Cost Of Capital In Financial Management 4 Nov

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COST OF CAPITAL IN FINANCIAL MANAGEMENT

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COST OF CAPITAL IN FINANCIAL MANAGEMENT

Dr. T.K. Jain.

AFTERSCHO☺OLCentre for social entrepreneurship

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Jitu Global Inc. issues 10% preference shares at a discount of 10%. What is the cost of capital?

• Let us assume that the face value is Rs. 100. Dividend will be 10.

• Cash realised is 100 – 10 = 90

• Ke (cost of capital) 10 / 90 =11%


Goti Global Inc. issues 20% preference shares at a premium of

5%. What is the cost of capital?

• Let us assume that the face value is Rs. 100. Dividend will be 20

• Cash realised is 100 +5 = 105

• Ke (cost of capital) 20/105 =19%


Goti Global Inc. issues 20% preference shares at a premium of

5% for 10 years. He will redeem these at 10% premium. What is the

cost of capital?

• Let us assume that face value is 100.

• Dividend = 20

• Redemption value 110, realised value 105

• Ke = (20 + ((110 – 105) / 10)) / (average of 110 and 105)


solution

• Ke = (20 + ((110 – 105) / 10)) / (average of 110 and 105)

• (20 + .5)/107.5

• =19% answer.


Risk free rate of return = 10%, Market Portfolio rate of return for software companies = 15%. Kap

Softwares has beta of 1.75. What is the cost of capital of Kap

Softwares?

• Formula = Rf (risk free rate) + beta (Market rate – Risk free rate)

• = .10 + 1.75 (.15-.10)

• =18.75% answer.


Dhawal World Inc. has growth rate of 15%. Current market price of his shares are 5000. Last year he gave

Rs. 10 as dividend. What is the cost of retained earnings of this

company as per DCF approach?

• Formulae (Projected dividend of next year)/ (current market price) + growth rate

• =(10*1.15) / 5000 + .15 = 15.23% answer.


Vinod & Pankaj Inc. have beta of 1.1. Market rate is 14%. Risk free

rate is 8%. What is the cost of capital of this company as per

CAPM? • Formula = Rf (risk free rate) + beta

(Market rate – Risk free rate)

• .08 + 1.1 (.14 - .08)

• =14.6 % answer.


Sarika Global Inc. has 15% debt of $20 tr.18% Preference shares of

$10 Tr. And Equity of $ 90 Tr. Cost of equity is 20%. Tax rate is 40%.

What is the overall cost of capital?

• =(.15*(1-.4)*(20/120) )+(.18*(10/120)+(.2*(90/120))

• =18% answer.


Ajay Ltd. Has a plan to raise debt. He will get Rs. 100 Crore loan @ 12%. He will pay 40% tax to the

government of India? What will be his cost of debt?

• = .12 (1-.4)

• =7.20% only


Goutam Buchha has following options: (suggest which is the best)

Tax rate is 50% • Equity = $ 250 tr.@

20%• Debt = $ 50 Tr. @

12%• Preference = $ 30 Tr.

@ 15%

• Equity = $ 50 tr.@ 25%

• Debt = $ 200 Tr. @ 15%

• Preference = $ 80 Tr. @ 18%


Solution

• 1st option:

• (.20*250/330) + .12 * (1-.5)*(50/330)+.15*(30/330) = 17.42%

• 2nd option:

• (.25*50/330) + .15 * (1-.5)*(200/330)+.18*(80/330) = 12.69%

• 2nd option is much better (but risky also).


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