Introduction of cost of capital

Cost of capital is also called discount rate or minimum

required rate of return or hurdle cost.
Cost of capital may be defined as the minimum rate of
return the firm requires from investment in order to leave
unchanged the market value of the firm. The return the
firm’s investors could expect to earn if they invested in
securities with comparable degrees of risk
The cost of capital represents the overall cost of financing
to the firm
The cost of capital is normally the relevant discount rate to
use in analyzing an investment
The overall cost of capital is a weighted average of the
 Importance of cost of capital
• Investment/capital-budgeting decisions
• Usage of debt in its capital structure
• Management’s performance
Types of cost of capital
1 Explicit cost and Implicit cost
2 Future and historical cost
3 Specific cost and combined cost
4 Average cost and marginal cost
 Cont..
An implicit cost is a cost that has occurred but it is not
initially shown or reported as a separate cost. On the
other hand, an explicit cost is one that has occurred and
is clearly reported as a separate cost. E.g. rent, wages
Explicit cost involves cash outflow in firm of interest,
dividends etc. whereas implicit cost does not involve
any such cash outflows.
Explicit cost are called out-of-pocket costs whereas
implicit costs are called economic costs.
Explicit cost can be measured and therefore can be
recorded in the books. However, implicit costs cannot be
measured exactly and hence not recorded in the books.
 Factors affecting cost of capital

• Risk free interest rate

• Business risk
• Financial risk
• Other considerations
 Measurement of risk
• Based on few assumptions:-
• The business risk of the firm remains
unchanged even after acceptance of the
proposal being evaluated. Every firm has a
particular level of business risk which is
determined by the composition of its assets.
• Financial risk will also remain same.
• Cash flows are taken on after-tax-basis.
Sources of finance:-
• Cost of debt
• Cost of preference shares
• Cost of equity
• Cost of retained earnings
• Combination of cost and weight of each source of
capital (weighted average cost of capital
10%debentures of F.V. 100
INTEREST 100@10% = 10
Tax rate = 40%
P&L
Interest 10 income (assume) 80
N/P 70
Tax payable 70 of 40% = 28
Or without interest
N/P 80 Income 80
Tax payable 80@40% = 32
Tax saving 4
 Measurement of specific costs
Cost of redeemable is debt which is not required to be paid during the
lifetime of the company. Such debt carries no coupon rate of interest.
Costs of bonds and debentures- cost of debt is defined as the rate of
return that must be earned on debt finance investments in order to
keep unchanged the earnings available to equity shareholders.
1. cost of Irredeemable Debt/ perpetual Debt:
Before tax
Ki = I ÷ NP
I = interest payment annually
NP = net proceeds or issue price of bond/debenture
Ki = cost of irredeemable debt (before tax)
Adjusting tax:
Adjusting tax:- debt is tax deductible, therefore firm
gets saving in payment of tax. Effective cost of debt
reduced due to its tax deductibility. So the actual or real
cost of debt is determined after considering tax rate.
Kd = Ki (1-t) or
= I(1-t)/NP or
= I (1-t)/MP
Kd = cost of irredeemable debt (after tax)
MP = market price
I = INTERST
Net proceeds:- fresh issue already issue
net proceeds (issue price) current market
price
Q 1 A Ltd. Issued 10% perpetual debt of Rs. 1,00,000.
The company’s tax rate is 50%. Determine the cost of
capital (before tax as well as after tax) assuming the
debt is issued at (i) par (ii) 10 % discount (iii) 10 %
premium.
Ans. AT par Before tax = 10%
After tax = 5%
Discount before tax = 11.11%
After = 5.55%
Premium before tax = 9.09%
After = 4.54%
 2. Cost of Redeemable debt
• Cost of redeemable is debt which required to be paid during
the lifetime of the company. Such debt carries coupon rate of
interest.
• Cost of redeemable debt is calculated by equating the net cash
outflow(after adjusting tax saving) of the instrument to the net
cash inflow or its net market price realized.
Net proceeds formula :-
CI0 = FV + Pm – D – FC
FV = Face value; Pm = premium; D = discount; FC = flotation cost;
Cio = net proceeds
• When the amount of principal is repaid in one lump-sum amount
then the cost of debt can be calculated below formula.
Trial and Error Method
Q 2 ABC Ltd. Issues 15% debentures of the face value
of Rs. 1,000 redeemable after 5 years, debentures
issued at discount of 5% and the floatation cost is
estimated to be 1%. Find the cost of debentures given
that the firm has 50% tax rate.
Po = 1,000 – 50 – 10 = 940
Q 3 ABC Ltd. Issues 10% debentures of Rs. 1,000 each
redeemable after 5 years. The debentures issued at
discount of 5% and the floatation cost is estimated to
be 1%. Find the cost of debentures given that the firm
has 50% tax rate.
 When the principal is repaid in many
installments.
• Short cut method cannot applied when the
principal is repaid in many installment.
• Q A co. issued 10% debentures aggregating
Rs.1,00,000. The floatation cost is 5%. The co.
has agreed to repay the debentures at par in
5 equal installments starting at the end of year
1. The company’s rate of tax is 50%. Find the
cost of debt.
 Q A co. issued 10% debentures aggregating
Rs.1,00,000. The floatation cost is 5%. The co. has
agreed to repay the debentures at par in 5 equal
installments starting at the end of year 1. The
company’s rate of tax is 50%. Find the cost of debt.
Years Amount of After tax outflow Principal After tax cash outflow
ANS.interest I(1-t) repayment
1 10,000 5000 20000 20000+5000 = 25,000
2 8000 4000 20000 24000
3 6000 3000 20000 23000
4 4000 2000 20000 22000
5 2000 1000 20000 21000
After cash outflows may be discounted at an
appropriate rate
Cash outflows PV FACTOR 7% PV FACTOR 6% TOTAL PV 7% TOTAL PV 6%
25,000 0.935 0.943 23375 23575
24,000 0.873 0.890 20,952 21360
23,000 0.816 0.840 18,768 19320
22,000 0.763 0.792 16,786 17424
21,000 0.713 0.747 14,973 15687
94,854 97,366

