Cost of Capital

(a)The CFO of KKK Limited started restructuring of company's capital structure. He is concerned with what the company has to pay for the capital it has mobilized through various sources of finance. The cost of capital has to be specially considered because cost of capital has direct effect on profit earning capacity of the company. Therefore, it is necessary for the CFO to take into consideration the cost of capital which should not be burdensome for the company and should try to develop an optimum capital structure so that the cost of capital can be minimized.

The CFO is considering the restructuring plan and possibility of raising ₹ 50,00,000 by issuing equity shares, preference shares and debentures. The details are as follows:

Market Price of :

Equity shares is ₹ 18, Preference shares is ₹ 12, and Debenture is ₹ 12.

Earnings per share of the company are ₹ 2. The corporate tax rate is 50%.

You are the Company Secretary of the Company, help the CFO in determining weighted average cost of capital (using weights based on market values.)

( a )Ganeshan Limited is evaluating a project that has the following cash flow stream associated with it :

The cost of capital is 15 percent. Calculate the terminal value of cash inflow of the company.

(c)The following figures relate to the capital structure of ABC & Co.

You are required :

(i)Compute the total market value of ABC & Co.

(ii)Overall cost of capital.

Ignore Taxation and assume Net Income Approach.

Pizza Bite is an all-equity firm with a current cost of equity of 18%. The EBIT of the firm is ₹ 3,06,000 annually forever. Currently, the firm has no debt but is in the process of borrowing ₹ 5,00,000 at 9% interest. The tax rate is 34%. What is the value of the unlevered firm ?

(A)₹ 9,82,350

(B)₹ 9,14,850

(C)₹ 10,84,725

(D)₹ 11,22,000

........... is the rate of return associated with the best investment opportunity for the firm and its shareholders that will be forgone if the projects presently under consideration by the firm were accepted.

(A)Opportunity Cost

(B)Future Cost

(C)Explicit Cost

(D)Specific Cost

Which of the following is controllable factor affecting the cost of capital of the firm ?

(A)Dividend policy

(B)Level of interest rates

(C)Tax rates

(D)Taste of customers

A firm’s overall cost of capital :

(A)Is the required return on the total assets of a firm.

(B)Is another term for the firm’s internal rate of return.

(C)Is unaffected by changes in the tax rate.

(D)Varies inversely with its cost of debt.

AS Ltd. has 12,000 equity shares of 100 each. Sale price of equity shares is ₹ 120 per share; floatation cost will be ₹ 10 per share. Expected dividend growth rate is 5% and expected dividend at the end of the financial year is ₹ 11 per share. What is the cost of equity shares of S Ltd. ?

(A)0.15

(B)0.1475

(C)0.1278

(D)0.1122

Debt as percentage of total capital of Agra Ltd. is 20%. Its cost of equity is 16% and pre-tax cost of debt is 12%. Tax rate is 25%. What is overall cost of capital of Agra Ltd. ?

(A)16%

(B)14%

(C)15%

(D)14.6%

The liability side of National Ltd. Balance Sheet shows Equity capital ₹ 50 Lakh and Retained Earnings ₹ 80 Lakh. Face value of its share is 100 each and market value is ₹ 300 each. If the investors expect a dividend of ₹ 16 by the end of year and growth rate is 5%, and if the cost of floatation of issuing fresh Equity is 6%, what is the Cost of Retained Earnings on the basis of dividend growth model ?

(A)21.33%

(B)16.00%

(C)11.00%

(D)10.33%

(c)A company has an EBIT of ₹ 10,00,00,000 and belongs to a risk class of 15% i.e., its overall cost of capital is 15%. What is the cost of equity capital if it employs 10% debt to the extent of 30%, 40% or 50% of total capital of ₹ 50,00,00,000/- Assume net operating income approach applies.

