pool Ne ees ee portant input in capital budgeting decisions.An investors’ investment in Cos of cai ch as shares, debentures, public deposits, etc. of a company are on the basis of eee v3 euurn An investment decision depends upon the cost of capital Cost of ce eae scp return that the company must earn on it investments. The chapter ical is he mit ¢ eae the concept of cost of capital and its measurement 1) INTRODUCTION Teco of capital is the most important and essential input for jaseeeeseremueniaaas bg francal decisions. Without considering cost of capital, no Cot a ere /fmom evaluate an investment project. Cost of capital serves aS | totum of hurdle rate. yardck forjudging how good a project is for the firm. A com- | sss i obains funds from different sources like equity share capital, preference share capi |@pidlforits investment needs. It can also plough back a part of its undistributed profit again into s.Allthese sources of capital has a cost. The firm should pay to the suppliers of funds at arate : eed or expected by them. Hence ,the cost of capital is that rate at which suppliers of hy aid. to obtain required funds for financing a firm’s investment activities. eer gay Shareholder’s wealth is regarded as the basic objective of financial management. hecreumaie nth @ view to increase the shareholder's wealth to the maximum possible ata rate ea, When raised funds has a cost then these funds should be employed by a mi rate of return, Beh should at least be equal to their cost. Hence, cost of capital is the ° tive investment dares business should earn on its investment, It acts as a cut-off-rate or Sl beng decision ne ane Ttis used as a discount rate for discounting future cashflows in Rigg funds, Italsodene, The cost of capital depends upon the degree of risk perceived by Pilot aig eas in a "pends upon the degree of risk undertaken by a business while invest- ‘torent sources oF fan Srerall cost of capital of a firm is the weighted average of cost of a: i ee re dey te pro! nearing he a Of Cost of Capi od Deena et pene saat eS ee reeset | Mae amd Cen eee of management oe Pounds aye matt cot of TS bef won pany, ised are eset ed on ‘view, cost of capital mest peminimum required rate of ag pipes OF COST OF CAPITAL icators of better project Te borOWINgTNE” acat of AP ty ‘of capi ‘camingorga Feeding EES os a il“ oe of capitals any discon tea Mites pesofcstoapial et caper raged avenge con APN ineconomictene® 4. gyptostand Implicit cost peau cash teams” TH F gediccostand Combined cost 5 Future costand eee sp_Besic eS offunds require erage c cost oy Ca Ben a 31 Baplct Cost and Implicit Cost stand Marginal cost F siete eg eae ct Cot plicit cost of capital isthe rate of nt rate for discounting Fut eerie ata fem pays to Tetum either pes Tecash fon alt cost of any Source of capital finance. As per | Explcl Sow el any aay capital isthe discokeg | ©2BtGl is he dongs eee mt rate that Ie ee present value ofthe cc on Seren ‘s that are | See j eae nt of he rncng pry wt | cian tan neetee Seta icc: (eee | Sater art rien Sea felctcostfcapital involves both cash peepee pla ie once Te 3 ee re tS pore catofiate Ee nc a en llbor 5 ber dene soles fried & Cotofa frum vnichonsis of risk frerehums pis be mi fr cpio ar projet Risk associated with a projects of two 7 coset ve la oes when cm " Se ee ese or dividend). The its busines | a Dis present value of cash outflows is rate which pcan opel ong onl eine reacting tance roma lose ens a Sey cial ance Co Pisa 72 uroRTANCE OF COST OF CAPITAL oe ee Tech nea cigcie Oe ene se ee piel Coleg af spas by ney ofiterest The explicit lb 1a lowed a Scat deco ae based on tect SPA Cost of expt as atinfow with € 1,00,000 payable that terial rate of retum foro evaluating iswestment decisions (0) deciding the debt content in overall capital suc tcplamount at the end of 5** year. apeble every yea as interest wd Sete tet maragement financial Perormance = ies as it Decisions: Inthe NPV method of capital budgeting apt ia (Gash Inflow & ‘Tocalculate NPY, all the cash flowsare ds 10,00,000 when the NPV tus out tobe positive. tal In the IRR method, a project i accepted es ° Femina atef eur or cost of ait tbe tic capi, In bh he case, cost fal 2 sll nr one hurlers. Therefore, n order tomes he 3 (re pasate ctl should beri. Sothe cost of capital isregarded as 4 Sandan toallocte the funds ofthe firm in various projets. 5 ion (Usage of Debt ints Capital-Structure: Costof capitals quit usefuin deciding hed 11,00,000" fe, Tis wil rece Egg ling the explicit cost of, [.*(1,00,000 + 10,00,000) ‘capital in the abox Wve example, the following equation may be inovenl cpl szuctue ofa fm Interest on deb is tax-deductib Faces finn which in tam duces it overall cot of capita ncrease in dot of debt d= ‘firm may increase its financial risk but this can be offset b) y lower cost ‘ac fe dal soe a ge RSE CHC, rate kportat smlderation in deciding an optimum pital = Ne aH aee G (2 Mages Peformance: Peormanc of te vvanagement canbe | Oily in trendy eimatine ie oped pelt sophie ca nt ofa TS et ts Beplict i Eg retum ofa projet can be compared with its cost of capital Mes! ‘which the funds are provided.i or Meacurmeet ot et og eof PVEA ile A (PVIF for your ene SIE (i) When issued at 10% discount ee ee 4 tn ty at higher rs Steet ter ptt and cost) 1 te Cet = 7513791) + 1000062) = 29 Yalu calcu eee rate fe mount is much lesser than @ ogg, * 21 =% 905.34 ‘Aftertaxcost ie ea (0) When sud 10% premio Farris Eo sper 0 pefretncon = zy, 16,000 ~ 190% 75-9534 venitg x90 050) 450% 398+ 2 on 005 Pieeeat eat aanhi ky =9.088 Redeemable Debt: While calculating When the amount of rina involves lot of calcu ee eee rene an ne med Oe ote Sor weer mate one Pa amour then te cost of Set can from th sp il eu tes tions and tine, led shortcut = Cost of redeom hod (Redeemable ‘Method t-Met a co, COR | trea ge yy = MASDHORV=NyN ag oe & kal Oka eae none SET = ol an teatt (roan et ma redemption value; f = Taxcrate, Ebon es oa where, ky issue