8891234155 ca_akshaykumark CA Akshay Kumar (AIR 6)

COST OF CAPITAL

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QUESTION 1 (RTP MAY 2020)
PK Ltd. has the following book-value capital structure as on March 31, 2020:
(`)
Equity share capital (10,00,000 shares) 2,00,00,000
11.5% Preference shares 60,00,000
10% Debentures 1,00,00,000
3,60,00,000
The equity shares of the company are sold for ` 200. It is expected that the company will pay next year a dividend of ` 10 per
equity share, which is expected to grow by 5% p.a. forever. Assume a 35% corporate tax rate.
Required:
(i) COMPUTE weighted average cost of capital (WACC) of the company based on the existing capital structure.
(ii) COMPUTE the new WACC, if the company raises an additional `50 lakhs debt by issuing 12% debentures. This would
result in increasing the expected equity dividend to `12.40 and leave the growth rate unchanged, but the price of
equity share will fall to ` 160 per share.
QUESTION 2 (PAST YEAR JULY 2021 – 10 MARKS)
Following are the information of TT Ltd.:

Particulars
Earnings per share ` 10
Dividend per share `6
Expected growth rate in Dividend 6%
Current market price per share ` 120
Tax Rate 30%
Requirement of Additional Finance ` 30 lakhs
Debt Equity Ratio (For additional finance) 2:1
Cost of Debt
0-5,00,000 10%
5,00,001 - 10,00,000 9%
Above 10,00,000 8%
Assuming that there is no Reserve and Surplus available in TT Ltd.
You are required to:
(a) Find the pattern of finance for additional requirement
(b) Calculate post tax average cost of additional debt

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 8891234155 ca_akshaykumark CA Akshay Kumar (AIR 6)

(c) Calculate cost of equity

(d) Calculate the overall weighted average after tax cost of additional finance.
QUESTION 3 (PAST YEAR DEC 2021 – 5 MARKS)
Book value of capital structure of B Ltd. is as follows:

Sources Amount
12%, 6,000 Debentures @ ` 100 each ` 6,00,000
Retained earnings ` 4,50,000
4,500 Equity shares @ ` 100 each ` 4,50,000
` 15,00,000
Currently, the market value of debenture is ` 110 per debenture and equity share is ` 180 per share. The expected rate of
return to equity shareholder is 24% p.a. Company is paying tax @ 30%.
Calculate WACC on the basis of market value weights.
QUESTION 4 (PAST YEAR JAN 2021 – 10 MARKS)
The Capital structure of PQR Ltd. is as follows :

`
10% Debenture 3,00,000
12% Preference Shares 2,50,000
Equity Share (face value ` 10 per share) 5,00,000
10,50,000

Additional Information:
(i) ` 100 per debenture redeemable at par has 2% floatation cost & 10 years of maturity. The market price per debenture is
` 110.
(ii) ` 100 per preference share redeemable at par has 3% floatation cost & 10 years of maturity. The market price
per preference share is ` 108.
(iii) Equity share has ` 4 floatation cost and market price per share of ` 25. The next year expected dividend is ` 2 per
share with annual growth of 5%. The firm has a practice of paying all earnings in the form of dividends.
(iv) Corporate Income Tax rate is 30%.
Required:

Calculate Weighted Average Cost of Capital (WACC) using market value weights.

QUESTION 5 (RTP NOV 2020)

CALCULATE the WACC using the following data by using:
(a) Book value weights
(b) Market value weights
The capital structure of the company is as under:
Particulars (`)
Debentures (` 100 per debenture) 5,00,000

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 8891234155 ca_akshaykumark CA Akshay Kumar (AIR 6)

Preference shares (` 100 per share) 5,00,000

Equity shares (` 10 per share) 10,00,000
20,00,000

The market prices of these securities are:

Debentures ` 105 per debenture

Preference shares ` 110 per preference share

Equity shares ` 24 each.

Additional information:
(i) ` 100 per debenture redeemable at par, 10% coupon rate, 4% floatation costs, 10-year maturity.

