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    1. Cost of Capital

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    Surendra Rathod

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    1. Cost of Capital

    Uploaded by

    Surendra Rathod
    4 views53 pages

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    Copyright:

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    Download as pptx, pdf, or txt
    4 views53 pages

    1. Cost of Capital

    Uploaded by

    Surendra Rathod

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    You are on page 1of 53

    Cost of Capital

    • For example, if a company


    has issued 10% debentures
    and the tax rate is 50%, the
    cost of debt will be

    • (1 - 0.5) 10% = 5%
    Practice Example
    • A company issue 12% irredeemable
    debentures of Rs. 20,000. The company is in
    60% tax bracket. Calculate cost of debt capital
    at par, at 10% discount and at 10% premium
    • A company issue 10% irredeemable
    debentures of Rs. 30,000. The company is in
    40% tax bracket. Calculate cost of debt capital
    at par, at 5% discount and at 5% premium
    Sol:
    Kd = I +(P –NP)/n *100
    (P +NP)/2
    = 2500 + ( 25,000 – 25,462.5)/10 *100
    (25,000+25,462.5)/2
    = 0.09725*100
    Kd(Before tax)=9.725%
    Kd(After tax)= =9.725% (1-0.5) = 4.863%

    NP = 250*105 – 3% *(250*105)
    = 26,250 - 787.5 = 25,462.5
    Sums
    • Problem 1:
    A company raised a loan by selling 400 debentures with an 8% rate
    of interest at a discount of Rs. 10 per debenture (Par value = Rs.
    100), redeemable at the end of the 7th year. Underwriting and
    other issuance costs amounted to 2% of the proceeds. The tax rate
    is 40%. Calculate the cost of debt capital.

    • Problem 2:
    A company issued 500 debentures with a 12% interest rate at a
    premium of Rs. 15 per debenture (Par value = Rs. 100), redeemable
    at the end of the 5th year. Underwriting and other issuance costs
    amounted to 1.5% of the proceeds. The tax rate is 30%. Calculate
    the cost of debt capital.
    Solution Problem 1
    Sol:

    Kd = I +(P –NP)/n *100


    (P +NP)/2
    = 3200 + ( 40,000 – 35,280)/7 *100
    (40,000 + 35,280)/2
    = 3200 + 674.28*100
    37,640
    = 3874.28 /37640 *100
    Before Tax = 10.29 %
    After Tax =10.29 % (1-0.4)
    Kd =6.18%

    Net Proceeds:
    •Issued at a discount of Rs. 10, so issue price per debenture = Rs. 100 - Rs. 10 = Rs. 90
    •Total proceeds before costs = 400 debentures × Rs. 90 = Rs. 36,000
    •Issuance costs = 2% of Rs. 36,000 = Rs. 720
    •Net Proceeds = Rs. 36,000 - Rs. 720 = Rs. 35,280
    The cost of equity capital represents the return required by
    equity investors for investing in a company. It can be estimated
    using various methods, such as the Dividend Discount Model
    (DDM) and the Capital Asset Pricing Model (CAPM). Let's
    explore these methods with a brief explanation:

    1. Dividend Discount Model (DDM)


    • The DDM calculates the cost of equity based on the
    dividends a company pays to its shareholders and the
    growth rate of those dividends. The formula is:
    Problem 1: Using the Dividend Discount Model (DDM)
    • A company is currently paying an annual dividend of Rs. 5
    per share. The dividend is expected to grow at a constant
    rate of 6% per year. The current market price of the stock is
    Rs. 100 per share. Calculate the cost of equity capital.
    Practice Example
    Example 1
    A company is currently paying an annual dividend of Rs. 8
    per share. The dividend is expected to grow at a constant
    rate of 4% per year. The current market price of the stock is
    Rs. 120 per share. Calculate the cost of equity capital.
    Example 2
    A company is currently paying an annual dividend of Rs. 3
    per share. The dividend is expected to grow at a constant
    rate of 7% per year. The current market price of the stock is
    Rs. 50 per share. Calculate the cost of equity capital.
    Example 1 Example 2
    Problem 2: Using the Capital Asset Pricing Model (CAPM)
    A company's stock has a beta of 1.2. The risk-free rate is 4%,
    and the expected return on the market is 10%. Calculate the
    cost of equity capital using the CAPM formula.
    Practice Examples

    Example 1
    A company's stock has a beta of 0.8. The risk-free
    rate is 3%, and the expected return on the market
    is 9%. Calculate the cost of equity capital using the
    CAPM formula.
    Example 2
    A company's stock has a beta of 1.5. The risk-free
    rate is 5%, and the expected return on the market
    is 12%. Calculate the cost of equity capital using
    the CAPM formula.
    Example 1 Example 2

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