of debentures - Se aie ‘for edoomabie ly = Net cash inflow fm ach outflow on interest payment in time 1 Anon interest payment deter sna Cott + COL, + CO} «- CO}, = Casto nterest paymentin time erin pgf | of debentures in Years oat. utes soon up tothe year ty after adjusting ta, ee eee Gran pe of debts RECN 5 | ee ony NO Tce value= ig & brokerage fee a sate yearof matt ip arava cor, = Principal epayment inthe year ee ee "etoncni sete repayment isin mabe of annual irtallments hen the cost of bt can by Pca sa ae rom the following formule: nave. = ey NB er etaenapee P= 0orthe present dividend is positive. £2) Dividend payout ratio is constant. Big. Gsrentmarket price isa function of future expected dividends ofthe Share Example 10. A company has issued equity 6% of issue pri ‘a dividend at 15% per shar, deem a charges of issue price. The company expects to pay a dividend at 15% pe (k=) (011-006) Solution: ac 5 cles gon dS BR (-6%of 11) (11-0.66) 15 Ei ag 01850 14.50%" _t , ‘Concept and Measurement Cost ot Capt Ds e= Varying growth rates in dividends: Following is the equation consid = = nase SEP8 Varying eset ae Me ona) Srpdrsy, FDsdrays = 0 pe Dy = Dil +3) years mo Bey ony tS ae vines, 02 Taal + 6 «20x L1R6 «tay * we end of the 2nd year = 2247 /(227% 6x) <¢ ry te for first 1-5 year re at the ens )= T1355 Where, gis the growth ra years, gon " Efe gem ne ones 5 yee ie 620 ean, Be Bice Ith ur end omar xample2, Dp Tecan as teflwing trend of paymentodividends verte a Sliema i reach market price ofthe equity share depends upe te ns Non TS eaten Ghaeholding. According this approach eat 6 12.00 1 30 2 | 2 om | Cece om : 1050 te ‘ t09 i aes 50 WE soto cot Eaming per Share CCmvent mart price ofa shares € 140 Hoatation cost per shareis 4. Calculate, Fa proces ofan eat share @ Growth rates in dividends. Z iO =e é (@ Costof equity share when market price is 140. Ih pasarnaitpriceol eature “100 soto ee (@) Growth rates in dividends /P Ratio = 578 ratio 12in6* year is equal 0950 (1+ )° go Total_earning_available—ta_equity jee ‘otal current value of equity shares y/P = Eaming-price ratio = Price edming ratio ew uty Cost of new equity canbe find out adjusting the lotion css flows ec) acting per are K= Bf) Netproceeds per share 1H The current market price of the share of a company is 8100. The compan’scurest s1e¥ 2000,000. Its shares outstanding are 200,000. The company wants toraise atonal sel shares at 144600000. The floatation cost is 810 per share (10%) and the company can se of 10%, Find out the cost of equity assuming thatthe company's earings (+9 ‘Werwlltryt find compound values in Table A-1, growth rate for 5 years nearto 12565 (0) Caeaating cos of ety Costofequity = 2a +Growth Rate Expected dividend = 12 (1 +5%) = 12.60 Costoequity = 2% 59, «14% ed Onto atannaate a a Sado ‘share. Alsofind the price ofthe share ofthe company atthe end of year 2. Solution Ce = toe = 0.167 + 0,06 = 0.227 = 27.7%a Cntr ewe cay re the cost of equity capital itis ane calculated by traland enorme tate the (jv) Capital-Asset Pricing Model (CAPM) Approach, AAs per this approach, return on any security depends upon the level of a8 internal ate of vi enone : rity is directly proportional ys ay poate ‘security. The expected return from a security the rg chy ' igher is the expectation of return and viens, ate, eA security. The higher isthe rik, higher pe cere at] maa linear relationship between expected return and risk. There, mooie feet t Co” | Pea) 2 security investment ie =“ ee (© Uneystematic risk aa i ( Systematicrisk ee E 5 Risk due to change in m es Re alae pe « | ‘2 “is prsncf lk ofa anberefured or iminated ough pea ost a Henceitisa avoidable risk. me ronment factors lke government policy, change in ad a Sages Poy, was € 200 in Jan. 1, 2006. The present vag intrest rte inflation, purchasing power et. iscalle systema 8 price 4 Peak see rb Sao nS gee i en ven i in market value of a ; ‘offcient @) factor which measures change Fa security de me coat nt ved Snogh detain ea Be cict tenes ee : Ge bute the entire profits as dividend to. >= I a eed sere a ote (CARMA li ase of systematic ak trough the following eri "ska ne armen proposals Its generally std tat rane {oregon by the sare ave any cost. But this isnot true. Suppose these aN ‘one k= B+ lg 4) ares : ad eae Mere been distributed among the sharchol ha Where, k, = Cost of equity capital : Ft aly totes he dea yf dividend tented = Eapeied ret on rik free scutes pre gmne ret onit. Therefore the costo raed ms 8 = Concent of systematic Fisk ein oregoneby the sharcholder isabel = Expecied tum onthe yer notervods tei sopra. fesnedeaingsatleastequltothertethatwould St ae ed by the shareholders if these earnings were wees ame (0) Realised Yield Approach 2 ‘This approach is based on the premise that actual returns earned by the investors inthe be repeated in the future. According to this approach, cost of equity capital shouldbe deve on the basis of eis actually realized by the investors on their equity shares. Past mente Aivdends fora parla period shouldbe considered while calculating cost of equity cra approach gives us good resis in those cases where companies are earnings good an step Example 15, A purchased 5 shares in a company ata cost of © 200 on January 1, 2006. Heit] ‘onJanuary, 2011 for® 252 The yearly dividends received by him in each year areas fllns ie, As per this approach, the returns expected from |Al pa ha Odili ino es panne: liereined enrings somewhere cla ie ouside he ve cpeet rs ae 72006 1100 compared withthe investment in company’s own | Maeweenieennrsoenbn 07 1.00 Spot firm ears 20% on its own project. Firmisavaiable Gongs mint veel 2008 1150 temalopportuity where returs wouldbe 6% ater _gonguysom pic 2009 11860 Tk Then the cost of retained earnings would be 16%. nears 210 1150 fio that the cost of retained earnings is equa tocost feat capital. Aginitisottve lings is alw n the cost of ital because ofthe presence of Calculate the cost of equity capital. amings