(ii) ` 100 per preference share redeemable at par, 5% coupon rate, 2% floatation costand 10-year maturity.
(iii) Equity shares has ` 4 floatation cost and market price ` 24 per share.
The next year expected dividend is ` 1 with annual growth of 5%. The firm has practice ofpaying all earnings in the form of
dividend. Corporate tax rate is 30%. Use YTM method to calculate cost of debentures and preference shares.
QUESTION 6 (RTP MAY 2021)

Indel Ltd. has the following capital structure, which is considered to be optimum as on 31st March, 2021::
Particulars (`)
14% Debentures 60,000
11% Preference shares 20,000
Equity Shares (10,000 shares) 3,20,000
4,00,000

The company share has a market price of ` 47.20. Next year dividend per share is 50% of year 2020 EPS. The following is the
uniform trend of EPS for the preceding 10 years which is expected to continue in future.

Year EPS (`) Year EPS (`)

2011 2.00 2016 3.22
2012 2.20 2017 3.54
2013 2.42 2018 3.90
2014 2.66 2019 4.29
2015 2.93 2020 4.72
The company issued new debentures carrying 16% rate of interest and the current market price of debenture is ` 96.
Preference shares of ` 18.50 (with annual dividend of ` 2.22 per share) were also issued. The company is in 30% tax bracket.
(A) CALCULATE after tax:
(i) Cost of new debt
(ii) Cost of new preference shares
(iii) New equity share (assuming new equity from retained earnings)
(B) CALCULATE marginal cost of capital when no new shares are issued.
(C) DETERMINE the amount that can be spent for capital investment before new ordinary shares must be sold, assuming

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 8891234155 ca_akshaykumark CA Akshay Kumar (AIR 6)

that the retained earnings for next year’s investment is 50 percent of earnings of 2020.
(D) COMPUTE marginal cost of capital when the fund exceeds the amount calculated in (C), assuming new equity is
issued at ` 40 per share?

QUESTION 7 (RTP NOV 2021)

Kalyanam Ltd. has an operating profit of ` 34,50,000 and has employed Debt which gives total Interest Charge of ` 7,50,000. The
firm has an existing Cost of Equity and Cost of Debt as 16% and 8% respectively. The firm has a new proposal before it, which
requires funds of ` 75 Lakhs and is expected to bring an additional profit of ` 14,25,000. To finance the proposal, the firm is
expecting to issue an additional debt at 8% and will not be issuing any new equity shares in the market.
Assume no tax culture.
You are required to CALCULATE the Weighted Average Cost of Capital (WACC) of Kalyanam Ltd.:
(i) Before the new Proposal
(ii) After the new Proposal
QUESTION 8 (RTP MAY 2022)

The information relating to book value (BV) and market value (MV) weights of Ex Limited is given below:

Sources Book Value (`) Market Value (`)

Equity shares 2,40,00,000 4,00,00,000
Retained earnings 60,00,000 -
Preference shares 72,00,000 67,50,000
Debentures 18,00,000 20,80,000
Additional information:
I. Equity shares are quoted at ` 130 per share and a new issue priced at ` 125 per share will be fully subscribed;
flotation costs will be ` 5 per share on face value.
II. During the previous 5 years, dividends have steadily increased from ` 10 to ` 16.105 per share. Dividend at the end of
the current year is expected to be ` 17.716 per share.
III. 15% Preference shares with face value of ` 100 would realise ` 105 per share.
IV. The company proposes to issue 11-year 15% debentures but the yield on debentures of similar maturity and risk class is
16%; flotation cost is 2% on face value.
V. Corporate tax rate is 30%.
You are required to DETERMINE the weighted average cost of capital of Ex Limited using both the weights.
QUESTION 9 (PAST YEAR MAY 2022 – 10 MARKS)
A company issues:
 15% convertible debentures of ` 100 each at par with a maturity period of 6 years. On maturity, each debenture will
be converted into 2 equity shares of the company. The risk - free rate of return is 10%, market risk premium is 18%
and beta of the company is 1.25. The company has paid dividend of ` 12.76 per share. Five year ago, it paid dividend
of ` 10 per share. Flotation cost is 5% of issue amount.
 5% preference shares of ` 100 each at premium of 10%. These shares are redeemable after 10 years at par.
Flotation cost is 6% of issue amount.
Assuming corporate tax rate is 40%.
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8891234155 ca_akshaykumark CA Akshay Kumar (AIR 6)

(i) Calculate the cost of convertible debentures using the approximation method.
(ii) Use YTM method to calculate cost of preference shares.

