Cost of Debt Capital

Q.1 A company issues 12% debentures of Rs. 5,00,000 repayable after 10

years at a discount of 4% and incurs Rs. 10,000 for underwriting,
brokerage etc. Calculate cost of debt.
Ans. 12.98%
Q.2 In the above example if debentures are issued at par and no floatation
cost. Calculate cost debt.
Ans. 12%
Q.3 When debentures are issued at premium and redeemed at par on
maturity with flotation cost of Rs. 10,000. Calculate cost debt.
Ans. 11.52%
Q.4 If debentures are redeemable at premium and floatation cost is Rs.
10,000. Calculate cost of debt.
Ans. 12.51%
Cost of perpetual debentures (Iredeemable)
Q.5 A company issues 12% debentures of Rs. 5,00,000 at par and incurs
Rs. 10,000 as issue expenses. Calculate cost of debt.
Ans. 12.24%
Preference Share Capital
Q.1 A company issues 11% preference shares of Rs.100 at par and the
issue expense per share is Rs.2. Calculate the cost of preference share
capital.
Ans. 11.22%
Q.2 A company wishes to issue 1,000, 9% preference shares of Rs. 100
each. The other expenses of capital issue are : underwriting 2%, brokerage
0.5%, printing etc. Rs. 500. Calculate cost of capital if issue has been made
(a) at par, (b) at discount of Rs. 5 per share and (c) at a premium of Rs. 6
per share. What will be the effect on cost of capital if present corporate
tax on its earnings is 30%?

Ans. (a) Kp after tax = 9.27%, Before tax Kp= 13.24% (b) Kp after
tax= 9.78%, Before tax Kp = 13.97% (c) Kp after tax = 8.73%,
Before tax Kp= 12.47%

Q.3 Y Ltd. issues 50,000 10% preference shares of Rs. 100 each
redeemable after 10 years at a premium of 5%. The cost of issue is Rs.2
per share. Calculate cost of preference share capital. Assume corporate tax
rate of 30%.

Ans. 10.54%, Before Tax = 15.05%

Cost of Equity Capital

Q.1 XYZ Ltd. issued 10,000 equity shares of Rs. 10 each at a premium of RS. 2 each..
The company has incurred issue expenses of RS. 5,000. The equity shareholders expect
the rate of dividend of 18% p.a. Calculate cost of equity share capital.

Ans. Ke = 15.65%

In case of existing equity shares, market price Rs. 21 is to be taken as basis for
calculation of cost of equity capital, what will be the Ke?

Ans. 8.57%.

Q.2 A company issues 5,00,000 equity shares of Rs. 10 each and has earned a profit of
Rs. 6,00,000 after tax. If the market price of these shares is Rs. 16 per share, calculate
cost of equity capital.

Ans. Ke= 7.5%

Q.3 A Ltd. has issued 2,000 equity shares of Rs. 100 each as fully paid. The company
has earned a profit of Rs. 20,000 after tax. The market price of these shares is Rs. 160
per share. On these shares dividend of Rs. 8 per share has been paid. Calculate cost of
equity capital using (i) D/Y method and (ii) E/Y method.
Ans. D/Y method Ke = 5%, E/Y Method ke = 6.25%.

Q.4 The present market price of a company’s equity share is Rs. 60 and dividend paid
for the previous year is Rs. 4.50. If 8% growth rate in the dividend is expected,
calculate cost of equity capital.

Ans. 16.1%.

Q.5 XYZ Ltd. has its share of Rs. 10 each quoted on the stock exchange, the current
price per share is Rs. 24. The dividends per share over the last four years have been
Rs. 1.20, Rs. 1.32, Rs. 1.45, and Rs. 1.60. Calculate the cost of equity shares.

Ans. 17.33%

Cost of Retained Earnings

Q.1 Calculate cost of retained earnings if Ke is 12%, personal income tax rate is 22%
and brokerage rate is 1%.

