Cost of Capital
 QUESTION FOR PRACTICE Q.1. Assuming that the firm pays tax at 50% rate, compute the after tax cost of capital in the following cases: (a) A 14.5% preference share sold at per .(b) A perpetual bond sold at per, coupon rate being 13.5%.(c) A ten year 8% Rs. 1,000 per bond sold at Rs. 950.(d) A common share selling at a market price of Rs. 120 and paying a current dividend of Rs. 9 per share which is expected to grow at a rate of 8% . Ans. 14.5%, 6.75%, 4.61%, and 16.1% Q.2. Calculate the cost of capital each of the following cases : (i) A 7- year Rs. 100 bond of a firm can be sold for a net price of Rs. 907.75 and is redeemable at a premium of 5%. The coupon rate of interest is 15% and tax rate is 55%.(ii) A company issues 10% Irredeemable Preference Shares at Rs. 105 each (FV = 100).(iii) The current market price of share is Rs. 90 and the expected dividend at the end of current year is Rs. 4.50 with a growth rate of 8%. (iv) The current market price of a share is Rs. 134. The company has just paid a dividend of Rs. 3.50 with expected growth of 15% over next 6 years and a growth rate of 8% thereafter.(vi) The current market price of share is Rs. 100. The firm needs Rs. 1,00,000 for expansion and the new shares can be sold only at Rs. 95. The expected dividend at the end of current year is Rs. 4.75 with a growth rate of 6%. Also calculate the cost of capital of new equity.(vii) A company is about to pay a dividend of Rs. 1.40 per share having a market price of Rs. 19.50. the expected future growth in dividends is estimated at 12%. Ans. (i) 7.74%, (ii) 9.52%, (iii) 13%, (iv) 12%, (v) 10.75% and 11% and (vi) 20.66% Q.3. An investor purchased 5 share in a company at a cost of Rs. 240 on Jan. 1, 1996. He held them for 5 years and finally sold them in Jan. 2001 for Rs. 300. The amount of dividend received by him in each of these 5 years was Rs. 14,14,14.50, 14.50 and Rs. 14.50 respectively. Find out the cost of equity capital. Ans. The IRR of the dividends and sale proceed comes to 10% which is the cost of capital. Q.4. PQR Ltd. is attempting to find out the cost or equity shares it is proposing to issue. The current price of the equity share is Rs. 64 per share and the flotation cost of new share is Rs. 2.50 per share. The dividend of Rs. 3 is expected at the end of current year the dividends paid for the last 6 years are Rs. 2.34, 2.43, 2.54, 2.65, 2.75 and Rs. 2.86 respectively. Find out the growth rate, cost of retained earnings and cost of equity capital. Ans. g = 4%, kr = 8.7% and ke = 8.88% Q.5. XYZ Ltd. has an annual profit of Rs. 50,000 and the required rate of return of the shareholders will have to incur 3% brokerage cost of the dividends received and invested by them for making new investments. Find out the cost of retained earnings to the firm given that the tax rate applicable to shareholder is 30%. Ans. kr = 6.79% Q.6. XYZ Ltd. intends to issue new equity shares of which the current market value is Rs. 125 per share. The flotation cost is estimated to be 3%. The dividends paid by the company during last 5 years are Rs. 10.70,11.45,12.25,13.11 and 14.03. Find out the growth rate in dividends, cost of new equity shares and the cost of exiting equity shares given that the same growth rate continues in future. Ans. g = 7%, ke = 19.38% (New shares) and ke = 19.01% (Exiting shares) Q.7. ABC Ltd. has all equity capital structure with a cost of capital of 15%. The company decides to raise Rs. 2,00,000, 12% debt and use the proceeds to retire the equity. The expected level of EBIT is' Rs. 90,000 which is expected to remain unchanged. Assuming net income approach assumptions are applicable, calculate value of equity, debt and the value of firm before and after change in capital structure. Also calculate weighted average cost of capital after the change. Q.8. A company's share is quoted in the market at Rs. 40 currently. The company pays a dividend of Rs. 2 per share and investors expect a growth rate of 10% per year. Compute:(i) The company's cost of equity capital.(ii) If anticipated growth rate is 11% p.a., calculate the market price per share using cost of equity capital calculated above.(iii) If the company's cost of equity capital is 16% and anticipated growth rate is 10% p.a., calculate market price if dividend of Rs. 2 per share is to be maintained. Q.9. Equity share of A Ltd. is currently selling in the market at Rs. 100. Dividends paid in the last 5 years are Rs. 4.00, Rs. 4.25, Rs. 4.60, Rs. 4.85 and Rs. 5.05. The company wants to issue new equity shares and has been advised to price them at Rs. 90. Floatation costs are likely to be Rs. 8 per share- Calculate the growth rate, cost of existing and new equity for the company. Q.10. Equity share of P Ltd is currently priced at Rs. 60. Dividend expected at the end of one year from now is Rs. 6. Cost of equity for companies of similar risk is 18%. What is the expected growth rate ?What is expected to happen if due to some adverse development in the capital market, the growth rate projection is revised down to 5% Q.11. Q.6. X Ltd. has operating profit of Rs. 8,60,000 and a fixed finance burden of Rs. 60,000. The company is subject to income tax payment of Rs. 2,00,000. The company has 3,00,000 Equity shares of Rs. 30,00,000 and 18% Debentures of Rs. 3,12,500. The market price of Equity share is Rs. 12. Find : (i) EPS(ii) Cost of equity(iii) Cost of debt (kd) Q.12. X Ltd. has assets of Rs. 32,00,000 that have been financed by Rs. 18,00,000 of equity shares (of Rs. 100 each), General Reserve of Rs. 3,60,000 and Debt of Rs. 10,40,000. For the year ended 31-03-2010 the company's total profits before interest and taxes were Rs. 6,23,000. X Ltd. pays 8% interest on borrowed capital and is in a 40% tax bracket. The market value of equity as on 31-03-2010 was Rs. 150 per share. What was the weighted average cost of capital? Use market values as weights.