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1- Company ABC wants to issue more common stock face value Rs.10.

Next
year the Dividend is expected to e Rs.! per share assumin" a Dividend "rowth
rate of 10#pa. $he lawyers% fee and stock roker commission will cost Rs.1 per
share. &nvestors are confident aout company ABC so the common share is
floated at market price of Rs.1' (i.e. )remium of Rs.'*. &f the capital structure of
company ABC is enterin" common e+uity then what is the company WACC, -se
Retained .arnin" Approach to calculate the result. (/arks01*

Calculate Re+uired R2R for Common 3tock usin" 4ordon%s 5ormula
r 0 (D&617)o* 8 "
)o 0 market price 0 1'
Div1 0 Next Dividend 0 !
4 0 "rowth rate 0 10#
r 0 (!71'*810# 0 !!.10#

Now &f company wanted to issue the stock via new float then it has to pay the
lawyer fee and roker commission which 1 Rs.

Net proceed 0 1' 9 1 0 11
r 0 (!711*810# 0 !!.10# 0 !:.::#
1- If the Capital Asset Pricing Method Approach is appropriate, compute the required
rate of return for each of following stocks. Assume a risk free rate of 0.0 and e!pected
return for the market portfolio of 0.1". #Marks$10%
3tock A B C D .
Beta !.0 1.1 1.0 0.; 0.!
Re+uire 0.0<8(0.1!= 0.0<8(0.1!= 00.0<8(0.1!= 00.0<8(0.1!= 00.0<8(0.1!=
d rate of
return 0
risk free
rate of
return 8
(market
risk= risk
free rate
or
return * >
eta
Rf 8
(Rm=
Rf*>B
Rm 0 .
1!
Rf 0 .0<

0.0<*>!
0 11#
0.0<*>1.1

0 1:.1#
0.0<*>1

1!#
0.0<*>.;

0 11.10#
0.0<*>.!

0<.'#
1= Longstreet Communication Inc.(LCI) has the followin" capital structure
which is consider to e optimal.
Det )referred 3tock Common 3tock Total Capital
!1# 11# '0# 100%

?C&%s net income expected this year is @1;A1B!.C'A its estalished dividend
payout ratio is :0#A its tax ratio is B0#A and investor expect earnin" and dividend
to "row at a constant rate of <# in the future. ?C& paid a dividend of @:.'0 per
share last year(D
0
* and its stock currently sells at a price of @'0 per share.
$reasury Bond yield 11# and avera"e has a 1B# expected rate of return and
?C& eta is 1.11. $he followin" terms apply to new security offerin".
Common: New common stock would have floatation cost of 10#.
Preferred: New preferred stock could e sold to the pulic at price of @100 per
shareA with a dividend of @11.
e!t: Det could e sold at interest rate of 1!#.

(A)" 5ind the Component Cost of DetA )referred 3tockA Retained .arnin" and
New Common 3tock, (/arks0;*
?C&%s net income expected this year is @1;A1B!.C'A its estalished dividend
payout ratio is :0#A its tax ratio is B0#A and investor expect earnin" and dividend
to "row at a constant rate of <# in the future. ?C& paid a dividend of @:.'0 per
share last year(D
0
* and its stock currently sells at a price of @'0 per share.
$reasury Bond yield 11# and avera"e has a 1B# expected rate of return and
?C& eta is 1.11. $he followin" terms apply to new security offerin".
Common: New common stock would have floatation cost of 10#.
Preferred: New preferred stock could e sold to the pulic at price of @100 per
shareA with a dividend of @11.
e!t: Det could e sold at interest rate of 1!#.

