Cost of Capital-Practice Set

A company has 10 per cent perpetual debt of Rs. 1,00,000. The tax rate is 35%. Determine the
cost of capital (before tax as well as after tax) assuming the debt is issued at (i) par, (ii) 10 percent
discount, and (iii) 10 percent premium. (Ans. Before tax cost of capital (i) = 10 percent, (ii) 11.11
percent, and (iii) 9.09 percent)
A company issues 11 percent irredeemable preference shares of the face value of Rs. 100 each.
Floatation costs are estimated at 5 percent of the expected sale price, (a) what is cost of preference
capital if preference shares are issued at (i) par, (ii)10 percent premium and (iii) 5 percent
discount? (b) Also compute cost of preference in these situations assuming 13.125 percent
dividend tax. (Ans. (a) (i) 11.6%, (ii) 10.5%, (iii) 12.2% and (b)- (i) 13.1%, (ii) 11.9%, (iii)
13.8%)
Suppose that dividend per share of a firm is expected to be Rs. 1 per share next year and is
expected to grow at 6 percent per year perpetually. Determine the cost of equity capital, assuming
the market price per share is Rs. 25. (Ans. 10%)
(Hint. Use Dividend model)
Calculate the cost of equity for the following companies.
Name of Company
Beta factor
ACC Ltd
0.8
ABB Ltd.
0.7
RIL Ltd.
0.5
Risk free return is 8% and Return on market index is 26.33%.
(Ans. 22.66, 20.83, 17.16)
(Hint. Use CAPM model)

A company issues 11 percent debentures of Rs. 100 for an amount aggregating Rs. 1,00,000 at 10
percent premium, redeemable at par after five years. The companys tax rate is 35 percent.
Determine the cost of debt both before tax and after tax using short cut formula. (Ans. 8.57%
before tax)

6.
A company has on its books the following amounts and specific costs of each type of capital.
Type of Capital
Debt
Preference
Equity
Retained Earnings

Book Value
4,00,000
1,00,000
6,00,000
2,00,000

Market Value
3,80,000
1,10,000
12,00,000(combined value of
equity and retained earnings)

Specific Cost (%)

5
8
15
13

13,00,000

Determine the weighted average cost of capital using (a) Book value weights and, (b) Market Value
weights. How are they different? Can you think of a situation where the weighted average cost of capital
would be the same using either of the weights.
(Ans. (a) 11.1%, (b) 11.9%)