Ans. Kr = 9.27%

Q.2 Find out cost of retained earnings from the following data:

DPS: Rs. 15

Personal income tax rate: 30%

MPS: Rs. 110

Brokerage on investment of dividend: 1%

Ans. 9.45%

Q.3 Find out cost of Retained Earnings from the following information: (Rights Offer
Approach)
DPS: Rs. 9

Personal income tax rate: 30%

Personal capital gains tax rate: 20%

MPS: Rs. 100

Ans. 7.87%

Q.4 Calculate the cost of retained earnings from the following information:

MPS: Rs. 140

Brokerage: 3%

Growth in expected dividend: 5%

Expected dividend per share on new shares: Rs. 14

Shareholders personal income tax rate: 22%

Ans. 11.35%

Weighted Average Cost of Capital

Book Value Weights

Q.1 Following information is available with regard to the capital structure of ABC Ltd.

Sources of Funds Amount (Rs.) After tax cost of Capital

Equity Share Capital 3,50,000 12%
Retained Earnings 2,00,000 10%
Preference Share Capital 1,50,000 13%
Debentures 3,00,000 9%
Ans. 10.85%

Market Value Weights

Q.2 The following is the capital structure of High Sky Ltd.

Sources of Funds Amount (Rs.) After tax Cost of Capital

Equity Share Capital 10,00,000 11%
(1,00,000 shares of Rs. 10
each)
Preference Share Capital 2,50,000 8%
(25,000 shares of Rs. 10
each)
Retained Earnings 5,00,000 11%
9% debentures 7,50,000 4.5%

Additional Information: The debentures are trading at 94%, preference shares at par and equity
shares at Rs. 13.50 per share.

Find out the weighted average cost of capital based on market value weights.

Ans. 8.6%

Q.3 Calculate weighted average cost of capital from the following information:

Capital Structure of ABC Ltd. Amount (Rs.)

Equity Share capital (Shares of Rs. 10 each 1,00,000
fully paid)
Reserves (General) 50,000
Long term debt 1,00,000
Total 2,50,000

Additional Information: Market price of per share of ABC Ltd. is Rs. 60 and earning per share is
Rs. 6. The expected growth rate of earnings is 5% per annum. Cost of debt (before tax) is 12%
per annum. Applicable corporate tax rate is 40%. Use market value weights and show your
workings.

Ans. 13.8%

Q.4 The capital structure of Blackstone Ltd. as on 31.3.2018 is as follows:

 Sources of Funds Amount (Rs.)
Equity Capital (100 lakh equity share of Rs. 10 Rs. 10 crores
each)
Reserves and Surplus 2 crores
14% Debentures of Rs. 100 each 3 crores

For the year ended 31.3. 2018, the company has paid equity dividend at 20%. As the company
is a market leader with good future, dividend is likely to grow by 5% every year. The equity
shares are now traded at Rs. 80 per share on the stock exchange. Income tax rate is 50%.

(i) Compute current weighted average cost of capital using book value weights.

(ii) The company has plans to raise a further Rs. 5 crores by way of long term loan at 16%
interest. It will result into fall of market value of equity shares to Rs. 50 per share. What will be
the new weighted average cost of capital of the company?

Ans. (i) 7.4% (ii) 8.45%

Q.5 The capital structure of Blackstone Corp. is as under:

Source of Finance Amount (Rs.)

2,000 6% Debentures of Rs. 100 each (first 2,00,000
Issue)
1,000 7% Debentures of Rs. 100 each 1,00,000
(second issue)
2,000 8% Cumulative Preference shares of 2,00,000
Rs. 100 each
4,000 Equity shares of Rs. 100 each 4,00,000
Retained earnings 1,00,000

The earnings per share of the company in the past years have been Rs. 15. The shares of the
company are sold in the market at book value. The company’s tax rate is 50% and
shareholders’ personal tax liability is 10%. Find out the weighted average cost of capital.

Ans. 8.43%