(A)" 5ind the Component Cost of DetA )referred 3tockA Retained .arnin" and
New Common 3tock, (/arks0;*
Cost of e!t
$ 0 B0# $ax Rate
Rd 0 1!# interest Rate of det
After=tax cost of detD
Rd(1 = $* 0 1!#(1 = 0.B0* 0 1!#(0.'0* 0 ;.!0#.
Cost of preferred stoc#:
Div 0 11
)rice 0 100
Eps 0 Div7price of share
Eps 0 117100 0 11#
Cost of retained earnings (using CAP$ met%od)
Re 0 Rf 8 (Rm=rf* > eta 0 11# 8 (1B# = 11#*1.11 0 11.1#.
Cost of ne& common stoc#
5 0 .10 flotation cost
Do 0 :.'0 last year dividend
)o 0 '0 9 ' 0 1B )rice of share. After flotation cost
40 <# "rowth rate
Div1 0 Next year dividend we can "et it y this formula 0 Do(18"*
Ee 0 (Div17 )o*8 "
Ee 0 (Do(18"*7)o*8"
By addin" values in formula
Ee0 (:.'0(18.0<*71B*8.0< 0 1'.!'#
(')" Fow much new capital could e raised efore ?C& must sell new e+uity,
(/arks0:*
Company ABC issues a 2 Year Bond of Par Value Rs 1000 and a Coupon Rate of 10%
pa (and annual coupon payments). Company ABC pays an n!estment Ban" Rs #0
per Bond to structure and
mar"et t$e %ond. &$ey decide to sell t$e Bond for Rs '#0 (i.e. At a (iscount). At t$e
end of t$e first year) Company ABC*s ncome +tatement s$o,s t$e Coupon nterest
paid to Bond$olders as an e-pense.
nterest represents a &a- +a!in. or +$ield. Based on t$e /et ncome and ndustry
+tandard) t$e 0ar.inal Corporate &a- Rate is 10% of /et ncome. Assumin. t$at t$e
2 Year Bond represents t$e 2/3Y form of Capital) calculate t$e After4&a- 5ei.$ted
A!era.e Cost of Capital (5ACC) % for

Solution
Calculate Re+uired R2R usin" Bond )ricin" or )6 5ormula
)6 0 1007 (18r>* 81007 (18r>* G! 810007 (18r>*G!
0 1007 (18r>* 8 11007 (18r>*G !
0 Net )roceeds 0 N) 0 /arket )rice =$ransaction Costs
0 <10 = 10 0 Rs <00
0 1007(18r>*8 (1007(18r>*G!*8 (10007(18r>*G!*= <00
3olve the Huadratic .+uation for )re=$ax Re+uired R2R 0 r>
-sin" the Huadratic 5ormulaD r> 0 1'# AND r 0 = 1 #

Calculate After $ax Cost of Det
rD 0 rD> ( 1 = $C *
$ 0 :0#
0 1'#(1=.:0* 0 11.!0#

Calculate Iei"hted Cost of Capital (IACC*
IACC 0 rD JD. 8 r) J) 8 r. J. .
0 rD JD 8 0 8 0
0 11.! (1* 0 11.! #
6ind t$e Beta on a stoc" .i!en t$at its e-pected Return is 17% t$e Ris" free rate is
8% and t$e 9-pected return on t$e 0ar"et portfolio is 12% (0ar"s #)
Solution

r 0 rR5 8 Beta (r/ = rR5*.
r01'#
Rf0B#
r/01!#
B0,
1'# 0 B# 8 Beta (1!# = B#*.
1'#=B#0Beta>C#
1!#7C#0Beta
1.&$'eta
.B&$ of a firm is Rs. 100A Corporate $ax is :1#
a* .+uity is 100# and r. is !0#
* Det is 100# and &nterest is 10#
5ind IACC. /arks10

a* IACC 0 rD JD. 8 r) J) 8 r. J. .
IACC00808!0#(100*
IACC0!0#

* Ihen 100# deit
rD(1=t*
10#>(1=.:1*
00.0'1
0'.1#
IACC 0 rD JD. 8 r) J) 8 r. J. .
IACC0'.1#(100* 8 0 8 0 0 '.1#


rD0 Rate of Det
JD0 wei"hted avera"e of det
r)0 rate of )roffered 3hares
J)0 wei"hted avera"e of preferred shares
r.0 Rate of e+uity (common shares*
J.0 wei"hted avera"e of e+uity
.B&$0.arnin" efore &nterest K taxes ("ross profit*
1. Risk free Rate is 11# and expected /arket Return is !0#. 5/ Corporation has a et of
1.< and 4old Corporation has eta of 1.1. 5ind .xpected Return on 5/ Corporation and
4old Corporation.

r : rR6 ; Beta (r0 4 rR6).
B:1.'
r0:20%
rR6:1#%
r:1#%;1.'(#%)

<old Company=
B:1.#
r0:20%
rR6:1#%
r : rR6 ; Beta (r0 4 rR6).
r:1#%;1.#(#%)
.B&$ of a firm is Rs. !00 and corporate tax rateA $c is :0 #. &f the firm is 100# .+uity and r. is
!0#. $hen calculate IACC.