Year 1 2 3 4 5 6 7 8 9 10
PVIF 0.03, 0.971 0.94 0.915 0.888 0.863 0.837 0.813 0.789 0.766 0.744
t 3
PVIF 0.05, 0.952 0.90 0.864 0.823 0.784 0.746 0.711 0.677 0.645 0.614
t 7
PVIFA 0.03, 0.971 1.913 2.829 3.717 4.580 5.417 6.230 7.020 7.786 8.530
t
PVIFA 0.05, 0.952 1.859 2.723 3.546 4.329 5.076 5.786 6.463 7.108 7.722
t

Interest rate 1% 2% 3% 4% 5% 6% 7% 8% 9%
FVIF i, 5 1.051 1.104 1.159 1.217 1.276 1.338 1.403 1.469 1.539
FVIF i, 6 1.062 1.126 1.194 1.265 1.340 1.419 1.501 1.587 1.677
FVIF i, 7 1.072 1.149 1.230 1.316 1.407 1.504 1.606 1.714 1.828

QUESTION 10 (RTP NOV 2022)

Bounce Ltd. evaluates all its capital projects using discounting rate of 15%. Its capital structure consists of equity share
capital, retained earnings, bank term loan and debentures redeemable at par.
Rate of interest on bank term loan is 1.5 times that of debenture. Remaining tenure of debenture and bank loan is 3 years and
5 years respectively. Book value of equity share capital, retained earnings and bank loan is ` 10,00,000, ` 15,00,000 and `
10,00,000 respectively. Debentures which are having book value of ` 15,00,000 are currently trading at ` 97 per debenture.
The ongoing P/E multiple for the shares of the company stands at 5.

You are required to CALCULATE the rate of interest on bank loan and debentures if tax rate applicable is 25%.

QUESTION 11 (MTP NOV 2022 SERIES I – 5 MARKS)

The capital structure of a Company is given below:

Source of capital Book Value (`)

Equity shares @ ` 100 each 24,00,000
9% Cumulative preference shares @ ` 100 each 4,00,000
11% Debentures 12,00,000
40,00,000

The company had paid equity dividend @ 25% for the last year which is likely to grow @ 5% every year. The current market
price of the company’s equity share is ` 200.

Considering corporate tax @ 30%, you are required to CALCULATE:

(i) Cost of capital for each source of capital.
(ii) Weighted average cost of capital.

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8891234155 ca_akshaykumark CA Akshay Kumar (AIR 6)

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QUESTION 12 (MTP NOV 2022 SERIES II – 10 MARKS)
The financial advisor of Sun Ltd is confronted with following two alternative financing plans for raising ` 10 lakhs that is
needed for plant expansion and modernization.
Alternative I: Issue 80% of funds with 14% Debenture [Face value (FV) ` 100] at par and redeem at a premium of 10% after 10
years and balance by issuing equity shares at 33 % premium.

Alternative II: Raise 10% of funds required by issuing 8% Irredeemable Debentures [Face value (FV) ` 100] at par and the
remaining by issuing equity shares at current market price of `125.
Currently, the firm has an Earnings per share (EPS) of ` 21
The modernization and expansion programme is expected to increase the firm’s Earnings before Interest and Taxation (EBIT) by `
200,000 annually.
The firm’s condensed Balance Sheet for the current year is given below:
Balance Sheet as on 31.3.2022

Liabilities Amount (`) Assets Amount (`)

Current Liabilities 5,00,000 Current Assets 16,00,000
10% Long Term Loan 15,00,000 Plant & Equipment (Net) 34,00,000
Reserves & Surplus 10,00,000
Equity Share Capital (FV: ` 100 each) 20,00,000

TOTAL 50,00,000 TOTAL 50,00,000

However, the finance advisor is concerned about the effect that issuing of debt might have on the firm. The average debt
ratio for firms in industry is 35%.He believes if this ratio is exceeded, the P/E ratio of the company will be 7 because of the
potentially greater risk.

If the firm increases its equity capital by more than 10 %, he expects the P/E ratio of the company will increase to 8.5
irrespective of the debt ratio.

