3. COST OF CAPITAL PROBLEM NO: 1 PROBLEM NO: 2 MASTER MINDS. No.1 for CA/CWA & MEC/CEC

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1 No. for CA/CWA & MEC/CEC PROBLEM NO: 3. COST OF CAPITAL Calculation of K d From the given information Face value 0 NSP Redemption value 5 Rate of Int 5% No of yrs (N) 7yrs Tax Rate 55% K d Int ( Tax ) RV + RV + NSP 2 NSP N ( 0.55) % Calculation of K d Face value 0 NSP 90 Redemption value 5 Rate of Int 2% No of yrs (N) 5yrs Tax Rate 35% PROBLEM NO: 2 K d Int RV + RV + NSP 2 ( Tax ) NSP N ( 0.35) % IPCC_36e_F.M_Cost of Capital_Assignment Solutions 3.

2 Ph: /26 PROBLEM NO: 3 Calculation of K d Face value 00 Flotation Cost 0 NSP 900 (,000 0) Interest Rate 5% Tax Rate 50% Step: Calculation of CFS Year Installment Int (-Tax) CFS Step: 2 Calculation of K d in IRR method. IRR Calculation in company s point of vice because there is involvement of flotation co NPV at st guess rate NPV at 2 nd guess rate Year CFS % P Values p. Values (248) (245) (2) 0.97 (207) (79) 0.72 (74) (52) (46) (27) (22) (7) 6 NP VatL NPV atl NPV atl IRR L + x( L L ) 7 % + x(2% %) % + (%) %(App.) PROBLEM NO: 4 Calculation of K p From the given information Face value 0 Flotation 4% 4 NSP 96 (0 4) Rate of P.D 5% K p P. D NSP % IPCC_36e_F.M_Cost of Capital_Assignment Solutions 3.2

3 No. for CA/CWA & MEC/CEC PROBLEM NO: 5 Calculation of K p i) If issued at 5% Discount from the given information. Fv 0 Discount 5 Issue price Flotation cost 0 NSP 95 Rate of P.D % P.D K p NSP 95.5% ii) If issued at 5% premium. NSP 5 (0 + 5(Premium)) K p 5 9.5% Calculation of ke under CAPM approach. From the given information Risk free Return R f % Market Return R m 5% Risk factor B.75 K e R f + β (R m -R f ) % +.75 (5%-%) 8.75% From the given information Face value 0 DPS 0 (0x5%) 5 Growth Rate (g) 2% DPS (5)(.2) 6.8 MP 0 68 DPS K e + g MP 0 PROBLEM NO: 6 PROBLEM NO: 7 IPCC_36e_F.M_Cost of Capital_Assignment Solutions 3.3

4 Ph: / % PROBLEM NO: 8 Calculation of cost of equity (IRR method) NPV at st guess rate % NPV at 2 nd guess rate 2% Year CFS PVF@% P Values PVF@2% P Values 0 (38) (38) (38) th NPV.76 (0.25) NPV atl IRR L + + (L 2 L) NPV atl NPV atl % % + ( 2% % ) Part I Calculation of WACC Step - Calculation of Specific COC i) Calculation of K d K d % ( - 0.5) 5% ii) Calculation of K p K p 9% iii) Calculation of K e 2 PROBLEM NO: 9 Step-2 K e DPS % % g 3L 2L 5L WACC 5% + 9% +3.82%.2% L L L Part II Calculation of WACC Step : Calculation of Specific COC i) Calculation of K d Kd % (-0.5) 5% Kd 2 2% (-0.5) 6% ii) Calculation of K p K p 9% IPCC_36e_F.M_Cost of Capital_Assignment Solutions 3.4

5 No. for CA/CWA & MEC/CEC iii) Calculation of K e K e DPS MP 0 + g 9 + 5% % E W Z ee Step2: Calculation of WACC 3L 5L 9% 5L 5L 2L 5L 5L 5L WACC (K 0 ) ( 5% ) + ( 6% ) + ( 9% ) + ( 4.375% ) Step: Calculation of Specific COC i) Calculation of K d Int( t) K d MP 0 2% ( 0) 80 ii) Calculation of K p K p N.A iii) Calculation of K e 2 5% 80 PROBLEM NO: K e DPS l Where DPS DPS 0 ( + g) 2 ( + 0.) % % iv) Calculation of K r K r K e 8% Step: 2 calculation of WACC Source Amount Spec. CoC Cost Equity % (80,000 x 27.5) Debt % (4,00,000 x 80%) WACC % IPCC_36e_F.M_Cost of Capital_Assignment Solutions 3.5

