Tutorial Sheet
Cost of Capital
IM-9;187(9.1) Assuming that a firm pays tax at a 50 per cent rate,
compute the after tax cost of capital in the following cases:
a) A ten year, 8 per cent, Rs.1000 par bond sold at Rs.950 less
4% underwriting commission.
b) A preference share sold at Rs100 with a 9 per cent dividend
and a redemption price of Rs110 if the company redeems it in
five years.
c) An ordinary share selling at a current market price of Rs.120,
and paying a current dividend of Rs9 per share, which is
expected to grow at a rate of 8 per cent.
d) An ordinary share of a company, which engages no external
financing, is selling for Rs50. The earnings per share are
Rs.7.50 of which sixty per cent is paid in dividends. The
company reinvests retained earnings at a rate of 10 per cent.
KJ-3; 7.10 (7.16) The Hypothetical Ltd is wishing to calculate its
cost of equity capital using CAPM. From the information provided
to the firm by its investment advisors – it is found that the risk free
rate of return equals to 10 percent; the firm’s beta equal to 1.50 and
the return on market portfolio equals 12.5 percent. Compute the
cost of equity capital.
KJ-3; 7.21 (7.34) Aries Ltd wishes to raise additional finance of
Rs10 lakhs for meeting its investment plans. It has Rs210000 in the
form of retained earnings available for investment purposes. The
following are the further details:
D/E mix 30:70; Cost of debt – Upto Rs180000, 10% (before tax)
and Beyond Rs180000, 16% (before tax); EPS Rs4; D/P – 50% of
earnings; Expected growth rate in dividend is 10%; Current market
price per share is Rs44; Tax Rate is 35%.
You are required to:
a) To determine the pattern for raising additional finance,
assuming the firm intends to maintain existing D/E mix.
b) To determine post tax average cost of additional debt.
c) To determine cost of retained earnings and cost of equity.
d) Compute overall WACC after tax cost of additional finance.
IM-9;191(14) A company has the following capital structure at the
end of 31 March 2003:
(Rs in million)
Share capital 6808
Reserve 34857
Long-term loan 538220
The company’s EPS, DPS, average market price and ROE for the
last seven years are given:
Year EPS DPS [Link]. ROE
Price
1997 21.55 5.28 143.04 20.9
1998 22.14 5.76 187.52 18.6
1999 26.40 5.76 312.32 11.7
2000 20.16 6.53 587.52 11.0
2001 20.40 7.68 366.72 9.5
2002 23.09 11.53 416.64 10.3
2003 22.00 7.68 355.20 8.4
You are required to calculate:
a) growth rate g using alternative methods
b) cost of equity using dividend growth model
c) weighted average cost of capital using i) book value weights
ii) market value weights
Assume that the interest rate on debt is 11 per cent and the
corporate income tax rate is 35 per cent.