ProblemsFinancial Management Practice Problem Cost of Capital 1. A 5 years Rs.100 debenture of a firm can be sold for a net price of 96.50. The coupon rate of interest is 14% p.a. and it will be redeemed at 5% premium on maturity. The firm tax rate is 40%. Compute after-tax cost of debenture. kd I(1- t) F-P 105 - 96.50 14(1- 0.40) 5 n 100 100 = 9.35% 105 96.5 FP 2 2 Where Cost of debenture = Kd Annul Interest payment per debenture capital = I Corporate tax rate =t Redemption Price per debenture = F Net amount realized per debenture= P Maturity period =n 2. A Company issues 10000 10% preference shares of Rs. 100 each redeemable after 10 years at a premium of 5%. Calculate the cost of preference capital. kp D 105 - 100 F-P 10 10 n 100 100 = 11.71% 105 100 FP 2 2 Kp = Cost Of Preference Capital. D = Preference Dividend Per Share F = Redemption Price P = Net Amount Realized Per Share. N = Maturity Period. 3. A company issues 1000 7% preference shares of Rs. 100 each at a premium of 10% redeemable after 5 years at par. Compute the cost of preference capital. kp D 100 - 110 F-P 7 5 n 100 100 = 4.76% 100 110 FP 2 2 Kp = Cost Of Preference Capital. D = Preference Dividend Per Share F = Redemption Price P = Net Amount Realized Per Share. N = Maturity Period. 1 76 g 0.100 each fully paid) Retained earnings 13. g =Constant growth rate applicable to dividends. Calculate the cost of equity capital. g =Constant growth rate applicable to dividends. The coupon rate is 12%. 7.18.05 = 0. D = Preference Dividend Per Share F = Redemption Price P = Net Amount Realized Per Share. Sale price is Rs.95 F-P 12 15 100 = 12. The equity of mercury Ltd. kp D 110 . calculate the cost of preference shares. 4 per share last year.100 preference share redeemable at a premium of Rs. has Rs. has the following book value Capital Structure Equity Capital (Rs. Sun Ltd.10% with 15 years maturity. Pe= Current market price. Pe= Current market price. ke D1 18 g 0.05) g 0.06 = 0. ke D1 4(1. Pe= Current market price.24 on the stock exchange. has its share of Rs. Calculate the cost of equity capital. Dell Ltd. ke D1 1.5 2 .68% n 100 110 95 FP 2 2 Kp = Cost Of Preference Capital. 10 each fully paid) 11% Preference Shares (Rs.26= 26% Pe 90 D1=Expected at the end of the first year. 10 each quoted at Rs.95.50% Pe 40 D1=Expected at the end of the first year. N = Maturity Period. g =Constant growth rate applicable to dividends. 90 each. The subsequent growth in dividends is expected at the rate of 6%. is traded in the market at Rs. The last dividend paid Rs.1. 40 per share and it had paid a dividend of Rs.17= 17% Pe 24 D1=Expected at the end of the first year. 5. The share of a company is selling at Rs. The investor’s market expects a growth rate of 5% per year.4. The expected current year dividend per share is Rs.155 = 15.5% Debenture 15% term loan (Rs in crores) 15 1 20 10 12. XYZ Ltd. 8.10 = 0. Compute the cost of equity. 6.60. The subsequent growth in dividends is expected at the rate of 10%. 739 0. D1 3. Income tax rate applicable to the company is 50%. is currently selling at Rs. are selling at Rs. What will be the new WACC of the company? 3 . 