Problems in Cost of Capital

Cost of Debt Irredeemable

1. Julian Industries Ltd., issues 5,000, 12% debentures of Rs.100 each at par. The tax rate is 40%.
Calculate the cost of debt before and after tax.

2. Juhi Co Ltd., issued 10% irredeemable debentures of Rs.1,00,000. The company is in the 30%
tax bracket. Calculate the cost of debt (before and after tax), if the debentures are issued at: a)
par, b) 10 % premium and c) 10 % discount.

3. Victor Co Ltd., issued Rs.2,00,000, 9% debentures at a premium of 10%. The floatation(issue

expenses) were 2%. The tax rate is 40%. Compute the cost of debt before and after tax.

4. Liberty company Ltd., issues Rs.50,000, 8% debentures at a premium of 10%. The cost of
issue is 2%. Income tax rate applicable is 60%. Calculate the cost of debt before and after tax.

5. Jayaram and Co issued Rs.60,000, 10% debentures at a discount of 5%. The issue expenses
were Rs.2,000. Assuming a tax rate of 40%, calculate the cost of debt (before and after tax).

6. Vinoth Ltd., issues 10,000, 10% debentures of the face value of Rs.10 each at a discount of
10%. The cost of issue is 3%. The company is in the 50% tax category. Calculate the cost of debt,
before and after tax.

7. Vimal and Co issued Rs.5,00,000, 8% debentures. Tax rate applicable is 60%. Calculate the
cost of debt (before and after tax) if the debt is issued at:
a) par
b) 10% premium
c) 10 % discount

8. Lal and Co issued Rs.10,00,000, 8% debt of Rs.10 each. The tax applicable is 60%. Cost of
issue is 4%. Compute the cost of debt when it is issued at par, at a premium of 5% and at a
discount of 10%.

Cost of Debt Redeemable

1. ABC Ltd., issues debentures of Rs.1,00,000 and realizes Rs.98,000 after allowing 2%
commission to brokers. The debentures carry an interest rate of 10%. The debentures are due
for maturity at the end of the 10th year. Calculate the cost of debt.

2. Vikas Ltd., issued 10,000, 9% debentures of Rs.100 each at a premium of 5%. The maturity
period is 5 years and the tax rate is 50%. Compute the cost of debentures, if they are
redeemable at par.

3. Sunrisers Ltd., issues Rs.50,00,000, 12% redeemable debentures at a discount of 10%. The
floatation costs are 4% and the debentures are redeemable after 5 years. Calculate the cost of
debt, before and after tax rate of 30%.

4. Amulya Ltd., issues 15% debentures of Rs.1,00,000, repayable at the end of the 10th year. The
tax rate is 30%. Determine the cost of capital (before and after), assuming the debt is issued at
a) par, b) 10% premium and c) 10% discount.

5. ABCL issues 10,000 bonds of Rs.100 each at 14% p.a. Marketing costs are Rs.20,000. The
bonds are to be redeemed after 10 years and the company is taxed at the rate of 40%.
Compute the cost of debt if the bonds are issued a) at par, b) at a discount of 5%, and c) at a
premium of 5%.

Cost of Preference share capital (Irredeemable)

1. BPL Ltd., issued 20,000, 10% shares of Rs.100 each. The issue expenses were Rs.2 per share.
Calculate the cost of preference share capital if the shares are issued a) at par, b) at a premium
of 10%, and c) at a discount of 5%.

2. Acer Ltd., issues 10,000, 10% preference shares of Rs.100 each at a discount of 5%. The cost
of issue is Rs.2 per share. Calculate the cost of preference share capital.

3. Aspire Co raised preference share capital of Rs.2,00,000 by issuing 10% preference shares of
Rs.10 each. The cost of issue is 2% and brokers commission is 4%. Calculate the cost of
preference share capital.

Cost of Preference share capital (Redeemable)

1. Upkar Ltd., has issued 10% preference shares amounting to Rs.1,00,000 that are redeemable
at the end of the 10th year. The cost of underwriting is 2%. Calculate the cost of preference
capital.

