Module 4

One-Mark Questions with Answers

Question 1
Define the term 'Cost of Capital' in one sentence.

Answer:
The cost of capital is the minimum rate of return that a company must earn on its
investments to maintain its market value and satisfy the expectations of its investors.

Question 2
What does the acronym WACC stand for?

Answer:
Weighted Average Cost of Capital

Question 3
State the formula for calculating the after-tax cost of debt when irredeemable
debentures are issued.

Answer:

Kd={I×(1−T)}/NP
Where I = Interest, NP = Net Proceeds, T = Tax Rate

Question 4
According to the Gordon's Dividend Discount Model, what is the formula for
the cost of equity (Ke)?

Answer:

Ke={D1/P0}+g
Where D₁ = Expected dividend next year, P₀ = Current market price, g = Constant
growth rate

Question 5
What is the formula for the Capital Asset Pricing Model (CAPM) to calculate the
cost of equity?

Answer:

Ke=Rf+β(Rm−Rf)
Where R_f = Risk-free rate, β = Beta, R_m = Market return

Question 6
Why is the cost of debt calculated on an after-tax basis?

Answer:
Interest on debt is a tax-deductible expense, which reduces the taxable income of the
company, creating a tax shield that lowers the effective cost of debt.

Question 7
Which component of capital does not have an explicit cost: Equity shares,
Preference shares, or Retained earnings?

Answer:
Retained earnings (They have an implicit opportunity cost but no explicit cost like
dividend or interest)

Question 8
What are flotation costs?
Answer:
Flotation costs are the expenses incurred by a company when issuing new securities,
such as underwriting fees, legal fees, printing costs, and registration fees.

Question 9
State whether the following statement is True or False:
"The cost of preference shares is tax-deductible."

Answer:
False (Preference dividends are paid from after-tax profits and are not tax-
deductible)

Question 10
If the risk-free rate is 5%, the market return is 12%, and beta is 1.5, what is the
cost of equity as per CAPM?

Answer:

Ke=5%+1.5×(12%−5%)=5%+1.5×7%=5%+10.5%=15.5%

Question 11
What is the significance of the Weighted Average Cost of Capital (WACC) in
capital budgeting?

Answer:
WACC serves as the hurdle rate or minimum required rate of return for evaluating
investment projects; a project is accepted only if its return exceeds the WACC.

Question 12
Between book value weights and market value weights, which is theoretically
superior for calculating WACC?

Answer:
Market value weights are theoretically superior as they reflect the current economic
value of the firm's capital structure.
Question 13
Define 'Marginal Cost of Capital' (MCC).

Answer:
Marginal Cost of Capital is the cost of raising an additional rupee of new capital; it
represents the weighted average cost of the next unit of financing.

Question 14
If a company's cost of equity is 16% and the cost of debt (after tax) is 8%, with
a debt-to-equity ratio of 1:1, what is the approximate WACC? (Assume no
preference shares)

Answer:
Weights: Debt = 0.5, Equity = 0.5

WACC=(0.5×16%)+(0.5×8%)=8%+4%=12%

Question 18
A company issues 10% debentures of ₹100 each at par. The tax rate is 30%.
Calculate the after-tax cost of debt.

Answer:

Kd=10%×(1−0.30)=10%×0.70=7%

Question 19
What is the impact of an increase in the corporate tax rate on the after-tax cost
of debt?

Answer:
The after-tax cost of debt decreases because the tax shield (interest × tax rate)
increases with higher tax rates.

Question 20
Define 'Optimal Capital Structure' in relation to the cost of capital.
 Answer:
Optimal capital structure is the mix of debt and equity that minimizes the overall
Weighted Average Cost of Capital (WACC) and maximizes the value of the firm.

Three-Mark Questions with Answers

Question 1
What is Weighted Average Cost of Capital (WACC)? Why is it considered the
minimum required rate of return for a company's investment projects?

Answer:

Definition:
Weighted Average Cost of Capital (WACC) is the average rate of return a company is
expected to pay to all its security holders (equity shareholders, preference
shareholders, and debt holders), weighted by the proportion of each source of
capital in the company's capital structure.