is always less tha eau capCOM ard Mester Cost ot capi civalve weights dohave some imitators pte securities Hctuateson day, Se luc pect the true value the security, 7°88 ieto vy ° eit price ofthe securities ae someting, brokerage cost while rising fresh equity and corporate dividend es while declaring gy. equity capital. The cost of retained earning canbe ce! ee (@) When there are no taxes and brokerage fee "Atesot stock marta ya : ava Reyes 00 paokvalueweigh'sdohave some advanager ing meat. ge ety ofthese values fom the publishes abrkerage fee: sai finan ()Onthe assumption oftses2n fata do not changeon day today bai ements —ipakd=D0-5)__ I oe ven rapist secknctay, Pee parks and franc nstttions se book val Where, K, = Costofretained coming oe Marginal weightreferstothe provers 3 roporton in which afm K, = Costof equity capital se abe tothe shareholders ig = es a sources of funds. This method ‘Used when new findsarn neste ney CAPITAL(WACO)/OVERALL io according to the requirement ofthe firm, renee tase and that 7.7 WEIGHTED AVERAGE COST OF SF ries hn fener oa oe MEd ips rte “COST OF CAPITAL WAC” ifferent sources. New capital may tal capital tal ox compote cost of capital and fr ital may nottobe raed nah fn von, “Te term cost of capital means overall cost of Dio different sound th shortcoming of marginal weight systemisthatitigoretie capital structure (ale a weighted average cost of capital AT Ty tearing cc at diferent ogo ing For example if the marginal costo debs ea bart Shoe pee a a pig Pot of mop ek ao Pe POON Titled oe There co of opt tation of weighted average Mowardsone source of capital. The company may bla claro fad and hei respecte sic Comput ight BeCostohagte Fe icraptpenum roar kee ppt ncn (WACO involves following three step fic costs). . ‘of the cost of each source of fund (specific :_Intarget weights system, a firm wants to! avea. (ie wight ofeach sorcef fn in the capital stricture ete on thebacig ere fdleretsourcesof fiance Hence hae ee icc book value or market value. : op Ne oa oo) rapt structure is decided in advance. The firm raise additonal nn nT (Gi) Calculation of sum of the product of specific cost anc weight ‘source of fund. ietarget weights in the desired period. funds in sucha way to or ee 16, Thefollowing is the capital-structure of XYZ Ltd. 7.7.1 Assigning Weights r ‘Amount ae esgscne elegoied on the basi of) Historical weights nd (i) Marginal weighs ig © conta weights ees cae Ey soca | 40000 aa istorical Weights: ‘Historical weights are the weights based on in ree (4,00,000 equity shares Orr a eof fandsia the existing capital structure ofa firm. These canbe further ci ‘oft 10each) into (?) Book value weights and (ii) Market value weights. nae 10,00,000 o% | ‘Book Value Weights Vs Market Value Weights: ee of 08ach) | Book valu weihtsare th proportions ofthe diferent sources of finance as record eo 10% Debentures 30,00,000, » | ‘statement of the firm. When shares and debts instruement are traded in stock mai ae ‘of 71,000 each ‘marke pric is used fo calculate market value weights of different sources of finance. Markt Retained eamings 2000000 Aisi oa will differ from the values recorded inthe books. ‘Market value weights are preferred over book value weights 4 ae ‘actual amount tobe received from the sale of stich securities, (i) Fresh capital can be ‘market price, therefore true cost ofeach source of finance should be based on current not on book values. because: (It approsint its dentures are being traded at 92%, preference shares at par andthe eq shares at Fdout the WACC based on book value weights and marke value weigh.Fundamentals of Financial Management WAC based on book value weights Bok voi | Weight | Specific Cost or z wo Captal(K) Equity share capital ooo | o4 oat Proference share capital | 10.00.00 | 0.) 0.08 Debentures 300000 | 03 0.05 Rotained eaming | _zaon000 | 02 ont | oao0000 | 40 WAC based on book values is = 89% ‘Alternatively without assigning weights ‘Source Bve | Specific Cost of] Composite Capital) | Equtystarecaptal | 4000000 ont | proferenceshare capital | 10,00,000 0.08 -30,00,000 0.05 wacc= e Concept an Messier at x value of equity of € 5600000 400.000 Fs canescens tn £21) hasbeen, vn we ys equ value of WACC bused on book ee vals eos % oot Be os market value weighs. NTAL COS: CAPITAL / MARGINAL Cos; sT OF CAPTT/ rAL PP geo = te ineemenal cov of addtional api eject Iti caeulated when there ia | Wa = opal ne aero Tine erie Pista te evaluate ose rect which eee So of atone Pirate tani rom te sonal anes rise eee Geert ocak ene pr. fm cs cheng aoe ees rctre beau of intoduton of daa Wel Pi gemay OF may nO chan, nds. The ratio of diferent esc of Tak because new project may bere aoe, ease of the ae be relatively more o less risky pate are. Cost of equity will increase ae te afferent source of funds innew cil debts may ‘increase because lenders may demand: duction of more debts. Further cost of oerents of debts in capital structure. increasing rate of ines with Beof dove changes wl make teu of preset Te i rate for evaluating anew project faulty. eee oy peje ercemetal cost of capil ie mathe ih Perec cue Uoeul for capil cigar acca emceoeed ting decisions. The marginal 100,00, WACC based on market value weights can be calculated as follows: Spon of margin! | Sean rccrvauw | Wagnt | SpsaioGostot] Wari eget ean ee sed at price. ‘marginal cost of capital should — é oo Crs conten] | Mee reginlesarerst of raising of additional funds ee ‘Equity share capital assscs | oon ont 0.0499 ‘punderstand I ctmasgial coctcl coptal eeu an come Preference share capital , 00. 