Cost of Capital

1. From the following information, determine the cost of equity using CAPM model a. Required rate of return on risk-free security is 8% b. Required rate of return on market portfolio of investment is 13% c. The firms beta is 1.6 (Ans. 16%) 2. XYZ Ltd. Has the following capital structure as per its balance sheet as on 31 march, 2009:Rs. In Lakh Equity share capital (Rs. 10 per share) 8 18% Preference share (Rs. 100 each) 6 Reserves & Surplus 2 13.5% debentures(Rs. 100 each) 16 14% term loan 8 The current market price of hte company shares is Rs. 50 and the growth rate is 9%. The current dividend is Rs. 5 per shares. The current market price of the preference share and debentures is RS. 110 and 95 respectively. Calculate the weighted average cost of capital using book value and market value weights. (hint. Cost of equity and retained earnings will be same in the case of book value and retained earnings will not be shown in the market value weights) (Ans. Book value 13.415%, market value 15.97%)
3. Gulmarg Ltd. Is having the following capital structure:Particulars Amount in million Rs. 10% Debt 30 10.2% Preferred stock 10 Common stock 60 The tax rate for the company is 34%. The company is paying the dividend of Rs. 5 per share and the current market price is Rs. 58.25. The growth rate is assumed to be 5%. Calculate the weighted average cost of capital for Gulmard Ltd. (Ans. 11.40%) 4. ABC issues bonds of par value of Rs. 2000 at 12% on 8% discount for 10 years.

Calculate its yield to maturity.

(Ans. 13.33%)

5. The balance sheet of XYZ ltd. Reveal the information shown in the following table:Source of funds Amount in Million Rs. Equity capital (Rs. 100 each) 400 12% debentures 600 16% Term loan 1,000

Calculate the weighted average cost of capital of the company. The company as a rule pays constant dividend at the rate of 20% p.a. The corporate tax rate is 50%. (Ans. 9.8%) 6. Dhanvantri Ltd. Has the following capital structure: Source of fund Amount in million Rs. Equity capital 5,000 shares of 100 each 5,00,000 9% preference share 1,50,000 12% debentures 3,50,000 The equity shares of the company has current market price of Rs. 105 and the company declared a dividend of 9%. The applicable tax rate for the company is 50%. The company can also raise additional loan at 10% for Rs. 5,00,000 to finance its expansion. Calculate the weighted average cost of capital for the firm before the financing and after the financing for the expansion. (ans. Before financing, 10.23%, after financing 8.42%) 7. A company wants to issue the debenture (face value of Rs. 100) at 10% interest today and which will redeemed in 5 years at par. At what price the company should issue debenture? (Ans. Rs. 100) 8. X ltd. Wants to issue 14% debenture of face value of Rs.100. The debentures are redeemed at par after 10 years at 10% premium. What should be the issue price, if the tax rate is 50%. (ans. Rs. 90)

Leverage
1. The following data relates to two companies , A and B Particulars A (Amount in million Rs.) Sales 100 Variable cost 40 Contribution 60 Fixed cost 32.5 EBIT 27.5 Interest 7.5 PAT 20 B(Amount in million Rs.) 125 40 85 50 35 10 25

Determine the operating, financial and total leverage for the two companies. (Ans. A DTL 3, B DTL 2.4) 2. Modern chemicals requires Rs. 25,00,000 for a new plant. This plant is expected to yield EBIT of Rs. 5,00,000 p.a. While deciding about the financial plan, the company considers the objective of maximising the EPS. It has three alternative to finance the project :a. By raising debt of Rs. 2,50,000 and rest equity shares b. By raising debt of Rs. 10,00,000 and rest equity shares c. By raising debt of Rs. 15,00,000 and rest equity shares The companys share is currently selling at Rs. 150 but is expected to decline to Rs. 125 in case the funds are borrowed in excess of RS. 10,00,000. The funds can be borrowed at the rate of 10% up to Rs. 2,500,000 and 15% over Rs. 2,50,000 and up to Rs .10,00,000 and at

20% over Rs. 10,00,000. The applicable tax rate is 50%. Which form of financing should the company choose? (Ans. EPS under A Rs. 10.6, B 12.08, C 13.12) 3. Bhaskar manufacture Ltd. Has equity share capital of RS. 5,00,000 (face value Rs. 100) to meet the expenditure of an expansion programme. The company wishes to raise Rs. 3,00,000 and is having the following four alternate sources to raise the funds:a. To have full money from the issue of equity b. To have Rs. 1,00,000 from equity and Rs. 2,00,000 from borrowing from a FI at 10% interest c. To have full money from borrowing from FI at 10% interest d. To have Rs. 1,00,000 in equity and Rs. 2,00,000 from 8% preference share. The companys EBIT is expected to increase to Rs. 1,50,000 after the expansion. The corporate tax rate is 50%. Select the most suitable plan to raise the required funds. (Ans. EPS A 9.38, B 10.83, C 12.00, D 9.83) 4. MP Ltd. Needs Rs. 20,00,000 for expansion. The expansion is expected to yield an annual EBIT of 16%. In choosing the financial plan , MP Ltd. Has an objective of maximising EPS. It is considering the possibility of issuing equity shares and raising debt of Rs. 2,00,000 or debt of Rs. 8,00,000 or of Rs. 12,00,000. The current market price per share is Rs. 50 and is expected to drop to Rs. 40 if the funds are borrowed in excess of Rs. 10,00,000. Funds can be borrowed at the rate indicated below:a. Upto Rs. 2,00,000 at 8% b. Over Rs. 2,00,000 and up to Rs. 10,00,000 at 12% c. Over Rs. 10,00,000 at 18%. Assume the tax rate of 40%. Determine the EPS for the three financing alternatives. (Ans. EPS A 5.07, B 5.80, C 5.16)