ADHISH SIR’S CLASSES 1

CHAPTER - COST OF CAPITAL

Question: 1

Answer: Cost of debentures – 5.47 %; Cost of preference capital – 10.10 %; Cost of equity capital –
15 %; Cost of retained earnings – 14.56 %; WACC (Book value weights – 11.34 %)

Question: 2 [CMA – Dec. 2013]

The capital structure of J ltd. is as under:
Rs.
Equity shares @Rs.10 each 1,00,000
9% preference shares @Rs.100 each 30,00,000
14% debentures @ Rs.100 each 70,00,000
The market price of these securities are :
Equity shares 35 per share
Preference share 120 per share
Debentures 110 per debenture
Other information are :
(i) Equity shares have a floatation cost of Rs.5 per share. The next year’s expected dividend is Rs.3
with annual growth of 5%. The company pays all earnings in the form of dividends.
(ii) Preference shares are redeemable at a premium of 10%, have 2% floatation cost and 10 year
maturity.
(iii) Debentures are redeemable at par, have 4% floatation and 10 per year maturity.
(iv) Corporate tax rate is 30%.
You are required to calculate the weighted average cost of capital using (i) book value weights and (ii)
market value weights.
Answer:
 ADHISH SIR’S CLASSES 2
Question: 3 [CMA – Dec. 2014]
st
The following is the capital structure of P ltd. as on 31 March, 2014 : 6,00,000 equity shares at Rs.10 each
fully paid
10,000 9% preference shares of Rs.100 each fully paid
30,000 12% debentures of Rs.100 each
The equity shares sells at Rs.20 per share. The dividend expected next year is Rs.2.5 per share. Which is
expected to grow at 5% per annum forever. Corporate tax rate is 30%.
(a) Compute the weighted average cost of capital based on the existing capital structure.
(b) If the company raises an additional debt of Rs.25,00,000 by issuing 14% debentures, resulting in
increasing the expectation on equity dividend to Rs.2.70 per share and leaving the growth rate unchanged
and the fall in equity share price to Rs.18 per share, find the revised weighted average cost capital.

Question: 4 [CMA – Dec. 2015]

G ltd. issues 20,000 , 12% debentures of Rs.100 each at premium of 10 per cent. The debentures are
redeemable are redeemable after the expiry of a fixed period of 10 years at 20 per cent premium. Calculate
the cost of debt after 30% tax.

Question: 5 [CMA – Dec. 2015]

A company has earning of Rs.5,00,000. The capital structure of the company has debt and equity in which
debt of Rs.8,00,000 is borrowed at 10%. The cost of equity capital is currently 12.5%. Calculate the value
of the firm and overall cost of capital by the net income approach. Ignore taxes. Take market value of debt
at par.

Question: 6 [CMA – June, 2016]

st
ABC ltd. has the following book value capital structure as on 31 March, 2016:
Particulars Amount (Rs.)
Equity share capital 40,00,000
11.5% preference shares 10,00,000
10% debentures 30,00,000
80,00,000
The equity share of the company sells for Rs.20. it is expected that next year the company will pay a
dividend of Rs.2 per equity share, which is expected to grow at 5% p.a. forever. Assume a 35% corporate
tax rate.
Using book value weight:
(i) Compute weighted average cost of capital (WACC) of the company based on the existing capital
structure.
(ii) Compute the new WACC, if the company raises an additional Rs.20 lakhs debt by issuing 12%
debentures, at par Rs.100 which would result in increasing the expected equity dividend to Rs.2.40 and
leave the growth rate unchanged, but the price of equity share will fall to Rs.16 per share.

Question: 7 [CMA – June, 2017]

A company issued 10,000, 10% preference share of Rs.10 each, cost of issue is Rs.2 per share. Calculate
cost of capital, assuming that the shares are issued (a) at par, (b) at 10% premium, and (c) at 5% discount.

Question: 8 [CMA – June, 2009]

The capital structure of Hilson ltd. as on March 31, 2009 is given below:
(Amount in Rs.lakh)
Equity shares (Rs.10 per share) 540
Reserves and surplus 360
8% preference shares (Rs.100 per share) 180
10% debentures (Rs.100 per debenture) 180
11% term loans 540
 ADHISH SIR’S CLASSES 3
1800
All these securities are traded in the capital markets
Recent prices are:
Rs.
Ex-dividend equity share price 15
Ex-dividend 8% preference share price 120
Ex-Interest 10% debenture market value 103
Additionally the following information are available:
Company’s equity beta – 1.06
Yield on long term treasury bonds – 8%
Stock market risk premium – 6%
The debentures are redeemable after 3 years and interest is payable annually.
The income-tax rate applicable to the company is 35%.
Required:
Using the information in the case, determine the weighted average cost of capital (WACC) of Hilson ltd.
based on market value weights.