1 0.08 0.0085 is a aan ecco | 020% oe bol, SRL is presenti having its existing capita structure of qu commana | pe | 38 | tae | eel Se ge ae at #6000 | 01.000 0.0890 Source of ‘Market Value ‘Specific Cost ‘Alternatively without assigning weights eee Ear La 06) Equity 400 15 Debt 200 8 | 600 | funding of € 100 lakhs. The projectcan be Tecompany is evaluating a project requiring a total . The cost of new debt is 10% With the ty would increase to 16% from 15% SSniation of more debts in capital structure, the cost of equi marginal cost of capital.Solution: rine r ta 20 ndinB ‘at which the specific cost of capital ofa somes rel of ple funding up toa cern cntt spare ee ad ea 90 tn fllowing formu oe ale or a anding uP toacerin cos of pce sue Debt s ‘Moximum Funding fom the source at a certsincost wacc= | Proportion of source of sn neconceptletustakean example aes ee tblished a target capital 1cture from gR Limited has establish pital structure Hence, WACC of the new capital structure has increased from the old capital nc page Eg iste cost of iy and debit diferent evel ane rs peers of 12.67% to 13.86%. ef ie liffeent errr oeer Calculation of Marginal Cost of Capital a ple €100 lake ne Upto € 50 lakhs ae Ure € 100 and upto 150 lakhs 18% | Above 50nd upto 100lans 175 rome € 160 and unto 200 lakhs 20% ‘Above & 100 and up 150 alts. 14x Wrong Approach of Calculating Marginal Cost of Capital capital is treated as the weighted avenge cost of rising sayy Generally marginal cost of feance. Accordingly manginal cost of capital is calculated as follows: 50 50 WAC (wrong) = 35g *0.16+ 399 < 0.10 = 13% But this approachis wrong, This approach ignores the effect of raising of new fundsoneisg 4 gyagn Estimation of break points a different levels of fundi inga taxrate of 50%, find out WAC at following levels of overall funding () azn akns (i) € 300 lakhs, funding () 100 aks erentage composition in target capital structure: 60% capil of the Fon, With new capital siracture the cost of entire equity has change, Hoag Equity 40% impact should also be taken into consideration. ‘Correct Approach of Calculating Marginal Cost of Capital ae The correct approach of calculating marginal cost of capital is to calculate the incremental cg {heakpoints in debt funding: raising additional funds. This can be calculated as follows: @ Maximum permissible overall funding with 10% cost of debt (After tax k,=5%) Incremental co ee funds = Differential cost of equity + Cost of additional det Maximum debt funding upto 10% ast ‘= (450 x 0.16 - 400 x 0.15) + 0.10 x 50 SPREE TEES = (72-60) +5 E50 1aKS _ ea, =12+5=%17 lakhs . 0.40 ‘Marginal cost of capital (cost of new funds) (i) Maximum permissible overall funding with 12% cost of debt (After tax k, = 6%) a 100 lakhs faa aan = 17% Se 250 lakhs {€) Mexinum permissible overall funding with 14% (taxk,=7%) 2150 lakhs. a = 8375 lakhs Hence, marginal cost of capital is 17%, This cost takes into account the change Pe 04 ucture and the resultant specific cost of different sources of finance.PRTG] Fundamentals of Financial M e break-Points at. {375 lakhs are the respective break. . ile distant ate oF miki required asia of daidng te copter st any pe sachs plc ge Om At ct tr co Hence, 8125 lakhs, 250 lakhs, Ay opialis te CB gp cont avenge and marginal crt and 14% (Before tax cost of debt) ak points in equity financing: Roses ing wth 16% cost of esity eyo a - os ‘Maximum equity funding up to 16% cost La is = ©1667 lakhs 06 eal fading with 18% cost of equity (i) Maxima permissible : us = pao veo Seen corte i a ral fading with 20% cst of equity i i - = cate de preference shares canbe redeemable or — (Gi) Maximum permissible either tough tral and error method or ted as per divi shortcut method. be calculated as per dividend appro. ee pbequity Om i Ba tl overal cs of pil anit cca oa a £200 Sa lakhs Ge 65833 snaccisalo | ia ie inccecierial cost of Bo additonal finance ras pagent of capital ee ence € 16567 lk, & 250 lak and 353.38 lake are the respective breakpoins 18% and 20% cost of equity. } Calculation of specific cos at different levels of funding F GvoraiLovel Funding From ‘Specific Costs| Ss Prieta. ‘Eqully ‘Debt Equity | Debt eda ets intake) (intakes) | (Ciniakhs) | (Cinlokhs) | (Cinfokhsy Cy 40 16 | 5 i debt We 5 1% 2 8 . tt eat ED +0 20 2 7 J (0 Bfre Tex fon o ifferent level of funding ‘Computation of WACC at different I . oe. Funding level (® in lakhs) wacc a 100 06 x0.16 + 04 x 0.05 = 0.116 = 11.6% aa 200 0.6 x00.18 + 04 x 0.06 = 0.132 = 132% Zarate) 300 66x 020 +04 x 0.07 = 0.148 = 148% BE cies Saher ‘Note: Proportions of funding from equity and debt remain same at all levels. 1 Tee Because ofthe increase inthe specific costs at different break points (level of funding) oe es ky = MeO +d+ aD [Rvs Ne] ost of capital (WAC) has increased.P= RF arky Oth) PD+(@RV-NEN Gil) Short-Cut Method Ay = (RV+NPYZ IM. Costof Equity (a) Dividend aR (@) Dividend Price Plus Growth Approach (0 Constant Groth Rate Varying Groth Rates a $ Daioe!, § Dadra", Dra Zareye ea ky ea ey + Bs, pence), ea t-2) Pye () Earming-Price-Approacls BRI kw EE /PRa 2 hop TB/P Ratio PE Ratio IW, Cost of Retained Earnings (6) When there are no taxes and brokerage fe: 4, k, ae aR te (0) On the assumption taxes and brokerage fe: k= k{1-N-B) V, Weighted Average Cost of Capital (WACC) y= hy ty + hy 10g + by Wy + hy 1, has issued 10% debt redeemable) for ¢ fg Neat te debt is issued 10/0000. The company in So ne cost (0) Atdiscount of 15% ce © 1a- 9 At Premium of 15%, le debt = “Ot petra interest payment cis from issue of debt at Discount of 15% me ky = 1000001 o50)=50% ‘a ~ 8,50,000 aoned at Premium of 15% i ky = 10000005) = 4.3% ‘« ~ 11,50,000 o ° Fry eae © 10000 17% deter 0 eh Te eres deisel etle ot? year he company in 35 nn me caclate the cost of debt after tax, if debentures are issued at {o Par &) 10% Discount (c) 10% Premium fp Horokerge i paid at 2%, what will be the cost of debentures, if isue i at pac? (A PE. M205) {9 @)When debentures are issued at par: ky =1 (1-1) = 120-035) =78% @) When debentures are issued at 10% discount: 10-0 +(RV=NPYN _ 12(1-0.35)+ (100-90)/ (RV + NPY (100 +90)/2 78+143 _ 923 Bn oe = OO =97M () When debentures are issued at 10% premium: ky = 12(4=0.35)+ (100-110)/7 _ 78-18 _ gap gar, (100 +110)/2 = 1) When debentures are issued at par and brokerage are paid at 2%: 12(1-0.35) + (100-98)/7 (100+ 98)/2 78+0286 _ogi7= 8176following situation, 5 Iwstration 3, Calculate the cost of debt for the snd floatation os (a) debertures are sod at pa and ows {@) debentures soldat discount hon cet 1% oe ue Waster asl at pent of ®% an ote is Oma beep zinerest on betes 10% Ace ale 18 810 rede, Py Concept end sotrer oi ss of 10% and floatation cost 10% of isp OMA Copty oe price = (100 ~10)= £90 Price then NP wig Assume thatthe copon ra gi yearend tncrteis 0% poco Sotation Nat 10(1=05)+(100-s1y5 ene qv-NP/N, 10-052 000-99/5 , 216. hy oe ® ev = NB aaars5/a «975 ~615% Bee Aerativey SS - 88 970% cot tae method Zan are ole “ea 5 EE 8- BOR ash 1% cash nto on account ofinterest payment (CO) willbe and in ee a Se cpl payer (COP) il be€ 10 50 we WI Ey lal and err ei uw eee ‘Siferent discounting rates. Let us try at 6% and 7% 2 Se cma a i Yer] eOucOP PUA St Tota PV ar a ae = 10% al S es 7 = 100 0821 ma SES caoat is : az 100 | 21060 | | 2= | ss fai-/*|*|s = /3 700) “a0 ‘be taken as cost of debt But fc sma for accurate — ot am Tesults we can do interpolation fen oe FOR wes none (8-8) By intepolation = 6% + $5769 -91.500 = 7778 = = 10% + (2058 cast of debt = 619% (#3) © ty O=BHAM-S/5 gare = 10+ 002 = 100% ti s | Ltd. is planning to raise 8 1 ‘Alternatively, we an nse tial and eror method Kena Lids oontene eee oe Theunderrting expenses are expected tobe: peferenc share of 100 each eas etloning cases: 2%, Find outthecostof preference tural Aargy ork W jeecence share are irredeemable Again we can try sand 7% Alipeicence share are redeemable at the end of 10 year at 15% premium. Use sh = 18. im, De Unset 208 Year co PFA Total PV at Caputo of con of preference share apt) c om 7% oe tence share are rredeemable: PD _ 12 15 5 4212 4.100 21,060 20500 4, = Np = gg = 0.1364: 5 100 oar ars | 74700 rar | Pbitprdience =< 00-2) «20 : [__ 95.760, 1.0 share are redeemable at the end of 10 year at 15% premium: bineranea 5, « D+QV=NPN = 6% +032% = 6.32% (RV+NPV2 R+(1s- fy = e(US—88)10 124270 | 4 pigs rea (lis+eeyi2 = 1015” ~ 101s eeES =~ scocahar beng wrand 45% deer Cong oe wal be after § years at 2 —_ a ee ats prem oon Cm eon Tas enn we shee Bw renee ee. piety eae. : ‘3 not oo p= MED= voy Racoutees apAMstemee st cosb are hich be She he ECA Detemine fe roca ct Bassett pRTINALTD 2 OS ENS NE Re seueof Sete = T20-DN-1D oT - 2S ease 5 devidend of Tis year and theexpecies paededeed y oe meets ASSET é Sel see current poe of shares ofthe company ks = Swans in renee ret a soo ® pao fro Sk RA a ae DB wee b= Geer ae s "a D.-Da+p=t0-me-1s f-Gweme ee te Co cheqany ween at pri cf Se share 5. as Epecedidcciond D.)= Dy +9)=4 0+ S)=42 noe 4 Ses r Mixesee2es a ese comet mast price WER IM Grow aS TE sete et peeing te weg shre Te hn Seemed © Cocetegaiy whe mat priv of be stare ES = eg = 22s: eae ts Ro naeenemsee Mri 7. Assng thatthe Sr pays cere tax at 4% rate compu the a ees ope ntebliewrass a = . (@ Tk preterenee hares sold at par. j @ A popes tend ad ape, gum ra beng IF : = (eB Ate year PN TLIO perbend said a 1550. } : ae (e) Amecunty hare sling ata masket price of € 110 and paying 2 current Gxadend ft HP | : ss omer : aS which s eqecind wo prow ata rate IP,hie Go Conca ard Measurement cn 505 «4 (Legh om EZ 505 Ge pt=2F 1am FETE Fesoresnn crac! = R seling price Find the cost of existing eau “ “Thefoataton costs tly be tof hese BP BY hy, eae widen Solutiog ets ft cane he owen ein dt seh) 1205 PTF a 4 yea Goh Danan i 1826 tin i = art p -O*8 ge , Dy 5 4 yrsng te apna ne # EA ng 0 ia, ** Ae willbe 13.60 (1 +8%) #14 “Tae evpeced avidend a wae 8h Dy=Dy (1 +3) 5.05(1.+006) ae 559 onal esty Sa * Elret ik pre + Reiser tee vided prot rate t= 2B 006 os 00554 cmnatnen oot) FE terion e 806" 03055 «139% 1465 opp = MSE son = 1176% 0% it te - gies 1976 soos % ® Dy = Dy (t+ )=505 ee = Dy (1+ 3) = 5.05 0 +006) = soscostt new ety capitis 1976 a ae Fyit-eek, geen 5a shares of PL. iscurentl pried at€ 6, Dividend expected atthe en actin a egy for compnies of sla sk 1% ‘Whats the expected grows 2 to happen if de o some adverse development in capital mack 5353 Ke= “+006 = 006508 + 096 «0:25 «12594 ys ctr s ued in be matt 200 “ Wats projection is revised down 0%, {B.Com GH, Debi Unga ye Se YOU CS ie investor's market expects growth rae ‘curently. The company pays = Migesta Pe centpe year. Yousre euaed D Ee a, costo capital ()Welnow, ka gy tS meGdiergg #8 22018-01nageg lt fap Peet rte pa pot oh carpe porte prejeionwihanean impacto pected iden and ecmag | Panu ele vdend 1 stb manned ‘sSperaentperencum, (aw sare, Let ts calcul: ef ie 1. Com, Da nent 85 Letfist calculate, D,=Dg(i+g) = 6=Do(1 +008) pseiaton of ost of ety capital) é », Dy zpg 2555 Rey +8 [D,=D,+9)=1(1 +005) <0 105) Revised D because of change in growth ate projection 5% P, =€20,g=005 Dy, =556(+005) => D, #5508 ba De, Sais 5838 — f= “GE +005 = 00525 +005=01105=1025% revsedoumentmitietpice: «B= A = ign oam ons “TM 1 233 ‘Mustation 11. Equity shares of A Lid.is currently sling inthe market at 100, Dividend padi a ‘5 years are 4.00,€4.25,€4.6),€4.85 nd 5.05.The company wants to issue nev equity shares nda Ran se ete Paton onary obs per share. Cale gor mdm, ABC Lele cvidend o 4 per sare lat yer Th conpany ep aie ira pr schedule: tng tl new enor copay. iB com i De ney Solution: = (Calan of gromth te . Wetnow, Py -Pvsg Where, FV = Future value =€5.05 oe Led | PY Hiren auc st * ¢ sows x 1 No.of periods = years Dy =D, 1+)—— Concept and Moa, EY fecerens trent amen tate = rina eae computation of WACC (Based on Marg Capita Ee elution: First of al we will aoa the vscnaiaoat Waoe Weigh | Wot Pu @ 15% Decode Fcight is 17.62% = ying capita srr of Be Dn z ‘Company Li, eee meine 00 shares of € 10 ex | Fares of €100 each 000 referee h Sato pee, £100 8 ce Dy ‘Where, D, = ted Dividend = rs puenneedasrbeynrt)" Zag Were epee Dividend «5.77159, Dee company’s egy shares £125 andi © orcar Divident growth rateis 8%, Pt Hated pre after 1 yee Wvidend of 812 er share es ck vate matty eee = oir te be cmp ed rept