= 6 + 97366 – 95000 ×(7-6)

97366 – 94,854
= 6.94%
 Cost of preference share
• cost of preference share is not adjusted for taxes because
preference dividend is not an expense. It is an
appropriation of profit.
• Cost of Irredeemable preference shares :
• Kp = PD ÷ NP
• PD = constant annual preference share capital
• NP = market price – issue price
• NP = Market price of preferred stock (1-flotation cost)
Q 6 A co. issues 10 % irredeemable preference shares of the
face value of Rs. 100 each. Flotation cost for such issue is
estimated to be 4 % of issue price. What would be the cost
of preference shares if they are issued at (i) par (ii) 10 %
 Cost of Redeemable preference share
Cost of redeemable preference share is calculated by
equating cash outflow of the instrument to the net
cash inflow or its net market price.
Short cut method
Kp = PD + (RV-NP)/N
(RV+NP)/2
Trial and Error Method:- formula
PD = Annual preference dividend at fixed rate of
dividend
Pn = amount payable at the time of redemption
n = redemption period of preference shares.
• Q A co. has issued 10% redeemable preference
shares of Rs. 2,00,000 redeemable after 10 years.
The floatation cost is 5%. Calculated cost of
preference share. Ans. 10.76%
• Q A Ltd. Has issued 2,000, 10% redeemable
preference shares of face value of Rs. 100 each to
be redeemed after 12 years. Floatation cost is
expected to be 1%. Calculate the cost of preference
shares. Ans. 10.13%
• Q A co. has issued 10% redeemable preference
shares of Rs. 2,00,000 redeemable after 10 years.
The floatation cost is 5%. Calculated cost of
preference share. Ans. 10.76%
Q 7 A Ltd. Has issued 2,000, 10% redeemable
preference shares of face value of Rs. 100 each to be
redeemed after 12 years. Floatation cost is expected
to be 1%. Calculate the cost of preference shares.
Ans. 10.13%
 Cont.

