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Home South Carolina ECONOMICS ECONOMICS 231 Cost of Capital Problems - Solved

Cost of Capital Problems - Solved - FINANCIA

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ECONOMICS 231

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FINANCIALMANAGEMENT

SOLVEDPROBLEMSCOSTOFCAPITAL
Problem1
Calculatethecostofcapitalinthefollowingcases:
i)

XLtd.issues12%DebenturesoffacevalueRs.100eachandrealizesRs.95perDeben
TheDebenturesareredeemableafter10yearsatapremiumof10%.
Y.Ltd.issues14%preferencesharesoffacevalueRs.100eachRs.92pershare.Thes
arerepayableafter12yearsatpar.

ii)

Note:Bothcompaniesarepayingincometaxat50%.
Solution
(i) CostofDebt
[Int+(RVSV)/N](1t)
kd
(RV+SV)/2
Int
t
RV
N
SV

=
=
=
=
=

Annualinteresttobepaidi.e.Rs.12
Companyseffectivetaxratei.e.50%or0.50
RedemptionvalueperDebenturei.e.Rs.110
Numberofyearstomaturity=10years
issuepriceperdebentureminusfloatationcosti.e.Rs.95

[12+(11095)/10](1.5)
kd =
(110+95)/2
[12+2.5](0.5)

7.25

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[12+2.5](0.5)
=
=
97.50

7.25

=7.43%
97.50

(ii) Costofpreferencecapital
D+(RVSV)/N
kp
(RV+SV)/2

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Where,
D
=
SV
=
N
=
RV
=

DividendonPreferencesharei.e.Rs.14
IssuePricepershareminusfloatationcostRs.92
No.ofyearsforredemptioni.e.12years
NetpricepayableonredemptionRs.100
RushiAhuja

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FINANCIALMANAGEMENT

14(10092)/12
kp =

(110+95)/2
14+.67

=
95
=15.28%
Problem2

a) AcompanyraisedpreferencesharecapitalofRs.1,00,000bytheissueof10%preferenceshare
Rs.10each.Findoutthecostofpreferencesharecapitalwhenitisissuedat(i)10%premium,a
(ii)10%discount.

b) Acompanyhas10%redeemablepreferencesharewhichareredeemableat6theendof10
fromthedateofissue.Theunderwritingexpensesareexpectedto2%.Findouttheeffectivecost
preferencesharecapital.

c) Theentiresharecapitalofacompanyconsistof1,00,000equityshareofRs.100each.Itscurren
earningsareRs.10,00,000p.a.ThecompanywantstoraiseadditionalfundsofRs.25,00,000by
issuingnewshares.Theflotationcostisexpectedtobe10%ofthefacevalue.Findoutthecosto
equitycapitalgiventhattheearningsareexpectedtoremainsameforcomingyears.
Solution
(a) Costof10%preferencesharecapital
(i)
WhenshareofRs.10isissuedat10%premium
Kp =D/P 0
=10/11x100
=9.09%
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=9.09%

(ii)

WhenshareofRs.10isissuedat10%discount
kp =PD/P0
=10/9x100
=11.11%

(b) Thecostofpreferenceshare(facevalue=Rs.100)maybefoundasfollows:
D+(RVSV)/N

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kp =

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(RV+SV)/2
RushiAhuja

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FINANCIALMANAGEMENT
Inthiscase
Page

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D
RV
SV

=
=
=

kp

10
100
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1002=Rs.98
10+(10098)/10
(100+98)/2

10.3%

(c) Inthiscase,thenetproceedsonissueofequitysharesareRs.10010=Rs.90andearningsper
shareisRs.10.
Costofnewequityis:
ke

D1 /p0

10/90

11.%

Problem3

AcompanyisconsideringraisingoffundsofaboutRs.100lakhsbyoneoftwoalternativemethod,
viz.,14%institutionaltermloanor13%nonconvertibledebentures.Thetermloanoptionwouldatt
nomajorincidentalcost.Thedebentureswouldhavetobeissuedatadiscountof2.5%andwould
involvecostofissueofRs.1,00,000.

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TERM

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