1.

  The H Co.s’ currently outstanding bonds have a 10% coupon. If its marginal tax rate is 35% what is H Co.s’ cost of
Interest rate = 10%
kd before tax= 10%
kd after tax = I*(1-t) 10%*(1-0.35)
6.50%

2. Tunney Industries can issue perpetual preferred stock at a price of Rs. 47.50 a share. The stock would pay a const
dividend of Rs. 3.50 a share. What is the company’s cost of preferred stock (kp) ?

kp= D/P P = D/kp

kp = 3.5/47.5 7.37%

3. The future earnings, dividends, and common stock price of CT Inc. are expected to grow 7% per year. CT’s comm
last dividend was Rs. 2 and it will pay a Rs. 2.14 dividend at the end of the current year.
a.     Using the DCF approach, what is the ke?
b.     If the firm’s beta is 1.6, the risk free rate is 9% and the average return on the market is 13%, what will be the fir
c.     If the firm’s bonds earn a return of 12% based on the bond yield plus risk premium approach, what will be ke?
d.     If you have equal confidence in the inputs used for the 3 approaches, what is your estimate of CT’s cost of com

P0 23 rf 9%
D0 2 rm 13%
D1 = D0+ g(D0) 2.14 B 1.6
g 0.07 rm - rf 4%

a. ke= (D1/P0)+g= 16.30%

b. CAPM=ke= rf+ B(rm-rf) 15.40%
c. ke= 12%+4% 16.00% it is given in the question that formula is bond
d ke= 15.90%

4. The Evanee Company’s next expected dividend D1is Rs. 3.8, its growth rate is 6% and the stock now sells for Rs.36
·       What is Evanee’s cost of retained earnings ?
·       What is Evanee’s % of floatation cost, f ?
·       What is Evanee’s cost of new common stock, ke?
D1=3.8
g= 6%
P0 = 36
f= 3.6
ke = D1 /P0 +g 16.56%
f = 3.6/36 10%
ke = (D1/(P0-f)) +g 17.73%

5. L Engg. has the following capital structure, which it considers to be optimal:

Debt – 25%
Preferred Stock – 15%
Equity – 60%
L Engg. expected net income this year is Rs. 34,285.72. Its established dividend pay-out ratio is 30%, its tax rate is 4
earnings and dividends to grow at a constant rate of 9%. L Engg. paid a dividend of Rs. 3.60 per share last year, and
per share. It can obtain new capital in the following ways:
Preferred: New preferred stock with a dividend of Rs. 11 can be sold to the public at a price Rs. 95 per share.
Debt: Debt can be sold at an interest rate of 12%
Determine the cost of each capital component and WACC.
The Company has following investment opportunities that are average risk projects:
Project Cost Rate of Return
A 10,000 17.40%
B 20,000 16.00%
C 10,000 14.20%
D 20,000 13.70%
E 10,000 12.00%
Which projects should the company accept ? Assume that the company does not want to issue any new equity?

NPAT 34285.7
Less: Dividends 10285.7
Retained Earnings 24000 60% 16.27% 9.76%
Debt 10000 25% 7.20% 1.80%
Preference 6000 15% 11.58% 1.74%
Total funds available 40000 WACC 13.30%

Kd= I ( 1-T) 7.20%

kp=D/P0 11.58%
kr= D1/P0 + g
D1= 3.924
kr= D1/P0 + g 16.27%

Projects which are higher than WACC - A,B,C,D

A 10,000 17.40% 1740 abc

B 20,000 16.00% 3200 bd
C 10,000 14.20% 1420 acd
D 20,000 13.70% 2740

6. Midwest Electric company uses only debt and equity. It can borrow unlimited amounts at an interest rate of 10%
equity. Its last dividend was Rs. 2, its expected constant growth rate is 4% and its stock sells at a price of Rs. 20. Mi
while Project B has a rate of return of 10%. All the company’s potential projects are equally risky and as risky as the

·       What is Midwest’s cost of common equity?

·       What is Midwest’s WACC?
·       Which project should Midwest select?