6 Ph: /26 PROBLEM NO: Calculation of WACC Step: Calculation of Specific COC i) Calculation of K d K d Int x RV + RV + NSP 2 ( Tax ) NSP N ( 0.5) % ii) Calculation of Kp K p RV NSP PD + N RV + NSP % iii) Calculation of K e K e DPS MP F 0 + g % Step: 2 i) Calculation of WACC based on Book value weights. 5L 20L 5L 20L L 20L WACC ( 5.5% ) + ( 5.3% ) + ( ) 7.69% IPCC_36e_F.M_Cost of Capital_Assignment Solutions 3.6

7 No. for CA/CWA & MEC/CEC ii) Calculation of WACC based on market value weights 5.25L 5.5L 24L L % (App) Workings: Book Value weights % debentures 5,00,000 Preference Share 5,00,000 Equity Share,00,000 20,00,000 Market Value weights Debt 5 5,00,000x 0 5,25, 000 WACC ( 5.5% ) + ( 5.3% ) + ( % ) Preference Share 5,00,000x 0 5,50, 000 Equity Share,00,000 Shares x 24 24,00,000 34,75,000 Step: Calculation of Specific COC i) Calculation of Cost of Equity (Ke) PROBLEM NO: 2 For the equity share capital For retained earnings DPS No floatation cost Ke + g F. Rs.5 DPS (Working note) Ke + g Rs.25 Rs.5 F. K e Rs Rs.25 Rs or 8.5% 0.8 or 8% WORKING NOTE: Calculation of growth rate (g): Present Value.6 Future value 4.9 No. of Years 5 We Know, PV FV x PVF (n yrs, %) x PVF (5yrs, r%) PVF (5yrs, r%) Trace this value against 5 years in PVF table g 6% IPCC_36e_F.M_Cost of Capital_Assignment Solutions 3.7

8 Ph: /26 ii) Calculation of K P PD K p MP 0 Rs.5 Rs or 4.29% iii) Calculation of K d Int K ( Tax ) d 5 RV + RV + NSP 2 ( 0.35) NSP N * 5 x Rs or.95% *Since yield on similar type of debentures is 6% so, company is required to issue debentures at discount. Market Price of Debentures Step 2: Calculation of WACC based on book value weights 20L 95L 30L 95L Coupon rate Market rateof int erest Rs Rs Sale proceeds from debentures issue Rs Rs.2 (i.e flotation cost) Rs L 95L 36L 95L WACC ( 8.5% ) + ( 8% ) + ( 4.29% ) + (.95% ) o ^ o Z o W^ o or 6.83% Calculation of WACC based on Market value weights (in Lakhs) Source of capital Weights Specific Cost (K) (MV K) Equity Shares 60* Retained Earnings 40* Preference Shares Debentures Total * Market Value of equity shall be apportioned between equity share capital and retained earnings in the ratio of book values IPCC_36e_F.M_Cost of Capital_Assignment Solutions 3.8

9 No. for CA/CWA & MEC/CEC 20 a) Equity shares x b) Retained earnings x Rs.4.99L Weighted average cost of capital (WACC) Rs.244.5L 072 or 7.2% PROBLEM NO: 3 Calculation of WACC Particulars A B C i) Cost of Equity 8% 20% 24% ii) Cost of Debt N.A 4% 5 25 iii) WACC 8% 6L x8% + 0 6L Workings Market value of Eq Rs x5 5L 6.25L 6.8%.25L 20% + 4% 6.25L ( ) ( ) Rs x20 Market value of debt N.A. Rs x25 0 5% % 6L 2L 24% + 5% 8L 8L ( ) ( ) Rs x2 Rs x80 0 Total market value Rs Rs Rs THE END IPCC_36e_F.M_Cost of Capital_Assignment Solutions 3.9

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