a , atin order to finance an expansion pln, he cong ee eka abe ated yen = 1489 «05725210 danse ef ue wb eco geet Pen ve = 1654 +5210 668.64 Sonera Desa dele eran tot en oe a a price of equity share is expected to dectne from 2125 10 pers OM Bae eather 86rupesGppon Hence apr is Problem stare hy a Cont, De in. 2 ) Det Usa) sa Caen of specie ons ofc jG) = pee Shee poasenveial O27 BF 2K Ts 100 = Arava Capital ace valu of ® 10) ce share) = 9% (given) so preference shares secre 1 cosy soca ay # ‘of Weighted Average Cost of Capita: ‘Stara’ 1 Pepe eben “0000 ‘amount | __Woorto) | Spat Con Ph | emcee ie) paratype hare ast en pad nthe pas odnary dividends hrepy 0000 oar Tat = ao mad thst frowns expected 1 conte Anncalnerest sede | srg f 667 he = Pees Tred saree cent qvoed at 2730 andthe eben a8 | OBEY somo | ove | an | em _| cane ered to enna te weighed average ost f capital (based on market as 00000 [1000 | _ eompar. [B.Com Deki aii ‘Sotin: Tred, WACC is 14.034 % rt aon wan oie onl en nn 2000 1 (hue og Whee, =Dy0.+4) = 201+ 030)=€220, Fy=82750, 29108 | et) ~ 20he010)~6220 Hak ¢ New con ot eqiy = 2S = f= OH 08-26 = mae Corto new er lan = 1-04) = 1% (1-04 6% Hore con ely and em an, weave alte WAC op as 4,= 25030 = 008 +010 = 018 = 18% 1 (@) y= jhe Where 1 12 of € 40000 = € 48.000: ‘Book Valve €| Weis (w) | Spee at Capea ato Mate rif eben = 0% of 4000 = 9.20000 Been 00) tan = | 800 : c= Sango =925 = 15% 500000 co. ea “ ‘Working: Calculation of market value of 20,00,000 ow __| __66 oy market vale of shareholders funds: T = €2750 + 80000 shares = 8200000 ne | aaIlustration 16, The following are the book values inthe capital structure of XY2 144, Eaquity shares Face value of € 10 cach) 8% Debentures (Face value of € 100 each) 12% Preference shares (Face value of € 100 each) 10% Term Loan © 15,00,000 “The company pad dividend of€ 9 per share last year. The dividend is expected Bom 5, vapteble tte conpay is 3% Al secre re traded inthe cy me Beiarante pay aura Dente 80 Pfc sare 00 man wo - lenge cot oop sing book vale weights and mart au wesc Find ot he 1B. Coma, Dan Seaton: Cleaton of Specific cost of Capital ney @ Costotequity capital h) = Dy(l+g) 2301 +005) <5 100 = 137% k, = 22S +005 =025 026% ee Mears WACCan pe Markt Valu Wg 10-1) | 80-03) Wve | Sow com (@ Costat debenture k= ype gy = 007 oF 7% ee 0% Content | PD 2 equtystere 8 | "405.000 (G) Costof preference shares (k) = Fm = jp =012= 12% en 2 < () Costoftemnioin ——(R) = K (1-1) = 10% (1-403) = 7% pet | ‘100 Serato (9 Calculation of Weighted Average Cost of Capital (Book Value Weights Basis) + _S# ‘WAC bad on Mate vale weighs 19.19% "Source of Capt a mnee il Woigh Coat) g ae ert) 3 [WAC as per market value weights is equal to 256% ar 16 050 2500 ee guts aati Boo oe a 2 unis 18. The balance sheet of M/s XYZ Company shows the following tems a tt Dewan doom | 01 7.09 au jen Teton room | 02 0700 ‘a Sg0 000 00 T5 Sources Re Hence, WACE based on book value weights is 175% Paid up Copal | | () Caleaiaonof lu We 400,000 equ shares ot? 10e8ch oman hed rere Cont of apt at Ve Weg Bas) See isa Source ot Ceptal a Market Value | — Walghts | Specific Cost ‘Weight Cost) 15% Non convertibie debentures, | ano000 SURES aS a. Cc) 10%. oa 14% Institutional oan seo | aut sha cept zsomo | oss 2800 15508 ——=—_— Preowee Share cape oom | axe 120 198 Sane Sm | oor | orm ome hm 7,90,000 0.101 07.00 1.397 700] — 10 acFRO] Fundamentals Financial Management Sa Conctot and Moss a c is 140 and the dividend prs Capa ‘Other relevant information about the company is given below: escent Te ey 0 pec oe ee, ie ee ee weighted average cost of melt veces | Dart. | mame ma | age ee Ot eg, th ee ® St computation of Speci Te eee | ar 3 = . Coney "Moerman aan 22) 4 450 » Calculate weighted average cost of capital Assume 2 1% rate of 50% 18Com, Da equity i) - Eaming price approach 750 30 “Sotaton (i) Calclation of cost of 15 =19% Be 208 > k= 5 5% 6 = Sao m7 = 97° 45 = 1 .015-19% m6 35 =° PDHRVNPN _B+(0-sy5 —evenry2 = +2 = RVENPY2~ —Gloorsay ys = 22 og etsef T= soispsasm 10-9 +RV-NPWN _ MA-059 5 7 EE wnekery bs ae ND ae 710585 7555 = "98.335 0.0768 = 768%, Hence 1, alo 1% = e ne ay 80-09-72 eee 2 : lanl fy = 16 (1 050) = = aco “Cetin of, 1% Institational foun: y= 14 ; @ Computation of Weighted Average cost of capital gon ea "0 | Skew [eames] ze | om | aap [7 Saeco! wes | serate | conc taro | om | S| um = Bs cm | sm | tS cam | 18% a | | is Frese suis cay | 1% ri = ————_| sae ‘shneremwetle Ss etna Be let value of equity share Le, 450000 has bended “a | he rato ofthe book values ,250 basen eet rom the follwing information, cau Hence, WACC (ofthe fis 11.50% a ing erecta amare ; 1 Saroie funds eae estration 19, otematina foods limited asthe following capital structure a ‘ io Paros ‘Book Vabe Meret vant eel = 2 aroved Funds aut cptl (250 shares of 10h) 250000 asn010 aD 7 Petre copt 0 sae 100 ae peas ocho pect ce) Tee oan (cluding inter corporat deposi) ™ Reseveand sais ‘walFeds s Derren 10 | ata rformatins a ‘ech camying 14 nee) ane [Noma yield on equity shareholders funds is 15% 640000 a acaren 2% = i bestonsecure loans is 1625% ett on unsecured loans is 20% ‘Taxtefor ABC Lt. is 40% com Deity 26271 ———S—i‘ eMa IDI tener rtm ange ar Conteh an Solution: Caleutaton of Specie cont of expel before tay avi ty aa Competition 8 WEE Reo be, by ator aed is * Greay OP a rT tea hee oT 20 020% SO ace (i) by fovtone rand 45) * 0d) #020 nh © ain ne tian ge Joan) # 40.25% (given pie) 0 207% (iver) ne tan) = 20% i) hy (anered (iu) hy (Unvmeured Ho (0) (ete tan) =f, (et a ‘an te 9 i 1 gona once, WACC (before tax) ofthe given capital structure Is 20.42% ‘Determine the weighted average cont of capital using book value weights based cn he Muatration 21. Mook Value Strcture! e 14% Pebenturon (100 per debenture) ‘40000 200000, fe: Cost of 8% debentures (k,) 19 Preference shares (€100 per share) Aaquiy sharon (€10 per share) Hecent market price ofall these necuritles are: aan ccd on BV win 123 a 3 ee i of pe oe at