COST OF CAPITAL

PROBLEMS

1. A company’s shares with a face value of Rs. 10 each are quoted at Rs.
50 in the stock market. Current rate of dividend is 50% and this is
expected to grow at a steady rate of 5% p.a. Calculate the cost of
equity capital of the company.

2. Calculate the approximate cost of companies debenture capital, when

it decides to issue 10000 nos. of 14 % non convertible debentures,
each of face value Rs. 100 at par. The debentures are redeemable at a
premium of 10% after 10 years. The average realization is expected
to be Rs. 92 per debenture and the tax rate applicable to the company
is 40 %

3. A company issues Rs. 10,00,000 , 12% debentures of Rs. 100 each.

The debentures are redeemable after the expiry of 7 years. The
company is in 35% tax bracket.
Required:
i. Calculate the cost of debt after tax, if debentures are issued at :
a. Par
b. 10% discount
c. 10% premium
ii. If brokerage is paid at 2% what will be cost of debentures, if
issued at par?

4. A Ltd is an all equity financed company. The current market price

of share is Rs. 180. It has just paid a dividend of Rs. 15 per share and
expected future growth in dividend is 12%. Currently, it is evaluating
a proposal requiring funds of Rs. 20 lacs, with annual inflows of Rs.
10 lacs for 3 years. Find the net present value of the proposal, if (i) if
it is financed from retained earnings, and (ii) if it is financed by
issuing fresh equity at market price with a floatation cost of 5% of
issue price.
5. Calculate the cost of capital in the following cases:
i. X Ltde issues 12% debentures of face value Rs. 100 each and realizes Rs.
95 per debenture. The debentures are redeemable after 10 years at 10%
premium.

ii. Y Ltd issues preference shares of face value Rs. 100 each carrying
a dividend of 14% and realizes Rs. 92 per share. The shares are
repayable after 12 years at par.
BOTH companies are paying income tax at 50%.

6. A Company is considering raising 100 lacs by one of the two

alternative methods viz., 14% institutional term loan and 13% non
convertible debentures. The term loan portion would attract no major
incidental cost. The debentures would have to be issued at discount of
2.5% and would involve Rs. 1 lac as cost of issue.
Advise the company as to the better option based on the effective cost of
capital in each case. Assume a tax rate of 35%.

7. A company is considering raising funds of about Rs. 100 lacs by one

of the two alternative methods viz., 14% term loan and 13% Non
convertible debentures. The term loan option would attract no major
incidental cost. The debentures would have to be issued at a discount
of 2.5% and would involve a cost of issue of Rs. 1.00 lac. Advise the
company as to the better option based on the effective cost of capital
in each case. Assume a tax rate of 50%.

8. XYZ Ltd has the following book value capital structure. (Rs. In
cr)
Equity capital ( in shares of Rs. 10 each, fully paid up at par) 15
11% preference capital ( in shares of 100 each fully paid up,par) 1
Retained earnings 20
13.5% Debentures ( of Rs. 100 each) 10
15% Term loans 12.5

The next dividend on equity shares per share is Rs. 3.60 and the dividend
per share is expected to grow at the rate of 7%. The market price per
share is Rs. 40.
Preference share redeemable after 10 years is currently selling at Rs. 75
per share.
Debentures redeemable after 6 years are selling at Rs. 80 per debenture.
The Income tax rate for the company is 40%.
(i) Required to calculate the weighted average cost of capital using;
a. Book Value proportions.
b. Market value proportions.