Assume Tax Rate of 25%. Assume target dividend pay-out under each alternative to be 60% for the next year and growth rate to be
10% for the purpose of calculating Cost of Equity
SUGGEST with reason which alternative is better on the basis of each of the below given criteria:
I. Earnings per share (EPS) & Market Price per share (MPS)
II. Financial Leverage
III. Weighted Average Cost of Capital & Marginal Cost of Capital (using Book Value weights)

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 8891234155 ca_akshaykumark CA Akshay Kumar (AIR 6)

QUESTION 13 (PAST YEAR NOV 2022 – 5 MARKS)

The following is the extract of the Balance Sheet of M/s KD Ltd.:

Particulars Amount (`)

Ordinary shares (Face Value ` 10/- per share) 5,00,000
Share Premium 1,00,000
Retained Profits 6,00,000
8% Preference Shares (Face Value ` 25/- per share) 4,00,000
12% Debentures (Face value ` 100/- each) 6,00,000
22,00,000
The ordinary shares are currently priced at ` 39 ex-dividend and preference share is priced at ` 18 cum-dividend. The
debentures are selling at 120 percent ex-interest. The applicable tax rate to KD Ltd. is 30 percent. KD Ltd.'s cost of equity has
been estimated at 19 percent. Calculate the WACC (weighted average cost of capital) of KD Ltd. on the basis of market value.

QUESTION 14 (RTP MAY 2023)

Amrit Corporation has the following book value capital structure:

Equity Capital (50 lakh shares of ` 10 each). ` 5,00,00000

15% Preference share (50,000 shares ` 100 each) ` 50,00,000
Retained earnings ` 4,00,00,000
Debentures 14% (2,50,000 debentures ` 100 each) ` 2,50,00,000
Term loan 13% ` 4,00,00000

The companies last year earnings per share was ` 5, and it maintains a dividend pay-out ratio of 60% and returns on equity is 10%.
The market price per share is ` 20.8. Preference share redeemable after 10 years is currently selling for ` 90 per share.
Debentures redeemable after 6 years are currently selling for ` 75 per debenture. The income tax rate is 40%.
(a) CALCULATE the Weighted Average Cost of Capital (WACC) using market value proportions.
(b) DETERMINE the Marginal Cost of Capital (MACC) if it needs ` 5,00,00000 next year assuming the amount will be raised by
60% equity, 20% debt and 20% retained earnings. Equity issues will fetch a net price of ` 14 and cost of debt will
be 13% before tax up to ` 40,00,000 and beyond ` 40,00,000 it will be 15% before tax.

QUESTION 15 (MTP MAY 2023 SERIES II – 10 MARKS)

Genzy Ltd. is planning to introduce a new product with a project life of 10 years. The initial equipment cost will be ` 2.5 crores.
At the end of 10 years, the equipment will have a resale value of 50 lakhs. A working capital of ` 30,00,000 will be needed and it
will be released at the end of the tenth year. The project will be financed with the following capital sources.

Particulars Amount (`) Issue Price

(Market
price)
Equity Share Capital of Face value ` 10 each 1,50,00,000 `30
Debentures of face value ` 100 each with a maturity of 10 years 90,00,000 `90
Preference shares of ` 100 each with a maturity of 10 years 60,00,000 `96

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 8891234155 ca_akshaykumark CA Akshay Kumar (AIR 6)

The existing yield on T-bills is averaging 8% p.a. The systematic risk measure for the proposed project is 1.6. NSE NIFTY is
expected to yield 14% p.a. on average for the foreseeable future. Debenture holders have been promised a coupon of 12% and
preference shareholders have been committed a dividend of 15%.
The sales volumes over 10 years have been estimated as follows:

Year 1 2 3-5 6-8 9-10

Units per year 70,000 98,000 2,10,000 2,50,000 1,20,000

A sales price of ` 300 per unit is expected and variable expenses will amount to 60% of sales revenue. Fixed cash operating costs
will amount to ` 40,00,000 per year. The loss of any year will be set off from the profits of subsequent years.

The company is subject to a 30 per cent tax rate. The company follows straight line method of depreciation which is to be
assumed to be admissible for tax purpose also.

CALCULATE the net present value of the project for the company and advise the management to take appropriate decision.

