PROBLEM (COST OF DEBT , BEING IRREDEEMABLE DEBENTURES)

A company issues 1,000, 15% debentures of the face value of Rs. 100 each
at a discount of Rs. 5. The under-writing and other costs are Rs. 5,000/- for
the total issue. Assuming a Tax rate of 50%, Compute the Cost of the
debentures per annum.

PROBLEM: (COST OF REDEEMABLE DEBENTURES)

18% DEBENTURES -TERMS OF THE ISSUE:

FACE VALUE
NUMBER OF DEBENTURES ISSUED
DISCOUNT ON ISSUE OF DEBENTURES
UNDERWRITING COMMISSION
OTHER EXPENSES ON THE ISSUE OF DEB
REDEMPTION TERMS
REDEEMABLE AT PAR AFTER TEN YEARS
COMPUTE THE ANNUAL COST OF THE DEBENTURE ISSUE
ASSUMING A TAX RATE OF 30%.

I(1 - t) + ((RV - NP) / N)

(RV + NP)/2

PROBLEM:
A company issued 10,000, 10% debentures of Rs. 100 each on 1.4.2016 to be
matured on 1.4.2021. If the market price of the debentures is Rs. 80.
Compute the cost of debt assuming 35% tax rate.

SOLUTION:
PROCEEDS OF THE DEBENTURE ISSUE
FACE VALUE
MARKET PRICE OF THE DEBENTURE
ANNUAL NET INTEREST COST
ANNUAL INTEREST PAYABLE
TAX SAVINGS THEREON
NET ANNUAL INTEREST COST

REDEMPTION VALUE

ANNUAL COST OF CAPITAL

ANNUAL COST OF DEB
=65000+((1000000-800000)/5)
AVERAGE VALUE OF DEBENTURES
(1000000+800000)/2
ANNUAL COST OF THE DEBENTURES

PROBLEM:
Reserve Bank of India is proposing to sell a 5-year bond of Rs. 5,000 at 8 per
cent rate of interest per annum. The bond amount will be amortised equally
over its life. What is the bond’s present value for an investor if he expects a
minimum rate of return of 6 per cent?

FROM THE POINT OF VIEW OF THE INVESTOR

Interest receivable at the

end of year 1
end of yr 2
end of yr 3
end of yr 4
end of yr 5

CASH FLOWS
0TH YEAR
 end of yr 1
end of yr 2
end of yr 3
end of yr 4
end of yr 5
PRESENT VALUE

PROBLEM: (Irredeemable Pref shares)

If Reliance Energy is issuing preference shares at Rs.100 per share, with a
stated dividend of Rs.12, and a (issue) floatation cost of 3% then, what is the
cost of preference share ?

Annual Dividend cost

Amount Realised from the issue
Cost of Preference shares

PROBLEM:
If Reliance Energy is issuing preference shares at Rs.100 per share, with a
stated dividend of Rs.12, and a (issue) floatation cost of 5% then, what is the
cost of preference share, if these shares are going to be redeemed at par after
10 years ?

Annual Dividend payable

Annual Floatation cost
Average Annual Cost
Average Share value
Average Cost of Preference shares

Weighted Average Cost of Capital: {For the problem refer to the Word file)

Equity Shares 1250000 15%

Reserves & Surplus
500000
(Retained earnings) 15%
Preference Shares 750000 14%
Loans or Debentures 2500000 18%

5000000
 SOLUTION:
FACE VALUE OF DEBEN=1000X100X(100-5)%
UNDERWITING AND OTHER COSTS
NET REALISATION FROM THE DEBENTURE I
ANNUAL INTEREST
FACE VALUE
INTEREST PAYABLE @ 15%
TAX SAVINGS DUE TO INT
INTEREST EXPENSES (NET)
ANNUAL COST OF DEBENTURES

SOLUTION:

FACE VALUE OF DEBENTURES x 90%

Rs. 1000 =1000*20000*90%
20000 UNDERWRITING COMMISSION
10% OTHER EXPENSES ON THE ISSUE OF DEB
Rs. 250000 NET AMOUNT REALISED ON THE ISSUE (NP)
100000
REDEMTION VALUE AFTER 10 YEARS (RV)

ANNUAL INTEREST PAYABLE

=20000000*18%
TAX SAVINGS THEREON
NET INTEREST COST PER ANNUM

COST OF CAPITAL PER ANNUM:

=2520000 +((20000000-17650000)/1
(20000000+17650000)/2
 WHY MARKET VALUE IS LESSER

BECAUSE OF LOCK IN P

1000000
800000

100000
-35000
65000

1000000

105000

900000
11.67%

400
320
240
160
80

DF DCF
-5000 1 -5000
 1400 0.9434 1320.75
1320 0.89 1174.8
1240 0.8396 1041.13
1160 0.7921 918.829
1080 0.7473 807.039
5262.55

12
100 minus 3 97
12.37%

12
0.5 (Rs.5 spread over ten years)
12.5
=(95+100)/2 97.5
=I103/I104 12.82%

Word file)

187500

75000
105000
450000

817500
16.35%
1000X100X(100-5)% 95000
ER COSTS 5000
THE DEBENTURE ISSUE 90000

100000
T PAYABLE @ 15% 15000
NGS DUE TO INT 7500
T EXPENSES (NET) 7500
7500/90000 8.33%

URES x 90% 18000000

0000*90%
-250000
E ISSUE OF DEB -100000
ON THE ISSUE (NP) 17650000

R 10 YEARS (RV) 20000000

3600000

1080000
R ANNUM 2520000

000000-17650000)/10) 2755000
0+17650000)/2 18825000
14.63%
ALUE IS LESSER ?

