Cost of Capital - Question 3 If WACC is based on Book Value, d

If WACC is based on Market Value

=YIELD(settlement, maturity, rate,pr,redemption, frequency,basis)

Cost of Bond Cost of Preference Share
Purchase Date 6/12/2021 Dividend / Value of Preference sh
Maturity Date 6/11/2036 [Market Value]
Coupon Rate 7.50% 6 / 91 = 6.59%
Present Value 93
Maturity Value 100
Frequency 2
Basis 0

Before Tax Kd 8.33%

After Tax Kd = Before Tax Kd X (1 - Tax Rate)

=8.33%*(1-35%)
Kd = 5.4145% Kp = 6.59%

Weighted Average Cost of Capital = WACC

Market Value of the Firm = 42,64,00,000 Kd

Kp
Hurdle Rate = 12.8082% Ke

Capital Structure - Question 1

Calculation of EPS [Earning Per Share]
Economy Normal Economy Strong
EBIT 28,000
Less: Interest -
EBT 28,000
 Since No Tax, EAT 28,000
[Earning to Equity SH]
Number of Equity Shares 5,000
EPS 5.600

% of Change

Company plans for a Debt amount of $ 90,000

Borrow & Settle Equity Shares - $ 90,000
Current Market Price of a Share = 2,50,000 / 5,000 = 50

Number of Shares that can be bought throgh $ 90,000 / 50 = 1,800 Shares Bought B
Earlier Number of Shares 5000
Now Purchased Back (Bought Back) 1800
Balance outstanding 3200

Calculation of EPS [Earning Per Share]

Economy Normal Economy Strong
EBIT 28,000
Less: Interest 6,300
EBT 21,700

Since No Tax, EAT 21,700

[Earning to Equity SH]
Number of Equity Shares 3,200
EPS 6.781

% of Change

Capital Structure - Question 2 Return on Capital Employed = Earning Before Interest &
5.6 Million Debt : 2.8 Million
Equity : 2.8 Millio
Calculation of EPS [Earning Per Share]
 All Equity Firm Levered Firm
EBIT 350,000
Less: Interest -
EBT 350,000

Since No Tax, EAT 350,000

[Earning to Equity SH]
Number of Equity Shares 160,000
EPS 2.188

% of Change

All Equity Firm Levered Firm

EBIT 500,000
Less: Interest -
EBT 500,000

Since No Tax, EAT 500,000

[Earning to Equity SH]
Number of Equity Shares 160,000
EPS 3.125

% of Change

Break Even EBIT (Financial Break Even) means, level of EBIT at which EPS will

In case of All Equity Firm, EPS is :: EBIT (1-Tax Rate) / Number of Shares

In Case of Levered Firm, EPS is :: [EBIT - Interest] X (1 - Tax Rate) / Number of Sha

For Break Even EBIT :: EBIT / Number of Shares = [EBIT - Interest] / Number o

EBIT / 1,60,000 = [EBIT - 2,24,000] / 80,000

Multiply both sides with 80,000 :: EBIT / 2 = [EBIT - 2,24,000] / 1

EBIT = [EBIT - 2,24,000] X 2

 EBIT = 2 EBIT - 4,48,000

4,48,000 = 2 EBIT - EBIT

4,48,000 = EBIT

All Equity Firm Levered Firm

EBIT 448,000
Less: Interest -
EBT 448,000

Since No Tax, EAT 448,000

[Earning to Equity SH]
Number of Equity Shares 160,000
EPS 2.800 Indifferent

% of Change
d on Book Value, denominator for Kp will be face value of Preference shares
d on Market Value, denominator for Kp will be market value of Preference shares

Formula - No Percentage
ce Share Cost of Equity
ue of Preference shares CAPM Model
[Market Value] Risk Free Rate + Beta (Risk Premium)
Risk Premium = Market Return - Risk Free Rate

5% + 1.25 ( 8.5%)

15.63%

Ke = 15.63

Weightage Based on Market Price Market Value Product

5.41% 1,05,000 Bonds X $ 930 97,650,000 5,287,259
6.59% 2,50,000 Shares X $ 91 22,750,000 1,499,225
15.63% 90,00,000 Shares X $ 34 306,000,000 47,827,800
426,400,000 54,614,284
B A
Weighted Average Cost of Capital 12.8082% [Sum of Product / Sum o
[A / B]

30% -50%
Economy Strong Economy Recession
36,400 14,000
- -
36,400 14,000
 36,400 14,000

5,000 5,000
7.280 2.800

30.00% -50.00%

0 Shares Bought Back

30% -50%
Economy Strong Economy Recession
36,400 14,000
6,300 6,300
30,100 7,700

30,100 7,700

3,200 3,200
9.406 2.406

38.71% -64.52%

ng Before Interest & Tax (1 - Tax Rate) / (Equity + Preference Shares + Debentures) = 15%
Debt : 2.8 Million
Equity : 2.8 Million ROCE = 3,50,000 / 56,00,000 = 6.2500%
Levered Firm
350,000
224,000 28,00,000 X 8% = 2,24,000
126,000
If Cost of Debt is less than Return on Capital Employed, then Borrowing
126,000

80,000
1.575

-28.00%

Levered Firm ROCE = 5,00,000 / 56,00,000 = 8.9286%

500,000
224,000 28,00,000 X 8% = 2,24,000
276,000

276,000
If Kd (Cost of Debt) is less than ROCE, then EPS will increase in Levered
80,000 If Kd (Cost of Debt) is more than ROCE, then EPS will decrease in levere
3.450

10.40%

at which EPS will be equal for Levered and Unlevered (All Equity) Firm

of Shares

) / Number of Shares

terest] / Number of Shares

Levered Firm
448,000
224,000
224,000

224,000

80,000
2.800

0.00%
m of Product / Sum of Weight]
es) = 15%
yed, then Borrowing is good

l increase in Levered Firm

ill decrease in levered firm