The PV factors are to be taken as rounded figures upto 2 decimals. Use market value weights to COMPUTE overall cost of
capital.
QUESTION 16 (PAST YEAR MAY 2023 – 10 MARKS)

Capital structure of D Ltd. as on 31stMarch, 2023 is given below:

Particulars `
Equity share capital (` 10 each) 30,00,000
8% Preference share capital (` 100 each) 12% 10,00,000
Debentures (` 100 each) 10,00,000

 Current market price of equity share is ` 80 per share. The company has paid dividend of ` 14.07 per share. Seven years
ago, it paid dividend of ` 10 per share. Expected dividend is ` 16 per share.

 8% Preference shares are redeemable at 6% premium after five years. Current market price per preference share is
` 104.

 12% debentures are redeemable at 20% premium after 10 years. Flotation cost is ` 5 per debenture.

 The company is in 40% tax bracket.

 In order to finance an expansion plan, the company intends to borrow 15% Long-term loan of ` 30,00,000 from bank. This
financial decision is expected to increase dividend on equity share from ` 16 per share to ` 18 per share. However, the
market price of equity share is expected to decline from ` 80 to ` 72 per share, because investors' required rate of
return is based on current market conditions.
Required:
(i) Determine the existing Weighted Average Cost of Capital (WACC) taking book value weights.
(ii) Compute Weighted Average Cost of Capital (WACC) after the expansion plan taking book value weights.

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8891234155 ca_akshaykumark CA Akshay Kumar (AIR 6)

Interest Rate 1% 2% 3% 4% 5% 6% 7%
FVIFi,5 1.051 1.104 1.159 1.217 1.276 1.338 1.403
FVIFi,6 1.062 1.126 1.194 1.265 1.340 1.419 1.501
FVIFi,7 1.072 1.149 1.230 1.316 1.407 1.504 1.606

QUESTION 17 (RTP NOV 2023)

Jason Limited is planning to raise additional finance of ` 20 lakhs for meeting its new project plans. It has ` 4,20,000 in the form of
retained earnings available for investment purposes. Further details are as following:

Debt / Equity Mix 30 / 70

Cost of Debt
Upto ` 3,60,000 8 % (before tax)
Beyond ` 3,60,000 12 % (before tax)
Earnings per share `4
Dividend pay-out 50% of earnings
Current Market Price per share ` 44
Expected Growth rate in Dividend 10 %
Tax 40%

You are required:

(a) To determine the cost of retained earnings and cost of equity.
(b) To determine the post-tax average cost of additional debt.
(c) To determine the pattern for raising the additional finance, and
(d) Compute the overall weighted average after tax cost of additional finance.

QUESTION 18 (MTP NOV 2023 SERIES I - 5 MARKS)

ABC Company’s equity share is quoted in the market at ` 30 per share currently. The company pays a dividend of ` 3 per share
and the investor’s market expects a growth rate of 7% per year.
You are required to:
(i) CALCULATE the company’s cost of equity capital.
(ii) If the company issues 10% debentures of face value of ` 100 each and realises ` 95 per debenture while the
debentures are redeemable after 10 years at a premium of 10%, CALCULATE cost of debenture using YTM?
Assume Tax Rate to be 50%.

QUESTION 19 (MTP NOV 2023 SERIES II - 5 MARKS)

Q Ltd. has the following capital structure at book-value as on 31st March 2022:

Particulars (`)
Equity share capital (10,00,000 shares) 4,00,00,000
12% Preference shares 80,00,000
11% Debentures 2,00,00,000
6,80,00,000

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8891234155 ca_akshaykumark CA Akshay Kumar (AIR 6)

The equity shares of the company are sold for ` 400. It is expected that the company will pay next year a dividend of ` 20
per equity share, which is expected to grow by 5% p.a. forever. Assume a 30% corporate tax rate.
Required:
(i) COMPUTE weighted average cost of capital (WACC) of the company based on the existing capital structure.

(ii) COMPUTE the new WACC, if the company raises an additional ` 50 lakhs debt by issuing 12% debentures. This would result
in increasing the expected equity dividend to ` 25 and leave the growth rate unchanged, but the price of equity share will
fall to ` 300 per share.

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