IACC 0 rD JD. 8 r) J) 8 r. J. .
IACC00808!0#(100*
IACC0!0%
Explain the equation of EBIT when it is equal to Break Even Point. MARKS-

An indicator of a companyLs profitailityA calculated as revenue minus expensesA excludin" tax
and interest. .B&$ is also referred to as Moperatin" earnin"sMA Moperatin" profitM and Moperatin"
incomeMA as you can re=arran"e the formula to e calculated as followsD
('IT ) *e+enue " ,perating (-penses
Also known as )rofit Before &nterest K $axes ()B&$*A and e+uals Net &ncome with interest and
taxes added ack to it.
Breakeven )ointD Huantity of 3ales at which .B&$ 0 0
.B&$ 0 2p Revenue = 2p Costs 0 2p Revenue = 6ariale Costs 9 5ixed Costs
0 )H = 6H = 5. Ihere )0 )roduct )rice (Rs*A H0 Huantity
or
N-nits 3oldA 60 6ariale Cost (Rs*A 50 5ixed Cost (Rs*. 3o &5 .B&$ 0 0
then )H=6H=5 0 0 so Breakeven H 0 5 7 () = 6*
Calculate the market value of e+uity for a 100# e+uity firm usin" the followin" information
extracted from its financial statementsD
.B&$ 0 Rs. 10A 000A return on e+uity is 1!#A amount of e+uity is Rs. 100A 000. tax rate is :1#.

3oultion
5irst all all we net to calculate Net income

Net income 0 .B&$ 9 &nterest 9 tax
Net income 0 10A000 9 0 9 (.:1> 10A000* 0 :!A100

Now to calculate the market value of firm
Net income7 return on e+uity
0 :!1007.1! 0 !;0C::.:
market value of unlevera"ed frim (100# e+uity firm* e+uity 8 deit
0 !;0C::.: 8 0

0 !;0C::
.arnin"s efore interest and taxes (.B&$* of 5irm is Rs.1000 and Corporate $ax RateA $c is :0#
a. &f the 5irm is 100# .+uity (or -n=?evered* and r. 0 :0# then what is the
IACC- of -n=levered 5irm,
Ans.....
1* Net income 0 .B&$ = & = $ax
0 1000 = 0 = :0# (0.:*
0 ;00
!* .+uity (-n=?* 0 N&7Re
0 ;007:0# (0.:*
0 !::B
:* IACC(-n=?* 0 .+uity 8 Det
0 !::B 8 0 3o
0 !::B Fere is note that wacc is e+ual to e+uity
0 :0# Oitna e+uity k rate ho"a otahi IACC ho of -n=levered firm.....
!. &f the 5irm takes Rs.1000 Det at 10# &nterest or /ark=up then what is the
IACC?
of ?evered 5irm, ($here is no chan"e in return in e+uity*
Ans......
1*Net income 0 .B&$ = & = $ax
0 1000 = .1(1000* = :0# (<00*
0 ':0
!* .+uity (-n=?* 0 N&7Re
0 ':07:0# (0.:*
0 !100
:*IACC (?* 0 .+uity 8 Det
0 !100 8 1000
0 :100
5ormulaD...
IACC 0 Rd>(1 = tc*Jd 8 Re>Je
0 .1>(1 = 0.:*>(10007:100* 8 0.:>(!1007:100*
0 0.!!1C0'
0 !!.1C0'#
A 100# .+uity (un 9 levered* firm as total Assets of Rs. 10000 wei"hted avera"e cost of capital
for an un 9 levered firm (IACC-* is :1# and cost of det for un 9 levered firm (r d u * of !0# it
then adds Rs. !0000 of det financial Risk increases cost of dets (r d ?* of leverd 5irm to 1C#
(/arks 1*
Re+uired
Ihat is levered firms Cost of e+uity (r e ?*,
Ihat will e the IACC ? of levered 5irm

Assuming Pure $$ .ie& " Ideal $ar#ets: $otal /arket 6alue of Assets of 5irm
(6* is
-NCFAN4.D. 6alue of un levered firm 0 6alue of levered firm. AlsoA IACC
remains
-NCFAN4.D y Capital 3tructure and Det.
P IACC- 0 IACC? 0 :1#

Re 0 cost of e+uity
Rd 0 1C # cost of det
. 0 market value of the firmLs e+uity
D 0 market value of the firmLs det 0
6 0 . 8 D
.76 0 percenta"e of financin" that is e+uity
D76 0 percenta"e of financin" that is det
$ 0 corporate tax rate
Re 0 ,
IACCu 0 :1#

r.A? 0IACC 8 Det7.+uity (IACC? = rDA?*
Re 0 :1# 8 !0007BC000(:1#=1C#* :1.;0#


IACC 0 .76 >Re 8 D76 > Rd > (1= $*
Now y plu""in" values
60 .8D 0 BC0008!000 0 10000
:1# 0 (BC000710000* > Re 8 (!000710000*> 1C#
y rearran"in" e+uation
:1# 0 <.' Re 8 .00;!
.<'Re 0 :1# = .00;!
Re 0 (:1#=.00;!* 7 .<' 0 :1.;0#