Why WACC is the Minimum Required Rate of Return:

• Cost of Financing: WACC represents the blended cost of all funds used to finance
operations and investments. Any project must earn at least this rate to cover the cost
of raising capital.
• Shareholder Wealth Maximization: If a project earns less than WACC, it fails to
provide the required return to investors, leading to a decline in the firm’s market
value.
• Opportunity Cost: WACC reflects the opportunity cost of capital for investors.
Therefore, it serves as the minimum acceptable return (hurdle rate) for new
investments.

Question 2
Distinguish between the Cost of Debt and the Cost of Equity. Why is the cost of
debt calculated on an after-tax basis while the cost of equity is not?

Answer:
 Basis Cost of Debt Cost of Equity

Variable dividend or capital

Return Fixed interest payment
appreciation

Lower risk (secured, priority in

Risk Higher risk (residual claim)
liquidation)

Tax
Tax-deductible expense Not tax-deductible
Treatment

Cost Generally lower Generally higher

Reason for After-tax Cost of Debt:

Interest paid on debt is a legitimate business expense deductible from taxable
income. This creates a tax shield that reduces the effective cost. For example, if
interest rate is 10% and tax rate is 30%, the after-tax cost is only 7%. This tax benefit
is not available for equity dividends, which are paid from after-tax profits. Hence, cost
of equity is calculated on a pre-tax basis.

Question 3
A company's equity share is currently traded at ₹120 per share. The company is
expected to pay a dividend of ₹6 per share next year, and dividends are
expected to grow at a constant rate of 5% per annum. Calculate the cost of
equity using the Gordon's Dividend Discount Model.

Answer:

Given:

• Current Market Price (P₀) = ₹120

• Expected Dividend (D₁) = ₹6
• Growth Rate (g) = 5% = 0.05

Formula:
 Ke={D1/P0}+g
Calculation:

Ke=(6/120)+0.05=0.05+0.05=0.10 or 10%
Result: The cost of equity is 10%.

Question 4
The risk-free rate of return is 6%, the expected market return is 14%, and a
company's beta (β) is 1.3. Calculate the cost of equity using the Capital Asset
Pricing Model (CAPM). Briefly explain what beta represents in this context.

Answer:

Given:

• Risk-free Rate (Rf) = 6%

• Market Return (Rm) = 14%
• Beta (β) = 1.3

Formula:

Ke=Rf+β(Rm−Rf)
Calculation:

Ke=6%+1.3×(14%−6%)=6%+1.3×8%=6%+10.4%=16.4%

Result: The cost of equity is 16.4%.

What Beta Represents:

Beta measures the systematic risk or volatility of a stock relative to the overall

market. A beta of 1.3 indicates that the stock is 30% more volatile than the market. If

the market moves up by 1%, the stock is expected to move up by 1.3%, and vice

versa.
 Question 5
A company has issued 9% irredeemable debentures of ₹100 each. The
debentures are currently traded at ₹90 in the market. The corporate tax rate is
35%. Calculate the after-tax cost of debt.

Answer:

Given:

• Interest Rate = 9% → Interest (I) = ₹9 per debenture

• Net Proceeds (NP) = ₹90
• Tax Rate (T) = 35% = 0.35

Formula:

Kd={I/NP}×(1−T)
Calculation:
Kd=(9/90)×(1−0.35)=0.10×0.65=0.065 or 6.5%
Result: The after-tax cost of debt is 6.5%.

Question 6
A company issues 10% preference shares of ₹100 each at a discount of 5%. The
shares are redeemable after 8 years at par. Calculate the cost of preference
shares using the approximation method. (Ignore flotation costs)

Answer:

Given:

• Face Value (FV) = ₹100

• Redemption Value (RV) = ₹100
• Dividend (D) = 10% of ₹100 = ₹10
• Net Proceeds (NP) = ₹100 – 5% discount = ₹95
• Life (n) = 8 years

Approximation Formula:

Kp=[D+(RV−NP)/n]/(RV+NP)/2
Calculation:

Kp=[10+(100−95)/8]/(100+95)/2=[10+(5/8)]/(195/2)=(10+0.625)/97.5=10.6
25/97.5=0.10897 or 10.90%
Result: The cost of preference shares is 10.90%.