Q 9 A co. issued 10% preference shares of Rs. 100

each at a floatation cost of 2%. Find the cost of
preference capital if it is redeemable after 10 year at a
premium of 10%. Ans. 10.94%
When the principal is repaid in many installments.
• Q ABC Ltd. Issues 15% preference shares of the face
value of Rs. 1000 each at a flotation cost of 1% and
the discount is 5%. If the preference shares are
redeemable in 5 annual installments of Rs. 200 each
starting from the end of year 1. ans 17% and 18%
• 17.85%
 Cost of Equity Share Capital
• Cost of equity capital is the expectation of the
equity shareholders from the co. for their
invested funds.
• Computation of cost of equity capital is difficult
in comparison to cost of debt and preference
capital. This is so because like debenture
holders and preference shareholders, equity
shareholders do not get fixed rate of interest or
dividend. In fact the cost of equity capital is the
expectation of the equity shareholders from
the co. for their invested funds.
Cost of equity share capital can be measured
according to following approaches:
• Dividend-price approach
• Dividend price plus growth approach:-
• (i) when dividends grow at uniform rate
• (ii) when dividends grow at different rates
• Earning-price approach
• CAPM approach
• Relised yield approach
(i) Dividend-Price Approach -: Acc. To dividend-price
approach, cost of equity is calculated by dividing the
expected dividend per share to the net proceeds from the
issue of an equity share or its net market price realized.
( i) calculation of cost of new equity: =:
Ke = D1/Po
D1 = expected dividend per equity share
Po = net proceeds from issue of an equity share after
adjusting discount/premium, flotation cost etc.
(ii) calculation of cost of existing equity
Ke = D1/Po
Po= current market price per equity share (net proceeds)
Q 10 A co has issued equity shares of Rs. 10 each at a
premium of 10%. Floatation charges are 6% of issue
price. The co. expects to pay a dividend at 15% per
share, determine the cost of equity capital.
 (ii) Dividend-Price Plus Growth Approach
This approach takes into account the growth
expectations of share-holders in the dividend income
streams to calculate the cost of equity.
A) When dividends grow at uniform rate perpetually.
Ke = D1 + g
Po
D1 = dividend per share expected at the end of year
[D1 =Do (1+g), where Do = last year dividend per
share]
Po = current market price (net proceeds)
g = constant growth in dividends
Q 11 The current market price of an equity share is Rs.
95. The expected dividend per share is Rs.5. The
dividend is expected to grow at the rate of 6%.
Calculate the cost of equity capital. Also calculate
market price of the share at the end of the year 1 and
2 assuming constant growth rate of dividend.
Assumptions :-
• Do>0 or the present dividend is positive
• Dividend payout ratio is constant
• Ke > g
current market price is a function of future expected
dividends of the share.
 b) Varying growth rates in dividends
(out of syllabus)
Q The current market price of a share is Rs. 134. The
co. 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.
• Q Deep telecom ltd. Has the following trend of
payment dividends over the past 6 years.
Year Dividend per share Rs.

