40 tayangan

Diunggah oleh Rajesh Govardhan

- cfproj
- 3. Cost of Capital
- Ebit Eps Analysis
- Financial Analysis and Management
- Hudson's Bay Co. v.5.0 (September 6)
- Financial management - -Cost of capital
- corporate finance
- Ahmad Hayat
- Cost of Capital
- Corporate Finance
- Cima F3 Notes
- Capital Cash Flows, APV
- FinMan Reviewer
- M-5
- Capital Structure
- Capital Structure
- financialmanagementpondicherry-140323121153-phpapp01
- FIN_202_S1_2016
- Cost_of_Capital.pdf
- Chapter 16 Planning the Firm's Financing Mix2

Anda di halaman 1dari 99

nd

Semester

Amity Global Business School

Kavitha Menon

1

Introduction

Every company needs funds for:

Working capital for current business operations

Long term investments launching new product,

improvisation of existing product, aggressive

positioning & marketing of product, expansion,

restructuring, acquisition, modernization, contingency

requirements & replacement of long-term assets from

time to time.

2

Introduction

Hence, they should know:

How much funds they require,

From where will they procure the required funds, &

At what cost the funds will be available & procured.

3

Introduction

Small

amounts

Short

maturity

period

Cost is,

therefore

less

Also less

risky

Short

term

funds

Large

amounts

Large

maturity

period

Cost is high

Greater

uncertainty

& risk

Long

term

funds

4

Introduction

As cost of long term funds is high, companies need to

manage such funds & try to control the cost & risk

involved with it.

Inefficient management of such funds can lead to high

cost of capital for the company, which in turn

decreases the profits thereby depleting the value 0f the

company.

5

Concept of cost of capital

6

Investor

Or

lender

Company

or

borrower

Return on lent

money

Cost of borrowed

money

=

Company pays cost to investors

for lending their money

Lends money at an expected

return

Cost Of Capital

The rate that must be earned on the funds or capital

employed by the company.

The minimum rate of return that a firm must earn on

its investments for the market value of the common

stock of the firm to remain unchanged

It is also referred to as a hurdle rate because this is

the minimum acceptable rate of return.

It is the compensation expected by the investors from

the company for the time & risk taken up by them.

7

Cost Of Capital

Any investment which does not cover the firms cost

of funds will reduce shareholder wealth (e.g. if you

borrowed money at 10% to make an investment

which earned 7%, it would reduce your wealth)

Hence if

where r = rate of return

k = cost of capital

8

Value Maximization r > k

Leads to

Meaning

When we say a firm has a cost of capital of, for

example, 12%, we are saying:

The firm can only have a positive NPV on a project if

return exceeds 12%

The firm must earn 12% just to compensate investors for

the use of their capital in a project

The use of capital in a project must earn 12% or more

9

Required Rate of Return

Vs

Cost of Capital

Required rate of return :

is from the investors point of view

Cost of capital :

is the same return from the firms point of view

Appropriate discount rate:

is the same rate yet again to be used in the present

value calculations

10

Significance

Evaluating Capital budgeting decision

Designing a firms optimal capital structure such

that value of the firm is maximum & cost of capital

is minimum

Appraising the financial performance of top

management by comparing the profit & the cost of

capital (r>k)

11

General economic conditions

Demand for and supply of capital within the economy and the

level of expected inflation

Market conditions:

As the marketability of a security increases, investors required

rates of return decrease, lowering the companys cost of capital.

Amount of financing:

Requests for larger amounts of capital increase the firms cost of

capital.

A firms operating and financing decisions

Business Risk- The risk to the firm of being unable to cover the

fixed operating costs.

Financial Risk- The risk of being unable to cover required

financial obligations like interest & preference dividends.

12

Factors determining the cost of capital

Components of cost of capital

Three components of cost of capital, k

The riskless cost of the particular type of financing, r

j

The business risk premium, b

The financing risk premium, f

Or

k = r

j

+ b + f

13

Sources of funds

Common stock (Equity Shares)

Preferred stock (Preference Shares)

Bonds & debentures (debt)

Retained earnings (profit the company makes but does

not give to the shareholders in the form of dividends)

14

Specific Cost

Since different sources of funds have different risks,

investors require different rates of return on various

securities, thereby causing different cost of capital to the

firm.

