Problems in Cost of Capital 1.

A company has on its books the following amounts in the Capital -----------------------------------------------------------------------------------------------Types of Capital Book Value Market value Cost ------------------------------------------------------------------------------------------------15 % Debt (Irredeemable) 4,00,000 3,80,000 15 % 12 % Preference Shares 1,00, 000 1,10,000 12 % Equity 6, 00, 000 20 % Retained Earnings 2, 00,000 12,00,000 -----------------------------------------------------------------------------------------13,00,000 16,90,000 ------------------------------------------------------------------------------------------Assume tax rate = 35 % Compute the overall cost of capital of the firm by using book value weights and market value weights. 2. From the following capital structure of XYZ Ltd, determine appropriate weighted average cost of capital Equity shares (1,00,000) Preference shares Debentures Bank loan Rs 38,00,000 8,00,000 50,00,000 18,00,000

Additional information 1.Cost of equity is 20 % 2.Dividend indicated on preference shares is 12 % 3.Pre tax cost of debentures is 11 % 4. Interest on bank loan is 12 % 5. Corporate tax rate is 35 % 6. Market value of equity shares = Rs 50,00, 000 7. Market value of preference shares = Rs 8, 50,000 3. Multimedia network has the following book value capital structure Equity capital (10 million shares, Rs 10 par) Preference capital, 11 percent (100,000 shares, Rs 100 par) Retained Earnings 13.5 % (500,000 debentures, Rs 100 par) Terms loans 12 % Rs 100 million Rs 10 million Rs 129 million Rs 50 million Rs 80 million -------------------Rs 369 million

------------------The next expected dividend per share is Rs 1.50. The dividend per share is expected to grow at the rate of 7 %. The market price per share is Rs 20.00. Preference stock redeemable after 10 years is currently selling for Rs 75.00 per share. Debentures, redeemable after 6 years, are selling for Rs 80.00 per debenture. The tax rate for the company is 50 %. Calculate the overall cost of capital using market value weights. 4.The following information is available from the balance sheet of a company. Equity share Capital (20,000 shares of Rs 10 each) Rs 2,00,000 Retained Earnings 1,30,000 8 % Debentures 1,70,000 The rate of tax for the company is 35 %. Current level of equity dividend is 12 percent. Dividend is expected to grow @ 5 %. Determine the overall cost of capital 5. You are analyzing the beta for Hewlett Packard and have broken down the company into four broad business groups, with market values and betas for each group. Business Group Mainframes Personal Computers Software Printers Market Value of Equity $ 2.0 billion $ 2.0 billion $ 1.0 billion $ 3.0 billion Beta 1.10 1.50 2.00 1.00

a. Estimate the beta for Hewlett Packard as a company. b. If the treasury bond rate is 7.5%, estimate the cost of equity for Hewlett Packard. Estimate the cost of equity for each division. Assume the market return is 14 %. 6. You have collected returns on AnaDone Corporation (AD Corp.), a large diversified manufacturing firm, and the NYSE index for five years: Year 2002 2003 2004 2005 2006 AD Corp 10% 5% -5% 20% -5% NYSE 5% 15% 8% 12% -5%

a. Estimate the beta of the company b. If you bought stock in AD Corp. today how much would you expect to make as a return over the next year? [The six-month T.Bill rate is 6%] 2

c. Looking back over the last five years, how would you evaluate AD's performance relative to the market? (The risk free rate during the period was also 6% on an annual basis) d. Assume now that you are an undiversified investor and that you have all of your money invested in AD Corporation. What would be a good measure of the risk that you are taking on? 7. Bombay Chemicals Ltd wishes to raise additional finance of Rs 10 lakh for meeting its investment plans. It has Rs 2,10,000 in the form of retained earnings available for investment purposes. The following are the further details. 5 marks 1.Debt equity mix 30: 70 2.Cost of debt: upto Rs 1,80,000, 10 % (before tax) Beyond Rs 1,80,000, 12 % (before tax) 3.Earnings per share Rs 4 4.Dividend pay out, 50 % of earnings 5.Expected growth rate in dividend. 10 % 6.Current market price per share Rs 44 7.Tax rate 35 % You are required a. To determine the pattern for raising the additional finance, assuming the firm intends to maintain existing debt/equity mix. b.To determine the post tax average cost of additional debt c. To determine the cost of retained earnings and cost of equity d. Compute the overall weighted average after tax cost of additional finance. 8. Suppose you are an investor having a portfolio of Rs 13, 00,000. Your portfolio consists of 4 stocks with the following investments and betas: Stock Investment (Rs) Beta Aravind mills 4,00,000 1.50 Suzlon Energy ltd 6,00,000 0.50 Patni Computers 1,00,000 1.25 PVR cinemas 2,00,000 0.75 If the market required rate of return is 14 percent and the risk free rate is 6 percent, What is the fund required rate of return? Stock Aravind Mills Suzlon Patni PVR Total Investment 4,00,000 6,00,000 1,00,000 2,00,000 13,00,000 Propotion Beta Total Beta

9. HAL has the following capital structure Ordinary shares (200,000 shares) 4,000 10 % preference shares 1,000 14 % debentures 3,000 8,000 ------The share of the company sells for Rs 20.it is expected that company will pay next year a dividend of Rs 2 per share, which will grow at 7 percent forever. Assume a 50 percent tax rate. You are required to compute the weighted average cost of capital based on the existing capital structure. 10. Securities X and Y have the following characteristics Return % 30 20 10 5 -10 Security X Probability 0.10 0.20 0.40 0.20 0.10 Return % -20 10 20 30 40 Security Y Probability 0.05 0.25 0.30 0.30 0.10

You are required to calculate the expected return and standard deviation of return and coefficient of variation for each security. Which security would you select for investment and why? 11. The returns of the share of Pidilite industries and the Sensex for the past five years are given below. Sensex (%) - 12.5 1.7 7.2 11.5 6.3 What is Pidilites Beta ? 12. Royal Paints Limited is an all equity firm without any debt. It has a beta of 1.21. the current risk free rate is 8.5 % and the historical market premium is 9.5 %. Royal is considering a project that is expected to generate a return of 20 %. Assuming that the project has the same risk as the firm, Should the firm accept the project? 13. You have a portfolio of the following four shares. Share Beta Investment Pidilite ( %) - 5.1 % 6.7 7.1 18.9 11.9

GAC KOEL KBL KPCL

0.80 1.25 1.12 0.60

1,00,000 1,00,000 75,000 1,25,000

What is the expected rate of return on your portfolio if the risk free rate of return is 9 percent and the expected market rate of return is 16 percent ? 14.The shares of a chemical company are selling at Rs 20 per share. The firm had paid dividend @ Rs 2 per share last year. The estimated growth of the company is approximately 5 per cent per year. a. Determine the cost of equity capital of the company b. Determine the estimated market price of the equity shares if the anticipated growth rate of the firm (i) rises to 8 %, falls to 3 %. 15. From the following information supplied to you, determine the appropriate weighted average cost of capital, relevant for evaluating long term investment projects of the company. Cost of equity After tax cost of long term debt After tax cost of short term loans Source Equity Long term debt Short term debt Book value Rs 5,00,000 4,00,000 1,00,000 ----------------10,00,000 ---------------12 percent 7 percent 4 percent Market value Rs 7,50,000 3,75,000 1,00,000 -----------------------12,25,000 ------------------------