Cost of Capita l

1
· X
,
Ud iss ues Rs .50 000 8% d - l ,
. '
-• • 1' / . • o
" e Jcnlwcs. ic la x ra te appl ica ble lo the co1np;in y is 5 0 %.
·1·11c cus l o !'
f10at a t1on is ?o/r
- o.
c o mpute .
li1 e cos t o l de bt ca p ital if th e debentures a rc iss ued al (a) pa r (bJ
/ ()'1/,
"
pre mium (c) 5 % di sc o unt.
2. A
compa ny issu es R s. l 0,00,000 l 0% redee ma ble de bentures. T he cos t of /1 oat a ti o n a m o un ts to
R s .30,000. The d e bentures a re red eema bl e afte r 5 yea rs a nd th e tax ra te a ppl ica bl e to th e compuny is
5 0 % . C a lc ul a te the c ost of de be ntures if th ey are iss ued a t (a) pa r (b) a t 5% pre mium (c) a t S%

discount.

3. X Ltd ha s iss ued redeemabl e zero co upon bonds of Rs. / 00 eac h a t a di sco unt o f Rs.60 repaya bl e al

the end o f fourth year. Ca lcul a te th e cost of de bt.

4 . A co mpan y iss ues l 0,000 I 0 % preference shares of Rs ./ 00 eac h. Cos t of iss ue is Rs.2 pe r s ha re .
Ca lc ul ate cost of prefe rence ca p ita l if these sha res are iss ue d a t (a) pa r ( b) a t I 0 % pre m ium (c) a l 5%
dis co unt.
5 . A co mpa ny offers fo r publ ic s ubscripti on eq ui ty sha res o f Rs . l O eac h a l a pre m ium o f I 0 %. T he
co mpa ny pays 5% of the iss ue pri ce as underwriti ng commi ss io n . T he ra te of di vidend ex p ec te d by
th e equ ity s ha re ho lders is 20%. Yo u are required to ca lcula te th e cos t of e qui ty capita l. Will th e cos t
of cap ita l be di ffe rent if it is to be ca lc ula ted on th e presen t va lue of the equity s ha res , w h ic h is
Rs . 15?
6. Th e c urrent sales of an enterprise are of the va lu e of R s. 1,00,000 a nd its op era ting cos t a m o unt s to
Rs . 75,000. O utsta nding shares of th e co mpa ny are 10,000 in n umb e r a nd th e fi rm pl a ns to iss ue I 0
pe rce nt de bentures to ra ise Rs. 1,00,000. Yo u a re requ ire d to s how th e impac t o n the ea rn ings p er
sha re if th e company ea rn s o n th e bo rrowed fund s a re turn of(a) 10 % (b) 8 %.
7. From ihe fo ll ow in g de ta ils of X Limi ted ca lc ul a te th e cos t of eq uity ca p ital.
a) Each sha re is of Rs. l 50 eac h.
b) Th e und erw riting cos t per share a mo un ts to 2%.
c) T he fo ll ow ing are th e di vide nd pa id by the co mpany fo r th e last five years
Y ea r I D ivide nd per share
(Rs .)
2 00 7 10 .50
- - - --
2 008 11.00
2009 12.50
- I

20 10

20 1 1
12 .75

13.40
j
d) The co mpan y has a fixed div idend pa you : r:il io . - -
c) The ex pected d i vidend on the llC\\ ' shi!rc:; 11mounts !o J< s . 14 . lo p er sh are .
 8. The ent ire c 1p ital employed by '.1 compan
. . of' one lakh ,·qu 1ty ~han.: ~ of R~.1 OU -,·
y cun ~1st~ h

~ arc Rs· · IO I·,l kl'L per, . annum.

current carn inl'.s , ..I.he compan y wa nts to ra is
. e add 1.11onal
. funds u.. ,. ~5
01
lakh s by iss uing new ·sh·ctres.
. Tlic I7oatatron
. costs arc expected to be 10'% of the fa ce \a lue ,

share s. Yo u arc rcc1u ired to ca IcuIate the cost ol- equ ity cap ital
. prcs urrn·ng that the earn mgs· o f l l .t
compan y arc CXjJCC
' te d to rema ·rn stable over the nex t few years.
9. /\BC Ltd . is earn ing a net profit of Rs.50,000 per annum. The sharehold ers required rate o:· return is
I 0%. It is expected that retained earnings, if dis tributed among the shareholders. can be in\ csted by
them in sec urit ies of similar type carrying return of I 0% per an num . It is further expected that the
share hold ers will have to incur 2% of the net dividends rece ived by th em as brokera ge cost for
mak ing new investments. The shareholders of the comp any are in 30% tax brac ket. You are requ i;·ed

to calc ul ate the cost of retained earnings to the company.

I 0 . The fo llow ing is the cap ita l stru cture of a firm :

I Aftr.r-tax Cost ,)f cap it al(%)
- Amount (Rs.)
Source of finance I

lE
Equity (pa id-up) shan~capital
4,50,000 I -
I

\8
1,50,000 I

Reta ined earnings -- ·

------- - - - 11
1,00,000
Preference share cap ital I
3,00,000
8 \
Debt I ----\
- - -- I 0,00,000
Tota l I
Ca lculate the weighk:d average cos t of capital.

11 . You are given the following facts about a firm

a) Ri sk-free rate of return is 11 %.

b) Beta c,.)efficient of th e firm is 1.25 .
Compute the cost of equity capita! using CA PM ass uming a market return of 15% next year. What would be

th e cost of equity if the beta ri ses to l. 75?