Following is the information of ABC Limited : Equity Share Capital – ₹ 1,200 lakhs

(Assume a 30% tax rate)

EVA is :

(A)₹ 216

(B)₹ (151.20)

(C)₹ 64.8

(D)₹ (64.8)

Given data D = 7, P = 50, growth rate = 8.4%, then ke on the basis of dividend growth model will 0 0 be :

(A)8.54%

(B)23.58%

(C)8.55%

(D)15.18%

Which of the following is an uncontrollable factor affecting the cost of capital ?

(A)Level of Interest Rates

(B)Tax Rates

(C)Both (A) and (B)

(D)None of the above

A company issue 20% irredeemable debentures of ₹ 20,000. The company is in 30% tax bracket. Calculate cost of debt capital, if it was issued at 10% premium.

(A)15%

(B)14%

(C)15.55%

(D)12.73%

According to CAPM the cost of capital (ke) is :

(A)Rf + (Rm – Rf) β

(B)Rm + (Rm – Rf) β

(C)Rf + (Rf – Rm) β

(D)Rf + (Rm – Rf)

BNK Ltd. has a cost of debt (pre-tax) of 7%, a cost of equity of 11%, and a cost of preferred stock of 8%. The firm has 1,04,000 shares of common stock outstanding at a market price of ₹ 20 a share. There are 40,000 shares of preferred stock outstanding at a market price of ₹ 34 a share. The bond issue has a total face value of ₹ 5,00,000 and sells at 102% of face value. The tax rate is 34%.

What is the approx. weighted average cost of capital for BNK Ltd. using market value weights ?

(A)6.14%

(B)6.54%

(C)8.60%

(D)9.14%

A company has currently 25,000 equity shares of ₹ 100 each and its’ earnings as available for equity shareholders are ₹ 4,00,000. Its current market price is ₹ 128 and the growth rate of EPS is expected to be 10%. Calculate the cost of equity using Earnings-price Ratio approach.

(A)15%

(B)13.75%

(C)16.25%

(D)14.5%

The cost of equity capital is all of the following EXCEPT :

(A)The minimum rate that a firm should earn on the equity-financed part of an investment

(B)A return on the equity-financed portion of an investment that, at worst, leaves the market price of the stock unchanged

(C)By far the most difficult component cost to estimate

(D)Is generally lower than the after-tax cost of debt

Ashok Ltd. is having 12% debentures for ₹ 20,00,000 in its capital structure. If the incomes of the company are subject to 30% tax, the cost of debt is :

(A)15.6%

(B)12%

(C)8.40%

(D)3.60%

................. is the rate of return associated with the best investment opportunity for the firm and its shareholders that will be forgone if the projects presently under consideration by the firm were accepted.

(A)Explicit Cost

(B)Future Cost

(C)Opportunity Cost

(D)None of the above

CC Industries Ltd. has net assets of ₹ 1,70,000 which have been financed with ₹ 58,000 of debt, ₹ 1,00,000 of equity and a general reserve of ₹ 12,000. The firm’s total profits after interest and taxes for the year ended 31st March 2022 were ₹ 15,000. It pays 10% interest on borrowed funds and is in the 30% tax bracket. It has 1000 equity shares of ₹ 100 each, selling price at a market price of ₹ 130 per share. What is the weighted average cost of capital using book value weights if Earnings-price Ratio approach is followed and growth rate of EPS is zero ?

(A)7.68%

(B)9.97%

(C)8.72%

(D)10.11%

Gamma Ltd. has furnished the following information : Earnings Per Share (EPS) ₹ 4 Dividend payout ratio 25% Market price per share ₹ 50 Rate of tax 30% Growth rate of dividend 10% The company wants to raise additional capital of ₹ 12 lakhs including debt of ₹ 6 lakhs. The cost of debt (before tax) is 10% up to ₹ 3 lakhs and 15% beyond that. The weighted average cost of capital of additional funds raised by the company on the basis of dividend growth model is approx. :

(A)9.35%

(B)11.35%

(C)10.45%

(D)12.25%

Retention ratio is 0.60 and return on equity is 15.5%, D0 = 10, P0 = 70 then Ke = ?

