Additional Problems

Problem 1:
Multiplex Limited has debt in three forms - Debentures, Bank Loan and Commercial Paper
Details of Debentures:
Face Value (Rs.) 1000
Coupon Rate 12%
Remaining period to maturity 4 Years
current market price (Rs.) 1040
Total no. of debentures 100000
Details of Bank Loan

Current Outstanding Loan amount Rs. 300 M
Interest on current outstanding 13%
The company wants to borrow Rs. 200 M and the current interest rate is 12%
Commercial Paper
Face Value of 1 CP (Rs. 1 M) 1
Market Value of 1 CP (Rs. M) 965000
Amount borrowed through CP (RS. Million) 48.25 (Repayable : Rs. 50 M)
Balance maturity - 6 months
Tax Rate: 35%

Find out the Cost of Capital of Debt for this company.
Solution:
Calculation of average cost of debt for Multiplex Limited
Multiplex Limited: Debenture details
Face value Rs. 1,000
Coupon rate 12%
Remaining period to Yield to maturity using the approximate

maturity(in years) 4 formula
Current market price 1,040 =(B3*B4+(B3-B6)/B5)/(0.4*B3+0.6*B6)
Illustration of Commercial paper cost calculation

Face value 1,000,000 The implicit interest rate for the remaini
Remaining period(in years) 0.5 =B9/B11-1
Current market price 965,000 The implicit interest rate/discount rate
Formula used =(1+F9)^(1/B10)-1
Calculation of the average cost of debt
(Amounts in million)
YTM or
Current
Debt Instrument Face Value Market Value Coupon RateRate
Non-convertible debentures 1000 1040 12% 10.7%
Bank loan 200 200 13% 12%
Commercial paper 50 48.25 NA 7.39%
Total = 1288.25
Average cost of debt using market value proportions and yields 10.81%
Formula used=E16*(C16/C19)+E17*(C17/C19)+E18*(C18/C19)
Post-tax cost
of debt
Tax rate = 35% = 7.03%
mited
10.7%
6)/B5)/(0.4*B3+0.6*B6)
3.63%
B9/B11-1
7.39%
d =(1+F9)^(1/B10)-1
Tutorial Notes
Commercial paper is a short term debt instrument issued at discount and repaid at par value.
Example: Issue price 48.25, Redemption price 50. The discount is equivalent to interest. No interest
is payable for CP
Tutorial Notes
Return ( also known as Yield to Maturity) :
(Face Value * Coupon Rate)+ (CMP - Face Value)/Remaining Period
Average Investment:
40%*Face Value + 60% * Market Value
Return/Average Investment = Cost of capital
Return/Investment:
3.63% Half Yearly Interest (Simple interes
7.39% Effective Annual Interest (Annual c
As per the first table above

The rate applicable for a fresh loan to be considered for CoC, Current rate
not relevant
As per the second table above
WACC: Cost of capital of each Debt* Proporationate Market Value
Cost of Capital before considering tax
Interest is a tax deductible expenditure. Hence there is tax benefit. The effective cost is net of tax
benefit
11% * (1-tax rate)

Yearly Interest (Simple interest for six months)
ctive Annual Interest (Annual compound interest)
Additional Problem 1 - Cost of Debt (Problem 14.1 in the Book)
Abacus Limited issued 15 Year 14% bonds five years ago. The bond which has face value
of Rs. 100/- is currently selling for Rs. 108/-. What is the pre-tax cost of the debt?
What is the post tax cost of the debt? Assume a tax rate of 35%
Solution:
Life of the bond ( in years) 15
Period elapsed since the issue of the
bond (in years) 5
Face value of the bond Rs. 100
Current selling price of the bond Rs. 108
Coupon rate 14%
Tax rate 35%
(a) Pre-tax cost of debt (using the

approximate formula) 12.6%
(b) Post-tax cost of debt (using the
approximate formula) 8.19%
Solution:
Problem 2: Based on the following, work out the cost of Capital for the Preference Shares issued by Mutiplex Limited:
Face Value Rs.100

Dividend Rate 11%
Maturity period 5 years
Price (if it is sold today) Rs. 95
Solution: Tutorial Notes

Return Same like Debentures
12 Coupon Rate + (Premium or addl value/Remaining period)
Investment
97 60% weightage for current value and 40% for face value
Cost of Capital
12.37%
d by Mutiplex Limited:
maining period)
for face value

Additional Problem 2 - Cost of Preference Shares (Problem 14.2 in the Text Book)
Omega Enterprises issued 10 year 9% Preference shares four years ago. The preference
share which have a face value of Rs.100 is currently selling for Rs. 92. What is the cost of preference shares?
Assume tax rate is 30%.
Solution:
Life of the preference shares ( in years) 10
Period elapsed since the issue of the bond (in

years) 4
Face value of the preference shares Rs. 100
Current selling price of the preference shares

Rs. 92
Coupon rate 9%
Cost of preference shares 10.85%
Tax rate is not relevant as dividend is not tax

deductible
Solution:
0.108543417367
Problem 3: (using CAPM approach)
Calculate the cost of equity of H Ltd. whose risk free rate of return equals 10%. The firm’s beta equals 1.75 and the return on t
Solution (When beta is given, Capital Asset Pricing Model is u

Risk free return 10% CoEquity = Risk free return + [Beta * (Market return
Beta 1.75
Market Risk premium 5.00% Return on the Market portfolio - Risk free return
Cost of Equity 18.8%
Problem 4: (Dividend+ Growth Model)