2. MUL has issued Rs.1,00,000, 15% preference share capital of Rs.100 each redeemable after 7
years. The cost of issue came to 3%. Calculate the cost of preference share capital.
.

3. Honda Ltd., issues 10,000, 10% preference shares of Rs.100 each, at a premium of 5%. These
shares are redeemable after 10 years. The cost of issue is Rs.2 per share. Calculate the cost.

4. Jayant Co Ltd., issued 5,000, 10% preference shares of Rs.100 each at a premium of 10%. The
shares are redeemable after 10 years. Floatation costs are 4%. Calculate the effective cost of
preference share capital.

5. Bata Ltd., issues 10,000, 10% preference shares of Rs.100 each at a discount of 5%. The
shares are redeemable after 10 years and the issue expenses are 4%. Calculate the cost of
capital.

Cost of equity capital

a) Dividend Price Approach(D/P)
1.MUL issues one crore equity shares of Rs.100 each at a premium of 10%. The company has
been consistently paying a dividend of 18% for the past 5 years. It is expected to maintain the
same in future also.
i) Compute the cost of equity capital
ii) What will be the cost of equity capital if the market price of the shares is Rs.200?

2. Suzlon Co offers for public subscription equity shares of Rs.10 each at a premium of 10%. The
company pays 5% of the issue price as underwriting commission. The rate of dividend expected
by the equity share holders is 20%.
You are required to calculate the cost of equity capital. Will your cost of capital be different if it
is to calculated on the present price of Rs.15?

3. Anand Ltd., offers for public subscription equity shares of Rs.10 each at a premium of 10%.
The company pays an underwriting commission of 5% on the issue price. The equity share
holders expect a dividend of 15%.
i) Calculate the cost of equity capital
ii) Calculate the cost of equity capital if the market price of the shares is Rs.20.

b) Dividend Price plus growth(D/P+g)

1. Market price of an equity shares of GMR Ltd., is Rs.80. The dividend expected a year hence is
Rs.1.60 per share. The share holders anticipate a growth of 7% in dividends. Calculate the cost
of equity capital.

2. The current market price of a companys share is Rs.100. The company plans to issue new
shares to raise Rs.1,00,00,000. The net proceeds per share will be the market price less the
floatation costs which is 5% of the share price.
If the company plans to pay a dividend of Rs.4.75 and the growth in dividend is expected to be
8%, calculate the cost of new issue of equity shares.

3. A company plans to issue 1,000 shares of Rs.100 each. The floatation cost is 5%. The
company pays a dividend of Rs.10 per share and the growth in dividend is 5%. Compute the
cost of new equity share.
If the shares are currently quoted at Rs.150 in the market, what would be the cost of capital?

c) Earnings price (E/P) approach

1. Blue Star Ltd., is a dynamic growth firm. It pays no dividends and anticipates a long-run
future earnings of Rs.7 per share. The current market price of the companys share is Rs.55.45.
Floatation costs for the issue of equity shares would be about 10% of the share price. Calculate
the cost of equity.

2. The entire capital of Lal and Lal Ltd., consists of 5,00,000 shares of Rs.100 each. The profit
after tax of the current year is Rs.50,00,000. The company wants to raise Rs.2,00,00,000 by
issuing new shares. The floatation costs are expected to be 10% of the face value of the shares.
Calculate the cost of equity capital assuming that the earnings of the company are expected to
be stable over the next 5 years.

3. Vijay Ltd., wants to raise Rs.50,00,000 by the issue of new equity shares. The relevant
information is given below:
No of existing equity shares
: 10,00,000
Profit after tax
: Rs.60,00,000
Market value of existing shares
: Rs.4,00,00,000
a) Compute the cost of existing equity capital
b) Compute the cost of new capital if the shares are issued at a price of Rs.32 per
share and the issue expenses are Rs.2 per share.