(A)14.9%

(B)25.84%

(C)16.1%

(D)24.91%

A company has a cost of equity of 10% and an interest rate of 6%. The company’s debt-to-equity ratio is 1.5, and the corporate tax rate is 40%. What is the company’s weighted average cost of capital ?

(A)7.2%

(B)6.16%

(C)7.6%

(D)8.4%

Which of the following actions will not generally cause an increase in WACC ?

(A)Increase in proportion of equity

(B)Increase in proportion of debt

(C)Both (A) and (B)

(D)Neither (A) nor (B)

One-fourth of the total market value of X Ltd. consists of loan stock, which has a cost of 11%. Another company, Y Ltd., is identical in every respect to X Ltd., except that its capital structure is all-equity, and its cost of equity is 15%. According to Modigliani and Miller, if we ignored taxation and tax relief on debt capital, what would be the cost of equity of X Ltd. ?

(A)16.33%

(B)15.50%

(C)17.00%

(D)14.83%

(c)The following is an extract from the financial statement of XYZ Ltd :

(₹ in lakh) (₹ in lakh)

The market price per equity share is ₹ 12 and per debenture ₹ 93.75. Calculate :

(i)EPS

(ii)Percentage cost of capital to the company for the debenture funds and the equity.

One-fifth of the total market value of X Ltd. consists of loan stock, which has a cost of 10%. Another company, Y Ltd. is identical in every respect to X Ltd., except that its capital structure is all-equity, and its cost of equity is 16%. According to Modigliani and Miller approach, if we ignored taxation and tax relief on debt capital (proposition I), what would be the cost of equity of X Ltd. ?

(A)16.5%

(B)17.5%

(C)18.5%

(D)19.5%

‘‘Cost of capital may be defined as the rate that must be earned on the net proceeds to provide the cost elements of the burden at the time they are due’’. This definition has been given by :

(A)William and Donaldson

(B)John J. Hampton

(C)Solomon Ezra

(D)James C. Van Horne

Which is not the factor affecting cost of capital that the company has control over ?

(A)Capital Structure Policy

(B)Dividend Policy

(C)Investment Policy

(D)Management Policy

A company issued 20000 7% preference shares of ₹ 50 each at premium of 4%. Flotation cost was ₹ 2 per share. Applicable income tax rate is 20%. Cost of preference share capital will be :

(A)7%

(B)6.73%

(C)7.29%

(D)5.6%

A company has outstanding 2,00,000 equity shares of ₹ 100 each and 5,00,000 8% preference shares of ₹ l0 each. Apart from the dividend on preference shares, the company has paid a dividend of ₹ 12, ₹ 13.2 and ₹ 14.52 respectively for last 3 years on its equi ty shares. If the current market price of equity shares is ₹ 140, the cost of equity share capital as per Dividend Growth Model approach will be :

(A)29.96%

(B)25.97%

(C)21.41%

(D)20.37%

A Ltd. requires an amount of ₹ 5,00,000 to finance a pro ject. It was decided to raise such finance by the issue of debentures. Cost of debt (before tax) up to ₹ 2,00,000 is l0% and 13% (before tax) for additional amount. Applicable tax rate is 30%. What is the average marginal cost of capital of new finance of ₹ 5,00,000 ?

(A)7.26%

(B)7.96%

(C)8.26%

(D)8.96%

Which of the following statements is true from the perspective of weighted average cost of capital ?

(A)Generally, WACC calculated using book value weights will be overstated if the market value of the shares is higher than the book value

(B)Generally, WACC calculated using book value weights will be understated if the market value of the shares is higher than the book value

(C)Generally, WACC calculated using book value weights will be understated if the market value of the shares is lower than the book value

(D)None of the above

Which of the following scholar commented :

‘‘Cost of Capital is the rate of return the firm required from investment in order to increase the value of the firm in the market place’’ ?