Risk with equity capital > risk with preference capital> risk

with debt

In case of companies

Cost of equity > cost of preference shares > cost of debt

In case of investors

Return of equity > return of preference shares > return of debt

15

Specific Cost

Example:

Cost of debt

Cost of preference shares

Cost of equity capital

Cost of retained earnings

16

Weighted Average Cost of Capital (WACC)

When the specific costs are combined to arrive at the

overall cost of capital.

Also called composite cost of capital, combined cost of

capital or just cost of capital.

17

Computation of Cost of Capital

Steps:

1. Computation of cost of specific sources of a capital,

viz., debt, preference capital, equity and retained

earnings, and

2. Computation of weighted average cost of capital

18

19

Flotation Costs

When a company sells securities to the public, it must

use the services of an investment banker

The investment banker provides a number of services

for the firm, including:

Setting the price of the issue, and

Selling the issue to the public

The cost of these services are referred to as floatation

costs, and they must be accounted for in the WACC

Generally, we do this by reducing the proceeds from the

issue by the amount of the flotation costs, and

recalculating the cost of capital

20

21

Cost of Debt

Includes :

Term loans from banks & financial institutions

Debentures

Bonds

Debt may be perpetual or redeemable debt.

Also, it may be issued at par, at premium or

discount.

22

Cost of Debt

Regarding Cost of Debt, k

d

:

Equals the current interest cost or coupon rate

to borrow new funds

Current interest rates are determined from the

going rate in the financial markets

Before tax cost of debt is the rate of return

required by the lenders

23

Tax Adjustment

The interest paid on debt is tax deductible

The higher the interest charges, lower would be the

amount of tax payable by the firm.

As a result, the after-tax cost of debt to the firm will be

substantially lower than the investors required rate of

return.

After-tax-cost of debt = k

d

= k

i

(1-t)

Where t is the corporate tax rate & k

i

is before tax

cost of debt

Loss making firms will not have after tax cost of debt.

When calculating WACC, after-tax-cost of debt is to be

used

24

Formula for cost of perpetual debt

1. Before tax cost of debt 2. After tax cost of debt

where,

k

i

- before tax cost of debt

k

d

after tax cost of debt

P

0

- net proceeds of the debt

I - the amount of interest

t tax rate

25

0

P

I

k

i

=

) 1 ( t k k

i d

=

Net proceeds from the issue (P

0

)

Where

P

0

= Net proceeds from the issue

FV = Face Value of Debt

P

m

= Premium

D = Discount

F = Floatation Costs (i.e. cost of raising funds including

underwriting, brokerage & issue expenses

26

F FV P =

0

F P FV P

m

+ =

0

F D FV P =

0

Issued at par

Issued at a

premium

Issued at a

discount

Exercise

Y Ltd issued Rs. 2,00,000, 9% debentures at a premium of

10%. The costs of flotation are 2% of issue price .The tax

rate is 50%. Compute the after tax cost of debt.

Net proceeds = 200,000 + 20,000 2% * 220,000 = 215,600

27

) 1 (

0

t

P

I

k

d

=

) 50 . 1 (

600 , 215

000 , 200 * % 9

=

d

k

% 17 . 4 =

d

k

Exercise

A company has a 10% perpetual debt of Rs. 100,000.

The tax rate is 35%.

Determine the cost of capital (before & after tax)

assuming the debt is issued at

(i) par

(ii) 10% premium

(iii) 10% discount.

Assume floatation costs at 1% of face value

28

Formula for cost of redeemable debt

The debt repayable after a certain period is known as

redeemable debt

where,

I - the amount of interest

RV Redeemable value

P

o

net proceeds from the sale

n term of the debt in years

t tax rate

29

) (

2

1

) (

1

0

0

P RV

P RV

n

I

k

i

+

+

=

) (

2

1

) (

1

) 1 (

0

0

P RV

P RV

n

t I

k

d

+

+

=

Exercise

A company issued Rs. 1,00,000 10% redeemable

debentures at a discount of 5%. The cost of flotation

amount to Rs. 3,000. The debentures are redeemable

after 5 years. Compute before tax and after tax cost

of debt. The tax rate is 50%.

