FINANCIAL

MANAGEMENT
SUBMITTED TO: SUBMITTED BY:
Dr. Ajay Verma Prerna Sinha
Jalpa Madeka
Shimona Rashi
Manika Khandelwal
Poonam Jajodia
Vaishali Burdak
MINI CASE
OF
COST OF
CAPITAL
 SUMMARY

Suman Joshi, Managing director of

omega textile, was reviewing two very
different investment proposals. The
first one is for expanding the capacity
of the current project and the second is
for diversifying into a new line of
business.
We need to find WACC (Weighed
Average Cost Of Capital) with the
help of following data
Liabilities Amount 1200 Assets Amount

Equity Capital 350 Fixed Assets 700

Preference 100 Investment 100

Capital
Reserve and 200 Current Assets , 400
Surplus Loans and
Advances
Debentures 450

Current 100
Liabilities and
Provisions
1200 1200
 Omegas target capital structure has 50 percent
equity, 10 percent preference, and 40 percent debt

Omega has Rs.100 par, 10 percent coupon, annual

payment, non-callable debenture with 8 year to
maturity. These debentures are currently selling at
RS.112

Omega has Rs.100 par, 9 percent, annual dividend,

preference share with residual maturity of 5 years.
The market price of these preference shares is
Rs.106
 Omegas equity share is currently selling at
Rs.80 per share. Its last dividend was Rs.2.80
and the dividend per share is expected to
grow at a rate of 10 percent in future

Omegas equity beta is 1.1, the risk free rate

is 7 percent, and the market risk premium is
estimated to be 7 percent

Omegas tax rate is 30 percent

 The new business that Omega is
considering has different financial
characteristics than Omegas existing
business. Firm engaged purely in such
business have, on an average, the
following characteristics:
Their capital structure has debt and equity in
equal proportion.
Their cost of debt is 11 percent.
Their equity beta is 1.5.
 Ques. What is Omegas post-
tax cost of debt ?
Denotations:
r 10%
Bv -100
Bo -112
N 8 yrs

Formula for finding Kd

Current value of debenture = interest (PVIFA Kd, n ) +maturity value (PVIF Kd, n )
At 7%

112 = 10(PVIFA 7%, 8) + 100(PVIF 7%, 8 )

= 10(5.971) + 100(0.582)
=59.71+58.2
=117.91

At 8%
112 = 10(PVIFA 8%, 8) + 100(PVIF 8%, 8 )
= 10(5.747) + 100(0.540)
= 57.47 + 54.0
= 111.47
 Interpolation:
Actual 112 Difference

5.91

At 7% 117.91

6.44

At 8% 111.47

= 0.07 + (0.08-0.07)5.91/6.44
=7.92 %
Post tax cost of debt
= 7.92(1-0.30)
= 5.54 %
Ques. What is Omegas
cost of preference?
Denotations:
r 9%
Bv -100
Bo -106
N 5 yrs

Formula for finding Kp

Current value of share = interest (PVIFA Kp, n )
+maturity value (PVIF Kp, n)
At 7%
106 = 9(PVIFA ) + 100(PVIF
7%, 5 7%, 5 )
= 9(4.100) + 100(0.713)
=36.9 + 71.3
=108.2

At 8%
106 = 9(PVIFA ) + 100(PVIF
8%, 5 8%, 5 )
= 9(3.993) + 100(0.681)
= 35.937 + 68.1
= 104.03
 Interpolation:
Actual 106 Difference

2.2

At 7% 108.2

4.17

At 8% 104.03

= 0.07 + (0.08-0.07)2.2/4.17
=7.53
Ques. What is Omegas estimated cost
of equity using dividend discount model?

Div0 = 2.80
P0 =80
G =10%

Ke = Div1 / P0 + g
=2.80(1.10)/80+ 0.10
= 0.385 + 0.1080= 0.1385
= 13.85%
Ques. What is Omegas estimated cost of
equity using the capital asset pricing model?

Denotations:
Rm- 7
(Rm-Rf)-7
- 1.1
Ke= Rf+ (Rm-RF)
= 7 + 1.1(7)
= 14.70%
Ques. What is Omegas WACC using
CAPM for the cost of equity?

Sources Proportio Cost WACC

of fund n
Equity 0.5 14.7 7.35

Preference 0.1 7.53 0.753

Debentures 0.4 5.54 2.216

10.319
Ques. What would be your estimate cost of capital for the new
business?

Sources Proportio Cost WACC

of Fund n
Equity 0.5 17.5 8.75

Debenture 0.5 7.7 3.85

12.6

Ke = Rf + (Rm-Rf)
= 7 + (7) 1.5
= 17.5%