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Problems On Cost of Capital

This document provides 14 problems related to calculating the cost of capital for companies. The problems cover calculating the after-tax cost of debt, cost of preferred equity, cost of common equity, weighted average cost of capital (WACC) using both book and market values, and accounting for factors like taxes, floatation costs, and dividend growth rates. The goal is to determine the rates of return required by a company's debt holders, preferred shareholders, and common shareholders to calculate its WACC.

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766 Rutu Khadapkar
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304 views

Problems On Cost of Capital

This document provides 14 problems related to calculating the cost of capital for companies. The problems cover calculating the after-tax cost of debt, cost of preferred equity, cost of common equity, weighted average cost of capital (WACC) using both book and market values, and accounting for factors like taxes, floatation costs, and dividend growth rates. The goal is to determine the rates of return required by a company's debt holders, preferred shareholders, and common shareholders to calculate its WACC.

Uploaded by

766 Rutu Khadapkar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Problems on Cost of Capital

1. A Company has Rs. 5 million debt outstanding with a coupon rate of 12%. Currently, the yield
to maturity on these bonds is 14%. If the firm’s tax rate is 40%. What is the Company’s after tax cost
of debt?

2. A Company’s Rs. 100 8% preferred stock is currently selling for Rs. 85. What is the
company’s cost of preferred equity?

3. The expected dividend is Rs. 2.50 per share of a stock priced at Rs. 25. What is the cost of
equity if the long term growth in dividends is projected to be 8%?

4. An analyst gathered the following data about a company:


Capital Structure Required rate of return
30% Debt 10% for debt
20% preferred stock 11% for preferred stock
50% common stock 18% for common stock
Assuming a 40% tax rate, what after tax return must the company earn on its investments.

5. A Company is planning a $50 million expansion. The expansion is o be financed by selling $20
million in new debt, $30 million in new common stock. The before tax required rate of return
is 9% for debt and 14% for equity. If the company is in the 40% tax bracket, what is the
company’s marginal cost of capital?

6. The following is the capital structure of ABC Co Ltd as on 31.3.2008

Rs.
Equity Shares : 10000 shares of Rs. 100 each 10,00,000
10% preference shares of Rs. 100 each 4,00,000
12% Debentures 6,00,000
20,00,000
The market price of the company’s share is Rs. 110 and the next expected dividend would be
Rs.10 . The dividend growth rate is 6%.

i) If the company is in the 50% bracket, compute the weighted average cost of capital
ii) Assuming that in order to finance an expansion plan, the company intends to borrow a fund
of Rs. 10 lakhs bearing 14% rate of interest, what will be the company’s revised weighted
average cost of capital? This financing decision is expected to increase dividend from rs. 10
to Rs. 12 per share. However, the market price of equity share is expected to decline from
Rs. 110 to Rs. 105 per share. Calculate the revised weighted average cost of capital.

(Ans: 11.35% ; 10.67%)


7. XYZ Ltd has the following book value capital structure:

Equity Capital ( in shares of Rs. 10 each fully paid up at par) Rs. 15 crores
11% Preference Capital ( is shares of Rs. 100 each , fully paid up at par) Rs. 1 crore
Retained earnings Rs. 20 crores
13.5% debentures of Rs. 100 each Rs. 10 crores
15% Term loans Rs. 12.5 crores
The next expected dividend on equity shares per share is Rs. 3.60; the dividend per share is
expected to grow at the rate of 7%. The market price per share is Rs. 40. Preference stock,
redeemable at par after 10 years is currently selling at Rs. 75 per share. Debentures, redeemable at
par after six years are selling at Rs. 80 per debenture. The income tax rate for the company is
40% . The income tax rate for the company is 40%. Calculate the weighted average cost of capital
using :

a. Book value proportions;


b. Market value proportions
8. JKL Ltd. has the following book value capital structure as on 31st March 2015

Equity Share Capital ( 2 lakh shares) Rs. 40 lakhs


11.5% Preference Shares Rs. 10 lakhs
10% Debentures Rs. 30 lakhs
Total Rs. 80 lakhs
The equity share of the company sells for Rs. 20. It is expected that the company will pay next
year a dividend of Rs. 2 per share which is expected to grow at 5% p.a for ever. Assume a 35% tax
rate. Required: Compute the WACC based on the existing capital structure.

9. A company issues Rs. 10 lakh, 12% debentures of Rs. 100 each. The debentures are
redeemable after the expiry of a fixed period of 7 years. The Company is in the 35% tax
bracket. Calculate the after tax cost of debt is the debentures are issued;
i. At par
ii. 10% discount
iii. 10% premium
iv. If the brokerage is paid at 2% what will be the cost of debentures if the issue is at par?
10. If Reliance Energy is issuing preferred stock at Rs. 100 per share, with a dividend of Rs. 12
and a floatation cost of 3% what is the cost of preference share?
11. XYZ Co. issues 2000 10% preference shares of Rs. 100 each at Rs. 95 each. Calculate the cost
of preference shares?
12. A Company has paid a dividend of Re 1 per share ( of face value of Rs. 10) last year and it is
expected to grow @10% next year. Calculate the cost of equity if the market price per share is
Rs. 55.
13. Calculate the cost of equity capital of H Ltd whose risk free rate of return equals 10%. The
firm’s beta equals 1.75 and the return on the market portfolio equals 15%.
14. Calculate WACC using the following data by using a. Book value weights and b. Market value
weights

The capital structure is as under:

Debentures ( Rs. 100 per debenture) Rs. 5,00,000


Preference shares ( Rs. 100 per share) Rs. 5,00,000
Equity shares (Rs. 10 per share) Rs. 10,00,000
Rs. 20,00,000
The market prices of these securities are:
Debentures – Rs. 105 per debenture; Preference Rs. 110 per preference share; Equity Rs. 24.
Additional information:
a. Rs. 100 per debenture redeemable at par, 10% coupon rate, 4% floatation costs, 10 year
maturity
b. Rs. 100 per preference share redeemable at par, 5% coupon rate, 2% floatation costs and 10
year maturity
c. Equity shares has Rs. 4 floatation costs and market price of Rs. 24 per share.
The next year dividend is Rs. 10 with an annual growth rate of 5%. The firm has a practice
of paying all earnings in the form of dividends. Corporate tax is 50%.

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