30

Exercise

ABC Ltd. issues 15% debentures of face value of Rs. 100

each, redeemable at the end of 7 years, the debentures

are issued at a discount of 5% and the floatation cost is

estimated to be 1%.

Find out the cost of capital of debentures given that

the firm has 50% tax rate.

31

32

Cost of Preference Capital

It is the dividend expected by the preference shareholders.

In case of preference capital, payment of dividends is not

legally binding

Preference dividend is not tax deductible, unlike interest

payments on debt, as its an appropriation of earnings

They are paid out after corporate tax has been paid. No

adjustment is required for taxes while computing k

p

Since interest is tax deductible & preference dividend is not,

the cost of preference capital is substantially higher

than the after tax cost of debt

Preference capital can be redeemable or irredeemable.

33

Formula for Cost of Irredeemable

Preference Shares

If Preference shares are perpetual,

Where

k

p

cost of preference capital

P

0

net proceeds

D

p

annual preference dividend

D

t

Dividend distribution tax

34

0

) 1 (

P

D D

k

t p

p

+

=

Exercise

A company issued 10,000, 10% preference share of Rs.

10 each, Cost of issue is Rs. 2 per share.

Calculate cost of capital, if these shares are issued (a)

at par , (b) at 10% premium, and (c) at 5% discount.

35

Exercise

A company issued 100,000, 8% irredeemable

preference shares of Rs. 500 each. Issue expenses are

2% of face value. Assuming 10% dividend tax payable

by the company, compute the cost of preference capital

if the shares are issued:

(i) at par

(ii) at 10% discount

(iii) at 10% premium

36

Formula for Cost of Redeemable

Preference Shares

where,

D

p

- the amount of preference dividend

RV Redeemable Value

P

0

net proceeds from the sale

n term of the preference share in years

37

) (

2

1

) (

1

0

0

P RV

P RV

n

D

k

p

p

+

+

=

Exercise

A company issues 1,00,000 10% preference share of Rs.

10 each. Calculate the cost of preference capital if it is

redeemable after 10 years.

a) At par b) at 5% premium

38

Exercise

Calculate cost of preference capital

(a) A company issued 12% preference shares of Rs. 500

each, at Rs. 450 redeemable after 5 years at par. The

cost of flotation is expected to be 5% of issue price.

(b) A company issued 12% preference shares of Rs. 500

each, at Rs. 550 redeemable after 5 years at par. The

cost of flotation is expected to be 5% of issue price.

(c) A company issued 12% preference shares of Rs. 500

each, at Rs. 450 redeemable after 5 years at Rs. 520.

The cost of flotation is expected to be 5% of issue

price.

39

Exercise

ABC Ltd. issues 15% preference shares of the face value

of Rs. 100 at

Par

Premium of 10%

Discount of 5%

Find the cost of capital of preference share if

The preference shares are irredeemable, and

If the preference shares are redeemable after 10 years at a

premium of 10%.

Floatation cost of 4% of issue price.

40

41

Cost of Equity Capital

Minimum rate of return that a firm must earn on the

equity-financed portion of an investment project in

order to leave unchanged the market price of the shares

Equity capital can be raised:

internally by retained earnings

or

the firm can distribute dividends & raise capital by new

issue of equity shares

In both the cases the shareholders are providing funds

to the firms to finance their capital expenditures

Equity shareholders required rate of return would be

same

42

Example

A firm accepts an investment project involving an outlay

of Rs. 1000 which is to financed by equity & debt in the

ratio of 75:25. The project will earn Rs. 110 every year.

Required rate of return on equity is 12% and cost of debt

is 8%.

If the project earns less than Rs. 110, it would give a

return less than that required by investors leading to

decline in market price of shares.

This rate is the cost of equity

43

Rs.

Total Return

Less: Interest on debt 25% * 1000 * 8%

110

20

Amount available to equity shareholders 90

Rate of return on equity = Rs. 90/750 * 100 = 12%

Is equity capital free of cost?

It is often said the equity shares have no cost of

capital no fixed rate of dividend, no commitment to

pay such dividend (sole discretion of the BoD), such

shareholders are the last claimants on the profits of

the company.

