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Alpine Ltd: Cost of Capital

Sanjeev Kumar, a recent MBA pass out, has joined Alpine Ltd. as Assistant Finance Manager. He has been given details of a project which company wants to appraise. He has been given the responsibility to analyze the project and present the report to CFO within next ten days. The new project will require an investment of Rs. 5 crore. Alpine Ltd., a leading auto part manufacturer, was found in 1990 by Sh. Vedant Sharma, with the majority of its sales being made in southern India. In the recent past company has seen tremendous growth and now wants to expand its operations in Northern India. Until the early part of decade capital investment projects were selected on the basis of average rate of return calculations but since last 5 years the procedure has been replaced with using NPV method as selection criteria for taking new projects. Since past five years company is using a cost of capital of 12% as a discount rate to evaluate projects. This rate was determined by taking weighted average cost of capital Alpine had incurred in raising funds from market over the previous 10 years. Sanjeev has been given the task to find out cost of capital for new project so that it can be evaluated using NPV criteria. The company wants that 50% of capital should be raised through equity, 20% through preference shares and 30% though debt capital. Snajeev has observed that the strong growth pattern exhibited in past 5 years will continue indefinitely. Through his research he found that Alpine could issue additional equity shares, which have a par value of Rs.45 and market value of Rs.65. The expected dividend for the next year would be Rs.4.5 per share with an expected growth rate of 9% per year for the foreseeable future. Further the flotation cost is assumed to be Rs. 2.5 per share. Irredeemable Preference shares could be issued for 12% with the help of merchant bankers with a par value of Rs.100. The issue involves flotation cost of 6%. Finally Sanjeev finds that an addition of Rs. 40 lakhs could be raised in the form of debentures through private placement with a maturity period of 7 years at an interest rate of 12%. Any amount raised over Rs. 40 lakh with the same maturity can be raised at 15%. The debentures can be issued and

redeemed at a face value of Rs.100 and there is no flotation cost. Alternatively; company can issue 11% bonds worth Rs. 1.20 crores with a maturity of 10 years. If firm needs to issue any further bonds they can be issued for a maturity of 10 years with an interest rate of 13%. The flotation cost of issue is expected to be 5%. The bonds can be issued at a face value of Rs.100 and will be redeemed at par. If the corporate tax rate is 35%: Q1. Find out the capital structure of the new capital? Q2. What is the cost of equity and Preference shares? Q3. Which particular source of debt will company use in raising the debt capital? Q4. What is the weighted average cost of new project?