(A)Ezra Solomon

(B)John J. Hampton

(C)James C. Van Horne

(D)I.M. Pandey

Though the cost of retained earnings is generally as equal to the cost of equity capital, it is not to be adjusted for :

(A)Tax

(B)Floatation cost

(C)Under-pricing

(D)All of the above

The capital structure of a company consists of 9% ₹ 8,00,000 bank loan. It also has 50000 equity shares of ₹ 10 each. The company is expecting EBIT of ?

2,00,000 per annum. If the cost of equity capital of the company is 10%, what is the overall cost of capital of the firm on the basis of Net Income Approach ?

(A)9.52%

(B)9.62%

(C)9.72%

(D)9.82%

A company issued 20,000 9% preference shares of ₹ 100 each at 5% discount. Floatation cost amounted 2% of the face value of shares. These are redeemable after 7 years at par. Applicable income tax rate is 30%. Cost of preference shares is :

(A)10.36%

(B)9.56%

(C)9.97%

(D)10.3%

A company has 20,000 equity shares of ₹ 200 each and its current earnings for equity shareholders is ₹ 3,60,000. The growth rate expected in EPS is 7%. The current market price of company’s shares is ₹ 240 each. The approximate cost of equity capital of the company on the basis of Earnings-price Ratio approach is :

(A)15%

(B)12%

(C)8%

(D)9%

A company has 1,00,000 outstanding equity shares of ₹ 100 each with current market price of ₹ 124, 50000 9% preference shares of ₹ 50 each with market price of ₹ 47.5 each and floatation cost of 3%. It also has 20000 8% debentures of ₹ 100 each, selling for ₹ 106 each presently. If the specific costs of equity shares, preference shares and debentures are 13.5%, 10% and 7.5% respectively, the WACC (%) of the company using book value weights is :

(A)12.06

(B)13.31

(C)11.78

(D)13.81

A company has equity share capital of ₹ 50 Lakhs with specific cost of 13%, preference share capital of ₹ 30 Lakhs with specific cost of 11% and Bank Loan of ₹ 20 Lakhs with specific cost of 8% in its existing capital structure. The company is planning to raise additional ₹ 50 Lakh through equity that is expected to cost 12%. If this amount is raised, the approx. marginal cost of capital will be :

(A)0.23%

(B)0.32%

(C)0.19%

(D)1.11%

Current market rate of X Ltd.’s equity share is ₹ 80 per share. The company is expected to pay a dividend of ₹ 4 per share with an annual growth of 10%. In this case the rate of return would be :

(A)5.5%

(B)10.5%

(C)12%

(D)15%

Which of the following is correct regarding cost of capital?

(A)When interest rates increases, cost of equity decreases, thereby decreasing cost of capital

(B)When tax rate increases, cost of debt decreases, thereby increasing cost of capital

(C)An increase in interest rate will affect the cost of debt and potentially the cost of capital

(D)None of the above

A Ltd. issued 8% debentures (face value ₹ 10 each) worth ₹ 100 Lakh at par. A Limited falls in 30% tax bracket. The effective cost of debentures will be:

(A)5.5%

(B)5.6%

(C)6%

(D)8%

ABC Ltd. floated 20000 10% preference shares of ₹ 100 each redeemable after 10 years at face value. Floatation cost amounted to ₹ 2 per share. Applicable tax rate is 30%. Cost of preference shares will be:

(A)10.4%

(B)10.5%

(C)10.3%

(D)10.6%

A Ltd. issued equity shares of ₹ 10 Lakh comprising of 1 lakh shares of ₹ 10 each. The current market price per share is ₹ 50 and current dividend paid is ₹ 5 per share. The dividend is expected to grow @ 5% per annum. On the basis of dividend growth model, the cost of equity will be:

(A)15%

(B)15.2%

(C)15.5%

(D)16%

B Ltd. has equity shares of ₹ 25 Lakh comprising of 25000 shares of ₹ 100 each in its capital structure. The current market price per share is 110 and profit after tax is ₹ 5 Lakh. The expected growth rate in earnings is 10%. On the basis of Earnings Price Ratio approach, the cost of equity will be:

(A)25%

(B)15%

(C)20%

(D)12%

Which of the following is correct regarding cost of retained earnings ?

