Cost of capital

Q1 Assuming the corporate tax rate of 35%, compute the after tax cost of capital in the following
situations: (i) Perpetual 15% Debentures of `.1,000, sold at a premium of 10% with no flotation costs. (ii)
10-year 14% Debentures of `.2,000, redeemable at par, with 5% flotation costs.

Q2Calculate the Cost of Capital from the following cases: (i) 10-year 14% Preference shares of Rs.100,
redeemable at premium of 5% and flotation costs 5%. Dividend tax is 10%. (ii) An equity share selling at
`Rs.50 and paying a dividend of Rs`.6 per share, which is expected to continue indefinitely. (iii) The
above equity share if dividends are expected to grow at the rate of 5%. (iv) An equity share of a
company is selling at `Rs120 per share. The earnings per share is Rs.20 of which 50% is paid in dividends.
The shareholders expect the company to earn a constant after tax rate of 10% on its investment of
retained earnings.

Q3From the following information, determine the appropriate weighted average cost of capital, relevant
for evaluating long-term investment projects of the company. Cost of equity 0.18 After tax cost of long-
term debt 0.08 After tax cost of short-term debt 0.09 Cost of Reserve 0.15 Sources of capital

Book Value (BV) Market Value (MV)

Equity: Capital `3,00,000 ` 7,50,000

Reserve 2,00,000 –

Long-term debt 4,00,000 3,75,000

Short-term debt 1,00,000 1,00,000

10,00,000 12,25,000