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1. Hauser Chemical Company has issued bonds at 12% interest rate. If the company faces tax rate of 35%, what is the effective rate of interest? Ans 1 . Effective Interest Rate = Int. Rate ( 1- Tax Rate) = 12 * (1-0.35) = 7.8% 2. Calculate the effective cost of debt for each of the following situations: The face value of the debenture is Rs 100, coupon rate of interest on debentures is 10%, maturity period is 10 years and tax rate is 30% a. Debentures are sold at par and floatation costs are 5%
Ans 2 a Effective Interest Rate = 10(1-0.30) +[(100 95)/10] = 7.69% [(100 + 95)/2]
b. Debentures are sold at a premium of 10% and floatation costs are 5% of issue price.
Ans 2 b Effective Interest Rate = 10(1-0.30) +[(100 104.5)/10] = 6.40% [(100 + 104.5)/2]
c. Debentures are sold at a discount of 5% and floatation costs are 5% of the issue price
Ans 2 b Effective Interest Rate = 10(1-0.30) +[(100 90.25)/10] = 8.38% [(100 + 90.25)/2]
3. Reuben Company is considering raising Rs 100 lakh by one of the two alternative methods given: a. 14% institutional term loan b. 13% non convertible debenture
The term loan option has no further costs associated but debentures will be issued at a discount of 2.5% and would involve an issue cost of Rs 1 lakh. Advise the company which is a better option based on effective rate of interest.
Ans 3. Effective Cost of term Loan is 14% as tax rate is not given Effective Cost of Debentures = 13,00,000+[(100,00,000 96,50,000)/1] = 16.79%
[(100,00,000 + 96,50,000)/2] So Debentures Effective cost is higher and the firm is better off with Term Loan
4. Assuming a corporate tax rate of 35%, compute the after tax cost of capital in the following situations:
a. A perpetual 15% debenture of Rs 1000 sold at a premium of 10% with no floatation costs.
Effective Interest Rate = 150(1-0.35) = 8.86% 1100 b. A ten year 14% debenture of face value Rs 2000 redeemable at par with 5 %
floatation costs.
Effective Interest Rate = 280(1-0.35) +[(2000 1900)/10] = 9.84% [(2000+1900)/2]
c. An equity share selling at Rs 50 and paying a dividend at fixed rate of Rs 6 per share every year.
Ke = (6/ 50 ) = 12%
d. The same equity share as described above if dividends are expected to grow at 5%
Ke = (6 (1.05)/ 50) + .05 =17.6%
5. The equity shares of Raja Footwear are selling at Rs 20 per share. The firm has paid dividend of Rs 2 per share last year. Estimate cost of equity for the firm when constant growth rate is expected to be 5%
Ke = (2 (1.05)/ 20) + .05 =15.5%
6. Hirachand Motors has a target capital structure of 40% debt and 60% equity. The interest rate being paid on bonds of the company is 9% and the tax rate for the company is 40%. The companys CFO has concluded that companys WACC is 9.96%. What is the cost of companys cost of equity?
WACC = wdkd + weke 9.96% = 0.4 * (9 * (1-.4)) + 0.6 * ke So ke = 13%
7. Winston Industries capital structure consists only of debt and equity. The company pays an interest of 11% on its debt. It currently pays a dividend of Rs 2 per share and the current market price of the share is Rs 24.75. The companys dividend is expected to grow at a constant rate of 7% per year. The companys tax rate is 35% and its WACC is 13.95%. What percentage of companys capital structure consists of debt financing?
WACC = wdkd + weke 13.95% = wd* (11 * (1- 0.35)) + (1 - wd ) * (2 (1.07)/ 24.75) + .07) So wd = 0.2 and we = 0.8
8. Eastern Electric Company uses only debt and equity. It can borrow at unlimited amounts at an interest rate of 10% as long it maintains its target capital structure which is 45% Debt and 55% equity. Its last dividend was Rs 2, its expected constant growth rate is 4% and the market price of the stock is Rs 20. The tax rate is 40%. Calculate its WACC.
WACC = wdkd + weke = 0.45* (10 * (1- 0.4)) + 0.55 * (2 (1.04)/ 20) + .04 = 10.62%
10. From the following information, calculate the WACC for the company:
Cost of Equity : 12%
After tax Cost of Long Term Debt : 7% After tax Cost of Short Term Debt : 4% Source of Capital Equity Long Term Debt Short Term Debt Total Amount (Rs) 500,000 400,000 100,000 1,000,000
11. The Swan Companys cost of equity is 16%. Its before tax cost of debt is 13%. The tax rate faced by company is 40%. Using the following sources of funds, calculate WACC Sources Amount (Rs lakhs)