ACHARYA INSTITUTE OF TECHNOLOGY, BANGALORE

DEPARTMENT OF MBA
COST OF CAPITAL-PROBLEMS
1.A Ltd has 16% preference shares of 25 lakhs, redeemable after 10 years at a premium of 20.
What would be the cost of preference shares if there are issued at (i) premium of 10%, (ii)
discount of 10% (June 2013/10MBA23)
2. Compute WACC under each of the following three financing plans. If Ke=15%, Kp=10
percent and kd=8 percent. ( June 2013/12MBA25)

Financing plan Weight of equity Weight of preference Weight of debt capital

capital

1 0.50 0.30 0.20

2 0.30 0.40 0.30

3 0.20 0.30 0.50

(June 2013/12MBA25)
3. A company has 10 percent perpetual debt of Rs.1,00,000. The tax rate is 35 percent.
Determine after tax(kd) cost of debt capital if issued at (i) par and (ii) 10 per premium.
(June 2013/12MBA25)
4. Calculate the expected rate of return for each security using CAPM

Security Beta

Alpha 0.6

Theta 1.0

Gama 1.2

The risk free ratio is 6% and the expected return on market is 15%. (Dec 2012/10MBA23)
5. As a financial analyst of a large electronics company, you are required to determine the
weighted average cost of capital of the company using market value weights. The following
information is available: The Company’s present book value capital structure:

Debentures (Rs.100 per debenture) Rs.8,00,000

Preference shares (Rs.100 per share) Rs.2,00,000

Equity shares (Rs.10 per share) Rs.10,00,000

All these securities are traded in the capital markets. Recent prices are:
Debentures Rs.110 per debenture, preference shares of Rs.120 per share and equity shares Rs.22
per share. Anticipated external financing opportunities are:
(i)Rs.100 per debenture redeemable at par; 10 years maturity, 11% coupon rate, 4% floatation
cost, sale price Rs.100
(ii) Rs.100 preference share redeemable at par; 10 years maturity, 12% dividend rate, 5%
floatation cost, sale price Rs.100. (iii) Equity shares Rs.2 per share floatation costs, sale price
Rs.22. In addition, the dividend expected on the equity share at the end of the year is Rs.2 per
share; the anticipated growth rate in dividend is 7% and the firm the practice of paying all its
earnings in the form of dividend. The corporate tax rate is 35%.
(Dec 2012/10MBA23)&June 2010/08MBA23)
6.The PQR company has the following capital structure on 31st March 2012:

Ordinary shares(2,00,000 Rs.40,00,000

shares)

10% preference shares Rs.10,00,000

14% debentures Rs.30,00,000

Total Rs.80,00,000

The shares of the company sells for Rs.20. It is expected that company will pay next year a
dividend of Rs.2 per share which will grow at 7% forever. Assume 50% tax rate. You are
required to: (i) Compute a weighted average cost of capital based on the existing capital structure
(ii) Compute the new weighted average cost of capital if the company raises an additional of
Rs.20 lakh debt by issuing 15% 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. (June 2012/10MBA23)
7.The following is the capital structure of Zenith Co.Ltd as on 31-12-2010
Equity shares (10,000 shares of Rs.100 each) Rs.10,00,000
10% preference shares (of Rs.100 each) Rs.4,00,000
12% Debentures Rs.6,00,000
The market price of the company’s share is Rs.110 and is expected that a dividend of Rs.10 per
share would be declared after one year. The dividend growth rate is 6%.
(i) If the company is in the 50% tax bracket, compute the weighted average cost of capital.
(ii) Assuming that in order to finance an expansion plan, the company intends to borrow a fund
of Rs.10,00,000 bearing 14%, what will be the company’s revised weighted average cost of
capital? This financing decision is expected to increase dividend from Rs.10 to Rs.12 per share.
However, the market price of equity share is expected to decline from Rs.110 to Rs.105 per
share. (June 2011/10MBA23)
8. Following information is available relating to risk free rate (Rf) and market return(Rm)

Year Rf(%) Rm(%)