average cost of capital based on esting capi strecane weight but the price of share ‘unchanged rice will fall to 15 per share Jealation of wore Bae sunita company has the flloning cx 1 00000 shares) sono lope % 01000 oxutty shaves €20'M he company’ forever. The tax may be expected that Presumed at 8 ey cme, company 507 You ae Ried ener ted average cost of capital if the stat company raises an ures. This would result in fy aaitional € 20500 die my Specie dridend © tant ae 0B eco ceca D, Cont of Euity k= Png = Uni 203, 206, Sener Quon, 2 Heo - » =010+ 007-037 ost of Preference share (k,) = 6% (given) a 0-1 8% (1-050) = 4%, (jciialation of Weighted Average Cost of Capital (Book Value Weights B Debentures C180 per debenture; preference shares : € 120 per share; equity share: 22 per tae Mot | Sciex Om | Mase Dividend expected on equity ahares atthe end of the year is €2 per share; anticipated gov ividentstt Mc Hhecompany pay all learnings in the form of dividends, Corporate tx rls Solution: Calculation of Specific Costs of Capital », O hep en where, D, = Expected dividend €2, Py = €22.and g.=7% 2 A +0107 a» 0.0009 + 0.07 « 0.1609 » 16.09% M-9 ye {= Tex rate = 40%, NP = Net proceeds from issue or sales of debentures = €110 (1-04) Tig" 007636 = 7.64% rp as NP "io he where, I= Annual interest payment = 14% = € 14 per debenit (tat hea 125" 125% where, PD = 15% = € 15, NP= € 120 0500 ar = 0.125 is = os 4 | im cs a i Thelore, WAC is 10.75% li) When company raises an additional debt of & 20,00,000 by issuing 10% debenture: New cost of equity (k) = 4007 = 0.20 + 007 = 027 002% ‘Cost of 10% debentures (k,) = k, (11) = 10% (1-050) =5%. mof New Weighted Average Cost of Capital (Book Value Weighs Basis) eee[6% Proforonce share Revised WACC is 13.60% Mustration 23. Equity capital 6.000; +o,c,000 | enDebenure 3000000 10% Deberaze _2900.00 5900.00 00 9% Preference share 12% Debentures 10% Term Loan company hi ‘Theequity shares of the company has OfrTTowth rate is SY pa. Tax rate is 50% Cy [BBS (H) Delhi Unio Sem. 1t9 per share for the next year: The average cost of capital Soltion: Calculation of specific cost of capital D, Cosofequityeapitl k) =p +8 > 4-705 shares of € 100 each) 8 “ver Ltd. has the following the capital structure: 5,00,000 x 000 3,50,000, 5,00,000 ws current market price of 105and company deeared ry ene a Be +005 = 01357 or 1357% pn of ection of eat digg 35 *°95 0359, osm D, iS gcorarials) = ph +g = P0428 6005.9 mm 84 gprs te) = ane = 10=p ve = OD, as noe wp > 809 921% i) =K 0-9 = gotten oe 2% 1-03) cate of Weighed Averse Cos of Capital ook Vasey Weights Bas) ‘Spectic Coat at zt 186 al | ce ao he e | an iit onbook ve wephsisiaam | sion of Weighted A ted Average Cost of Cs Cont of preference shares) = 9% (given) col Mart Vas ¢ my Cotet aches ()= KCl) ma 12H (1-050) = 6, @ eon loon (is) Cost of term loan @= K0-9 = 1 x rane e Tighe Average Cost of Capital (Book Value Weighs Basis) ton = me ‘Book Valve € ‘Weagnts | Specific Cost | Composite Cos por be ‘Saredf Copia! a o 006) wah) 1357 4518 market value weights i 154% Egaty Share Cail 00.000 oa aon accep a aso 8 om take value of equity shares ie, 8257 treet | Bf ER ee bee se ee ao hn a an ee ae 00.000 600 se | Pi, The cop stuctur of XYZ Lids as unde tee 4500000 ‘Hence, WACC based on book value weights is 649% ‘9% Debentures : Noe 24. Bharat Li, haste following capital structure as per its Balance Sheet sa stark 11% Preference shares ae lastrtion eat Equity shares (face value € 10 pe share) 000) ‘shares of € 10 each) # 10,00,000, Fp Se Bre Capi (uy pi hres of 100 cach) i Vip ebene rat a i Ht eben redeemable at pr, has tin cd 0 es of may Te mat 125% Debentures (ally paid of 100 each) ec ieserre 15. 12% Term Loan oa ela per ee eee icerable st Par, has 3% floatation cost and 10 years of maturity. The ‘ _ (8 uty share has: Additonal formato: () Capenty quoted pices in the stock exchange: 4 lotation cost and market price pe shareof 24 The expt de 2 Eau Share, @ 6125, Preference Shares @ 60; Debentures @ 95 cet] eMBancal growth "The fimniasspackectpayagaenigpatetenldon ( Forthe lst yes he company had paid equity dividend of 8 er share whichis Capua income tax rate is 35% ‘grow @ 5% pa. forever. The Corporate tax rate is 30% ‘weighted average cost of capital (WACC) market value weight Cane Weighed verge Cs f Cpa sing) Book Value Weights) ait Ae ag Be cm fap NTE on, om, DAU 2 age pital using (a) ICARCE) BBS. (H) Delhi Unix. Sem eelation: Cakaaton of Specifics of Capita () Cost of Debenture(k) sy, 91=039}4100=10250)/19 ra-n+av-NON « 2°05 -10250)/2 wey? 585-028 «gis = 548% = ines preference shares (iy) ° earnings (,): The costo retain err er opa, 1200 MRSDV/I0 _, 1-02 oon es i oan cot 4 Ng _ AGN IDE « ~ qo0910282)/2 “Tora =0 ut Whe rey and may be calcalated ss fon fap a fo ere cage pee Dy, fa: caters cn (G@ Costat qty epi beg e8 > Ts 0m 0005-9, emer 2 905 = 0:10 +005 = 015 or 15 ono O38 oy Re Bits eas % computation of WACC based on Book Vale We, 5%, ; Market Value Weights, ‘Book Valve % ight ‘Computation of WACC based on ae & = otvaiet | wos | Ooo iy e ae Ee ail Ripe aioe 2p87 oe ry Deter 0 0138 1057 a ramecoencr | sama | ae | 1600 ca rata [_ 1000 ae a a £2 2200, 8 FT bs sets of € 52,000 fat have ben WCC is 50% yu the following informat pi eral Reserve of €3,60,000 and Debt of 10, byt ae an mamnacing company hat upped Yo te flowing inernaio ot tc eet dee were G23 Ca eee tg A =— ee mart vale of equly aso B00 a te eon rosa | es ea Use markt values weigh pear acres = 72000 | Faedosses eee ee, snato | Cirrtssels al ee : 450000 c. ; es Interest ra Prot er inerest = Tes Tax @ 40% == Profit ater tax ae ‘floatation ‘No. of Equity shares (N) 323880 a co) epauce shares ale price 10 pe share, 2 Hotton costs. PAT _ $2580 5 (ii) Eu shares: sale price 115 per share, floation costs €5 per share. 