Raj Textiles Ltd. wishes to determine its cost of equity capital. The prevailing market price of the share is Rs. 50 per share.
The firm expects to pay a dividend of Rs. 4 at the end of the coming year 2003. The dividends paid on the equity shares over th
Year Dividend
2002 3.8
2001 3.62
2000 3.47
1999 3.33
1998 3.12
1997 2.97
The firm maintained a fixed dividend payout from 1996 onwards. The annual growth rate of dividends, g , is approximately 5 p
What is the cost of equity?
Cost of Equity = Dividend/ 13.00%

Market Price
+
Growth
Problem 5: (Earnings Price Ratio Model)

A firm has Rs. 5 EPS and 10% growth rate of earnings over a period of 3 years. The current market price of equity share is Rs. 5
Cost of Equity = Current EPS * (1+g)^n 6.655

Current Market Price 50
13.31%
a equals 1.75 and the return on the market portfolio equals to 15%.
Capital Asset Pricing Model is used)

return + [Beta * (Market return - Risk free Return)]
et portfolio - Risk free return
he share is Rs. 50 per share.

paid on the equity shares over the past six years are as follows :
vidends, g , is approximately 5 percent.
rket price of equity share is Rs. 50

Problem 6:
A Company has the capital structure as given below:
Equity: 60% Preference: 5% Debt 35%.
The Cost of capital of Equity is 16%, Preference capital is 14% and debt: 8%.
Find out the weighted average cost of Capital for the company.
Solution:
Calculation of the WACC

Cost of equity 16%
Cost of preference 14%
Cost of debt 12%
Tax rate = 30%
Weighted
Cost [(1)
Source of Capital Proportion (1) Cost ( x (2)]
Equity 0.60 16.00% 9.60%
Preference 0.05 14.00% 0.70%
Debt 0.35 8.40% 2.94%
WACC = 13.24%
Additional Problem 3: (Weighted Average Cost of Capital)
Rao Corporation has a target capital structure of 60% equity and 40% debt. Its cost of equity is 18%
and its pre-tax cost of debt is 13%.
Tax rate is 35%. What is the WACC of Rao Corporation.
Proportion Cost Prop. Cost

Equity 60.0% 18.0% 10.8%
Debt 40.0% 8.5% 3.4%
Weighted Average Cost of Capital 14.18%
Solution:
prop cost prop cost
equity 60% 18% 10.800%
debt 40% 8.5% 3.3800%
14.1800%
Additional Problem 4: Cost of Equity & WACC (Problem 14.4 in Text Book)
Unix Limited's equity beta is 1.2. The market risk premium is 7% and risk free rate is 10%.
Unix has debt equity ratio of 2: 3. It is pre-tax cost of debt is 14%. If the current tax rate
is 35%, what is the WACC?
Solution:
Equity Cost of Capital: % Proportion Prop. CoC
18.4% 60% 11.0%
Cost of Debt:
9.1% 40% 3.6%

Solution:
equity 60% 18.4% 11.0400%

debt 40% 9.1% 0.828100%
14.680000%
Additional Problem 5: (WACC) (Problem 14.5 in Text book)
Azeez Corporation's WACC is 12% and the tax rate is 35%. Azeez's pre-tax cost of debt is 14% and its debt equity
ratio is 1:1. The risk free return is 11% and market risk premkum is 8%. What is the beta of Azeez's equity?
Step 1: % Proportion Prop. Cost

Cost of Equity 50%
Cost of Debt 9.1% 50% 4.6%
Step 2: % Proportion Prop. Cost

Cost of Equity 14.9% 50% 7.5%
Cost of Debt
Weighted Average Cost of Cap 9.1% 50% 4.6%
Step 3:
(Beta = x)
14.90% = 11%+x(8%)
3.90% = .08x
x = 0.4875
Beta value = 0.4875
nd its debt equity
ez's equity?
Solution:
debt 50% 9.1% 4.55%

equity 50% 14.9% 7.45% pretax 14%
12% posttax 9.1%

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What are the different types of debt instruments discussed?

What are the different types of debt instruments discussed?

How is the cost of debt calculated for each type of debt instrument?

How is the cost of debt calculated for each type of debt instrument?

Problem 1:

Details of Bank Loan

Tax Rate: 35%

Coupon rate 12%

Remaining period to Yield to maturity using the approximate

Illustration of Commercial paper cost calculation

Return ( also known as Yield to Maturity) :

(Face Value * Coupon Rate)+ (CMP - Face Value)/Remaining Period

As per the first table above

11% * (1-tax rate)

(a) Pre-tax cost of debt (using the

Face Value Rs.100

Solution: Tutorial Notes

for face value

Life of the preference shares ( in years) 10

Period elapsed since the issue of the bond (in

Face value of the preference shares Rs. 100

Current selling price of the preference shares

Cost of preference shares 10.85%

Tax rate is not relevant as dividend is not tax

Solution (When beta is given, Capital Asset Pricing Model is u

Problem 4: (Dividend+ Growth Model)

Cost of Equity = Dividend/ 13.00%

Problem 5: (Earnings Price Ratio Model)

Cost of Equity = Current EPS * (1+g)^n 6.655

Capital Asset Pricing Model is used)

et portfolio - Risk free return

he share is Rs. 50 per share.

vidends, g , is approximately 5 percent.

rket price of equity share is Rs. 50

Calculation of the WACC

Proportion Cost Prop. Cost

Weighted Average Cost of Capital 14.68%

equity 60% 18.4% 11.0400%

Step 1: % Proportion Prop. Cost

Weighted Average Cost of Capital 12.0%

Step 2: % Proportion Prop. Cost

Weighted Average Cost of Capital 12.0%

debt 50% 9.1% 4.55%

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