Y Whose funds requirements are Rs, 6.5 Lacs and Rs.14 lacs
respectively.
2. If a project is expected to give after tax return of 10%determine under what conditions it would
be acceptable.

Problem No: 29 Convertible Debentures

Logitech Ltd. has issued 50,000 units of convertible debentures, each with a nominal value of Rs.100 and
a coupon rate of interest of 10%payable yearly. Each Rs. 100 of convertible debentures may be
converted into 40 ordinary shares of Logitech Ltd. In three years time. Any stock not converted will be
redeemed at 110 (that is at rs.110 per 100 nominal value of stock Logitech Ltd Ordinary share on the
conversion day is A Rs 2.5 Per share B) Rs.3 per share . Compute cost of debt