Question: 9 [Study Material]

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.

Question: 10 [Study Material]

Calculate the Cost of Capital from the following cases:
(i) 10-year 14% Preference shares of `100, redeemable at premium of 5% and flotation costs 5%. Dividend
tax is 10%.
(ii) An equity share selling at `50 and paying a dividend of `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 `120 per share. The earnings per share is `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.

Question: 11 [Study Material]

From 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

Question: 12 [Study material]

In considering the most desirable capital structure of a company, the following estimates of the cost of debt
and equity capital (after tax) have been made at various levels of debt- equity mix:
Debt as a percentage of total capital employed Cost of debt (%) Cost of equity (%)
0 5.0 12.0
10 5.0 12.0
20 5.0 12.50
 ADHISH SIR’S CLASSES 4
30 5.50 13.0
40 6.0 14.0
50 6.50 16.0
60 7.0 20.0
You are required to determine the optimal debt-equity mix for the company by calculating composite cost
of capital.

Question: 13 [Study Material]

Determine the weighted average cost of capital using (i) book value weights; and (ii) market value weights
based on the following information:
Book value structure: `
Debentures (`100 per debenture) 8,00,000
Preference shares (`100 per share) 2,00,000
Equity shares (`10 per share) 10,00,000
20,00,000
Recent market prices of all these securities are:
Debentures: ` 110 per debenture;
Preference share: ` 120 per share; and
Equity shares: ` 22 per share
External financing opportunities are:
(a)`100 per debenture redeemable at par, 10 year maturity, 13% coupon rate, 4% flotation cost and sale
price `100;
(b)`100 per preference share redeemable at par, 10 year maturity, 14% dividend rate, 5% flotation cost and
sale price `100; and
(c) Equity share –`2 per share flotation costs and sale price `22 Dividend expected on equity share at the
end of the year is `2 per share; anticipated growth rate in dividend is 7%. Company pays all its earnings in
the form of dividends. Corporate tax rate is 50%.

Question: 14 [Study Material]

The present capital structure of a company is as follows:
`(million)
Equity share (Face value = `10) 240
Reserves 360
11% Preference Shares (Face value = `10) 120
12% Debentures 120
14% Term Loans 360
1,200
Additionally the following information are available:
Company‘s equity beta 1.06
Yield on long-term treasury bonds 10%
Stock market risk premium 6%
Current ex-dividend equity share price `15
Current ex-dividend preference share price `12
Current ex-interest debenture market value `102.50 per `100
Corporate tax rate 40%
The debentures are redeemable after 3 years and interest I paid annually. Ignoring flotation costs, calculate
the company‘ weighted average cost of capita (WACC).

Question: 15 [Study Material]

 ADHISH SIR’S CLASSES 5
Aries Limited wishes to raise additional finance of `10 lacs for meeting its investment plans. It has
`2,10,000 in the form of retained earnings available for investment purposes. The following are the further
details:
1. Debt/equity mix 30% / 70%
2. Cost of debt upto`1,80,000 10% (before tax) beyond `1,80,000 16%(before tax)
3. Earnings per share `4
4. Dividend payout 50% of earnings
5. Expected growth rate in dividend 10%
6. Current market price per share `44
7. Tax rate 50%
You are required to:
(i) To determine the pattern for raising the additional finance.
(ii) To determine the post-tax average cost of additional debt.
(iii) To determine the cost of retained earnings and cost of equity, and
(iv) Compute the overall weighted average after tax cost of additional finance.

Question: 16
A Company issues shares of Rs.10,00,000, 10% redeemable debentures at a discount of 5%. The cost of
floatation amount to Rs.30,000. The debentures are redeemable after 5 years. Calculate before tax and after
tax cost of debt assuming tax rate of 50%.

Question: 17
A 5-year Rs.100 debenture of a firm can be sold for a net price of Rs.96.50. The coupon rate of interest is
14 %per annum and debenture will be redeemed at 5% premium on maturity. The firm tax rate is 40%.
Compute the after tax cost of debentures.

Question: 18 [CMA – June, 98]

Calculate the cost of capital in the following cases:
(i) X Ltd. issues 12 % debentures of face value Rs. 100 each and realizes Rs. 95 per debenture. The
debentures are redeemable after 10 years at a premium of 10 %.
(ii) Y Ltd. issues preference shares of face value Rs. 100 each carrying 14 % dividend and the realizes Rs.
92 per share. The shares are repayable after 12 years at par.
Note – Both companies are paying income tax at 50 %.

