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Debt and Equity cost

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Question 1
XYZ Ltd. has the following book value capital structure:
Equity Capital (in shares of Rs. 10 each, fully paid up- at par)
Rs. 15 crores
11% Preference Capital (in shares of Rs. 100 each, fully paid
up- at par)
Rs. 1 crore
Retained Earnings
Rs. 20 crores
13.5% Debentures (of Rs. 100 each)
Rs. 10 crores
15% Term Loans
Rs. 12.5 crores
The next expected dividend on equity shares per share is Rs. 3.60; the dividend per share is
expected to grow at the rate of 7%. The market price per share is Rs. 40.
Preference stock, redeemable after ten years, is currently selling at Rs. 75 per share.
Debentures, redeemable after six years, are selling at Rs. 80 per debenture.
The Income tax rate for the company is 40%.
Required
(i) Calculate the weighted average cost of capital using:
(a) book value proportions; and
(b) market value proportions.
(ii) Define the weighted marginal cost of capital schedule for the company, if it raises Rs. 10
crores next year, given the following information:
(a) the amount will be raised by equity and debt in equal proportions;
(b) the company expects to retain Rs. 1.5 crores earnings next year;
(c) the additional issue of equity shares will result in the net price per share being fixed at
Rs. 32;
(d) the debt capital raised by way of term loans will cost 15% for the first Rs. 2.5 crores and
16% for the next Rs. 2.5 crores. (Final- Nov. 2000) (12 marks)
Answer
(i) (a) Statement showing computation of weighted average cost of capital by using Bookvalue
proportions
Source of finance
Amount
(Book
value)
(Rs. in
crores)
Weight
(Book value
proportion)
Cost of
capital
Weighted
cost of
capital
(a)
(b)
(c)= (a)x(b)
Equity capital
15
0.256
0.16
0.04096
(Refer to working note 1)

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 Question 1 XYZ Ltd. has the following book value capital structure: Equity Capital (in shares of Rs. 10 each, fully paid up- at par) Rs. 15 crores 11% Preference Capital (in shares of Rs. 100 each, fully paid up- at par) Rs. 1 crore Retained Earnings Rs. 20 crores 13.5% Debentures (of Rs. 100 each) Rs. 10 crores 15% Term Loans Rs. 12.5 crores The next expected dividend on equity shares per share is Rs. 3.60; the dividend per share is expected to grow at the rate of 7%. The market price per share is Rs. 40. Preference stock, redeemable after ten years, is currently selling at Rs. 75 per share. Debentures, redeemable after six years, are selling at Rs. 80 per debenture. The Income tax rate for the company is 40%. Required (i) Calculate the weighted average cost of capital using: (a) book value proportions; and (b) market value proportions. (ii) Define the weighted marginal cost of capital schedule for the company, if it raises Rs. 10 crores next year, given the following information: (a) the amount will be raised by equity and debt in equal proportions; (b) the company expects to retain Rs. 1.5 crores earnings next year; (c) the additional issue of equity shares will result in the net price per share being fixed at Rs. 32; (d) the debt capital raised by way of term loans will cost 15% for the first Rs. 2.5 crores and 16% for the next Rs. 2.5 crores. (Final- Nov. 2000) (12 marks) Answer (i) (a) Statement showing co ...
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