Cost of .+uity for ?evered 5irm
0 r.A? 0 Risk 5ree &nterest Rate 8 Business Risk )remium 8 5inancial Risk
)remium.
=========================
BC industries have a eta of 1.1. $he risk free rate is C# and the expected return on the market
portfolio is 1: #.
$he company presently pays a dividend of @1 a shareA and investors expect it to experience a
"rowth in dividends of 10 percent per
annum for many years to come.
a. Ihat is the stock%s re+uired rate of return accordin" to the CA)/,
. Ihat is the stock%s present market price per shareA assumin" this re+uired return,

A)

Beta 0 1#
Rf 0 C#
R m0 1:#

Re+uried rate of return 0 Rf 8 (Rm 9 Rf* > eta

Re+uired rate of return 0 C#8(1:#=C#*>1.1 0 11.1#

')

4 0 10#
Div1 0 1

Re 0 (Div17 )o*8 "

Re 0 (17)o*8 10#
11.1# = 10# 0 17)o
)o 0 1711.1# 0 :!.10 Rs

=======
3tock ? and the MmarketQ has the followin" rates of returns over the past four
years.
/ear 0toc# L $ar#et
!001=== 1!.00#===== 1B.00#
!00'=== 1.00# === !.00#
!00;=== 11.00#====== 1B.00#
!00C=== =;.00# ====== =:.00#
Additional Information:
'0# of your portfolio is invested in 3tock ? and the remainin" B0# is invested in
3tock R. $he risk=free rate is '# and the market risk premium is also '#. Rou
estimated that 1B# is the re+uired rate of return on your portfolio. Ihile 3tock ?
has the eta of 0.<BCB.
*e1uired:
/ou are re1uired to calculate t%e !eta of 0toc# /2
Beta of portfolio



Re+uried rate of return 0 Rf 8 (Rm 9 Rf* > eta
1B# 0 '# 8 '# eta
'# eta 0 C #
Beta of portfolio 0 C7' 0 1.::

$he eta of a portfolio is simply the wei"hted avera"e of the etas of the stocks in the portfolio
Beta of portfolio 0 wei"hted avera"e of ? (eta of ? * 8 wei"hted avera"e of R
(eta of R*

1.:: 0 .'(.<BCB* 8 .B (eta of R*
1.:: = .1'<0B 0 .B eta of R

Beta of R 0 .;'7.B 0 1.<0
(-plain t%e follo&ing conditions:
&RR SIACC
&RR TIACCT 3/?
&RR S3/?
&RR SIACCS 3/?
3oultion
&RR SIACC
you should not invest in this proUect as rate of return is less then IACC. other
words you can you your returns are less the cost of capital.
&RR TIACCT 3/?
we should take this proUect as its rate of rerun is hi"her then the IACC and
it offers etter rate or return then .fficient market offers.
RR S3/?
is showin" rate of return which is
lower than 3/? the company will not invest ecause it is not "ivin" as much
rate of return as efficient market is offerin"
RR SIACCS 3/?
&RR lower than IACC and 3/? company should not invest as &RR is not enou"h to cover the
IACC plus its returns are lower then returns offered y efficient market.
3irms A and ' are identical e-cept t%eir use of de!t and t%e interest rates
t%e4 pa4. 3irm A %as more de!t and t%us must pa4 a %ig%er interest rate.
*e1uirement:
'ased on t%e data gi+en !elo&5 %o& muc% %ig%er or lo&er &ill !e t%e A6s
*,( t%at of '5 i.e.5 &%at is *,(
A
" *,(
'
2

Applica!le to 'ot% 3irms 3irm A6s ata 3irm L6s ata
Assets *s. 750005000 e!t ratio 80% e!t ratio 90%
('IT *s.:005 000 Int. rate 19% Int. rate 10%
Ta- rate 7:%

3or compan4 A 80% le+erage so e1uit4 &ill !e 70% of 750005000 ) ;00000
('IT ) :005000
Interest (19% of :005000) ) (<000)
('T =;=5000
Ta- (7:% of ('T) (1=>900)
?et income 7=:5>00
(-pected *,( ()?I@(1uit4) 7=:5>00@ (;00000) ) 7>.=9%



3or compan4 ' 90% le+erage so e1uit4 &ill !e >0% of 750005000 ) 9=00000

('IT ) :005000
Interest (10% of :005000) ) (:000)
('T =;:5000
Ta- (7:% of ('T) (1=>:00)
?et income 7=<5:00
(-pected *,( ()?I@(1uit4) 7=<:00@ (9=00000) ) 1=.=7%

*,(
A
A *,(
'
) 7>.=9 A 1=.=7
)97.;;