Question: 19 [CMA – Dec. 2000]

Calculate the approximate debenture’s capital, when it decides to issue 10,000 nos. of 14 % non –
convertible debentures, each of face value Rs. 100, at par. The debentures are redeemable at a premium of
10 % after 10 years. The average realisation is expected to be Rs. 92 per debenture and the tax rate
applicable to the company is 40 %.

Question: 20 [CMA – June, 1980]

Your company’s share is quoted in the market at Rs. 20 currently. The company pays a dividend of Re. 1
per share and the investor’s market expects a growth rate of 5 % per year.
Compute:
(i) The company’s equity cost of capital.
(ii) If the anticipated growth rate is 6 % p.a. calculate the indicated market price per share.
(iii) If the company’s cost of capital is 8 % and the anticipated growth rate is 5 % p.a. calculates the
indicated market price if the dividend of Re. 1 per share is to be maintained.

Question: 21 [CMA - Dec. 1996]

The capital structure of Yati Ltd. as on 31.3.2006 is as follows:
Equity capital: 100 lakhs equity shares of Rs. 10 each Rs. 10 crores
Reserves Rs. 2 crores
14 % debentures of Rs. 100 each Rs. 3 crores
 ADHISH SIR’S CLASSES 6
for the year ended 31.3.2006 the company has paid equity dividend at 20 %. As the company is a market
leader with good future, dividend is likely to grow by 5 % every year. The equity shares are now traded at
Rs. 80 per share in the stock exchange. Income tax rate applicable to the company is 50 %.
Required:
(i) The current weighted cost of capital.
(ii) The company has plans to raise a further Rs. 5 crores by way of long term loan at 16 % interest. When
this takes place the market value of the equity shares is expected to fall to Rs.50 per share. What will be
the new weighted average cost of capital of the company.

Question: 22 [CMA – Dec. 2002]

A company has the following capital structure:
Equity share capital 10,00,000
Reserves and surplus (retained earnings) 8,00,000
12 % debentures: 5,000 of Rs. 100 5,00,000
Total 23,00,000
(i) If the company is paying dividend at 27 %, calculate the cost of equity and weighted average cost of
capital, based on book values.
(ii) If the market value of equity shares is Rs. 15 each and if the debentures are quoted at Rs. 95 each, what
is the weighted average cost of capital, based on market values.
Note – Tax rate in both cases is 50 %.

Question: 23 [CMA – Dec. 2000]

AB Ltd. estimates the cost of capital and debt components of its capital for different levels of debt: equity
mix as follows:
Debt as % of total capital Cost of equity Cost of debt (before tax)
0 16 % 12 %
20 % 16 % 12 %
40 % 20 % 16 %
60 % 25 % 20 %
Suggest the best debt: equity mix for the company. Tax rate applicable to the company is 50 %. Show
workings.

Question: 24
Aries Ltd wishes to raise additionally finances of Rs. 10 Lakhs for meetings its investments plans. It has
Rs. 2,10,000 in the form of retained earnings available for investments purposes. The following are the
further details.
(1) Debt/ equity mix 30%:70%
(2) cost of debt up to Rs. 1,80,000 10% (Before tax)
Beyond Rs. 1,80,000 16 % (before tax)
(3) Earnings per share Rs. 4
(4) Dividend pay out 50% of earnings
(5) Expected growth rate in dividend 10%
(6) Current market price per share Rs. 44
(7) Tax rate 50%
You are required:
(a) To determine the pattern for raising the additional finance
(b) To determine the post-tax average cost of additional debt.
(c) To determine the cost of retained earnings and cost of equity and
(d) Compute the overall weighted average after tax cost of additional Finance.

Question: 25 [Work book]

Asif J. Ltd. has 12% perpetual debt of ` 4,00,000. The tax rate is 40%. Ascertain the cost of debt assuming
that the debt is issued (i) at par, (ii) at a discount of 10%, and (iii) at a premium of 10%.
 ADHISH SIR’S CLASSES 7
Question: 26 [Work book]
Sona Awal Ltd. issued 12% debentures @ `100 each in order to raise `15,00,000 to finance a project. The
flotation cost was 10%. The debentures were redeemable at par at the end of 5 years. The income tax
rate applicable to the company was 40%. Ascertain the cost of debt.

Question: 27 [Work book]

Ratul India Ltd. issues 15% irredeemable preference shares. Its face value is `100 and the expense relating
to the issue of shares is 10%. Ascertain the cost of such preference share if it is issued - i) at par,
ii) at a discount of 10% and iii) at a premium of 10%.

