Cost of Capital

1. A company has issued 15% perpetual debt of $1,000,000 for a new project. Tax rate is 40%.
Determine cost of capital, assuming that debt is issued:
a. At par
b. At 10% discount
c. At 10% premium

2. A company issues new 15% bonds of $1,000 face value to be redeemed after 10 years for a
project. Bonds are sold at 5% discount. Floatation costs of 3% would be incurred. Tax rate is
40%. Calculate the cost of debt for evaluating the project.

3. A company issues new 12% bonds of $1,000 face value for a new project to be redeemed
after 8 years. Bonds are sold at 5% premium. Floatation costs of 2% would be incurred. Tax
rate is 40%. Calculate the cost of debt for evaluating the project.

4. A company issues new 10% bonds of $1,000 face value for a 15 year project to be redeemed
at par after 15 years. Bonds are sold at 10% premium. Floatation costs of 4% would be
incurred. Tax rate is 40%. Calculate the cost of debt for evaluating the project.

5. A company issues new 14% bonds of $1,000 face value to be redeemed at premium of 5%
after 14 years. Bonds are sold at par to start a new project. Floatation costs of 3% would be
incurred. Tax rate is 40%. Calculate the cost of debt for evaluating the project.

6. A company issues for a project 10% bonds of $1,000 face value to be redeemed at premium
at 4% after 6 years. Bonds are sold at 3% discount. Floatation costs of 2% would be incurred.
Tax rate is 40%. Calculate the cost of debt for evaluating the project.

7. Calculate cost of debt for each of the following situations assuming tax rate of 30%, coupon
interest rate of 10%, face value of each bond is $1,000 and maturity of debt is 20 years:
a. Bonds are sold at par and floatation cost is 2%
b. Bonds are sold at 10% premium and floatation cost is 3%
c. Bonds are sold at 5% discount and floatation cost is 4%

8. Star company has issued bonds with 5 years life having face value of $1,000. Bonds are sold
for $900 each and are to be redeemed at 5% premium. Interest rate is 12% and tax rate is
30%. Calculate cost of debt

9. A company issues 14% irredeemable preference shares of $100 face value. Floatation costs
are estimated about 5% of the sale price. Calculate cost of preference shares to be used for
evaluation purposes assuming shares are issued at:
a. Par
b. 10% premium
c. 5% discount
10. Dividend per share of a firm is expected to be $1 at the end of year and then is expected to
increase at 6% annually for an indefinite period. Assuming the market price of share to be
$25 calculate the cost of equity.

11. If risk free rate is 10%, beta of the stock is 1.50 and the market rate of return is 12.5%.
Calculate cost of equity.

12. Investors require 12% return on equity. Calculate the market price per share if the previous
dividend (Do) was $2 and dividends growth rate is expected to be:
a. 4%
b. 0%
c. -4%
d. 11%
e. 12%
f. 14%

13. A firm’s after tax cost of capital of the specific sources and the book and market values of the
funds are given below. Calculate weighted average cost of capital using book values and
market values.
Source Cost Book Value Market Value
Debt 10% $600,000 $550,000
Preference Shares 12% 400,000 500,000
Equity Shares 14% 1,000,000 1,500,000

14. The above firm wishes to raise additional $1,000,000 for a new project as follows:
Source Amount
Debt 500,000
Preference Shares 200,000
Equity Shares 300,000
Calculate the cost of capital to be used for evaluating the project using marginal weights.

15. A company has following sources and costs of funds:

Type of Capital Book Value Market Specific Cost
Debt $800,000 760,000 5%
Preference Shares 200,000 220,000 8%
Equity Shares 1,200,000 1,800,000 13%
Retained Earnings 400,000 600,000 12%
Calculate cost of capital using book value and market value weights.

16. A fast growing company wants to expand its total assets by 50% by the end of the year. You
have been given the company’s capital structure which it considers to be optimal.
8% bonds $800,000
9% preference shares 200,000
Equity shares 1,000,000
Total 2,000,000
New bonds would be sold at 14% coupon rate and will be sold at par. Preference shares will
have 15% rate and will also be sold at par. Equity shares currently selling at $100 can be sold
 to net $95. The shareholders’ required rate of return is 17% consisting of dividend yield of
10% and growth rate of 7%. Retained earnings are estimated to be $100,000. Tax rate is
40%.
a. Calculate the amount required for expansion project.
b. How much of the amount would be financed by each of the sources to maintain
optimal capital structure.
c. Calculate cost of capital of each source and weighted average cost of capital.

17. As a financial analyst of a large electronics company, you are required to determine the
weighted average cost of capital of the company using book value and market value methods.
Following information is available for perusal:
Present capital structure (Book values)
Bonds ($100 face value) $1,600,000
Preference shares ($100 par value) 400,000
Equity shares ($10 par value) 2,000,000
Total 4,000,000
All the securities are traded in capital markets. Current prices are as:
Bonds $110
Preference shares $120
Equity shares $22
Anticipated external financing opportunities are:
1. $100 bond redeemable at par, 10 year maturity, 13% coupon interest rate, 4%
floatation cost, sale price $100
2. $100 preference share redeemable at par, 10 year maturity, 14% dividend rate, 5%
floatation cost, sale price $100
3. Equity share $ 2 per share floatation cost, sale price $22
In addition the dividend expected on equity share at the end of year is $2 per share. The
anticipated growth rate in dividends is 7% and the tax rate is 40%