SECTION B
ECONOMICS FOR FINANCE (40 Marks)
4
1. Cost of Capital:
2. Components of Cost of Capital: COMPONENTS OF COST OF CAPITAL (KC OR KO)
Cost of Debt (Kd)
Cost of Preference Share Capital (Kp)
Cost of Retained Earning (Kr)
3. Cost of Debt (Kd): COST OF DEBTS (Kd)
Instalments
(a) Cost of Irredeemable Debenture:
Note:
(b) Cost of Redeemable Debenture (in Lump sum): Approximation Method:
Present Value Method (PV)/Yield to Maturity Method (YTM):
(c) Cost of Redeemable Debenture (in Instalments):
d) Cost of Zero Coupon Bonds (ZCB):
Note:
4. Cost of Preference Share Capital (K p):
COST OF PREFERENCE SHARE CAPITAL (KP):
4.4
(
a) Cost of Irredeemable Preference Share:
Note:
b) Cost of Redeemable Preference Share (in Lump sum):
Approximation Method:
Present Value Method (PV)/Yield to Maturity Method (YTM):
c) Cost of Redeemable Preference Share (in Instalments):
Note:
4.6
Note:
(
c) Realised Yield Approach:
(
d) Capital Asset Pricing Model (CAPM):
6. Cost of Retained Earnings (K r):
7. Weighted Average Cost of Capital (K0):
Proforma Statement of WACC
8. Marginal Cost of Capital (MCC): THEORY
Q1. Explain the significance of cost of capital. (4 Marks Nov. 2019)
Ans.
1 Evaluation of investment options:
2 Financing Decision:
3 Designing of optimum credit policy:
Q2. Distinguish between Unsystematic Risk & Systematic Risk. (2 Marks Nov. 2020)
Ans. Unsystematic Risk :
4.8
Systematic Risk :
PRACTICAL PROBLEMS
COST OF DEBT
Q1. A company issues 25,000, 14% debentures of `1,000 each. The debentures are redeemable after the expiry period 5 years. Tax rate applicable to the company is 35%.
Calculate the cost of debt after tax if debentures are issued at 5% discount with 2% flotation cost. (5 Marks Nov. 2015)
Note:
Q2. TT Ltd. issued 20,000, 10% Convertible debentures of `100 each with a maturity period of 5 years. At maturity the debenture holders will have the option to convert the debentures into equity shares of the company in the ratio of 1:5 (5 shares for each debenture). The current market price of the equity shares is `20 each and historically the growth rate of the shares are 4% per annum. Assuming tax rate is 25%.
Compute the cost of 10% debentures using Approximation Method and Internal Rate of Return Method. PV Factor are as under:
COST OF PREFERENCE SHARE CAPITAL
Q3. A company issued 40,000, 12% Redeemable Preference Shares of ` 100 each at a premium of ` 5 each, redeemable after 10 year at a premium of ` 10 each. The flotation cost of each share is ` 2. You are required to calculate cost of preference share capital ignoring dividend tax. (5 Marks May 2013)
COST OF EQUITY
Q4. JC Ltd. is planning an equity issue in current year. It has an earning per share (EPS) of ` 20 and proposes to pay 60% dividend at the current year end with a P/E ratio 6.25, it wants to offer the issue at market price. The flotation cost is expected to be 4% of the issue price. You are required to determine rate of return for equity share (cost of equity) before the issue and after the issue.
Q5. ABC Company’s equity share is quoted in the market at ` 25 per share currently. The company pays a dividend of ` 2 per share and the investor’s market expects a growth rate of 6% per year. You are required to:
(i) Calculate the company’s cost of equity capital.
(ii) If the anticipated growth rate is 8% per annum, calculate the indicated market price per share.
(iii) If the company issues 10% debentures of face value of `100 each and realises ` 96 per debenture while the debentures are redeemable after 12 years at a premium of 12%, what will be the cost of debenture? Assume Tax Rate to be 50%.
WEIGHTED AVERAGE COST OF CAPITAL
Q6. Beeta Ltd. has furnished the following information: Earning
: `4.00
The company wants to raise additional capital of ` 10 lakhs including debt of ` 4 lakhs. The cost of debt (before tax) is 10% upto ` 2 lakhs and 15% beyond that.
Compute the after tax cost equity and debt and the weighted average cost of capital. (4 Marks Nov. 2011)
Q7. The following details are provided by GPS Limited: Equity
The cost of equity capital for the company is 16.30% and Income Tax Rate for the company is 30%.
You are required to calculate the Weighted Average Cost of Capital (WACC) of the company. (5 Marks May 2014)
i Calculation of cost of Preference Share Capital K p : 12%
ii Calculation of cost of Redeemable Debentures Krd : 10.50%
iii Calculation of cost Convertible Debentures Kcd : 7%
Q8. A Ltd. wishes to raise additional finance of ` 30 lakhs for meeting its investment plans. The company has ` 6,00,000 in the form of retained earnings available for investment purposes. The following are the further details:
Debt equity ratio : 30 : 70
Cost of debt:
Upto `3,00,000 : 11% (before tax) and Beyond `3,00,000 : 14% (before tax)
Earning per share : `15 per share
Dividend payout : 70% of earnings
Expected growth rate : 10%
Current market price : `90 per share
Company’s tax rate : 30%
Shareholder’s personal tax rate : 20%.
You are required to:
1. Calculate the post tax average cost of additional debt.
2. Calculate the cost of retained earnings and cost of equity.
3. Calculate the overall weighted average (after tax) cost of additional finance. (8 Marks May 2015)
Ans.
1. Post tax average cost of additional debt:
7.70%
2. Cost of retained earning & cost of equity:
3. Overall cost of additional finance:
Q9. The X Company has following capital structure at 31st March, 20015, which is considered to be optimum:
The company’s share has a current market price of ` 23.60 per share. The expected dividend per share in next year is 50 per cent of the 2015 EPS. The EPS of last 10 years is as follows. The past trends are expected to continue:
The company issued new debentures carrying 16% rate of interest and the current market price of debenture is ` 96. Preference shares ` 9.20 (with dividend of ` 1.1 per share) were also issued. The company is in 50% tax bracket.
(i) Calculate the after tax cost of (a) New Debts, (b) New Preference Share, and (c) New Equity Share (assuming new equity from retained earnings).
(ii) Calculate the marginal cost of capital when no new share was issued.
(iii) How much can be spent for capital investment before new ordinary shares must be sold? Assuming that retained earnings for next year’s investment are 50% of 2015.
(iv) What will be marginal cost of capital when the fund exceeds the amount calculated in (iii), assuming new equity is issued at `20 per share?
(8 Marks May 2016)
FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE (FM & ECO) CRACKER
AUTHOR : NAMIT ARORA
PUBLISHER : TAXMANN
DATE OF PUBLICATION : JUNE 2023
EDITION : 5th Edition
ISBN NO : 9789357781060
NO. OF PAGES : 620
BINDING TYPE : PAPERBACK
DESCRIPTION
This book is prepared exclusively for the Intermediate Level of Chartered Ac countancy Examination requirement. It covers the questions & detailed an swers strictly as per the new syllabus of ICAI. The Present Publication is the 5th Edition for CA-Inter | Nov. 2023 Exam. This book is authored by CA Namit Arora, with the following noteworthy features:
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