Question 7
Explain the concept of flotation costs. How does the cost of newly issued equity
differ from the cost of retained earnings?

Answer:

Flotation Costs:
Flotation costs are the expenses incurred by a company when issuing new securities.
These include underwriting fees, legal fees, registration fees, printing costs, and other
administrative expenses. These costs reduce the net proceeds received by the
company from the issue.

Difference between Cost of New Equity and Cost of Retained Earnings:

Aspect Cost of New Equity Cost of Retained Earnings

Flotation
Includes flotation costs No flotation costs
Costs

Lower (Issue Price minus Flotation

Net Proceeds Equal to current market price
Cost)

Lower (by the amount of flotation cost

Cost Higher
effect)

Formula Ke = D₁/(P₀ – F) + g Kr = D₁/P₀ + g

Retained earnings represent funds already belonging to shareholders and involve no

issuance expenses, making them a cheaper source of equity financing compared to
new equity issues.
 Question 8
Differentiate between book value weights and market value weights used in
calculating WACC. Which approach is theoretically superior and why?

Answer:

Basis Book Value Weights Market Value Weights

Basis Based on historical accounting values Based on current market prices

Reflects Past financing decisions Current economic conditions

Stability More stable over time Fluctuates with market conditions

Relevance May not reflect true opportunity cost Reflects true opportunity cost

Theoretically Superior Approach:

Market Value Weights are theoretically superior because:

• They represent the true economic value of the firm’s capital structure.
• Investors evaluate returns based on current market prices, not historical costs.
• WACC calculated with market weights better reflects the current opportunity cost of
capital for investment decisions.

Seven-Mark Questions with Answers

Question 1
What do you understand by the ‘Cost of Capital’? Explain the significance of the
Weighted Average Cost of Capital (WACC) in capital budgeting decisions.

Answer:

Cost of Capital refers to the minimum rate of return that a firm must earn on its
investments to maintain its market value and satisfy the expectations of its investors
 (equity shareholders, preference shareholders, and debt holders). It represents the
overall cost of financing a firm’s operations and investments.

Significance of WACC in Capital Budgeting:

• Hurdle Rate: WACC serves as the discount rate or hurdle rate for evaluating
investment proposals. A project is accepted only if its Internal Rate of Return (IRR)
exceeds the WACC.
• Capital Budgeting Decisions: It helps in selecting the optimal mix of projects that
maximize shareholder wealth.
• Performance Evaluation: WACC is used to evaluate whether the firm is generating
returns above its cost of financing.
• Capital Structure Decisions: It aids in determining the optimal capital structure that
minimizes the overall cost of capital.

Question 2
A company has the following capital structure:

• Equity Share Capital (1,00,000 shares of ₹10 each): ₹10,00,000

• Retained Earnings: ₹5,00,000
• 10% Debentures (₹100 each): ₹5,00,000
• 12% Preference Shares (₹100 each): ₹2,00,000

The market price of an equity share is ₹25. The company is expected to pay a
dividend of ₹2 per share next year, which is expected to grow at 6% per annum.
The tax rate is 40%. Calculate the WACC based on book value weights and
market value weights. (4 Marks)

Answer:

Step 1: Calculate Cost of Each Component

• Cost of Equity (Ke): Using Gordon’s Model

Ke=(D1/P0)+g=(2/25)+0.06=0.08+0.06=0.14 or 14%

• Cost of Retained Earnings (Kr): Kr = Ke = 14% (opportunity cost)

• Cost of Debentures (Kd): After-tax
Kd=Interest Rate×(1−T)=10%×(1−0.40)=6%
• Cost of Preference Shares (Kp):
Kp=Dividend/Market Price=12/100=12%

(Note: Market price assumed equal to face value as not given separately)