1 9.50
2 10.00
3 10.50
4 11.00
5 11.50
6 12.00

Current market price of a share is Rs.140. Flotation cost

per share is Rs. 4. calculate
(i)Growth rates in dividends. (ii) cost of equity share
Q 12 A co. is planning to declare dividend of Rs. 20
next year. The co. has a growth rate of 6% and the
shares are being traded at Rs. 120 per share in the
market. Find the cost of equity share. Also find the
price of the share of the co. at the end of year 2.
• Ans cost of equity = 0.227
Price of the share at the end of the 2nd year 134.55
 (iii) Earning price approach
Acc. to earning price approach market price of the equity share depends
upon the earnings of the co. and cost of equity is calculated by dividing
earnings per share to the net proceeds per share from new equity or net
market price of the existing share realized.
Ke = Eo/Po
Ke = cost of equity
Po = net proceeds of an equity share
Eo = earning per share
Also, Ke = EPS × 100
present market price of the share
Or Ke = E/P = E/P ratio = 1/P/E ratio
Where, total earning available to equity shareholders
P = total current value of equity shares
E/P = Earning-price ratio and P/E = Price earning ratio
Cost of new equity
Q 13 The current market price of the share of a co. is
Rs. 100. The company’s current earnings are Rs.
20,00,000. Its shares outstanding are Rs. 2,00,000.
The co. wants to raise additional funds of Rs.
6,00,000. The floatation cost is Rs.10 per share (10%)
and the co. can sell shares at a discount of 10%. Find
out the cost of equity assuming that the company’s
earnings are stable. Ans. 80
 (iv) CAPM Approach out of syllabus
• Return on any security depends upon the level of risk
attached to that security. The expected return from
security is directly proportional to the risk attached to that
security. The higher is the risk, higher is the expectation of
return and vice-versa. Hence there is a linear relationship
between expected return and risk. There are two types
associated with a security investment.
• (i) unsystematic risk
• (ii) systematic risk
• CAPM calculates the cost of equity on the basis of 3
parameters i.e. the risk free rate, market return and b as a
measure of systematic risk through the foll. formula:
• Ke = kf+b(km-kf)
Q Expected return on risk free securities 6%
• Coefficient of systematic risk is 1.8, 0, .5, 1, 1.5
• Expected return on the market is 15%
• Expected return on risk free securities is 9%
calculate cost of equity capital
• Ans. Ke = 6% + 1.8 ( 15% - 6% ) = 22.20%
• Ke = 6% + 0 ( 15% - 6% ) = 10.50%
• 6% + .5 ( 15% - 6% ) = 15%
• 6% + 1 ( 15% - 6% ) = 15%
• 6% + 1.5 ( 15% - 6% ) = 19.5%
Q A firm having beta coefficient of 1.8 funds the
risk free rate to be 8% and the market cost of
capital at 14%. Calculate cost of capital of equity
share capital.
Ans. 18.8%
 (v) Realised Yield Approach
• This approach is based on the premise that
actual returns earned by the investors in the
past will be repeated in the future. Acc. To this
approach, cost of equity capital should be
determined on the basis of returns actually
realized by the investors on their equity shares.
Past records of dividends for a particular period
should be considered while calculating cost of
equity capital. This approach gives us good
results in those cases where companies are
earnings good and stable profits.
• Q. A purchased 5 shares in a co. at a cost of Rs.200
on January 1,2006. He sold them on January, 2011
for Rs. 252. The yearly dividends received by him in
each
Years
year are as follows:
Dividend Rs.
• 2006 11 calculate cost of equity capital
2007 11
2008 11.50
2009 11.50
2010 11.50

• Ans. 10%
 Cost of retained earnings
• The cost of retained earnings is the return forgone
by the share-holders on the dividend income.
• The firm is implicitly required to earn on the
retained earnings at least equal to the rate that
would have been earned by the shareholders if
these earnings were distributed to them.
• As per the external yield criterion, returns expected
from investing these retained earnings somewhere
else i.e. outside the co. are compared with the
investment in co.’s own project.
• (i) when there are no taxes and brokerage fee:
• (ii) on the assumption of taxes and brokerage fee:
(i) when there are no taxes and brokerage fee:
Kr = Ke = D1 + g
Po
(ii) on the assumption of taxes and brokerage fee:
Kr = Ke (1-T) (1- B)
Kr = cost of retained earnings
Ke = cost of equity capital
T = tax rate applicable to the shareholders
B = brokerage cost
Weighted average cost of capital (WACC)/ Overall cost of
capital
The term cost of capital means overall cost of capital or
composite cost of capital and may also be called WACC.
Computation of WACC involves 3 steps:
1. Calculate the cost of each source of funds(specific).
2. Finding the weight of each source of fund in the
capital structure either on the basis of their book
value or market value.
3. Calculation of sum of the product of specific cost
and weight of each source of fund.
Or
WACC (Ko) = Ke ×we + kd × wd + kp × wp + kr × wr
 Assigning weights
• Weights can be categorized on the basis of historical
weights, marginal weights, target weights.
• Historical weights can be classified into: book
values weights and market value weights.
• Marginal weights :- marginal weights refers to the
proportion in which a firm intends to raise new
capital from different sources of funds. This method
is used when new funds are to be raised and that
from different sources according to the requirement
of the firm. Marginal weights can be used to
calculate WACC of a new project when finance
through incremental capital raised in various ratio.
• Target weights :- in target weights system, a firm
wants to have a desired capital structure with target
proportions of different sources of finance. Hence
future capital structure which a firm consider as
optimum capital structure is decided in advance.
The firm raise additional funds in such a way to
achieve the target weights in the desired period.
Q 14 The following is the capital-structure of XYZ Ltd.
SOURCES AMOUNT SPECIFIC COST OF
CAPITAL

Equity share capital 40,00,000 11%

(4,00,000 equity
shares of Rs. 10
each)

Preference shares 10,00,000 8%

capital (1,00,000
shares of Rs. 10
each)