(A)Since the company is not required to pay dividend on retained earnings, there is no cost associated to it

(B)Opportunity cost of foregone dividends must be considered as cost of retained earnings

(C)Both (A) and (B) are correct

(D)None of the above

Which of the following statements is/are correct ?

(A)Weighted Average Cost of Capital using book value weights will be generally understated if the market value of shares is higher than book value

(B)The relationship of book value and market value of securities has nothing to do with calculation of weighted average cost of capital

(C)Both (A) and (B) are correct

(D)Both (A) and (B) are incorrect

ABC Ltd. has ₹ 50,00,000 in long term debts, ₹ 10,00,000 in preferred stock and ₹ 40,00,000 in common equity. All the values are on market value. The before tax cost of debts 10%. Cost of preferred stock are 11% and cost of common equity is 15%. Assume a tax rate of 40%. The overall cost of capital is ................

(A)10.90%

(B)10.46%

(C)11%

(D)12.90%

A Ltd. Co. issued 6%, 2000 irredeemable debentures of ₹ 100 each @ 10% premium. The company falls in 50% tax bracket. Find out the cost of debenture after tax.

(A)2.73%

(B)6.00%

(C)3.00%

(D)3.73%

A company has issued 10,000 equity shares of ₹ 100 each. Its current market price is ₹ 98 per share and the current dividend is ₹ 4.5 per share. The dividends are expected to grow at the rate of 10%. Compute the cost of equity capital.

(A)15.05%

(B)9.80%

(C)10.00%

(D)4.50%

The cost of retained earnings are often taken as equal to the :

(A)Cost of equity

(B)Cost of debenture

(C)Weighted Average Cost of Capital

(D)Any of the above

The capital structure of ABC Ltd. consists, debentures, preference share, equity shares and retained earnings. The weight of each security is 28.57%, 9.53%, 14.28% and 47.62% respectively. The specific cost of capital is 14.6%, 10.50%, 20.00% and 18.00% respectively. Determine the weighted average cost of capital (WACC).

(A)16.60%

(B)18.20%

(C)16.42%

(D)15.60%

P Ltd. issue ₹ 50,000 8% Debenture at a discount of 5%. The tax rate is 50%. The cost of debt capital is .......................

(A)5.42%

(B)5.1%

(C)4.42%

(D)4.21%

PQR Ltd. has expected earnings at ₹ 40 per share which is growing at 9% annually. Company follows fixed pay out ratio of 60%. The market price of its share is ₹ 500. What is the current cost of equity ?

(A)12%

(B)12.8%

(C)13.8%

(D)12.1%

A company has issued 50,000 equity shares of ₹ 100 each. Its current market price is ₹ 90 per share and the current dividend is ₹ 8 per share. The dividends are expected to grow at the rate of 10%. Compute the cost of equity capital :

(A)14.07%

(B)18.78%

(C)19.78%

(D)9.78%

The cost of each component of a firm’s capital structure multiplied by its weight in the capital structure is called :

(A)Marginal cost of capital

(B)The cost of debt

(C)Weighted average cost of capital

(D)Opportunity Cost

While calculating weighted average cost of capital which is not considered :

(A)Retained earnings

(B)Bank borrowings for working capital

(C)Cost of issue shares

(D)Weights are based on market value or on book value

A Ltd. issues ₹ 50,000 8% debentures at a discount of 5%. The tax rate is 50%. The cost of debt capital is :

(A)5.42%

(B)5.1%

(C)4.42%

(D)4.21%

A company issues 10,000 10% Preference Shares of ₹ 100 each redeemable after 10 years at a premium of 5%. The cost of issue is ₹ 2 per share. The cost of preference capital is :

(A)10.14%

(B)10.34%

(C)10.74%

(D)10.54%

Number of existing equity share = 8 crore, Market value of existing share = ₹ 55, Net earnings = ₹ 80 crore. Cost of equity on basis of Earning-price Ratio approach is :

(A)5.55%

(B)5.15%

(C)18.18%

(D)18.02%

ABC Ltd. has the following capital structure :

Equity share capital ₹ 10,00,000, 10% preference share capital ₹ 5,00,000, 8% Debenture ₹ 15,00,000. Cost of equity is estimated to be 15%. Calculate the Weighted Average Cost of Capital, assuming tax rate is 50%.