Step 2: WACC using Book Value Weights

Source Book Value (₹) Weight Cost Weighted Cost

Equity 10,00,000 0.4545 14% 6.363%

Retained Earnings 5,00,000 0.2273 14% 3.182%

Debentures 5,00,000 0.2273 6% 1.364%

Preference 2,00,000 0.0909 12% 1.091%

Total 22,00,000 1.0000 WACC = 12.00%

Step 3: WACC using Market Value Weights

• Market Value of Equity: 1,00,000 shares × ₹25 = ₹25,00,000

• Market Value of Retained Earnings: Assumed same as book = ₹5,00,000 (no
separate market)
• Market Value of Debentures: 5,000 debentures × ₹100 = ₹5,00,000
• Market Value of Preference: 2,000 shares × ₹100 = ₹2,00,000
• Total Market Value: ₹37,00,000

Source Market Value (₹) Weight Cost Weighted Cost

Equity 25,00,000 0.6757 14% 9.460%

Retained Earnings 5,00,000 0.1351 14% 1.891%

Debentures 5,00,000 0.1351 6% 0.811%

Preference 2,00,000 0.0541 12% 0.649%

Source Market Value (₹) Weight Cost Weighted Cost

Total 37,00,000 1.0000 WACC = 12.81%

Question 3
A company’s equity shares are currently traded at ₹180 per share. The company
expects to pay a dividend of ₹9 per share next year, and the dividends are
expected to grow at a constant rate of 8% per annum.

(a) Calculate the cost of equity using the Gordon’s Dividend Discount Model.

(b) If the Risk-Free Rate of return is 7%, the market rate of return is 15%,

and the company’s beta (β) is 1.2, calculate the cost of equity using the

Capital Asset Pricing Model (CAPM).

(c) As a financial analyst, which of the two computed costs would you

consider more reliable and why?

Answer:

(a) Ke=(D1/P0)+g=(9/180)+0.08=0.05+0.08=0.13 or 13%

(b) Ke=Rf+β(Rm−Rf)=7%+1.2×(15%−7%)=7%+1.2×8%=7%+9.6%
=16.6%
(c) The CAPM approach (16.6%) is generally considered more reliable for the

following reasons:

Risk Consideration: CAPM explicitly incorporates systematic risk (beta),

which reflects the stock’s sensitivity to market movements. Gordon’s model
assumes constant growth, which may not hold true in reality.

Market-Based: CAPM uses market-determined inputs (risk-free rate,

market risk premium), making it more objective and forward-looking.

Limitations of Gordon’s Model: The dividend growth model assumes a

constant growth rate perpetually and requires that the growth rate is less
 than the cost of equity. It also fails for companies that do not pay
dividends.

However, in practice, many analysts use an average of both methods to

arrive at a more balanced estimate of the cost of equity.

Question 4
A manufacturing firm has issued the following securities. Compute the cost of
each component, assuming a corporate tax rate of 35%.

(a) Debentures: 1,000, 12% debentures of ₹100 each, redeemable after 5

years at a premium of 5%. The debentures are currently sold at ₹96

each. (Use approximation method)

(b) Preference Shares: 500, 10% preference shares of ₹100 each,

redeemable after 4 years at par. The current market price of the

preference share is ₹92. (Use approximation method)

Answer:

(a)

Given:

• Face Value (FV) = ₹100

• Redemption Value (RV) = ₹100 + 5% premium = ₹105
• Interest (I) = 12% of ₹100 = ₹12 per debenture
• Net Proceeds (NP) = ₹96 (market price)
• Tax Rate (T) = 35%
• Life (n) = 5 years

Step 1: Pre-tax Cost of Debt (Approximation Formula)

Kdpre=[I+(RV−NP)/n]/(RV+NP)/2=[12+(105−96)/5]/[105+96]/2
=[12+(9/5)]/[201/2]=(12+1.8)/100.5
=13.8/100.5=0.1373 or 13.73%

Step 2: After-tax Cost of Debt

 Kd=Kdpre×(1−T)=13.73%×(1−0.35)=13.73%×0.65=8.92%

(b)

Given:

• Face Value (FV) = ₹100

• Redemption Value (RV) = ₹100
• Dividend (D) = 10% of ₹100 = ₹10 per share
• Net Proceeds (NP) = ₹92
• Life (n) = 4 years

Approximation Formula:

Kp=[D+(RV−NP)/n]/(RV+NP)2
={10+(100−92)/4}/(100+92)/2
=[10+(8/4)]/(192/2)
=(10+2)/96
=12/96=0.125 or 12.5%
Note: Preference dividends are not tax-deductible, so no tax adjustment is required.