But equity capital has a cost - involves opportunity

cost; ordinary shareholders provide funds to the firm

in expectation of dividends and capital gains

44

Difficulties in determining equity

investors rate of return

Two difficulties involved:

Difficult to estimate dividend payments

Depends upon company policy & strategic decisions

Cannot be estimated correctly & they grow over time

Difficult to estimate capital gains

Depends upon market conditions & investors

perceptions, which are difficult to forecast.re expected

to grow

45

Approaches to calculate

cost of equity

To overcome the difficulties, two widely

used approaches are used :

1. Dividend Approach

2. Capital Asset Pricing Model (CAPM)

Approach

46

Dividend Approach

Based on the dividend valuation model which assumes

that the value of a share (current market price of a

share) equals the present value of all future dividends

that it is expected to provide over an indefinite period.

47

Dividend Growth Model

Dividends are expected to grow at a constant rate

of g

g

P

D

k

e

+ =

0

1

48

Where,

k

e

= cost of equity

P

0

= Net proceeds per share/current market

price

D

1

= Expected dividend per share = D

0

(1+g)

g= expected growth in dividends

Net Proceeds in case of new

equity issue

Current market price in case

of existing

Can be written as follows:

These equations are based on the following assumptions:

Market price of the share is a function of expected

dividends

The Dividend is positive

The dividends grow at a constant rate

The dividend payout ratio i.e. (1 b) is constant, b

being retention ratio

Also called as GORDONs model

g k

D

P

e

o

=

1

49

Dividend Growth Model

Cost of Retained Earnings

A firms internal equity consist of its retained earnings.

The opportunity cost of the retained earnings is the

rate of return foregone by equity shareholders.

The shareholders generally expect dividend and capital

gain from their investment.

The required rate of return of shareholders can be

determined from the dividend valuation model

50

If the firm had distributed earnings to shareholders,

they could have invested it in the shares of the firm or

in the shares of other firms of similar risk at the

market price (P

0

) to earn a rate of return equal to k

e

Thus the firm should earn a return on retained funds

equal to k

e

to ensure growth of dividends & share

prices.

If a return less than k

e

is earned on retained earnings,

the market price of the firms share will fall.

51

Explanation

Exercise - 1

ABC Ltd plans to issue 1,00,000 new equity share of Rs.

10 each at par. The flotation costs are expected to be

5% of the share price. The company will pay a dividend

of Rs. 1 per share and the growth rate in dividend is

expected to be 5%. Compute the cost of new issue

share.

52

Exercise - 2

SQL Ltd. has just declared & paid a dividend at the

rate of 15% on the equity share of Rs. 100 each. The

expected future growth rate in dividends is 12%.

Calculate the cost of capital of equity shares given that

the present market value of the share is Rs. 168.

53

Exercise - 3

Epsilon Co.s last annual dividend was Rs. 4 per share

and both earnings & dividends are expected to grow at

a constant rate of 8%. The share now sells for Rs. 50

per share. Calculate the cost of retained earnings

using Gordons growth model

54

Exercise - 4

Investors require a 12% rate of return on equity shares

of Co. Y. What would be the market price of the shares

if the previous dividend was Rs. 2 and investors expect

dividends to grow at a constant rate of

(a) 4%

(b) 0%

(c) -4%

(d) 11%

(e) 12%

(f) 14%

55

Exercise - 5

A mining companys iron ore reserves are being

depleted, and its cost of recovering a declining quantity

of iron ore are rising every year. As a consequence, the

companys earnings & dividends are declining @ 8% per

year. If the previous years dividend was Rs. 10 and the

required rate of return is 15%, what would be the

current price of the equity share of the company?

56

Exercise - 6

The share of SQL Ltd. is presently traded at Rs. 50 and

the company is expected to pay dividends of Rs. 4 per

share with a growth rate expected at 8% p.a.

It plans to raise fresh equity capital. The merchant

banker has suggested that an under-pricing of Re 1 is

necessary in pricing the new issue besides involving a

cost of 50 paisa per share on miscellaneous expenses.

Find out the cost of existing equity shares as well as the

new equity given that the dividend rate and the growth

rate are not expected to change

57

Exercise - 7

The share of a company is currently selling at Rs. 100.