(A)6.67%

(B)8.67%

(C)9.67%

(D)7.67%

A company has currently 2,000 equity shares of ₹ 100 each and its earnings are ₹ 20,000. Its current market price is ₹ 110 and the growth rate of EPS is expected to be 5%. The cost of equity is .............. .

(A)10.94%

(B)9.55%

(C)9.95%

(D)11.60%

MNP Ltd. has a target capital structure of 60 percent common stock, 10 percent preferred stock, and 30 percent debt. Its cost of equity is 15 percent, the cost of preferred stock is 7 percent, and the cost of debt is 10 percent. The relevant tax rate is 40 percent. What is its WACC ?

(A)11.3%

(B)11.5%

(C)11.7%

(D)12.1%

The capital structure of KC Ltd. is :

The average rate of return on similar types of companies is 20%, while risk-free return is 10%. Rate of interest charged by bank is 18%. Weighted Average Cost of Capital (WACC) will be :

(A)16%

(B)13.55%

(C)16.25%

(D)17.05%

P Ltd. has 12% Debentures of ₹ 40 Lakh and 13% Debentures of ₹ 60 Lakh. If the corporate tax rate is 30%, then combined cost of debt after tax will be :

(A)12.60%

(B)8.75%

(C)8.82%

(D)12.50%

The cost of retained earnings is equal to :

(A)Dividend pay-out ratio

(B)Rate of return expected on the Equity Share

(C)Risk-free rate of return

(D)Dividend yield ratio

The Weighted Average Cost of Capital computations :

(A)Assign more weight to Equity.

(B)Assign more weight to Debentures.

(C)Excludes Retained Earnings.

(D)Assigns weights based on Market Value or Book Value.

The liability side of Shivanee Ltd.’s Balance Sheet shows Equity capital ₹ 25 Lakhs and Retained Earnings ₹ 50 Lakhs. Face value of its share is ₹ 100 each and market value is ₹ 300 each. If the investors expect a Rate of Return of 18%, and if the cost of floatation of issuing fresh Equity is 5%, what is the Cost of Retained Earnings ?

(A)17.50%

(B)18.00%

(C)9.00%

(D)8.75%

(iv)Calculate the Weighted Average Cost of Capital of Makkhu Ltd. from the following information :

Cost of Equity can be considered as Cost of Retained Earnings.

(a)Equity shares of YMC Corporation has a beta (  ), of 1.4. The risk-free rate is 9%, and the market return is 21%. Determine the risk premium on its equity shares. Further determine cost of equity using the suitable model.

(i)A Private Ltd. Co. has assets worth ₹ 32,00,000 as on 31st March, 2018 that has been financed as follows :

₹

For the year ended on 31st March, 2018, the Company’s total profits before interest and taxes were ₹ 6,23,000. The company pays 8% interest on borrowed capital and the tax bracket is 40%. The market value of equity share as on 31st March, 2018 was ₹ 150 per share.

Calculate the weighted average cost of capital using market value as weights.

(b)The firm is not required to pay dividends on retained earnings, so it may be argued that the retained earnings have no cost as such.

(a)X Ltd. issues 1,000, 6% preference shares of ₹ 100 each redeemable after a maximum period of 20 years at face value. The floatation cost is ₹ 4 per share. Find the cost of capital.

(iii)X Ltd. has furnished the following information :

The company wants to raise additional capital of ₹ 10,00,000 including debt of ₹ 4,00,000.

The cost of debt (before tax) is 10% up to ₹ 2,00,000 and 15% beyond that. Compute the after tax cost of equity and debt and the weighted average cost of capital.