Question 5
The following is the extract of the balance sheet of XYZ Ltd. as on 31st March:

Liabilities Amount (₹) Assets Amount (₹)

Equity Share Capital (₹10 each) 15,00,000 Fixed Assets 25,00,000

10% Preference Share Capital 5,00,000 Current Assets 15,00,000

12% Debentures 10,00,000

Retained Earnings 5,00,000

Current Liabilities 5,00,000

Total 40,00,000 Total 40,00,000

 Additional Information:

• The current market price of an equity share is ₹24. The last dividend paid was ₹1.60
per share, and dividends are expected to grow at 5% p.a.
• The tax rate is 40%.
• Preference share and debenture market prices are ₹90 and ₹105 respectively.

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

weights.

Answer:

Step 1: Calculate Number of Securities

• Equity Shares: ₹15,00,000 ÷ ₹10 = 1,50,000 shares

• Preference Shares: ₹5,00,000 ÷ ₹100 = 5,000 shares
• Debentures: ₹10,00,000 ÷ ₹100 = 10,000 debentures

Step 2: Calculate Market Values

• Equity: 1,50,000 shares × ₹24 = ₹36,00,000

• Retained Earnings: Market value not separately available; use book value =
₹5,00,000
• Preference Shares: 5,000 shares × ₹90 = ₹4,50,000
• Debentures: 10,000 debentures × ₹105 = ₹10,50,000
• Total Market Value: ₹36,00,000 + ₹5,00,000 + ₹4,50,000 + ₹10,50,000 = ₹56,00,000

Step 3: Calculate Cost of Each Component

• Cost of Equity (Ke): Using Gordon’s Model

D1=D0×(1+g)=1.60×1.05=₹1.68

Ke=D1P0+g

=1.6824+0.05
 =0.07+0.05=0.12 or 12%

• Cost of Retained Earnings (Kr): Kr = Ke = 12%

• Cost of Preference Shares (Kp):
Kp=Dividend/Market Price

=10/90=0.1111 or 11.11%

• Cost of Debentures (Kd): After-tax

Kd=Interest/Market Price×(1−T)

=12/105×(1−0.40)

=0.1143×0.60

=0.0686 or 6.86%

Step 4: Calculate WACC using Market Value Weights

Source Market Value (₹) Weight Cost Weighted Cost

Equity 36,00,000 0.6429 12.00% 7.715%

Retained Earnings 5,00,000 0.0893 12.00% 1.072%

Preference Shares 4,50,000 0.0804 11.11% 0.893%

Debentures 10,50,000 0.1875 6.86% 1.286%

Total 56,00,000 1.0000 WACC = 10.97%

Question 6
 A company is considering a project that requires an initial investment of ₹50
lakhs. The company’s existing capital structure consists of:

• Equity: ₹30 lakhs (Cost: 18%)

• Debt: ₹20 lakhs (Cost: 9% post-tax)

The company plans to raise the required ₹50 lakhs for the new project in a
manner that maintains the same debt-to-equity ratio (D/E) as the existing
structure. The cost of new debt will be 10% (post-tax) and the cost of new
equity will be 20%.

(a) Calculate the Weighted Average Cost of Capital (WACC) for the

new project.

(b) If the project is expected to generate an Internal Rate of Return

(IRR) of 15%, should the company accept the project? Justify

your answer.