D0 = 2 WACC
g= 4% Type of Capital
D1 = 2+4% (2) 2.08 Equity
P0= 20 Debt
ke = D1/P0 +g 14.40%
kd= I ( 1-T) 6.00%

7. Z Systems is considering the following independent projects for the coming year:
Project Req Invt ( Rs.) Rate of Return Risk
A 4 million 14% High
B 5 million 11.50% High
C 3 million 9.50% Low
D 2 million 9% Average
E 6 million 12.50% High
F 5 million 12.50% Average
G 6 million 7% Low
H 3 million 11.50% Low
Z’s WACC is 10%, but it adjusts for risk by adding 2% to the WACC for high risk projects and subtracting 2% for low ri
i. Which projects should Z accept if it faces no capital constraints?
ii. If Z can only invest Rs. 13 million which projects should it accept and what would be the dollar size of its capital bu
iii. Suppose Z can raise additional funds beyond the Rs. 13 million, but each new increment or partial increment of R
cause the WACC to increase by 1%. Assuming that Z uses the same method of risk adjustment, which projects shou
the dollar size of its capital budget?

Project Req Invt ( Rs.) Rate of Return Risk WACC Diff IRR & WACC

A 4 million 14% High 12% 2%

B 5 million 11.50% High 12% -0.5%
C 3 million 9.50% Low 8% 2%
D 2 million 9% Average 10% -1%
E 6 million 12.50% High 12% 1%
F 5 million 12.50% Average 10% 3%
G 6 million 7% Low 8% -1%
H 3 million 11.50% Low 8% 4%

i A,C,E,F,H 21
ii A,F,H 12
iii A,C,F,H 15

8. Following is the Balance Sheet of LLH Ltd. – a major FMCG Company – as on 31.3.2018.
Additional Details:
·       The market price of shares is Rs.160 while the face value is Rs. 10
·       Beta for the company is 0.85. Risk free rate is 6% while the market risk premium is 9%
·       Debentures are quoted at 15% discount. Coupon rate for debentures is 12% and for long term loan 14%
·       Corporate tax rate is 35%
·       Calculate WACC for LLH Ltd. and EPS is Rs. 10. Has Company created value?

Assets Rs. Liabilities Rs. Type of Capital

Net Fixed Assets 900 Equity Capital 100 Debentures
Investments 160 Rev & Sur 630 Long term loan
Current Assets 140 Debentures 200 Reserves
Long Term Loan 200 Equity Capital
Creditors 70
Total Assets 1,200 Total Liabilities 1,200
EVA = NOPAT - Capital* WACC
EPS= 10
Equity capital = 100
FV = 10
Number of shares = 100/10= 10
EBIT 205.85
less: Int 52.00 EVA = -2.365
NPBT 153.85
less: tax @ 35% 53.85
NPAT 100
EPS 10

NOPAT 133.8
 5% what is H Co.s’ cost of debt (kd) ?

e stock would pay a constant annual

w 7% per year. CT’s common stock currently sells for Rs. 23 per share, its

s 13%, what will be the firm’s cost of common equity using the CAPM approach?
proach, what will be ke?
timate of CT’s cost of common equity?

tion that formula is bond yield + risk premium

e stock now sells for Rs.36. New equity can be sold to net the firm Rs. 32.40 per share.
tio is 30%, its tax rate is 40%. Investor’s expect future
0 per share last year, and its stock currently sells for Rs. 54

e Rs. 95 per share.

issue any new equity?

40000
10000
 6360
5940
5900

at an interest rate of 10% as long as it finances at this target capital structure, which calls for 45% debt and balance
ls at a price of Rs. 20. Midwest’s tax rate is 40%. Two projects are available: Project A has a rate of return of 13%
ly risky and as risky as the firm’s other assets.

Weight Cost Weight*Cost

0.55 14.40% 0.0792
0.45 6.00% 0.027
WACC 10.62%
Project A is better to take as IRR> WACC
d subtracting 2% for low risk projects.

dollar size of its capital budget?

t or partial increment of Rs. 2 million of new capital will
ment, which projects should it now accept and what would be

Diff IRR & N WACC

New WACC
0.08 13% 1% 0.04
13% -2%
0.045 9% 1% 0.015
11% -2%
0.03 13% -1%
0.125 11% 2% 0.075
9% -2%
0.105 9% 3% 0.075

%
ong term loan 14%

Type of Capital Cost Values Cost *values

kd1 (15% dis) 9.18% 200 18.35
kd2 9.10% 200 18.20
kr 13.65% 630 86.00
ke 13.65% 100 13.65
Total Cost 136.20
Total Capital 1130
WACC 12.05%
% debt and balance
of return of 13%
1. A company estimates that its fixed operating costs are Rs. 5,00,000 and its variable costs are Rs. 3 per unit sold.
breakeven point? How many units must it sell before its operating income becomes positive?

