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Unit 3 - Practice Questions

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Unit 3 - Practice Questions

Uploaded by

itsbrightonwright
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© © All Rights Reserved
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Download as DOCX, PDF, TXT or read online on Scribd
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Cost of Capital

Problem 1

A company sells a new issue of 10 year, 12 per cent bonds of Rs. 100, each at par. It will pay
interest annually and repay bonds at par on maturity. What is the cost of bonds? If the tax rate
is 25 per cent, what is the after-tax cost of the bond?

Problem 2

A company sells a new issue of 10 year, 12 per cent bonds of Rs. 100 each, at par. It will pay
interest annually and repay bonds at 10 per cent premium on maturity. What is the cost of
debt? If the tax rate is 25 per cent, what is the after-tax cost of the debt?

Problem 3

Star Ltd. issued 10% debentures of Rs. 100 each for Rs. 1,00,000 at a discount of Rs. 5%.
The floatation cost is 8%. The company has agreed to repay the debentures at par after 8
years. The tax rate is 30%. Calculate the cost of debt before tax and after tax.

Problem 4

Rs. 1,000 debentures of a firm can be sold for a net price of Rs. 980. The rate of return is
12% per annum. The debentures will be redeemed at 5% premium on maturity. The maturity
period is 6 years. The tax rate applicable is 25%. Compute cost of debt before-tax and after-
tax.

Problem 5

A company issues 10% irredeemable preference shares. The face value per share is Rs. 100,
but the issue price is Rs. 95. What is the cost of preference shares? What is the cost if the
issue price is Rs. 105?

Problem 6

A company issues 500, 8% preference shares of Rs. 10 each, redeemable after 10 years at a
premium of 5%. The cost of issue is 1.5 per share. Calculate cost of preference shares.

Problem 7

A preference share sold at Rs. 100 with 9% dividend and redemption price of Rs. 110 if the
company redeems it in 5 years. Assuming that company’s tax rate is 25%. Compute the cost
of preference capital.

Problem 8

A company issues 1,000 equity shares of Rs. 100 at a premium of 10%. The company has
been paying 20% dividend to equity shareholders for the past 5 years and expects to maintain
the same in the future also. Compute cost of equity capital. Will it make any difference if the
market price of the equity share is Rs. 160.
Problem 9

X Ltd. issues 10,000 equity shares of Rs. 100 each at a discount rate of 5%. The company has
a trend of declaring a dividend at 10%. Compute cost of equity capital.

Problem 10

Suppose that the current market price of a company’s share is Rs. 90 and the expected
dividend per share next year is Rs. 4.5. If the dividends are expected to grow at a constant
rate of 8 percent, calculate the shareholders required rate of return.

Problem 11

A firm is currently earning Rs. 1,00,000 and its share is currently selling at market price of
Rs. 80. The firm has 10,000 shares outstanding and has no debt. The earnings of the firm are
expected to remain stable, and it has payout ratio of 100 percent. What is the cost of equity.

Problem 12

A company plans to issue 1,000 new shares of Rs. 100 each at apr. the floatation costs are
expected to be 5% of the share price. The company pays a dividend of Rs 10 per share
initially and the growth in dividends is expected to be 5%.

a) Compute the cost of a new issue of equity shares.


b) If the current market price of an equity share is Rs. 150, calculate the cost of existing
equity share capital.

Problem 13

Strava Lens Company Ltd. has 60% debt and 40% equity in its capital structure. The after tax
cost of debt and equity are 9% and 16% respectively. What is the overall cost of capital of the
firm?

Problem 14

Calculate the average cost of capital before tax and after tax from the following information
of XYZ Ltd. Assume the tax rate is 25%.

Proportion in the capital Before tax cost of Capital


structure (%) (%)

Equity Capital 25 24.44

Preference Capital 10 22.29

Debentures 50 7.99

Retained Earnings 15 18.33


Problem 15

From the following capital structure of Fresho Ltd. Calcualte overall cost of capital, using (a)
Book value weights and (b) Market value weights

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

Equity Shares of Rs. 10 each 4,50,000 9,00,000

Retained Earnings 1,50,000 -

Preference Share Capital 1,00,000 1,00,000

Debentures 3,00,000 3,00,000

The after tax cost of different sources of finance are equity share capital 12%, retained
earnings 11%, Preference Shares 9% and debentures 7%.

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