It wants to finance its capital expenditure of Rs. 100

million either by retaining earnings or selling new

shares. If the company sells new shares, the issue price

will be Rs. 95. The dividend per share next year is Rs.

4.75 and it is expected to grow at 6%.

Calculate -

(i) cost of internal equity (retained earnings)

(ii) cost of external equity (new issue of shares)

58

Estimating future growth in dividends

Growth in dividend can be extremely volatile &

sensitive depending upon the market, economic &

company factors.

It is expected future growth impossible to calculate it

accurately

Methods to estimate g

Past growth in dividends

Current retained earnings

59

Past growth in dividends

Example:

Dividends paid by the company during the last few

5 years are: Rs. 18, Rs. 17, Rs. 20. Rs. 24 and Rs. 25.

For accurate results, use TVoM formula

PV

n

= FV

n

* P VIF

(g,n)

Using the formula

P VIF

(g,n)

= 18 /25 = 0.72

Looking into the PVIF table

60

Period 8% 9%

5 0.735 .708

Past growth in dividends

Solve using the above formula:

g = 8.56%

61

(

+ =

PVIF HigherRate PVIF LowerRate

Q PVIF LowerRate

LowerRate g

(

+ =

708 . 0 735 . 0

72 . 0 735 . 0

% 8 g

Growth in earnings arises because a company increases

its investments and obtains a greater earnings.

Higher growth can be obtained through greater

retained earnings and investments in more profitable

assets

Thus, g = r * b

Where

r = rate of return obtained on new investment

b = retention ratio i.e. proportion of earnings retained

62

Current Retained Earnings

Example

The latest earnings and dividends of a company are Rs.

37 and Rs. 16 respectively. The expected rate of return

on new investment is 18%. Calculate expected growth

rate.

b = (37-16)/37 = 0.57

g = r * b

= 0.18 * 0.57

= 10.26%

63

Exercise - 8

An ordinary share of a company, which does not

engage in external financing, is selling for Rs. 50. The

earnings per share is Rs. 7.50 of which 60% is paid as

dividends. The company reinvests retained earnings at

a rate of 10%. Calculate cost of equity capital

64

Exercise - 9

Determine the cost of equity shares of company X:

i. Current market price of a share Rs. 150

ii. Cost of flotation per share on new shares Rs. 3

iii. Dividend paid on the outstanding shares over the past 6

years:

iv. Assume a fixed dividend payout ratio

v. Expected dividend on new shares at the end of the

current year is 14.10 per share

65

Year Dividend (Rs.)

1

2

3

4

5

6

10.50

11.02

11.58

12.16

12.76

13.40

Exercise - 10

XYZ Ltd. is attempting to evaluate the costs of internal &

external equity. The companys share is currently being

sold at Rs. 62.50 per share. The company expects to pay Rs.

5.42 per share at the end of the year. The dividends for the

past 5 years are given below:

The company expects to net Rs. 57.50 per share after

flotation costs. Calculate (a) growth rate of dividend (b)

flotation cost (%) (c)cost of internal equity (d) cost of

external equity

66

Year Dividend (Rs.)

2009

2008

2007

2006

2005

5.17

4.92

4.68

4.46

4.25

Dividend Distribution Tax

In India, as per the income tax act, a company is liable

to pay dividend distribution tax on the dividend

declared by it. The shareholders do not have to pay

any tax.

Then

Where, D

t

is the dividend distribution tax.

67

g

P

D D

k

t

e

+

+

=

0

1

) 1 (

68

Weighted Average Cost of Capital (WACC)

Also called Composite cost of capital or Overall cost of

capital

It is the rate of return that must be earned by the firm

in order to satisfy the requirements of the different

investors.

69

Steps in calculating WACC

70

Calculate the

cost of specific

sources of funds

Multiply the

cost of each

source by its

proportion in

the capital

structure

Add the

weighted

component

costs to get the

WACC.

WACC Vs Simple Average CC

WACC gives consideration to the proportion of various

sources of funds in the capital structure in a company,

which simple average does not.

71

Why WACC ?

Overall cost of capital is of utmost importance as this

rate is to be considered while deciding the optimal

financing mix for the firm and is to be used as the

discount rate or cut-off rate while evaluating the

capital budgeting proposals.