Answer:

Step 1: Determine Target Capital Structure

Existing D/E Ratio = ₹20 lakhs / ₹30 lakhs = 2/3 = 0.667

Target Structure:

• Debt = 0.667 / (1 + 0.667) = 0.667 / 1.667 = 0.40 or 40%

• Equity = 1 / (1 + 0.667) = 1 / 1.667 = 0.60 or 60%

Step 2: Calculate WACC for New Project

Since the project will be financed with new capital maintaining the same structure:

WACC=(Wd×Kd)+(We×Ke)
=(0.40×10%)+(0.60×20%)
=4%+12%=16%

(b)

The project should be rejected.

Justification:

• The project’s IRR (15%) is less than the WACC (16%).

• This means the project is expected to generate returns lower than the cost of
financing it.
• Accepting such a project would reduce shareholder wealth and the overall
value of the firm.
• The basic rule of capital budgeting is to accept projects only when IRR ≥
WACC (or NPV ≥ 0).

Question 7

(a) Explain why the cost of debt is always calculated on an after-

tax basis, whereas the cost of preference shares is not.

(b) A company issues 10,000 new equity shares of ₹100 each at a

premium of 10%. The issue expenses (flotation cost) amount to

₹5 per share. The company pays a dividend of ₹12 per share,

which is expected to grow at 5% indefinitely. Calculate the cost

of new equity. If the company had used retained earnings

instead of issuing new shares, how would the cost of equity

change?

Answer:

(a)

• Cost of Debt – After-tax Basis:

Interest paid on debt is a tax-deductible expense under the Income Tax Act.
This means that the actual cost to the company is reduced by the tax saved.
For example, if a company pays 10% interest and the tax rate is 30%, the
effective after-tax cost is only 7% (10% × 0.70). This tax shield makes debt
cheaper than other sources of finance.
• Cost of Preference Shares – No Tax Adjustment:
Dividends paid on preference shares are not considered a business expense
for tax purposes. They are paid out of after-tax profits. Therefore, there is no
 tax shield available, and the cost of preference shares is calculated on a pre-
tax basis (i.e., the dividend rate itself).

(b)

Step 1: Calculate Net Proceeds per Share

• Face Value = ₹100

• Premium = 10% of ₹100 = ₹10
• Issue Price = ₹110
• Flotation Cost = ₹5
• Net Proceeds (NP) = ₹110 – ₹5 = ₹105

Step 2: Calculate Cost of New Equity

Ke_new=(D1/NP)+g
=12/105+0.05
=0.1143+0.05
=0.1643 or 16.43%
Step 3: Cost of Retained Earnings

If retained earnings were used instead:

Ke_retained=D1/P0+g
=12/110+0.05
=0.1091+0.05
=0.1591 or 15.91%
Step 4: Comparison

The cost of new equity (16.43%) is higher than the cost of retained earnings (15.91%)
because flotation costs increase the effective cost of raising funds externally.
Retained earnings involve no issuance costs, making them a cheaper source of equity
financing.

Question 8
From the information provided below, compute the specific cost of each
component:

1. Equity: The current market price per share is ₹150. The current dividend per share is
₹13.50, and dividends are expected to grow at a rate of 6% p.a.
2. Retained Earnings: The shareholders’ required rate of return is 15%.
3. Debt: The company issues 11% irredeemable debentures for ₹2,00,000 at a discount
of 2%. The tax rate is 50%.
4. Preference Shares: The company issues 12% preference shares for ₹1,00,000
redeemable after 5 years at par. The issue expenses are 2% of the face value.

Calculate the cost of equity, cost of retained earnings, cost of debt (after tax),

and cost of preference shares.

Answer:

1. Cost of Equity (Ke)

D1=D0×(1+g)
=13.50×1.06
=₹14.31

Ke=D1/P0+g
=14.31150+0.06
=0.0954+0.06
=0.1554 or 15.54%
2. Cost of Retained Earnings (Kr)

The cost of retained earnings equals the shareholders’ required rate of return, as it
represents the opportunity cost to existing shareholders.