10 each fully paid) 1000000 12% Preference Shares (Rs.40.07 = 0.60 and the dividend per share is expected to grow at the rate of 7%.70 per share.0139 81.80per share in the stock exchange.1543 or 15. The Capital Structure of Hindustan Traders Ltd.t) 6 n 100 = Cost of Debentures k d 100 FP 100 80 2 2 Cost of equity ke =11.75 0.40) = 0.75 11 D 10 100 = 0.45% 9.1543 0.154 0.100 each fully paid) 200000 14% Debenture(Rs.60 g = 0. redeemable after 10 years. The income tax for the company is 40% .5% Debenture 8.009 0.22% Cost of term loan k t I (1 t ) = 0.0014 13.09 or 9% Cost of retained earnings = 16% WACC= (Ke x We )+ (Kp x Wp) +(Kd x Wd) + (Kt x Wt) WAAC (Market Value Weightage) Source Market value Weight Cost W.40) I(1.098 0.0.500000 by a way of long term loan at 16%. dividend is likely to grow b 5% every year.1600 0. Preference stock. 90 per debenture.95 per share Debentures. As the company is a market leader with good future.15(1-0. The market price per share is Rs.50 0. Preference stock.Calculate WACC. is currently selling at Rs.00 0.5(1.000 WACC= 0. as on 31-03-2010 is as follows: Equity Capital (Rs.80 F-P 13. redeemable after 5 years.16 or 16% Pe 40 F-P 100 .100 each fully paid) 300000 For the year ended 31-03-2010 the company has paid equity dividend at 20%.C Equity Capital 60. 80 per debenture. Debentures.1445 WACC = 14. b) The company plans to raise Rs.0110 15% term loan 12.25 1.75 per share. When this takes place the market value of the equity shares is expected to fall Rs.1122 0.00 0. The equity shares are now traded at Rs. redeemable after six years. are selling at Rs.3.1182 11% Preference Shares 0.0900 0. redeemable after six years. You are required to a) The weighted cost of capital on the basis of book value.The next expected dividend on equity shares per share is Rs.43% n 100 = Cost of Preference k p FP 100 75 2 2 100 . C Equity Capital 1000000 0. Calculate Pay Back Period of Project.0947 0.250 0.08 or 8% Cost of equity ke Source Equity Capital 12% Preference Shares 14% Debenture 16% term loan WACC = 10.200 0.0.150 0.C 1000000 0.0189 500000 0.1282 0.10 g = 0.84% D1 2.8000 for 10 years. An investment of Rs.50) = 0.10 g = 0.50) I(1.95 D 12 10 100 = 12.500 0.0642 12% Preference Shares 200000 0.82% n 100 = Cost of Preference k p 100 95 FP 2 2 100 .63% Pe 80 F-P 100 .1060 Capital Budgeting 1.100 0.0171 300000 0.000 WACC= 0.1000 0.47% n 100 = Cost of Debentures k d FP 100 90 2 2 WACC= (Ke x We )+ (Kp x Wp) +(Kd x Wd) + (Kt x Wt) Cost of equity ke WAAC (Book Value Weightage) Source Book value Weight Cost W.0171 14% Debenture 300000 0.0189 1500000 1.0963 0.0200 2000000 1.90 F-P 14(1.0800 0.40000 in a project is expected t o produce cash flow of Rs.t) 5 100 =9.60% Book value Weight Cost W.0947 0.1282 0.07 = 10% Pe 70 Cost of term loan k t I (1 t ) = 0.0500 200000 0.D1 2.07 = 9.667 0.133 0.16(1-0. 4 .000 WACC= 0.0984 WACC = 9. 20 Years 6. Ans: Pay Back Period of Project =7 Years 3. Year 0 1 2 3 4 5 6 Ans: Pay Back Period of Project A = 3years Pay Back Period of Project B = 4. Estimated life of project is 5 years.80000 over a period of 15 years. Assume the firm uses straight line depreciation and same is allowed for tax purposes. . From the following information Calculate Pay Back Period of Project A and B. A Project costing Rs. From the following information Calculate Pay Back Period of Project. The tax rate is 35%. It is expected to yield profits before depreciation and taxes during the 5 years Cash flows Project A Project B -100000 -100000 50000 20000 30000 20000 20000 20000 10000 30000 10000 40000 -----50000 5 .25 Years 5.Ans: Pay Back Period of Project =5 Years 2. A project requires an investment of Rs. Year Cash Flow 0 -70000 1 10000 2 20000 3 30000 4 45000 5 60000 Ans: Pay Back Period of Project = 4.22 