This overall CoC is calculated using WACC

72

Formula for k

o

WACC = Cost of Equity * Proportion of equity in the

financing mix (+) Cost of Debt * Proportion of debt in

the financing mix (+) Cost of preference capital *

Proportion of preference capital in the financing mix

73

w

e

w

d

w

p

Formula for k

o

Where

k

e

= Cost of equity

w

e

= Proportion of equity in the financing mix

k

d

= Cost of debt

w

d

= Proportion of debt in the financing mix

k

p

= Cost of preference capital

w

d

= Proportion of preference capital in the financing mix

74

p p d d e e

w k w k w k WACC * * * + + =

Which weights to use?

The question is which weights to use

Should we use the values given in the balance sheet,

which reflects the historical values of the amounts of

funds raised from various sources?

OR

Should we use the market values of the various claims?

75

Weights used -

Historical or existing weights

1. Book Value

2. Market Value

76

Book -Value Weights

Weights based on the actual or existing proportions of

different sources in the overall capital structure.

Readily available from published records of the firm

balance sheet which lists the long-term debts, equity &

preference capitals

The book value debtequity ratios are analysed by

investors to evaluate the risk of the firms in

practice

77

Book-value Weights (contd)

Source Total book value % of total

Long term debt Rs. 400,000 40%

Preference capital Rs. 100,000 10%

Equity capital Rs. 500,000 50%

Grand Totals Rs. 10,00,000 100%

78

The following table shows the calculation of the

book-value weights for Cost of Capital:

Market-value Weights

The problem with book-value weights is that the book

values are historical, not current values

The market recalculates the values of each type of

capital on a continuous basis. Therefore, market

values are more appropriate

Calculation of market-value weights is very similar to

the calculation of the book-value weights

The main difference is that we need to first calculate

the total market value (price * quantity) of each type

of capital

Market Value of Retained Earnings

Can be indirectly estimated.

Since retained earnings are treated as equity capital for

the purpose of calculation of specific cost of capital,

the market value of the ordinary shares may be taken

to represent the combined market value of equity

shares & retained earnings.

Separate market values of retained earnings & ordinary

shares allocated based on ratio of their book

values

80

Calculating the Market-value weights

Source Price per

unit

Units Total market

value

% of

total

Long term

debt

Rs. 905 400 362,000 31.15%

Preference

capital

Rs. 100 1000 100,000 8.61%

Equity capital Rs. 70 10,000 700,000 60.24%

Grand Totals Rs. 11,62,000 100%

81

The following table shows the current market prices:

Example

Sources of Finance Amount (Rs.) Cost (%)

Equity Share Capital 450,000 18

Reserves & surplus 150,000 18

Preference Capital 100,000 11

Debentures 300,000 8

82

Lohia Chemicals Ltd. has the following book value capital

structure as on 31

st

march 2010 and the expected after tax costs

of carious sources of finance:

Calculate WACC

Solution

Source Amount

(1)

Proportion

(2)

After-

tax cost

(3)

Weighted

cost

(4)=(2)*(3)

Equity Share

Capital

450,000 0.45 0.18 0.081

Reserves &

surplus

150,000 0.15 0.18 0.027

Preference

Capital

100,000 0.10 0.11 0.011

Debentures 300,000 0.30 0.08 0.024

Total 10,00,000 0.143

83

WACC = 0.143 = 14.3%

Alternative Solution

Source Amount

(1)

After-tax cost

(2)

Total cost

(3)=(1)*(2)

Equity Share

Capital

450,000 0.18 81000

Reserves & surplus 150,000 0.18 27000

Preference Capital 100,000 0.11 11000

Debentures 300,000 0.08 24000

Total 10,00,000 143000

84

WACC = (143000/1000000 ) * 100

= 14.3%

85

A firms after-tax cost of capital of the specific sources

is as follows

Cost of debt 8%

Cost of preference capital (inclu. DDT) 14%

Cost of equity funds 17%

The following is the capital structure:

Source Amount (Rs. )

Debt 300,000

Preference Capital 200,000

Equity Capital 500,000

Total 10,00,000

86

Calculate the weighted average cost of capital, k

o

, using

book-value weights

87

A company has on its books the following amounts &

specific costs of each type of capital

TYPE OF CAPITAL BOOK VALUE MARKET

VALUE

SPECIFIC

COSTS

Debt 400,000 380,000 5

Preference 100,000 110,000 8

Equity 600,000 15

Retained Earnings 200,000 12,00,000 13

13,00,000 16,90,000

88

Determine the weighted average cost of capital using (a)

book value weights (b) market value weights.

