TASK
- What is cost of capital?
- Define cost of capital.
- Cost of capital computation based on certain assumptions. Discuss.
- Explain the classification of cost.
- Mention the importance of cost of capital.
- Explain the computation of specific sources of cost of capital.
- How over all cost of capital is calculated?
- Explain various approaches for calculation of cost of equity.
- Rama company issues 120000 10% debentures of Rs. 10 each at a premium of 10%. The costs of floatation are 4%. The rate of tax applicable to the company is 55%. Complete the cost of debt capital . (Ans. 4.26%)
- Siva Ltd., issues 8000 8% debentures for Rs. 100 each at a discount of 5%. The commission payable to underwriters and brokers is Rs. 40000. The debentures are redeemable after 5 years. Compute the after tax cost of debt assuming a tax rate of 60%. (Ans. 3.69%)
- Bharathi Ltd., issues 4000 12% preference shares of Rs. 100 each at a discount of 5%. Costs of raising capital are Rs. 8000. Compute the cost of preference capital.
- Firm pays tax at 60%. Compute the after tax cost of capital of a preferred share sold at Rs. 100 with a 8%. Dividend and a redemption price of Rs.110, if the company redeems in five years. (Ans. 9.52%)
- Your company share is quoted in the market at Rs. 40 currently. The company pays a dividend of Rs. 5 per share and the investors market expects a growth rate of 7.5% per year:
(i) Compute the company’s equity cost of capital.
(ii) If the anticipated growth rate is 10% p.a. Calculate the indicated market price per share.
(iii) If the company’s cost of capital is 15% and the anticipated growth rate is 10% p.a. Calculate the indicated market price if the dividend of Rs. 5 per share is to be maintained. (Ans. (i) 20%, (ii) 1/10%, (iii) 1/5%)
- Mr. Subramanian is a shareholder in Alpha Company Ltd. Although earnings for the Alpha company have varied considerably, Subramanian has determined that long turn average dividends for the firm have been Rs. 5 per share. He expects a similar pattern to prevail in the future. Given the volatility of the Alpha’s minimum rate of 40%, should it be earned on a share, what price would
Subramanian be willing to pay for the Alpha is shares? (Ans. Rs. 12.50%)
- A Beta Ltd., iron steel reserves are being depleted and its costs of recovering a declining quantity of iron steel are rising each year. As a equal to it the company earnings and dividends are declining at a rate of 12% p.a. If the previous year’s
dividend (DO) was Rs. 40 and the required rate of return is 15%. What would
be the current price of the equity share of the company? (Ans. Rs. 95.14)
- The following items have been extracted from the liabilities side of the balance
sheet of Vivekananda company as on 31st December 2004.
Paid up capital Rs.
2500 Equity shares of Rs. 100 each 250000
Reserve and Surplus 350000
Loans:
10% Debentures 100000
12% Institutional Loans 300000
Other information about the company as relevant is given below:
Year ended Dividend Earnings Average
Market Price Per share Per share Per share
31st Dec. (Rs.) (Rs.) (Rs.)
2004 7.00 11.00 80.00
2003 6.00 10.00 60.00
2002 7.00 8.00 50.00
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Financial Management
You are required to calculate the weighted average cost of capital, using book
values as weights and earnings/price (E/P) ratio as the basis of cost of equity.
Assume 50% tax rate.
(Ans. Weighted average cost of capital=10.55%)
- The following is an extract from the financial statements of Ramakrishna Ltd.
(Rs. Lakhs)
Operating Profit 90
Less: Interest on Debentures 24
66
Less: Income Tax (50%) 33
Net Profit 33
Equity share capital (share of Rs. 10) 150
Reserve and Surplus 75
10% Debentures 150
375
The market price per equity share is 11 and per debenture Rs. 95.
(i) What is the earning per share?
(ii) What is the percentage cost of capital to the company for the equity and
debentures funds? (Ans. (i) Rs. 2.20, (ii) 20%)
(iii) Cost of debenture funds
Book Value = 5%
Market Price = 5.26%
- Raj Ltd. is currently earning Rs. 2,00,000 and its share is selling at a market price
of Rs. 160. The firm has 20,000 shares outstanding and has no debt. The earnings
of the firm are expected to remain stable, and it has a payout ratio of 100%. What
is the cost of equity? If the firms earns 15% rate of return on its investment
opportunities then what would be the firm’s cost of equity if the payout ratio
is 60%?
(Ans. (i) When the payout ratio is 100%, 12.5%
(ii) When the payout ratio is 60%, 13.5%)
- Kumar Industries Ltd. has assets of Rs. 80000 which have been financed with
Rs. 26,000 of debt and Rs. 45,000 of equity and a general reserve of Rs. 9,000
The firm’s total profit after interest and taxes for the year ended 31st March 2,000
were Rs. 6,750. It pays 10% interest on borrowed funds and is in the 60% tax
bracket. It has 450 equity shares of Rs. 100 each selling at a market price of Rs.
120 per share. What is the weighted average cost of capital?
(i) EPS Rs. 15
(ii) Cost of equity 12.5%
(iii) Average cost of capital 9.74.