Years 4. each requiring a cash out lay of Rs. Calculate Pay Back Period of Project. Rank the of the following projects based on Pay Back Period.33 Years Pay Back Period of Project B = 4 years Pay Back Period of Project C = = 4.560000 is expected to produce annual cash flow of Rs. 500000.1.000.00. Year Cash flows Project A Project B Project C 1 30000 30000 10000 2 30000 40000 20000 3 30000 20000 30000 4 30000 10000 30000 5 30000 5000 50000 Ans: Pay Back Period of Project A = = 3. Rs.140000. Rs.170000. The facility has a life expectancy of 5 years and no salvage value. Calculate ARR of Project. Determination of cash flows after taxes (CFAT) Solution : Year CFBT Depreciation PBT Taxes PAT 1 140000 100000 40000 14000 26000 2 160000 100000 60000 21000 39000 3 170000 100000 70000 24500 45500 4 150000 100000 50000 17500 32500 5 130000 100000 30000 10500 19500 Total 162500 ARR Average Annual Profit after depreciation & taxes 32500 100 = 100 =13% Average Investment 250000 Average Investment = Investment / 2 Average Annual Profit after Depreciation & taxes = PAT /years of life of project 7. From the information calculate the NPV and Benefit Cost Ratio of the project @ 12% discount rate. A Company is considering an investment proposal to invest new milling controls at a cost of Rs. Assume the firm uses straight line depreciation and same is allowed for tax purposes. Rs. 150000 and Rs.160000. 6 .50000. The tax rate is 35%.amounting to Rs. The estimated cash flows before depreciation and Tax (CFBT) from the investment proposal are as follows Year CFBT 1 10000 2 10692 3 12769 4 13462 5 20385 Compute Average rate of return Solution : Year CFBT Depreciation PBT Taxes PAT 1 10000 10000 0 0 0 2 10692 10000 692 242 450 3 12769 10000 2769 969 1800 4 13462 10000 3462 1212 2250 5 20385 10000 10385 3635 6750 Total 11250 ARR Average Annual Cash inflows after depreciation & taxes 2250 100 = 100 = 9 Avarage Investment 25000 8.130000. 636 0.909 0.995 NPV = Present Value of Future Cash Flows . BCR or Profitability Index 7 .Year 0 1 2 3 4 5 Solution : PV of the project is Year 1 2 3 4 5 Cash Flow -12000 4000 5000 7000 6000 5000 Cash Flow PVIF 4000 5000 7000 6000 5000 PV 0.567 3572 3985 4984 3816 2835 19192 NPV = 19192-12000 = 7192 Benefit Cost Ratio = 19192/12000 = 1.712 0. 9.Initial Investment.Initial Investment.751 0.621 PV 181800 165200 225300 204900 217350 994550 NPV = 994550-1000000 =5450 Benefit Cost Ratio = 994550/1000000 = 0. Year Cash Flow 0 -1000000 1 200000 2 200000 3 300000 4 300000 5 350000 PV of the project is Year 1 2 3 4 5 Cash Flow PVIF 200000 200000 300000 300000 350000 0.797 0.826 0.893 0.60 NPV = Present Value of Future Cash Flows .683 0. BCR or Profitability Index Present Value of Future Cash Flows / Initial Investment. From the information calculate the NPV and Benefit Cost ratio of the project @ 10% discount rate. BCR or Profitability Index Present Value of Future Cash Flows / Initial Investment.000 = 0. Also find Benefit Cost Ratio. Solution : Year 1 2 3 4 5 Project A 2000 1500 1500 1000 ----D.751 0.000 = 22.683 0.621 PV 1818 1239 1127 683 4867 Project B 3000 2000 2000 1000 1000 D.909 0.683 0.From the following information calculate the net present value of the two projects and suggest which of the two projects should be accepted assuming a discount rate of 10%.909 0. Information of projects A and B are as follows : Year Cash Flows Project A Project B 0 20000 30000 1 2000 3000 2 1500 2000 3 1500 2000 4 1000 1000 5 ----1000 Calculate NPV and Benefit Cost ratio of the project by assuming cost of capital is 10%.751 0.815 BCR Project A = 4867/20000 = 0.F 0.243 Project B = 7185/30. 