Sale 4
Var Cost 3
Contri 1 500000 BOE units 500000/1 500000
Fix Cost 500000 500000
Profit 0

2. The firms HL and LL are identical except for their leverage ratios and interest rates on debt. Each has Rs. 20 millio
in 2016 and has a 40% tax rate. Firm HL however has a leverage ratio Debt/ Total Assets of 50% and pays 12% inter
only 10% interest on its debt.
i. Calculate the rate of return on equity for each firm.
ii. Observing that HL has a higher return on equity, LL’s treasurer decides to raise the leverage ratio from 30% - 60%
interest rate on all debt to 15%. Calculate the new rate of return on equity for LL.

HL LL LL1
EBIT 4 4 4
Less: Interest 1.2 0.6 1.8
NPBT 2.8 3.4 2.2
Less: Tax 1.12 1.36 0.88
NPAT 1.68 2.04 1.32
Equity cap 50% & 10 14 8
ROE 16.80% 14.57% 16.50%

3. Wingler Communications supplies head phones to airlines for use with movie and stereo programs. The headph
for Rs. 28.80 per set, and this year’s sales are expected to be 4,50,000 units. Variable production costs for the expe
estimated at Rs. 1,02,00,000 and fixed production costs at present are Rs. 15,60,000. WCC has Rs. 4800000 of debt
shares outstanding and there are no preference shares. The dividend payout ratio is 70% and the tax rate is 40%.
The company is considering investing Rs. 72 lakhs in new equipment. Sales would not increase, but variable cost pe
would increase to Rs. 18 lakhs. WC could raise the required capital by borrowing Rs. 72 lakhs at 10% or by selling 2

i. What would be WC’s EPS under the old production process and under the new process if it uses debt and under
ii. At what unit sales level would WC have the same EPS, assuming it undertakes the investment and finances it wit
iii. At what unit sales level would EPS = 0 under the three production/ financing setups – under the old plan, the ne
plan with equity financing?
iv. On the basis of the analysis in parts iii, which plan is the riskiest, which has the highest expected EPS, and which
there is a fairly high probability of sales falling as low as 2,50,000 units and determine EPS with debt financing and E
sales to help assess the riskiness of the two financing plans.

New Process
Old Process Debt Equity
Sales 12960000.00 12960000.00 12960000.00
Less: Variable 10200000.00 8160000.00 8160000.00
Contribution 2760000.00 4800000.00 4800000.00
Fixed cost 1560000.00 1800000.00 1800000.00
EBIT 1200000.00 3000000.00 3000000.00
Less: Interest 384000.00 1104000.00 384000.00
NPBT 816000.00 1896000.00 2616000.00 100
Less: Tax @ 40% 326400.00 758400.00 1046400.00 40
NPAT 489600.00 1137600.00 1569600.00 60
Dividend 342720.00 796320.00 1098720.00
Retained Earnings 146880.00 341280.00 470880.00
EPS 2.04 4.74 3.27

PVR 21.30% 37.04% 37.04%

pvR CONT/SALE
400000x+2904000 = 800000
800000x - 400000x = 290400
400000x =
x
Contribution

Sales
4. JT Company is trying to determine its optimal capital structure. The company’s CFO believes the optimal debt ra
between 20% and 50%. Her staff has compile the following projections for the company’s EPS and stock price for v

Debt ratio Projected EPS(Rs.) Projected Stock

Price (Rs.)
20% 3.2 35
30% 3.45 36.5
40% 3.75 36.25
50% 3.5 35.5

Assuming that the firm uses only debt and Equity what is JT’s optimal capital structure? At what debt ratio is the co

WACC 30/70 0.4286

OPERATING LEVERAGE AND BREAK-EVEN ANALYSIS

Olinde Electronics Inc. produces stereo components that sell at P 5 $100 per unit. Olinde’s fixed costs are $200,000
unit, 5,000 components are produced and sold each year, EBIT is currently $50,000, and Olinde’s assets (all equity-fi
Olinde can change its production process by adding $400,000 to assets and $50,000 to fixed operating costs. This ch
variable costs per unit by $10 and (2) increase output by 2,000 units, but (3) the sales price on all units would have
permit sales of the additional output. Olinde has tax loss carry-forwards that cause its tax rate to be zero, it uses no
capital is 10%.
a. Should Olinde make the change? Why or why not?
b. Would Olinde’s break-even point increase or decrease if it made the change?
c. Suppose Olinde was unable to raise additional equity financing and had to borrow the
$400,000 at an interest rate of 10% to make the investment. Use the DuPont equation
to find the expected ROA of the investment. Should Olinde make the change if debt
financing must be used? Explain.