1 6 14

2 5 3

3 7 21

4 8 26

5 9 3

6 7 11

On the basis of the above information find out the cost of equity capital on the basis of CAPM
given that the beta factor is 0.863. (June 2011/10MBA23)
9. An investor holds the following portfolio:

Share Beta Investment

Alpha 0.6 Rs.3,00,000

Beta 1.0 Rs.1,80,000

Carrot 1.2 Rs.1,20,000

What is the expected rate of return on his portfolio, if the risk free rate is 6 percent and the
expected return on market portfolio is 15%. (Dec 2011/10MBA23)
10. Assuming that a firm pays tax at 50%, compute the after tax cost of capital, in the following
cases: (i) A perpetual bond sold at par, coupon rate of interest being 7%, (ii) A ten year 8%
Rs.1,000 bond, sold at Rs.950 less 4% underwriting commission
(iii) Rs.100 par value, preference share sold at Rs.100 with a 9% dividend and redemption price
of Rs.110, if a company redeems in 5 years (iv) An ordinary share selling at a current market
price of Rs.120 and paying a current dividend of Rs.9 per share, which is expected to grow at a
rate of 8%. (Dec 2011/10MBA23)
11.ABC Ltd has the following book value capital structure:
1.Equity capital (10 million shares @Rs 10/per share) Rs.100 million
 2.Preference capital----11%(100,000 shares, Rs.100 per share) 10
3.Retained earnings 120
4.Debentures, 13.5%(5,00,000 debentures, Rs.100 each) 50
5.12% loans 80
The next expected dividend per share is Rs.1.50. The dividend per share is expected to grow
@7%. The market price per share is Rs.20. Preference shares, redeemable after 10 years is
currently selling at for Rs.75 per share. Debentures, redeemable after 6 years are selling for
Rs.80 per dentures. The tax rate is 50%. Calculate the weighted average cost of capital using
(i) Book value proportions and(ii) Market value proportions (Dec 2010/08MBA23)
12. A firm’s after tax cost of capital of the specific sources is as follows:
Cost of debt=8%,Cost of preference share (including dividend tax)=14%,Cost of equity
funds=17%
The following is the capital structure:
Debt =3,00,000
Preference capital =2,00,000
Equity capital =5,00,000
Calculate the WACC, using book value weights (June 2013/08MBA23)
13. A company has 10% 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%
discount and (iii) 10% premium
(June 2013/08MBA2013)/June 2014/12MBA25)/Jan 17/12MBA25)
14. A company has on its books the following amounts and specific costs of each type of capital.

Type of capital Book value(Rs) Market value (Rs) Specific

costs(%)
Debt 4,00,000 3,80,000 5
Preference 1,00,000 1,10,000 8
Equity 6,00,000 12,00,000 15
Retained earnings 2,00,000 --- 13

13,00,000 16,90,000
 Determine the weighted average cost of capital using i) book value weights and ii)
market value weights.
(Jan2017/12MBA25 (June2010/05MBA& June2014/12MBA25)
15. From the following capital structure of a company, calculate the overall cost of capital using
i) Book value weights ii) Market value weights

Source Book value(Rs) Market value(Rs)

Equity share capital(Rs.10 shares) 45,000 90,000

Retained earnings 15,000 --

Preference share capital 10,000 10,000

Debentures 30,000 30,000

The after tax cost at different sources of finance is as follows: Equity share capital 14%,
Retained earnings 13%, Preference capital 10%, Debentures 5%. ( June 2009/08MBA23 &(Jan
2015/10MBA23)
16. Following is the capital structure of a company:

Rs.

Equity capital 4,00,000

10% preference share capital 2,00,000

Retained earnings 1,00,000

5% Debentures 3,00,000

Total 10,00,000

The cost of equity capital of the company is 15%, and retained earnings 8%, tax rate is
50%.Calculate the WACC. (Jan2015/12MBA25)
17.
The shares of consumer durable company are selling at Rs. 100 per share. Last year Rs.
10 per share, dividend was paid. Estimated growth of the company is 15% per year. You are
required to
i. Calculate Cost of equity capital of the company.
ii. If anticipated growth rate increases to 20%, calculate the estimated market price of equity
share.(February 2005).
SWARUPA RANJAN PANIGRAHI
Mobile no 8884511167