10. Year Cash flows Project A Project B 8 .621 PV 2727 1652 1502 683 621 7185 NPV Project A = 4867 – 20.826 0.000 = -15133 Project B = 7185 – 30.826 0.239 NPV = Present Value of Future Cash Flows .Initial Investment.F 0. 11.Present Value of Future Cash Flows / Initial Investment. 751 0. Year Cash Flow 0 100000 1 30000 2 30000 3 40000 4 45000 Solution : 9 .683 0.564 PV 18180 8260 3755 2049 1242 1128 34614 NPV = Present Value of Future Cash Flows .621 0.15 0.909 0.21 NPV of the project B is Year Cash Flow PVIF 1 20000 2 10000 3 5000 4 3000 5 2000 6 2000 NPV = 34614-30000 = 4614 Benefit Cost Ratio = 34614/30000 = 1.0 1 2 3 4 5 6 NPV of the project A is Year 1 2 3 4 5 6 -20000 5000 10000 10000 3000 2000 1000 -30000 20000 10000 5000 3000 2000 2000 Cash Flow PVIF 5000 10000 10000 3000 2000 1000 PV 0.683 0.826 0.621 0. 12.826 0. BCR or Profitability Index Present Value of Future Cash Flows / Initial Investment.751 0.564 4545 8260 7510 2049 1242 564 24170 NPV = 24170-20000 = 4170 Benefit Cost Ratio =24170/200000 = 1. From the information calculate the IRR of Project.909 0.Initial Investment. IRR 14 % (15 % 14 %) IRR = LRD + NPVL PV 60.592 13.595 Discount Rate 15% PVF PV 0.840 60.38% 100840 .595 .000 0.000 0.869 0.. 1 2 3 (1 r ) (1 r ) (1 r ) (1 r ) n 60000 15000 20000 30000 20000 1 2 3 (1 r ) (1 r ) (1 r ) (1 r ) 4 year 1 2 3 4 Total Annual Discount Rate 14% Cash flow PVF PV 15.035 15...285 By using interpolation tool.....000 3 ------30.000 0. 15% (16% . 13.59285 x R 10 .595 .756 0.571 13.769 30.60.000 ------1 ------15. From the following data calculate Internal Rate of Return Years Outflows Inflows 0 60.98630 IRR = LRD + NPVL x R PV LRD = Lower Rate Discount NPVL = Net Present Value at Lower rate PV= Difference between the PV at lower rate and the PV at higher rate R= Difference between the discount rates.155 15.877 20..15%) 100840 100000 = 15..170 11.000 4 ------20.ICO CIF3 CIFn CIF1 CIF2 .22% 60.000 0.. ... 1 2 3 (1 r ) (1 r ) (1 r ) (1 r ) n 30000 30000 40000 45000 1 2 3 (1 r ) (1 r ) (1 r ) (1 r ) 4 ICO = 26100+22680+26320+25740 = 100840 100000 If r = 15% If r =16% ICO = 25860+22290+25640+24840 = 98630 By using interpolation tool.000 = 14...120 19.380 20.000 ICO CIF3 CIFn CIF1 CIF2 . ..420 59.674 20.657 0.000 2 ------20.220 11.... . 1 2 3 (1 r ) (1 r ) (1 r ) (1 r ) n 100000 year 1 2 3 4 Total 30000 40000 60000 40000 1 2 3 (1 r ) (1 r ) (1 r ) (1 r ) 4 Annual Discount Rate 14% Discount Rate 15% Cash flow PVF PV PVF PV 30.1.000 0.000 0..000 2 ------40.000 ICO CIF3 CIFn CIF1 CIF2 ....21.190 .. From the following data calculate Internal Rate of Return Years Outflows Inflows 0 1.756 60.570 IRR = LRD + NPVL x R PV LRD = Lower Rate Discount NPVL = Net Present Value at Lower rate PV= Difference between the PV at lower rate and the PV at higher rate R= Difference between the discount rates.000 ------1 ------30.592 23680 0..000 3 ------60.769 30760 0. .18.1.21.LRD = Lower Rate Discount NPVL = Net Present Value at Lower rate PV= Difference between the PV at lower rate and the PV at higher rate R= Difference between the discount rates.877 26310 0..000 0.869 40.657 40.571 121190 26070 30240 39420 22840 118570 By using interpolation tool.190 . 14.000 4 ------40.000 = 1.674 40440 0.000 0.00.. 11 .00. 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