Question

CP India Ltd has the following capital structure, which it considers optimal:
Debt 25%
Preference Shares 15%
Equity shares 60%
Total 100%
Applicable tax rate for CPIL is 25%. and investors expect earnings and dividends to
grow at a constant rate of 9% in the future. Risk free rate of return is 6%, average equity share has expected rate of return of 15%. CPIL’s beta is 1.50. Following terms would
apply to new securities being issued as follows:
1. New preference can be issued at a face value of Rs. 100 per share, dividend and cost of issuance will be Rs. 8 per share and Rs. 4 per share respectively.
2. Debt will bear an interest rate of 10%.
Calculate
a. Component cost of debt, preference shares and equity shares assuming that CPIL does
not issue any additional equity shares.
b. WACC.

Answer 1

Answer:

a. Component cost of debt is:

0.1×(1 - 0.25) = 0.0750.1×(1−0.25)=0.075 or 7.5%.

Cost of preference shares is:

12/100 = 0.1212/100=0.12 or 12%.

and cost of equity shares is:

Ke = 0.06 + 1.5×(0.15 - 0.06) = 0.195Ke=0.06+1.5×(0.15−0.06)=0.195 or 11.25%.

b. WACC = 0.195×0.6 + 0.075×0.25 + 0.12×0.15 = 0.1538.WACC=0.195×0.6+0.075×0.25+0.12×0.15=0.1538.