10% Debentures of 30,00,000 5%

Rs. 1,000 each
Retained earnings 20,00,000 11%

Presently, debentures are being traded at 92%,

preference shares at par and the equity shares at Rs. 14
per share. Find out the WACC based on the book value
WACC ON BOOK VALUE
SOURCES BOOK VALUE WEIGHT (W) K = COST OF CAPITAL WEIHTED COST W×K
EQUITY 40,00,000 0.4 0.11 0.044
PREFERNCE 10,00,000 0.1 0.08 0.008
DEBT 30,00,000 0.3 0.05 0.015
RETAINED 20,00,000 0.2 0.11 0.022
TOTAL 1,00,00,000 1.0 0.089

Market value
Sources Market value Weight (W) K = COST OF CAPITAL WO = W × K
EQUITY 37,33,333 0.39 0.11 0.0439
PREFERENCE 10,00,000 0.10 0.08 0.08
DEBT 27,60,000 0.29 0.05 0.014
RETAINED 18,66,667 0.19 0.11 0.02029
TOTAL 93,60,000 0.97 W0 = 0.084
• Q ABC Ltd. Has the foll. Capital structure:
Equity share capital (4,00,000 40,00,000
shares of Rs. 10 each)

12% Preference shares 4,00,000

10% Debentures 6,00,000

The equity shares of the co. are quoted at Rs. 110 and
the co. is expected to declare a dividend of Rs. 15 per
share. Rate of growth of dividend is 8%, which is
expected to be maintain.
(i) assuming the tax rate of 40%, calculate WACC
(ii) the co. want to raise the additional term loan of Rs.
5,00,000 at 10%. Calculate the revised WACC assuming
the market price of equity share has gone down to Rs.
Incremental cost of capital/Marginal cost of capital
• Marginal cost of capital is the incremental cost of
additional finance raised for a new project.
• Q SR. Ltd. Is presently having its existing capital structure
of equity and debt inSOURCES
the market
FINANCE
OF
value
MARKET VALUE
ratio
(Rs. IN LAKH) 2:1 with
SPECIFIC COST
(K) (%)
following details: EQUITY 400 15
DEBT 200 8
The co is TOTAL 600
Evaluating a project
requiring a total funding of Rs. 100 lakhs. The project can b
financed equally with equity and debt of Rs. 50 lakh each.
The cost of new debt is 10% with the introduction of more
debts in capital structure, the cost of equity would increase
to 16% from 15%. Compute marginal cost of capital.
• Q Find the WACC through book value and market
value when the foll. Information is provided.
SOURCES OF BOOK SPECIFIC MARKET
FUNDS VALUE Rs. COST % VALUE
EQUITY SHARE 15,00,000 15 27,00,000
PREFERENCE 10,00,000 12 11,00,000
SHARE
DEBT 5,00,000 10 6,00,000
• Q International foods Ltd. Has the foll. Capital structure:
PARTICULARS BOOK VALUE Rs. MARKET VALUE Rs.

Equity capital 2,50,000 4,50,000

(25000 shares of
Rs. 10 each)
Preference 50,000 45,000
capital(500 shares
of Rs. 100 each
carrying 13%
dividend)
Reserve and 1,50,000 -
surplus
Debentures(1500 1,50,000 1,45,000
debentures of Rs.
100 each carrying
14% interest)
6,00,000 6,40,000

• The expected dividend per share is Rs.1.40 and the dividend per share is expected to grow
at a rate of 8% forever. Preference share are redeemable after 5 years at par where
debentures are redeemable after 6 years at par. Tax rate 50%.
• Q 3 The balance sheet of M/s XYZ co. has the foll.
Items as at 31st Dec 2009
SOURCES AMOUNT Rs.

• Other relevant Paid up capital

4,00,000 equity shares of Rs. 40,00,000
Information 10 each
Reserve and surplus 60,00,000
about the co. is 15% Non convertible
debentures
20,00,000

given below: 14% institutional loan 60,00,000

Year ended Dividend per Earnings per Market price

31st Dec. share Rs. share Rs. per share Rs.
2009 4 7.50 50
2008 3 6.00 40
2007 4 4.50 30

