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Cost of Capital Problems

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Nikhil Gulabani
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27 views5 pages

Cost of Capital Problems

Uploaded by

Nikhil Gulabani
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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17.

A Company issued 8% Debentures of the FV of Rs 500


redeemable at par after 5 years. Assuming 35% tax rate
and 5% flotation cost, determine the before tax and.
After tax cost of Debt if the Debentures are issued at a)
Par, B) 5% Discount C) 5% Premium.
18. A Ltd. Has the following capital structure as on 31st
Dec 2016.
10% Debentures Rs. 6,00,000
9% Preference Share capital Rs. 4,00,000
5,000 Equity Shares of Rs 100 each Rs. 5,00,000
The Equity shares of the company are quoted at Rs 100
and the company is expected to declare a dividend of Rs
9 per share for 2016. The company has registered a
growth rate of 5% which is expected to be maintained.
The tax rate applicable to the company is 50%.
Calculate.
a. The Weighted average cost of capital.
b. The revised weighted average cost of capital, if the
company raises additional term loan of Rs. 5,00,000 at
15%. In such a situation the company can increase
dividend from Rs. 9 to Rs. 10 per share but the market
price of the share will go down to Rs. 90.
19. You are supplied with the following information of
Mountain Eagle co Ltd to calculate the total Cost of
capital.
LIABILITIES ASSETS
Current Liabilities 9,00,000 Sy. Assets 39,00,000
Debentures 9,00,000
Preference 4,50,000
Equity Shares 12,00,000
Retained Earnings 4,50,000
TOTAL 39,00,000 39,00,000
Information:
1. Debentures are 10% with FV Rs. 1,000 bought back
after 20 years @ 5% premium, sold at par with 2%
floatation costs. Tax Rate – 50%.
2. Preference share Capital is @ 10% with sale Price Rs
100 per share which is the same as its FV with
floatation costs 2%.
3. Equity shares sale price Rs. 115 per share, floatation
cost Rs 5 per share. FV Rs 100 per share.
4. Half of the retained earnings are earned this year.
What is the minimum amount of earnings the company
has to earn in order to maintain the market value of its
shares?
Additional Questions:
I) Dividend Approach
a. Rana Ltd issues 5,00,000 Equity shares of Rs 10 each at a premium of 50%. The
company is paying a dividend at the rate of 40% to its equity shareholders for the past
10 years and expects to maintain the same in future also. Calculate cost of Equity

b. Rahul Ltd offers for public subscription Equity shares of Rs 10 each at a premium of
10%. The company pays 5% on Issues prices as underwriting commission. The rate of
dividend expected by equity shareholders is 20%. You are required to calculate the
cost of Equity capital.

II) Dividend + Growth Approach


c. The current market price of the Equity share of the company is Rs 90. The current
DPS is Rs 4.5. In case the dividends are expected to grow at the rate of 7%, calculate
the Equity cost of capital.

d. Calculate cost of Equity from the following information:


Market price per share Rs 150
The underwriting cost per share amounts to 2%.
The expected dividend of the new share amounts to R. 14.5 and the growth rate is 6%.

III) Earnings Approach


e. The entire capital employed by the company is 1,00,000 Equity shares of Rs 100
each. Its current earnings are Rs. 10,00,000 p.a. The company wants the raise
additional funds of Rs 25,00,000 by issuing new Equity shares. The underwriting cost
are expected to be 10% of the face value of the shares. You are required to calculate
cost of Equity capital assuming that the earnings of the company are expected to
remain stable for the next few years.

f. Calculate the cost of existing Equity share capital


Number of Equity shares are 10,00,000
Market price of the existing Equity shares is Rs 80
Net Earnings are Rs 80,00,000
Also calculate the new Equity capital assuming that the new share will be issued at a
price of Rs 52 per share and the cost of issue will be Rs 4 per share.

g. K Ltd. Issued 4,000 Equity shares at Rs 100 each fully paid. The company has earned
a profit of Rs 1,00,000 after tax. The market price of the share is Rs 200 per share.
The company has announced dividend at the rate of 15%. Calculate the price per
share by Dividend approach and the earnings approach.
IV) Earnings + Growth Approach

V) CAPM Approach (Capital Asset Pricing Model)


Noor Ltd wishes to capital its cost of capital using the CAPM approach. From the
following information provided to the firm by its advisor along with the firm’s own
analysis, it found that the risk-free rate of return is 10%. The firm’s beta is 1.5 and the
return on the market portfolio is 12.5%. Compute the cost of Equity capital.

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