Cost of Capital

CAPITAL

Equity Capital Debt Capital Preference Capital

Cost of Equity Capital Cost of Debt Capital Cost of preference
Capital

Using these we compute WACC (Weighted

average Cost of Capital)
 Cost of Debt Capital
Cost of Term Loan
Scenario 1: Tax Rate = 0%, Interest rate=20%,
Loan Amount = 100
No Loan Loan
EBIT 400 400
Interest 0 -20
EBT 400 400-20
Tax (@0%) 0 0
EAT 400 400-20
 Cost of Debt Capital
Cost of Term Loan
Scenario 1: Tax Rate = 25%, Loan Amount = 100

No Loan Loan
EBIT 400 400
Interest 0 -20
EBT 400 400-20
Tax (@25%) 100 100-5
EAT 300 300-15
Cost of Term Loan = Interest (1-tax)

What is the cost of term loan for a company for

which the applicable rate of tax is 20% and
which has borrowed Rs.100 cr at 12%? What if
the applicable tax rate is 30%?

9.6%

8.4%
 Cost of Debt Capital

Cost of Debenture (for the company)

Inflow for the company

Issue price

Outflow for the Company

Effective annual interest outflows for the company: Interest (1-t)

Redemption Price
 I (1 t )
n
F
P
j 1 (1 k d ) (1 kd )
j n

Kd= Post-tax cost of debenture

I: Annual Interest Payments per debenture

t: Corporate tax rate

F: Redemption price per debenture

P: Issue price of the debenture

Approximate Rate

( F P)
I * (1 t )
kd n
( F P)
n

Where:.

F is the redemption price

P is the issue Price

If a company issue Rs.100 Face value debentures at
Rs.95 and the coupon rate is 12% for a maturity of 5
years, then what is the cost of debenture to the
company? The applicable tax rate for the company
is 35%

9.03%
If a company issue Rs.100 Face value debentures at
par and the coupon rate is 10% for a maturity of 3
years, then what is the cost of debenture to the
company, if the debenture is redeemed at a premium
of Rs.5 to the face value? The applicable tax rate for
the company is 30%

8.53%
 Cost of Preference Capital

n
D F
P
j 1 (1 k p ) (1 k p )
j n

Kp= cost of preference share

D: Annual dividend payable per share

F: Redemption price per share

P: Issue price of the preference share

Approximate Rate

( F P)
D
kp n
( F P)
n

Where:.

F is the redemption price

P is the issue Price

 Cost of Preference Capital

A company issues Rs.100 face value preference

share at Rs.95. The dividend paid is 12% and
maturity is 5 years. What is the cost of preference
share to the company?

13.33%
A company issues Rs.100 face value preference
share at Rs.105 to be redeemed at face value. The
dividend paid is 10% and maturity is 3 years.
What is the cost of preference share to the
company?

Approximately 8%
 Cost of Equity Capital

1. Dividend Discounting model:

P0 = D1 / (Ke g)

2. CAPM (Capital Asset Pricing Model)

Ke = Rf + (Rm- Rf )
 Cost Of Equity Capital

3. Earnings Price Ratio

Ke = E1/ P0 or E0(1+g)/ P0

4. Bond Yield Plus Risk Premium

 Cost of Equity

5.Cost of Retained Earnings = Cost of Equity

6. Cost of External Equity

Cost of equity / (1-F)

ABC Ltd plans to issue Rs.10 face value shares for an amount
of Rs.10cr. However the company would incur a cost of 2% of
the issue size. If the companys cost of equity is 12%, what
would be the cost of the new issued capital.

12.24%
 Weighted Average Cost of Capital

K = wiKi

Where wi is the proportion of ith capital to the total Capital

Mahindra Hitek Ltd has the following capital structure based on market values:

Equity Capital (80,000 shares of Rs.10 face value) 100,00,000

15% Preference Capital (6000 shares of Rs.100 par value) 6,21,000

14% Debentures (Face Value of Rs.1000) 9,70,000

16% Term Loan 8,00,000

The dividend per share expected for the next year is Rs.3.50 and is expected to
grow at the rate of 12%. It is presently selling at Rs.125. Preference shares are
redeemable after 5 years at a premium of 5% and debentures are redeemable
after 10 years at face value. They are presently selling at 103.50 and Rs.970
respectively.
 If the applicable tax rate for the company is 40%. Compute
the cost of equity for the company.

Compute the cost of preference capital

Compute the cost of debenture and cost of term loan

Compute the WACC (Weighted average cost of capital)

using market value as weights
Cost of Equity = 14.8%

Cost of preference capital = 14.70%

Cost of debenture = 8.83%, Cost of term loan =

9.6%

WACC = 14%
 Weighted Marginal Cost of Capital

We have determined the weighted average cost of capital

irrespective of the financing required.

In real world as the financing increases so does the risk thus

leading to increase of the financing cost.

Thus we need to determine the weighted average cost of

capital for different levels of financing. In this we assume that
the company has similar proportions of financing in each
case.
Thus in effect we want to know the cost of capital for different
levels of financing. A table representing this is called the
schedule of weighted marginal cost of capital
Regarding the long term sources of finance for Shanbagh Ltd.
Following details are obtained from their merchant bankers:

Sources of Finance Range of new financing Cost (%)

from various sources
Equity 0-150 14
150-400 15
400 and above 16
Preference 0-20 15
20 and above 16
Debt (Post Tax Cost) 0-100 8
100-350 9
350 and above 10
The companys current capital structure is 40% equity, 10%
preference and 50% debt. Compute the weighted marginal
cost of capital schedule for various levels of financing
Equity Cost(%) Max/weight Total financing
0-150 14 375 0-375
150-400 15 1000 Above 375-1000
400 and above 16 Above 1000

Preference Cost Total Financing

0-20 15 200 0-200
20 and above 16 Above 200
Equity Cost(%) Max/weight Total financing
0-150 14 375 0-375
150-400 15 1000 Above 375-1000
400 and above 16 Above 1000

Preference Cost
0-20 15 200 0-200
20 and above 16 Above 200

Debt Cost
0-100 8 200 0-200
100-350 9 700 Above 200- 700
350 and above 10 Above 700
Range Capital Cost(%) Weight Cost*weight
0-200 Equity 14 0.4 5.6
Preference 15 0.1 1.5
Debt 8 0.5 4
Total 11.1
200-375 Equity 14 0.4 5.6
Preference 16 0.1 1.6
Debt 9 0.5 4.5
Total 11.7
375-700 Equity 15 0.4 6
Preference 16 0.1 1.6
Debt 9 0.5 4.5
Total 12.1
 Cost*wei
Range Capital Cost(%) Weight ght
700-1000 Equity 15 0.4 6
Preference 16 0.1 1.6
Debt 10 0.5 5
Total 12.6
Above 1000 Equity 16 0.4 6.4
Preference 16 0.1 1.6
Debt 10 0.5 5
Total 13