Calculate WACC Ans. Ko 11.50

• Q. From the foll. information, calculate the WACC before tax for ABC Ltd.
1 shareholder’s funds (Rs. In lakhs)
Share capital : equity 500
preference 100
Reserve 300
2 borrowed funds:
secured loans 800
unsecured loans (including inter corporate deposits) 700
Additional information:
(i) Normal yield on equity shareholders funds is 15%
(ii) Dividend rate on preference share 12%
(iii) Interest on secured loans is 16.25%
(iv) Interest on unsecured loans is 20%
(v) Tax rate for ABC Ltd. Is 40% ANS. KO = 20.42%
• Q book value structure Rs.
• 14% debentures(Rs.100 per debenture) 8,00,000
• 15% preference shares(Rs. 100 per share) 2,00,000
• Equity shares (10 per share) 10,00,000
• Rs. 110 per debenture, preference shares: Rs. 120 per share; equity
share: Rs. 22 per share. Dividend expected on equity shares at the
end of the year is Rs. 2 per share; anticipated growth rate in
dividends is 7%. The co. pays all its earnings in the form of
dividends. Corporate tax rate is 40%.
• Ans. specific cost of capital Kd 7.64%; Kp 12.50%; 16.09% Ko =
12.35%
• Q B Ltd. Has 25,000 equity shares of Rs. 10 each outstanding. These
are currently selling at Rs. 20. It also has 1,000 debentures of Rs. 100
each bearing a coupon rate of 10%. Debentures are selling at Rs. 125
in the market. A dividend of Rs. 3 per share has just been paid on
equity shares. Tax rate is 35% and growth rate is expected to be 5%.
Calculate WACC.
• Q A Ltd. Co. has the foll. Info. Rs.
Equity share capital(2,00,000 shares) 40,00,000
6% preference share capital 10,00,000
8% debentures 30,00,000
The market price of the co.’s equity share is Rs. 20. It is
expected that co. will pay current dividend of Rs. 2 per share. It
will grow at 7% forever. Tax rate 50%. Calculate : (i) WACC based
on existing capital structure
(ii) The new WACC if the co raises an additional Rs. 20,00,000
debt by issuing 10% 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 share.
Ans. (i) Ke 17%; Kp 6%; Kd 4% Ko 10.75%
(ii) Ke 27%; Kp 6%; Kd 4%; Kd 5% Ko 13.60%
• Q Silver Ltd. Has the foll. Capital structure: Rs.
• Equity share capital(5,000 shares of 10 each)
40,00,000
9% preference share capital 1,50,000
12% debentures 3,50,000
10% Term loan 5,00,000
The equity shares of the co. has current price of Rs.
105 and co. declared a dividend of Rs. 9 per share for
the next year. The dividend growth rate is 5% p.a. tax
rate is 50%. Calculate WACC.
ANS. Ke 13.57%; Kd 6%; Kp 9%; Kd 5% Ko 8.49%
Q Bharat Ltd. Has the foll. Capital structure as per its balance sheet as at 31 st march 2009:
Rs.
Equity share capital(fully paid shares of 10 each) 4
18% preference share capita(fully paid shares of Rs. 100 each)
3
Retained earnings 1
12.5% debentures 8
12% Term loan 4
Total 20
Additional info:
(i) Currently quoted prices in the stock exchange:
Equity shares @ Rs. 64.25
Preference shares @Rs. 90
Debentures @ Rs. 95
(ii) For the last year, the co. had equity dividend of Rs. 8 per share which is expected to
grow @5% p.a. forever.
(iii) Corporate tax is 30%
Calculate WACC (A) Book value weights (b) Market value Weights
Ans. (a) Ke 18.07%; Kp 20%; Kd 9.21%; Kd 8.4%; Ko 12.29%
(b) Ko 15.54% MV eq 20,56,000; pref 2,70,000; Retain ear 5,14,000; deb 7,60,000; term
Q The foll. Capital structure Of ABC Ltd: Rs. (in lakhs)
Equity share capital(face value of Rs.10 each) 5
12% preference share capita(face value Rs.100) 4

8% debentures(face value Rs.100) 6

Total 15
The equity shares of the co. has current price of Rs. 15 each.
The co. paid a dividend of Rs. 2 per share for the last year. The
dividend growth rate is 5% p.a. the preference shares and
debentures are being traded at 90% and 80% respectively. Tax
rate is 40%. Calculate WACC. Using book value weights and
Market value weights.
ANS. Book valueKe 19%; Kp 13.33%; Kd 6% Ko 12.29%
Market value Ke 7,50,000; Kp 3,60,000; Kd 4,80,000 Ko 13.7
9%
• Q A Ltd. Co. has the foll. Info. Rs.
Equity share capital(face value Rs. 10 per share) 5,00,000

