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Institute of Professional Education and Research (Technical Campus) Financial Management Practice Book

This document contains 10 practice questions related to financial management and cost of capital calculations. The questions cover topics such as cost of debt, weighted average cost of capital, capital budgeting, and capital structure. Readers are asked to calculate costs of equity and debt, WACC, project net present values, and earnings per share under different financing scenarios.

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mohini sen
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47 views3 pages

Institute of Professional Education and Research (Technical Campus) Financial Management Practice Book

This document contains 10 practice questions related to financial management and cost of capital calculations. The questions cover topics such as cost of debt, weighted average cost of capital, capital budgeting, and capital structure. Readers are asked to calculate costs of equity and debt, WACC, project net present values, and earnings per share under different financing scenarios.

Uploaded by

mohini sen
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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INSTITUTE OF PROFESSIONAL EDUCATION AND

RESEARCH (TECHNICAL CAMPUS)

Financial Management
PRACTICE BOOK
Module 3

1. KPL Limited keeps a perpetual fixed amount of debt in its books. It pays coupon of
15%. Its debt sells at par in the market. What is the cost of debt if the firm pays 35%
tax? What is the cost of debt it sells a) at 5% premium b) at 5% discount to the face
value?

2. Y. Ltd. issues 14% preference shares of face value Rs. 100 each Rs. 92 per share. The
shares are repayable after 12 years at par (income tax at 50%)

3. A&S Corporation common stock has a beta, β , of 1.2. The risk-free rate is 6%, and the
market return is 11%. Determine the risk premium on A&S common stock. Also
determine the A&S’s cost of common stock equity using the CAPM.

4. ABC Ltd. has expected earnings at Rs 30 per share which is growing at 8% annually.
Company follows fixed payout ratio of 50%. The market price of its share is Rs 300.
Find the following:
a) Current cost of equity
b) Cost of new equity if the firm issues fresh shares at current market price but with
floatation cost of 5%

5. A company is considering raising of funds of about Rs. 100 lakhs by one of two
alternative method, viz., 14% institutional term loan or 13% non-convertible
debentures. The term loan option would attract no major incidental cost. The
debentures would have to be issued at a discount of 2.5% and would involve cost of
issue of Rs. 1,00,000. Advise the company as to the better option based on the
effective cost of capital in each case. Assume a tax rate of 50%
6. Ambey Technology has a project costing Rs 15 crore for making high-end microchips
on hand. It shall provide the earning level of Rs 4 crore annually. With a view to
decide the desired capital structure the firm compiled following data with respect to
cost of debt and cost of equity for debt levels of 20% to 70% of the cost of the project,
that is reproduced below

INSTITUTE OF PROFESSIONAL EDUCATION AND RESEARCH (TECHNICAL CAMPUS)


7. A Limited has the following capital structure:
Equity share capital (2,00,000 shares) Rs. 40,00,000
6% preference shares Rs. 10,00,000
8% Debentures Rs. 30,00,000

The market price of the company’s equity share is Rs. 20. It is expected that company
will pay a dividend of Rs. 2 per share at the end of current year, which will grow at 7
per cent for ever. The tax rate may be presumed at 50 per cent. You are required to
compute the following:
i. A weighted average cost of capital based on existing capital structure. ii. The new
weighted average cost of capital if the company raises an additional Rs. 20,00,000
debt by issuing 10 per cent debentures. This would result in increasing the expected
dividend to Rs. 3 and leave the growth rate unchanged but the price of share will fall
to Rs. 15 per share.
iii. The cost of capital if in (b) above, growth rate increases to 10 per cent

8. As a financial analyst of a large electronics company, you are required to determine the
weighted average cost of capital of the company using (i) book value weights and (ii)
market value weights. The following information is available for your perusal: The
company’s present book value capital structure is: Rs.
Preference shares (Rs. 100 per share) 2,00,000
Equity shares (Rs. 10 per share) 10,00,000
Debentures (Rs. 100 per debenture) 8,00,000
All these securities are traded in the capital market. Recent prices are: Debentures @
Rs. 110 per debenture Preference shares @ Rs. 120 per share Equity shares @ Rs. 22
per share
Anticipated external financing opportunities are:
i. Rs. 100 per debenture redeemable at par; 10 year-maturity, 13% coupon rate, 4%
flotation costs, sale price Rs. 100.
ii. Rs. 100 preference share redeemable at par; 10 year-maturity, 14% dividend rate,
5% flotation costs, sale price Rs. 100.
iii. Equity shares: Rs. 2 per share flotation costs, sale price @ Rs. 22.In addition, the
dividend expected on the equity share at the end of the year is Rs. 2 and the
earnings are expected to increase by 7% p.a.

INSTITUTE OF PROFESSIONAL EDUCATION AND RESEARCH (TECHNICAL CAMPUS)


The firm has a policy of paying all its earnings in the form of dividends. The
corporate tax rate is 50%.
9. Alfa and Beta are two firms, identical in all respects except for their capital structure.
Alfa has no debt while Beta carries a debt of Rs 10 crore at pre-tax cost of 10%. Find
out the value of firms Alfa and Beta assuming tax of 35% and EBIT level of Rs 300
lakhs and cost of equity as 15% under net income approach. Also find the value of the
levered firm Beta under Net Operating Income Approach. What is the cost of equity
and WACC of firms Alfa and Beta under NI and NOI approaches?

10. Sales and earnings before interest and taxes (EBIT) for Ramswaroop Co. Ltd. during
2014 were Rs. 17,50,000 and Rs. 4,50,000 respectively. During 2013, interest
expenses were Rs. 4,000 and preference dividends were Rs. 10,000. These fixed
charges are expected to continue during 2015. An expansion is planned which will
require Rs. 1,75,000 and is expected to increase EBIT by Rs. 1,00,000 to Rs.
5,50,000.

The company is considering the following financing alternatives:


Alt.–1 Issue 5,000 shares of common stock to net the firm 35 per share. The firm
currently has 40,000 shares of common stock outstanding.
Alt.–2 Issue Rs. 1,75,000 of fifteen-year bonds at 8%. Sinking fund payments on these
bonds commence in 2014.
Alt.–3 Issue Rs. 1,75,000 of 8.5% preferred stock. Assume a 50% tax rate.

You are required to —


(i) Calculate the EPS for 2015 at the expected earnings before interest and taxes level
of Rs. 5,50,000 for each financing alternative.
(ii) Calculate the equivalency level of earnings before interest and taxes between the
debt and common stock alternatives.
(iii) Calculate the equivalency level of earnings before interest and taxes between the
preferred stock and the common stock alternatives.

INSTITUTE OF PROFESSIONAL EDUCATION AND RESEARCH (TECHNICAL CAMPUS)

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