LOCK IN PERIOD
ILLUSTRATION: 1

WHERE THE MATURITY PERIOD IS GIVEN (Practically, in most of the cases it shall be there):

Suppose an investor is considering the purchase of a five year, Rs.1,000 par

value bond, bearing a nominal rate of interest of 7 per cent per annum. The
investor’s required rate of return is 8 per cent. What should he be willing to
pay now to purchase the bond if it matures at par?

0TH YEAR -1000 1 -1000

END OF YEAR 1 70 0.9259 64.813

END OF YEAR 2 70 0.8573 60.011
END OF YEAR 3 70 0.7938 55.566
END OF YEAR 4 70 0.735 51.45
END OF YEAR 5 70 0.6806 47.642
END OF YEAR 5 1000 0.6806 680.6

960.082

ILLUSTRATION: 2

Compute the “yield-to-maturity” of 5-year bond, paying 6 per cent interest

face value of Rs.1,000 and currently selling for Rs.883.40

YTM = 9.00%

-883.4 55.04587 50.5008 46.33101

-883.4 60 60 60 60 1060

9.00%

ILLUSTRATION: 3

The government is proposing to sell a 5-year bond of 1,000 at 8 per cent

rate of interest per annum. The bond amount will be amortized (repaid)
equally over its life. If an investor has a minimum required rate of return of
per cent, what is the bond’s present value for him?
 Begng Interest Repayt Total Repayt Factors

Year 1 1000 80 200 280 0.9346

2 800 64 200 264 0.8734
3 600 48 200 248 0.8163
4 400 32 200 232 0.7629
5 200 16 200 216 0.713
PV ₹ 1,025.71
 , Rs.1,000 par
er annum. The
e be willing to

960.08 70
70
70
70
1070

g 6 per cent interest on the YTM=IRR

42.50551 38.99588 649.9314 883.3105

1,000 at 8 per cent

mortized (repaid)
uired rate of return of 7
PV

261.69
230.58
202.44
176.99
154.01
1025.71
X ltd., has the following balances in its Balance Sheet:

Capital Structure Rs.

Equity Shares 1250000

Reserves & Surplus (Retained
500000
earnings)
Preference Shares 750000
Loans or Debentures 2500000
5000000
The expected after-tax component costs of the
various sources of finance for X Ltd are as
follows:

Capital Structure Cost of Cap

Equity Shares 15% EXTERNAL EQUITY

Reserves & Surplus 15% INTERNAL EQUITY
Preference Shares 14%
Loans 18%

From the above information, compute the

Weighted Average Cost of Capital.

Answer:
Equity Shares 1250000 15% 187500
Reserves & Surplus (Retained
500000
earnings) 15% 75000
Preference Shares 750000 14% 105000
Loans or Debentures 2500000 18% 450000

5000000 817500
WACC 16.35%

OR
 Proportion to
Total Capital C of Cap %
A B AXB
Equity Shares 25.00% 15% 3.75%
Reserves & Surplus (Retained
earnings) 10.00% 15% 1.50%
Preference Shares 15.00% 14% 2.10%
Loans or Debentures 50.00% 18% 9.00%

WACC 16.35%
 X ltd., has the following balances in its Balance She

Capital Structure

Equity Shares
Reserves & Surplus (Retained
earnings)
Preference Shares
Loans or Debentures

The expected before-tax component costs of the

various sources of finance for X Ltd are as
follows, tax rate being 30%:

EXTERNAL EQUITY
INTERNAL EQUITY
Equity Shares
Reserves & Surplus (Retained earnings)
Preference Shares
Loans or Debentures
balances in its Balance Sheet:

Rs. Capital Structure

1250000 Equity Shares

500000 Reserves & Surplus
750000 Preference Shares
2500000 Loans

x component costs of the From the above information, compute the

ce for X Ltd are as Weighted Average Cost of Capital.

19BBS0031
19BBS0032
19BBS0017
19BBS0167
19BBS0180
1250000 15.0% 187500
500000 15.0% 75000
750000 14.0% 105000
2500000 12.6% 315000
5000000 682500
WACC 13.65%
 Cost of Cap

15%
15%
14%
18%

mation, compute the

ost of Capital.

RITHVIK
DIVYANSH AGARWAL
AKSHATH GUPTA
RAUNAK SHUKLA
CHAITHANYA