How are they different?

When will the WACC be the same , using either of the

weights

Exercise - 3

A firm finances all its investments by 40% debt & 60%

equity. The estimated required rate of return on equity

is 20% after taxes and that of debt is 8% after taxes.

The firm is considering an investment proposal

costing Rs. 40,000 with an expected return that will

last forever. What amount must the proposal yield per

year so that the market price of the share does not

changes? Show calculations to prove your point.

89

90

In considering the most desirable capital structure for a

company, the following estimates of the cost of debt

capital (after tax) have been made at various levels of

debt-equity mix:

You are required to find out the weighted average cost of

capital of the firm for different proportions of debt:

91

Debt as % of total

capital employed

Cost of debt (%) Cost of equity (%)

0

10

20

30

40

50

60

7.0

7.0

7.0

7.5

8.0

8.5

9.5

15

15

15.5

16

17

19

20

92

The following balances appear in the balance sheet of

Nagaraj Alloys Ltd.:

The company is expected to earn an EBIT of Rs. 900,000 p.a.

and the tax rate is 40%. The current market prices of equity

& preference shares are Rs. 12.50 and Rs. 8 respectively.

However, the debentures are being traded at par.

Calculate WACC, based on book value & market value

weights, given the retained earnings & dividends are valued

equally by shareholders.

93

Equity share capital of Rs. 5 each Rs. 800,000

10% preference share of Rs. 10 each Rs. 500,000

Reserves & surplus Rs. 600,000

12% debentures of Rs. 100 each Rs. 10,00,000

94

A limited company has the following capital structure :

The market price of the companys equity share is Rs. 20. It is expected

that the company will pay a dividend of Rs. 2 per share at the end of the

current year, which will grow at & 7% forever. The tax rate may be

presumes at 50%. Compute the following:

a) A weighted average cost of capital based on the existing capital

structure

b) The new WACC if the company raises additional Rs. 20,00,000 debt by

issuing 10% debentures. This would result in increasing the expected

dividend to Rs. 3 and leave the growth rate unchanged but the prices of

share will fall to Rs. 15 per share.

c) The cost of equity capital if in (b) above, the growth rate increases to

10%

95

Equity Share Capital (200,000 shares)

6% preference share capital

8% debentures

Rs. 40,00,000

Rs. 10,00,000

Rs. 30,00,000

Rs. 80,00,000

96

The capital structure of MNP Ltd. is as under:

Additional information:

Rs. 100 per debenture redeemable at par has 2% floatation cost and 10

years of maturity. The market price per debenture is Rs. 105.

Rs. 100 per preference share redeemable at par has 3% floatation cost

and 10 years of maturity. The market price per preference share is Rs.

106.

Equity share has Rs. 4 floatation cost and market price per share of

Rs. 24. The next year expected dividend is Rs. 2 per share with annual

growth of 5%. The firm has a practice of paying all earnings in the

form of dividends.

Corporate Income-tax rate is 35%.

Required : Calculate Weighted Average Cost of Capital (WACC) using

market value weights.

97

9% Debenture

11% Preference shares

Equity shares (face value : Rs. 10 per share)

Rs. 2,75,000

Rs. 2,25,000

Rs. 5,00,000

Rs. 10,00,000

98

A company wishes to determine the optimal capital

structure from the following information. Determine

the optimum capital structure from the viewpoint of

minimizing the cost of capital.