S 500000 665000 665000

VC 250000 280000 280000
Con 250000 385000 385000 40000
FC 200000 250000 250000
EBIT 50000 135000 135000
Int 0 0 40000
NPBT 50000 135000 95000
tax 0 0 0
NPAT 50000 135000 95000

Asset 500000 900000 900000

ROA 10% 15% 11%

Sales per unit = $100 Variable Cost per unit = $50 Contribution per unit = Sales price - Variable Cost = $50 Sales Uni
$500,000 EBIT = $50,000 Fixed Cost = $200,000 Break Even Point = Fixed Cost / Contribution per unit = $200,000 / $
Assets = $50,000 / $200,000 = 25% (EBIT used as tax rate is zero and debt is nil) Proposed change Sales Price per un
unit = $40 Contribution per unit = $55 Sales Unit = 7,000 Assets = $900,000 Fixed Cost = $250,000 EBIT = Sales * Co
Cost = 7,000 * $55 - $250,000 = $135,000 ROA = $135,000 / $900,000 = 15% Part a Olinda should not make the cha
because ROA has reduced from 25% to 15% Part b If...
ariable costs are Rs. 3 per unit sold. Each unit produced sells for Rs. 4. What is the company’s
omes positive?

rates on debt. Each has Rs. 20 million in assets , earned Rs. 4 million before interest and taxes
tal Assets of 50% and pays 12% interest on its debt whereas LL has a 30% leverage and pays

se the leverage ratio from 30% - 60% which will increase LL’s
LL.

ie and stereo programs. The headphones, which use the latest in electronic components, sell
ariable production costs for the expected sales under present production methods are
0,000. WCC has Rs. 4800000 of debt outstanding at an interest rate of 8%. There are 2,40,000
atio is 70% and the tax rate is 40%.
uld not increase, but variable cost per unit would decline by 20%. Also fixed operating costs
ng Rs. 72 lakhs at 10% or by selling 2,40,000 additional shares at Rs. 30 per shares.

ew process if it uses debt and under the new process it uses Equity?
es the investment and finances it with debt or with stock?
g setups – under the old plan, the new plan with debt financing and the new

the highest expected EPS, and which would you recommend? Assume here that
ermine EPS with debt financing and EPS with equity financing at that level of

New Process New Process

Debt Equity Old Process Debt Equity
9128347.83 7840800.00 5896800.00
7184347.83 4936800.00 3712800.00
400000x+2904000 800000x+2184000 1944000.00 2904000.00 2184000.00
1800000.00 1800000.00 1560000.00 1800000.00 1800000.00
1104000+400000x 384000+800000x 384000.00 1104000.00 384000.00
1104000 384000 384000.00 1104000.00 384000.00
400000X 800000X 0.00 0.00 0.00

240000x 480000x

x x 0.00 0.00 0.00

Unit Sales 316956.52 272250.00 204750.00

400000x+2904000 = 800000x+2184000
800000x - 400000x = 2904000 - 2184000
400000x = 720000
x 1.8
Contribution 3624000

Sales 9784800.00000001
y’s CFO believes the optimal debt ratio is somewhere
company’s EPS and stock price for various debt levels:

ructure? At what debt ratio is the company’s WACC minimised?

nit. Olinde’s fixed costs are $200,000, variable costs are $50 per
,000, and Olinde’s assets (all equity-financed) are $500,000.
0,000 to fixed operating costs. This change would (1) reduce
e sales price on all units would have to be lowered to $95 to
ause its tax rate to be zero, it uses no debt, and its average cost of

?
orrow the
quation
debt
 price - Variable Cost = $50 Sales Units = 5,000 units Assets =
Contribution per unit = $200,000 / $50 = 4,000 units ROA = EBIT /
) Proposed change Sales Price per unit = $95 Variable Cost per
ed Cost = $250,000 EBIT = Sales * Contribution per unit - Fixed
art a Olinda should not make the change even though EBIT is more
Start End https://drive.google.com/file/d/1ugCTIgp244pfOj2KR-eVQx6ovMRmaUk2/view
1:23:54 1:39:10

1 Constant dividend payout ration - Constant % of profit is given continuousely

2 Constant Dividend rate - Constant % on FV is given

3 Residual Policy- I will first calculate how much retained earnings are required or in new projec

1.  Bailey Corporation recently reported the following income statement:

SalesRs. 14,000,000.00
Operating Costs (exc depn)Rs. 7,000,000.00
EBITDA 7,000,000.00
Depreciation 3,000,000.00 Cost of cap = WACC
EBIT 4,000,000.00
Interest 1,500,000.00
NPBT 2,500,000.00
Taxes @ 40% 1,000,000.00
NPAT 1,500,000.00

