Question

A company was recently formed to manufacture a product. It has the following Capital Structure: S. No. Particulars 1. 9% Debentures 2. 7% Preference Shares 3. Equity Shares (24,000 Equity Shares of Rs. 10 each) 4. Retained Earnings Amount (Rs.) 18,00,000 per share is Cost of the 4. Total The Market Price of Equity Shares is Rs. 40 per share. A dividend of Rs. 4 proposed. The company has a marginal tax rate 50%. Compute the Weighted Average Capital of the company.​

Answer 1

Your question is incomplete. Please check below the full content.

A company has the following book value capital structure as on March 31, 2021.

Equity share capital (10,00,000 shares)   2,00,00,000

11.5% Preference Shares     60,00,000

10% Debentures      1,00,00,000

The equity shares of the company are sold for Rs. 200, it is expected that the company will pay next year a dividend of Rs. 10 per equity share, which is expected to grow by 5% p.a forever. Assume a 35% corporate tax rate.

Calculate the Weighted Average Cost of capital.

Concept:

The weighted average cost of capital (WACC) is a method of calculating a firm's cost of capital that assigns a proportional weight to each category of capital.

When calculating WACC, the cost of each capital source (debt and equity) is multiplied by the relevant weight by market value, and the results are then added up to reach the final result.

A WACC computation takes into account all capital sources, including bonds, common stock, preferred stock, and any other long-term debt.

Given:

• Equity share capital (10,00,000 shares)   2,00,00,000

• 11.5% Preference Shares                     60,00,000

• 10% Debentures                              1,00,00,000

• Market price of equity share                    200 per share

• Dividend                                       10 per share

• Growth rate                                 5% pa

• Tax rate                                         35%

Find:

Calculate the weighted Average cost of capital.

Solution:

a) Cost of Equity capital = (expected dividend/market price of share) + growth

Cost of Equity Capital = (10/200)+0.05

Cost of Equity capital = 10%

b) Cost of debentures = Interest(1-tax) / net proceeds

Cost of Debentures = 10,00,000 ( 1-0.35) / 1,00,00,000

Cost of Debenture = 6.5%

c) Refer table 1 for calculation of Weighted Average Cost Of capital.

Hence , the weighted average cost of capital is 9.28

#SPJ3