Page 337 - Corporate Finance PDF Final new link

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BRILLIANT’S Cost of Capital 337

5. Cost of Equity
D 1
K   g
e
P 0
Where, D = Expected dividend at the end of the year,
1
P = Current market price of share
0
g = growth rate
If D is not given D = D (1 g)
1 1 0
D = Dividend paid by company
0
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REVIEW QUESTIONS
Q.1. What is meant by cost of capital? / H¡${nQ>b H$s H$m°ñQ> go ³¶m Ame¶ h¡¡? [See Q.31]

Q.2. Write a short note on WACC. / g§{jßV {Q>ßnUr {b{IE… WACC. [See Q.32]
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PRACTICAL QUESTIONS
4.1.1 ABC Ltd. has its equity shares of ` 10 each quoted in a stock exchange has market price of
` 56. A constant expected annual growth rate of 8% and a dividend of ` 3.60 per share has
been paid for the last year. Calculate the cost of capital. [Ans. 14.94%]
4.1.2 Agro Industries Ltd. has assets of ` 3,20,000 which have been financed by ` 1,04,000 of
debt, ` 1,80,000 of equity shares and general reserve of ` 36,000. The company’s total
profits after interest and taxes for the year ended 31st March, 2013 were ` 27,000. It pays
8% interest on debt capital and is in 50% tax bracket. It has 1,800 equity shares of ` 100
each selling at a market price of ` 120 per share. What is the weighted average cost of
capital? [Ans. 9.7375%]
4.1.3 The capital structure of XYZ & Co. is comprising of 12% debenture, 9% preference share
and some equity share of ` 100 each in the ratio of 3:2:5. The company is considering to
introduce additional capital to meet the needs of expansion plans by raising 14% loan
from financial institutions. As a result of this proposal, the proportions of different above
sources would go down by 1/10, 1/15 and 1/6 respectively.
In the light of the above proposal, find out the impact on the WACC of the firm given that
(i) tax rate is 50%, (ii) expected dividend of ` 9 at the end of the year and (iii) the growth
rate, g, may be taken at 5%. No change is expected in dividends, growth rate, market price
of the share, etc. after availing the proposed loan.
[Ans. The new WACC of the company would change from 10.60% (present level) to 9.4%.]
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