Cost of capital computation based on certain assumptions. Discuss.

1. What is cost of capital?
2. Define cost of capital.
3. Cost of capital computation based on certain assumptions. Discuss.
4. Explain the classification of cost.
5. Mention the importance of cost of capital.
6. Explain the computation of specific sources of cost of capital.
7. How over all cost of capital is calculated?
8. Explain various approaches for calculation of cost of equity.
9. Rama company issues 120000 10% debentures of Rs. 10 each at a premium of
10%. The costs of floatation are 4%. The rate of tax applicable to the company
is 55%. Complete the cost of debt capital . (Ans. 4.26%)
10. Siva Ltd., issues 8000 8% debentures for Rs. 100 each at a discount of 5%. The
commission payable to underwriters and brokers is Rs. 40000. The debentures
are redeemable after 5 years. Compute the after tax cost of debt assuming a tax
rate of 60%. (Ans. 3.69%)
11. Bharathi Ltd., issues 4000 12% preference shares of Rs. 100 each at a discount
of 5%. Costs of raising capital are Rs. 8000. Compute the cost of preference
capital.

12. Firm pays tax at 60%. Compute the after tax cost of capital of a preferred share
sold at Rs. 100 with a 8%. Dividend and a redemption price of Rs.110, if the
company redeems in five years. (Ans. 9.52%)
13. Your company share is quoted in the market at Rs. 40 currently. The company
pays a dividend of Rs. 5 per share and the investors market expects a growth rate
of 7.5% per year:
(i) Compute the company’s equity cost of capital.
(ii) If the anticipated growth rate is 10% p.a. Calculate the indicated market
price per share.
(iii) If the company’s cost of capital is 15% and the anticipated growth rate is
10% p.a. Calculate the indicated market price if the dividend of Rs. 5 per
share is to be maintained. (Ans. (i) 20%, (ii) 1/10%, (iii) 1/5%)
14. Mr. Subramanian is a shareholder in Alpha Company Ltd. Although earnings for
the Alpha company have varied considerably, Subramanian has determined that
long turn average dividends for the firm have been Rs. 5 per share. He expects
a similar pattern to prevail in the future. Given the volatility of the Alpha’s
minimum rate of 40%, should it be earned on a share, what price would
Subramanian be willing to pay for the Alpha is shares? (Ans. Rs. 12.50%)
15. A Beta Ltd., iron steel reserves are being depleted and its costs of recovering a
declining quantity of iron steel are rising each year. As a equal to it the company
earnings and dividends are declining at a rate of 12% p.a. If the previous year’s
dividend (DO) was Rs. 40 and the required rate of return is 15%. What would
be the current price of the equity share of the company? (Ans. Rs. 95.14)
16. The following items have been extracted from the liabilities side of the balance
sheet of Vivekananda company as on 31st December 2004.
Paid up capital Rs.
2500 Equity shares of Rs. 100 each 250000
Reserve and Surplus 350000
Loans:
10% Debentures 100000
12% Institutional Loans 300000
Other information about the company as relevant is given below:
Year ended Dividend Earnings Average
Market Price Per share Per share Per share
31st Dec. (Rs.) (Rs.) (Rs.)
2004 7.00 11.00 80.00
2003 6.00 10.00 60.00
2002 7.00 8.00 50.00