11% preference share capital 2,25,000

9% debentures 2,75,000
Total 10,00,000
Additional info.
(i) Rs. 100 per debenture redeemable at par, has 2% floatation cost and 10
year maturity. The market price per debenture to Rs.105.
(ii) Rs. 100 per preference shares redeemable at par, has 3% floatation cost
and 10 year maturity. The market price per preference share to Rs.106.
(iii) The equity share has Rs.4 floatation cost and market price per share is
Rs.24. The expected dividend is Rs. 2 per share with annual growth of 5%.
The firm has a practice of paying all earnings in the form of dividends.
(iv) Corporate income tax is 35%
Calculate WACC using market value weights.
Ans. MV Ke 12,00,000; Kp 2,38,500; Kd 2,88,750 Ko 12.80%
• Q 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 reserves of Rs. 3,60,000 and
Debt of Rs. 10,40,000. for the year ended
31/3/2010 the co.’s total profit 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 31/3/2010 was Rs. 150
per share. What was the WACC? Use market values
as weights.
• Eps 18
• Ke 12, Kd 4.8% MV EQ 22,50,000; GR 4,50,000;
DEBT 10,40,000; Ko 10%
Q XYZ Ltd. Has the foll. Book value capital structure:
Rs. crore
Equity capital(Rs. 10 each) 15
12% preference capital (100 each) 1
Retained earnings 20
11.5% debenture(100 each) 10
11% term loan 12.5
he next expected dividend on equity shares per share in Rs. 3.60, the
dividend per share is expected to grow at the rate of 7%. The market price
per share is Rs. 40.
Preference share, redeemable after 10 years, is currently selling at Rs. 75
per share.
Debentures redeemable after 6 years, are selling at Rs. 80 per debenture.
Tax rate 40%. Calculate WACC using (i)book value (ii)market value weights.
Ans Kd 11.37%; Kp 16.57%; Ke 16%; Kt 6.6%; Ko 13.21%
MV eq 25,71,42,857; pref 75,00,000; re 8,00,00,000; term l 12,50,00,000 ;
Ko 14.10%
• Q Determine cost of capital using market and book value weights based on the
foll. Data: Rs.
• Debentures (1000 each per debenture) 16,00,000
• Preference shares(10 each per share) 4,00,000
• Equity shares (100 each per share) 20,00,000
All securities are traded in the capital markets and recent market prices are:

• Debentures 1100 per debenture

• Preference shares 12 per share
• Equity shares 200 per share
• Anticipated financing opportunities are:
(i) Rs. 1000 per debenture redeemable at par carrying 8% interest rate. Maturity
period is 20 years and flotation cost is 4%, sale price Rs. 1,000.
(ii) Rs. 10 preference shares redeemable at par carrying 10% dividend rate. Maturity
period is 15 years and flotation cost is 5%, sale price Rs. 10.
(iii) Equity shares; equity dividend at the end of the year is Rs. 20 per share, sale price
Rs. 200. Anticipated growth rate in dividend is 35%.
(iv) Tax rate 35%.
Ans. Kd 5.51%; Kp 10.60%; Ke 15%; Ko 10.76%
Ill 20 foll figures
Equity share capital 40,00,000
12% pref shares 4,00,000
10% deb 6,00,000
The equity share of the co. quoted at 110 and the co.
is expected to declare a dividend 15 per share . Rate
of growth of dividend is 8%, which is expected to be
maintained . Tax rate 40%
(i) Calculate wacc
(ii) The co. wants to raise the additional term loan of
5,00,000 at 10%. Calcualte the revised WACC
assuming the market price of equity share has
gone down to 105.
Q. SB enterprises. Calculate weights using market
value. The expected dividend per share is 1.40 and
the dividend per share is expected to grow at a rate
8% forever. Preference share are redeemable after 5
years at par where debentures are redeemable after 6
years at par. Tax rate 6%.
Particulars Book value Market value
Equity (25000 shares of 10 2,50,000 4,50,000
each)
Preference shares (500 shares 50,000 45,000
of 100 each carrying 13%
dividend)
Debentures (1500 debentures 1,50,000 1,45,000
of 100 each carrying 14%
interest)
Reserves and surplus 1,50,000 -