Question: 28 [Work book]

The current market price of an equity share of `100 is `150 and underwriting commission inclusive of all
Costs of issue is 5% on issue price. The dividend per share paid for the last five years were as follows –
Year 2012 2013 2014 2015 2016
` 10.00 10.80 11.67 12.60 13.61
The company has a fixed dividend payout ratio and current growth in earnings and dividend is likely to
be maintained in future. Estimate the cost of equity.

Question: 29 [MTP – Dec. 2017]

PKj Limited has obtained funds from the following sources, the specific cost are also given against them:
Sources of funds Amount Cost of capital
Equity shares 30,00,000 15 %
Preference shares 8,00,000 8%
Retained earnings 12,00,000 11 %
Debentures 10,00,000 9 % (Before tax)
You are required to calculate the weighted average cost of capital assuming that corporate tax rate is 30%.

Question: 30 [MTP – June, 2017]

PQR Ltd. operating income (before interest and tax) is `11,25,000. The firm’s cost of debts is 10% and
currently firm employs `37,50,000 of debts. The overall cost of capital of firm is 12%. Calculate cost of
equity.

Question: 31 [MTP – June, 2018]

ABC Ltd is considering raising of funds of `100 lacs by one of the alternative method. (I) 14 %
Institutional Loan.(II)13% Non Convertible Debentures. The term loan option would attract no separate
incidental cost. The debentures would have to be issued at discount of 2.5% and cost of issue is `100000.
Advise ABC Ltd as to which is better option. Assume tax rate 50%

Question: 32 [RTP – June, 2018]

Determine the cost of capital for H P Ltd using the book (BV) and market value (MV) weights from the
following information:
Equity shares `1,20,00,000 (Market value - `2,00,00,000)
Retained earnings `30,00,000
Preference shares `9,00,000 (Market value - `10,40,000)
Debentures `36,00,000 (Market value - `33,75,000)
Additional information:
(i) Equity: Equity shares are quoted at ₹130 per share and a new issue priced at ₹125 will be fully
subscribed; flotation costs will be ₹ 5 per share.
(ii) Dividend: During the previous 5 years, dividends have steadily grown from ₹10.60 to ₹ 14.19.
Dividend at the current year-end is expected to be ₹15 per share.
(iii) Preference shares: 15% Irredeemable Preference shares with face value of ₹ 100 would realise ₹ 105
per share.
(iv) Debentures: The company proposes to issue 11 year 15% Debentures but the yield on debentures of
similar maturity and risk class is 16%; flotation cost is, 2 %.
(v) Tax: Corporate tax rate is 35%. Ignore dividend tax.
 ADHISH SIR’S CLASSES 8
Question: 33
The shares of a company are selling at Rs. 40 per share and it had paid a dividend of Rs. 4 per share last
year. The investor’s market expects a growth rate of 5 % per year.
(a) Compute the company’s equity cost of capital.
(b) If the anticipated growth rate is 7 % per annum, calculate the indicated market price per share.

Question: 34
From the following information, determine the cost of equity capital using the CAPM approach.
(i) Required rate of return on risk free security, 8 %.
(ii) Required rate of return on market portfolio of investment is 13%.
(iii) The firm’s beta is 1.6.

Question: 35
Calculate the cost of equity from the following data / information:
Risk free return 10 %
Market return 12.5 %
Beta of equity 1.5

Question: 36
The market is giving an average return of 18 %. The risk free return is 11 %.
Required:
(i) What return would be expected from an investment having a beta factor of 0.9?
(ii) What beta factor would be necessary for an investment to yield a return of 21.6 %?

Question: 37
The shares of SV & Company are selling at Rs. 20 per share. The firm had paid dividend @ Rs. 2 per share
last year. The estimated growth of the company is approximately 5 % per year.
Required:
(a) Determine the cost of equity capital of the company.
(b) Determine the estimated market price of the equity shares if the anticipated growth rate of the firm
(i) Rises to 8 %, and (ii) Falls to 3 %.

Question: 38
(a) A company plans to issue 1000 new shares of Rs. 100 each at par. The floatation costs are expected to
be 5% of the share price. The company pays a dividend of Rs. 10 per share initially and the growth in
dividends is expected to be 5%. Compute the cost of new issue of equity shares.
(b) If the current market price of an equity share is Rs. 150, calculate the cost of existing equity share
capital.

Question: 39
A company offers for public subscription the shares of `10 at a premium of 10 %. The commission costs
for the company is 5 %. Dividend rate is 20 %. Calculate cost of equity.

Question: 40
A company issues new equity with each share at `150. The underwriting cost is 2 %. Following is the
dividend history of the company. The expected dividend on the new share is `14.10. Find the cost of
equity.
Year 1994 1995 1996 1997 1998
Dividend per share 10.50 11 12.50 12.75 13.40