99

Financing

Plan

Debt

Amount

Equity

Amount

After tax

cost of

debt (%)

Cost of

equity

(%)

A

B

C

D

800,000

600,000

500,000

200,000

200,000

400,000

500,000

800,000

14

13

12

11

20

18

16

18

- cfprojDiunggah olehrahulb824
- 3. Cost of CapitalDiunggah olehDiNesh Prajapati
- Ebit Eps AnalysisDiunggah olehSitaKumari
- Financial Analysis and ManagementDiunggah olehFerdousAzam
- Hudson's Bay Co. v.5.0 (September 6)Diunggah olehnabs
- Financial management - -Cost of capitalDiunggah olehSoledad Perez
- corporate financeDiunggah olehMaliha Khan
- Ahmad HayatDiunggah olehasad9058
- Cost of CapitalDiunggah olehsachinrema
- Corporate FinanceDiunggah olehAditya Bajoria
- Cima F3 NotesDiunggah olehPablo Ruibal
- Capital Cash Flows, APVDiunggah olehAvi Aggarwal
- FinMan ReviewerDiunggah olehPatricia Zamora
- M-5Diunggah olehMiriam Yates
- Capital StructureDiunggah olehabose06
- Capital StructureDiunggah olehkedar25h
- financialmanagementpondicherry-140323121153-phpapp01Diunggah olehNguyen Dac Thich
- FIN_202_S1_2016Diunggah olehherueux
- Cost_of_Capital.pdfDiunggah olehAditya Shrestha
- Chapter 16 Planning the Firm's Financing Mix2Diunggah olehapi-19482678
- Syllabus Course 20211 AY 2016 2017 ENGDiunggah olehAnnaMerlino
- Cost of Capital Problems.docxDiunggah olehshikha_asr2273
- Cost of CapitalDiunggah olehRadHika GaNdotra
- unit-2fm_1460739317273.docDiunggah olehnanakethan
- BCOM-VI-APR'16.pdfDiunggah olehMohitraheja007
- Homework 3.pdfDiunggah olehuniguy123
- Capital_Structure.docDiunggah olehMohammad Aref
- EVA AnalysisDiunggah olehanakpintar1701
- Capital TheoriesDiunggah olehYash Agarwal
- notes FMDiunggah olehSneha Jayal

- financeDiunggah olehAkshay Hemanth
- Manual of Regulations for Banks Vol 1Diunggah olehNeneng Kuna
- Divide and ConquerDiunggah olehKlaus
- BUS 401 Week 2 QuizDiunggah olehassignmentclick11
- Cash Flow Analysis, Gross Profit Analysis, Basic Earnings Per Share and Diluted Earnings Per ShareDiunggah olehMariel de Lara
- Test 1 w Answers (1)Diunggah olehVaniamarie Vasquez
- National Economy, Patrimony and Ammendment CasesDiunggah olehcatapult25
- Banking Foundation Course v2.1Diunggah olehdipak1480
- 27012542-Sources-of-Long-Term-FinanceDiunggah olehSusheel Thakur
- Corporate financeDiunggah olehLuckmore Chivandire
- JAYA ReportDiunggah olehtejas
- US Internal Revenue Service: p542--1997Diunggah olehIRS
- WACC.pptDiunggah olehMarwel Magtoto
- AMENDED ARTICLES OF INCORPORATION OF.docxDiunggah olehAnonymous m6dBBnd
- Plan for DemutualizationDiunggah olehfahd_faux9282
- Unit 4.pdfDiunggah olehPradeepa Stephen
- Ratio AnalysisDiunggah olehSajid Anotherson
- Chap 017Diunggah olehzeedanshan
- fcffginzu2014.xlsDiunggah olehPro Resources
- SynopsisDiunggah olehPradipna Lodh
- Tax 1 October 26Diunggah olehArgel Cosme
- Innovative Financial Instruments in IndiaDiunggah olehriyasacademic
- Aditya Birla GroupDiunggah olehNarendra Thummar
- Bridging Document Igcse Accounting 1Diunggah olehKhaled Turk
- SVFI - Summer 2017 - Legal & IP - Hans KimDiunggah olehFounder Institute
- the risk and return analysis of equity fund in sundaram mutual fundDiunggah olehmallesha02
- Ch 1 Structure and Role of the Financial MarketDiunggah olehLeo Yam
- MODAUD2 Unit 8 Audit of Equity T31516Diunggah olehmimi96
- IL_&_FS_AR_2011Diunggah olehAdi Krish
- COCOFED vs Sandiganbayan GR 177857-58 Sept 04, 2012Diunggah olehBerniceAnneAseñas-Elmaco