18,000 79833 oc Say 818 ‘WConputtion of Specific Costs: The corporat tax ates 35% and the expected growth in equity dividend is 8% per yest Te divide at ther of the current financial year's € per share. Assume that the company iss present capil structure and intends to maintain it. Detemine weighted average costo opt by Wp ‘value weights. {B.Com(#). Deli Solution: Calculation of Specific ns of Capita: PcutcDeent jee 10 +8V-NOyN _, 301-059)}40,05-2,480/20 _ 2754875 a (2.605+2,450)72 = 2S15 =k, ky =8% (1-04) = 48%boo structure & Crore) 15 1 20 10 125 ARV + NP? = SE 08072 69043533 «gyn37« 137% 0 (Cost of preference shares, P+ (RV-NP)2 = avenna 124(100-75)/10 *(100475)/2 (Gi) Cost of equity capital =P 4g 3M so07= a1sori6% a aaa 124250 75 6.57% =0.1657 (io) Cost of term loan (k) + Gi) =k (1-9 =11%(1-04) = 66% 4.150 hasbeen divide C2100 Ee ies: he (pbook value Weight (i) makati (885) Det 2 ac “no ighted “Chased on book value weights is 13.21% er wAct Sh market value of equity share MORCERL ang Average Com of Capita eg ‘Book Voie @ | = tow Fe ion of WEN AHI COR ila ap ace ae Merkot Value ® sh ay a | i asrnazesr snare capa = —_75,00,000 ere 42857 168 80000000, 128000000 | 1.250000 | oabert® | = tt va weigh 14305 60.00,00000 as eee and Retained eamings in the rato ofthe eek mes et ee ig DoerineCostl piling matateinenagren eee towing at sisgbookralcewegstadon eresooptl rue: ‘Debentures (€ 1,000 each per debenture) tH shares (10 enc per shar) une yy shares (10 each pet share) an vcutes are traded in the capital maths and ree msec Debenture 00 perdebne Pece shares ieee Equity shares 20 perstare Jape acing opportunities ae: {10 per debenture redeemable at par crying Sines Naty pedis esd flotation cost is 4%, Sale price & 1,000. eee {i €10 Preference shares redeemable at par carrying 10% dividend rat. Maturity perio i 1 yexs and flotation cost is 5%, sale price ¥ 10. (3) Equly shares; equity dividend at the en ofthe yearist20 persis prt 20 bd ‘growth rate in dividend is 5%. Corporate tax rate is 35% 1888 (0, Dei Un Sm. 1,203) Me:Ta rate given in question paper is 55%. thas been modified to 5%seer a : es of Capital cco ef 35) 0000-940)/20 tion: CHO TT 1-038) + 1000: ‘ ON ee ay aero Dy a nS ae 5242 _ possi = 551% 6 ors)! a q0-950/08 , 1400883 oct goat = on ca comet i eos ~qo-950)/2 975 a, Bear syonial a conserve? (oS Roa” ten always take issue price for coms sesnepic te ingen en nn = eights Basis) wae ast cf Capit Book Valve Wei a fp coast rock value weighs i 107% “Fees WACK based ca Cost of Capital (Market Value Weights Basis) (@) Caeton of Weighted Taat | Waeits [Costar Cantal | Weigh Coty | ‘Sarat all | to cor pat | ee fl 551 ts <5 mame | ai | ee | tm | Peanut com | | ta | Iwan si on povided by SRL, You st regu ein en Fo eg ro wean Nae vale wes Te Seleucia SRL 99000 Dette (10 pe dba) sng Pree pr sha) 2ap00 uy Share 10 pera) 0 etna ig za pa ‘Allthese secures ar tradedin the capital markets, Recent prices are 4 shares © 120 and equity shares @©€ 22. Anticipated external financing opportunites a8 eipeentse Mon ceperrso C1 redeemable at par 29 1 debenture Pat: 20-year mata pon are redeemable at re ference share Par: 15-year, at ag {Caper share foatation ons, ater tag ie expec cn trey te ne cent So itt p The corporat t Widen. The oro ie! of Specific cst of Capital ‘BV NDE 0056) 560029 8 gtr sae): PD+(V-Nny2 RV SNP) _10+100-95y5 ~ (00352 10403903 o75 | Cott equity capital (k,) ke = 00552 = 5.92% = 1060 = 10.60% Deze, Ka ql +s 3ry +005 [ Gotofretaned earnings k,) The cost of retained, D, 2 Seo anne Kap +8 > +005=1409% Clin of Weighted Average Cost of Capt ook Ve Weigh Ba dr, —— a to "tote earings (willbe equal costa A) But there is no floatation cost in respect of retained earnings. There te acta ec ‘anings willbe lower than equity and may be calculated as fulles. (he cont of reed z aah sue price (ale price i give, then always ike ine pic fo conpeabon a ‘Book Value € | Weights | Specie Coat | Weight Cost(A) (BY) CJ 3 a 10,00,000 | os | 582 Seed 8,00,000 0125 1060 1 20,00,000 0s so a 00,000 0125 408 = = Er zao000 | — 160 IMEC ed on book value weighs RATFundamentals of Financial Management (i) Calculation of Weighted Average Cost of Capital (Market Value Weights Basis) ? q ‘Source of Capital MarketValue® | Weights | CostofCapital | we | ch 2) (w% ‘OM Cos 95 | Debenture 41,00,000 0.1803 5.92 i Ps | Preference Share capital 6,00,000 0.0984 10.60 4 pe | Equity share capital 35,20,000 0.5770 15.00 ree Retained earings 8,80,000 0.1443 14,09 aia \ 61,00,000 7.000 ae ‘WACC as per market value weights is 12.80%. Note: Total market value of equity share ice., © 44,00,000 (2,00,000 x 22) has been divided bety, share capital and Retained earnings in the ratio of their book values, i.e., 5:1. eM ena Tlustration 31. ABC Ltd. wishes to raise additional finance of ® 20 lakhs for meeting its inves The company has &4,00,000in the form of retained earnings available for investment Purposes Trent are the further details : fli Debt equity ratio 25:75, Cost of debt at the rate of 10% (before tax) upto € 2,00,000 and 13% (before ia) that Eaming per share, 12. Dividend payout 50% of earnings. Expected growth rate in dividend 10y, ‘market price per share, ¥ 60. Company's tax rate is 30% and shareholder's personal tax rate is 20% (Calculate the post tax average cost of additional debt. Reshind (i Calculate the cost of retained earnings and cost of equity. (Git) Calculate the overall weighted average (after tax) cost of additional finance. [CA, PCE, May 2y Solution: (a) Pattern of raising capital : z ‘Debt (25/100) x 20,00,000 5,00,000 Equity (75/100) x 20,00,000 15,00,000 Total 20,00,000 Equity fund: Debt fun: Retained earning 4,00,000 10% debt Equity (additional) 11,00,000 13% debt Total 15,00,000, Total 0 K= Total terest 0) e occa <9 cooK 020) = 0.0826 = 8.26% Wi x=? += & +010 = 0.10 + 0.10 = 0.20 = 20% K,=K,(1-f) = 20(1-0.2)=16% where, , = shareholders’ personal tax rate (ii) Computation weighted average cost of capital Particulars ‘Amount After tax Equity Capital 11,00,000 20.00% Retained earning 4,00,000 16.00% Debt 5,00,000 8.26% Total 20,00,000 300 K 325,500, 109 = 16.27% 20,00,000