Kr=15%
3. Cost of Debt (Kd) – After Tax

• Face Value (FV) = ₹100 per debenture (assumed)

• Net Proceeds (NP) = ₹100 – 2% discount = ₹98
• Interest (I) = 11% of ₹100 = ₹11
• Tax Rate (T) = 50%

For irredeemable debt:

Kd=I/NP×(1−T)
=11/98×0.50
=0.1122×0.50
=0.0561 or 5.61%

4. Cost of Preference Shares (Kp)

• Face Value (FV) = ₹100 per share (assumed)
• Redemption Value (RV) = ₹100
• Net Proceeds (NP) = ₹100 – 2% issue expenses = ₹98
• Dividend (D) = 12% of ₹100 = ₹12
• Life (n) = 5 years

Kp=[D+(RV−NP)/n]/(RV+NP)/2
=[12+(100−98)/5]/(100+98)/2
=(12+0.4)/99
=0.1253 or 12.53%
Summary of Component Costs:

Component Cost

Cost of Equity 15.54%

Cost of Retained Earnings 15.00%

Cost of Debt (After-tax) 5.61%

Cost of Preference Shares 12.53%

Monthly Production

Annual production = 12,000 units

Monthly production = 12,000 / 12 = 1,000 units

Cost per Unit

• Raw Material = ₹40

• Labour = ₹20
• Overheads = ₹20
Total Cost = ₹80 per unit

Working Capital Components

(A) Raw Material Stock (2 months)

= 1,000 × 2 × 40
= ₹80,000
.
Final Working Capital Requirement

₹3,90,000
Reliable Ltd. has given the following information: (1) Current Liability Rs. 6 Lakh (2) Fixed Assets Rs.
60 Lakh (3) Inventory Rs. 3 Lakh (4) Current Assets Rs. 15 Lakh (5) Long Term Loan Rs. 60 Lakh You are
required to calculate (a) Quick Ratio, (2) Current Ratio, (3) Working Capital

If a company's cost of equity is 16% and the cost of debt (after tax) is 8%, with a debt-to-equity
ratio of 1:1, what is the approximate WACC? (Assume no preference shares)
A company's equity share is currently traded at ₹120 per share. The company is expected to pay a
dividend of ₹6 per share next year, and dividends are expected to grow at a constant rate of 5% per
annum. Calculate the cost of equity using the Gordon's Dividend Discount Model.
A company’s equity shares are currently traded at ₹180 per share. The company expects to pay a
dividend of ₹9 per share next year, and the dividends are expected to grow at a constant rate of 8%
per annum.

a. Calculate the cost of equity using the Gordon’s Dividend Discount Model.

b. If the Risk-Free Rate of return is 7%, the market rate of return is 15%, and the company’s
beta (β) is 1.2, calculate the cost of equity using the Capital Asset Pricing Model (CAPM).

c. As a financial analyst, which of the two computed costs would you consider more reliable
and why?

The risk-free rate of return is 6%, the expected market return is 14%, and a company's beta (β) is
1.3. Calculate the cost of equity using the Capital Asset Pricing Model (CAPM). Briefly explain what
beta represents in this context.
A company issues 10% preference shares of ₹100 each at a discount of 5%. The shares are
redeemable after 8 years at par. Calculate the cost of preference shares using the approximation
method. (Ignore flotation costs)
From the information provided below, compute the specific cost of each component:

1. Equity: The current market price per share is ₹150. The current dividend per share is ₹13.50,
and dividends are expected to grow at a rate of 6% p.a.

2. Retained Earnings: The shareholders’ required rate of return is 15%.

3. Debt: The company issues 11% irredeemable debentures for ₹2,00,000 at a discount of 2%.
The tax rate is 50%.

4. Preference Shares: The company issues 12% preference shares for ₹1,00,000 redeemable
after 5 years at par. The issue expenses are 2% of the face value.

Calculate the cost of equity, cost of retained earnings, cost of debt (after tax), and cost of
preference shares.
A manufacturing firm has issued the following securities. Compute the cost of each component,
assuming a corporate tax rate of 35%.

a. Debentures: 1,000, 12% debentures of ₹100 each, redeemable after 5 years at a premium
of 5%. The debentures are currently sold at ₹96 each. (Use approximation method)

b. Preference Shares: 500, 10% preference shares of ₹100 each, redeemable after 4 years at
par. The current market price of the preference share is ₹92. (Use approximation method)