Bailey’s total operating capital is Rs. 20 billion and it’s after tax cost of capital is 10%. Therefore, Bailey’s total after
During the past year Bailey made a Rs. 1.3 billion net investment in its operating capital.
a.  What is Bailey’s NOPAT for the year? 2,400,000.00
b. What is Bailey’s net cash flow for the year? 4,500,000.00
c. What is Bailey’s operating cash flow for the year? 5,400,000.00
d. What is Bailey’s free cash flow for the year? -1,294,600,000.00
e. What is Bailey’s EVA for the year? -1,994,600,000.00

2. Bowles Sporting Inc. is prepared to report the following 2012 income statement :
Sales 15200
Op Costs Rs. 11900
EBIT 3300
Interest 300
NPBT 3000
Taxes @ 40% 1200
NPAT 1800
Prior to reporting this income statement, the company wants to determine its annual dividend. The company has
500,000 shares of equity and its shares at Rs. 48 per share.
a. The company had a 40% dividend payout ratio in 2011. If Bowles wants to maintain this payout ratio in 2012,
what will be it’s per share dividend in 2012?
b. If the company maintains this 40% payout ratio, what will be the current dividend yield on the common’s stock?
c. The company reported NPAT of Rs. 1,500 in 2011. Assume that the number of shares outstanding has remained
constant. What was the company’s per share dividend in 2011?
d. As an alternative to maintaining the same dividend payout ratio, Bowles is considering maintaining the same per
share dividend in 2012 that it paid in 2011. If it chooses this policy, what will be the company’s dividend payout
ratio in 2012?

e. Assume that the company is interested in dramatically expanding its operations and that this expansion will
require significant amount of capital. The company would like to avoid transactions costs involved in issuing new
equity. Given this scenario, would it make more sense for the company to maintain a constant dividend payout rati
or to maintain the same per share dividend? Explain

a c
2012 2011

NPAT 1800 1500

Less: Dividend @ 40% 720 600
Retained 1080 900
DPS 0.00144 0.0012
Assumed share FVDividend Rate 0.14% 0.12%
b. Yeild DPS/MPS 0.0030% 0.0025%

d. NEW 2012

1800
600 33.33% Dividend Payout Ratio
1200
0.0012

e. Choose Dividend Rate Method

3. Axel Telecommunications has a target capital structure that consists of D/ E as 7:3. The company anticipates tha
budget for the upcoming year will be Rs. 3000000. If Axel reports net income of R. 2000000 and it follows a residua
payout policy , what will be its dividend payout ratio?
3. Axel Telecommunications has a target capital structure that consists of D/ E as 7:3. The company anticipates tha
budget for the upcoming year will be Rs. 3000000. If Axel reports net income of R. 2000000 and it follows a residua
payout policy , what will be its dividend payout ratio?

NPAT 2,000,000
Less Dividend 0
Retained 2,000,000

As we need 30lacs and we have only 20lacs we cant give any dividend as per the residual
Qx6ovMRmaUk2/view

Percentage remain the same but dividend changed

For e.g. if co. earns 100 20% = 20 is the dividend if it is 2
DPS IS THE SAME

required or in new project and wt ever is left the dividend is given

erefore, Bailey’s total after tax cost of operating capital is Rs. 2 billion.

7,000,000.00 EBITDA
FCF NOPAT + DEPN - Chn Asset & WC
NPAT can't coverup funding ppl

idend. The company has

 is payout ratio in 2012,

d on the common’s stock?

outstanding has remained

maintaining the same per

pany’s dividend payout

at this expansion will

s involved in issuing new
nstant dividend payout ratio

he company anticipates that its capital

000 and it follows a residual dividend
vidend as per the residual policy
me but dividend changed
% = 20 is the dividend if it is 200 * 20% = 40 is the dividend
1.  The H Co.s’ currently outstanding bonds have a 10% coupon. If its marginal tax rate is 35% what is H Co.s’ cost o
int 10%
Kd before tax 0.1
Kd 0.065

2. Tunney Industries can issue perpetual preferred stock at a price of Rs. 47.50 a
share. The stock would pay a constant annual dividend of Rs. 3.50 a share. What is
the company’s cost of preferred stock (kp) ?

p 47.5
d 3.5

kp 7.368%
te is 35% what is H Co.s’ cost of debt (kd) ?