Mini Case Of Cost Of Capital 4z5iw
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FINANCIAL MANAGEMENT SUBMITTED TO: Dr. Ajay Verma
SUBMITTED BY: Prerna Sinha Jalpa Madeka Shimona Rashi Manika Khandelwal Poonam Jajodia Vaishali Burdak
MINI CASE OF COST OF CAPITAL
SUMMARY
Suman Joshi, Managing director of omega textile, was reviewing two very different investment proposals. The first one is for expanding the capacity of the current project and the second is for diversifying into a new line of business.
We need to find WACC (Weighed Average Cost Of Capital) with the help of following data Liabilities
Amount
1200 Assets
Amount
Equity Capital
350
Fixed Assets
700
Preference Capital
100
Investment
100
Reserve and Surplus
200
Current Assets , Loans and Advances
400
Debentures
450
Current Liabilities and Provisions
100
1200
1200
• Omega’s target capital structure has 50 percent equity, 10 percent preference, and 40 percent debt • Omega has Rs.100 par, 10 percent coupon, annual payment, non-callable debenture with 8 year to maturity. These debentures are currently selling at RS.112 • Omega has Rs.100 par, 9 percent, annual dividend, preference share with residual maturity of 5 years. The market price of these preference shares is Rs.106
• Omega’s equity share is currently selling at Rs.80 per share. Its last dividend was Rs.2.80 and the dividend per share is expected to grow at a rate of 10 percent in future • Omega’s equity beta is 1.1, the risk free rate is 7 percent, and the market risk is estimated to be 7 percent • Omega’s tax rate is 30 percent
• The new business that Omega is considering has different financial characteristics than Omega’s existing business. Firm engaged purely in such business have, on an average, the following characteristics: Their capital structure has debt and equity in equal proportion. Their cost of debt is 11 percent. Their equity beta is 1.5.
Ques. What is Omega’s posttax cost of debt ? Denotations: r – 10% Bv -100 Bo -112 N – 8 yrs Formula for finding Kd Current value of debenture = interest (PVIFA At 7% 112 = 10(PVIFA 7%, 8) + 100(PVIF = 10(5.971) + 100(0.582) =59.71+58.2 =117.91 At 8% 112 = 10(PVIFA 8%, 8) + 100(PVIF = 10(5.747) + 100(0.540) = 57.47 + 54.0 = 111.47
7%, 8
)
8%, 8
)
Kd, n
) +maturity value (PVIF
Kd, n
)
Interpolation: Actual 112
Difference 5.91
At 7%
117.91 6.44
At 8%
111.47
= 0.07 + (0.08-0.07)5.91/6.44 =7.92 % Post tax cost of debt = 7.92(1-0.30) = 5.54 %
Ques. What is Omega’s cost of preference? Denotations: r – 9% Bv -100 Bo -106 N – 5 yrs Formula for finding Kp Current value of share = interest (PVIFA +maturity value (PVIF Kp, n)
Kp, n
)
At 7% 106 = 9(PVIFA
) + 100(PVIF
7%, 5
7%, 5
)
8%, 5
)
= 9(4.100) + 100(0.713) =36.9 + 71.3 =108.2 At 8% 106 = 9(PVIFA
) + 100(PVIF
8%, 5
= 9(3.993) + 100(0.681) = 35.937 + 68.1 = 104.03
Interpolation: Actual
106
Difference 2.2
At 7%
108.2 4.17
At 8%
104.03
= 0.07 + (0.08-0.07)2.2/4.17 =7.53
Ques. What is Omega’s estimated cost of equity using dividend discount model?
Div0 = 2.80 P0
=80
G
=10%
Ke = Div1 / P0 + g =2.80(1.10)/80+ 0.10 = 0.385 + 0.1080= 0.1385 = 13.85%
Ques. What is Omega’s estimated cost of equity using the capital asset pricing model?
Denotations: Rm- 7 (Rm-Rf)-7 β- 1.1 Ke= Rf+ (Rm-RF) β = 7 + 1.1(7) = 14.70%
Ques. What is Omega’s WACC using CAPM for the cost of equity?
Sources of fund
Proportio n
Cost
WACC
Equity
0.5
14.7
7.35
Preference
0.1
7.53
0.753
Debentures 0.4
5.54
2.216 10.319
Ques. What would be your estimate cost of capital for the new business?
Sources of Fund
Proportio n
Cost
WACC
Equity
0.5
17.5
8.75
Debenture
0.5
7.7
3.85
12.6
Ke = Rf + (Rm-Rf) β = 7 + (7) 1.5 = 17.5%
SUBMITTED BY: Prerna Sinha Jalpa Madeka Shimona Rashi Manika Khandelwal Poonam Jajodia Vaishali Burdak
MINI CASE OF COST OF CAPITAL
SUMMARY
Suman Joshi, Managing director of omega textile, was reviewing two very different investment proposals. The first one is for expanding the capacity of the current project and the second is for diversifying into a new line of business.
We need to find WACC (Weighed Average Cost Of Capital) with the help of following data Liabilities
Amount
1200 Assets
Amount
Equity Capital
350
Fixed Assets
700
Preference Capital
100
Investment
100
Reserve and Surplus
200
Current Assets , Loans and Advances
400
Debentures
450
Current Liabilities and Provisions
100
1200
1200
• Omega’s target capital structure has 50 percent equity, 10 percent preference, and 40 percent debt • Omega has Rs.100 par, 10 percent coupon, annual payment, non-callable debenture with 8 year to maturity. These debentures are currently selling at RS.112 • Omega has Rs.100 par, 9 percent, annual dividend, preference share with residual maturity of 5 years. The market price of these preference shares is Rs.106
• Omega’s equity share is currently selling at Rs.80 per share. Its last dividend was Rs.2.80 and the dividend per share is expected to grow at a rate of 10 percent in future • Omega’s equity beta is 1.1, the risk free rate is 7 percent, and the market risk is estimated to be 7 percent • Omega’s tax rate is 30 percent
• The new business that Omega is considering has different financial characteristics than Omega’s existing business. Firm engaged purely in such business have, on an average, the following characteristics: Their capital structure has debt and equity in equal proportion. Their cost of debt is 11 percent. Their equity beta is 1.5.
Ques. What is Omega’s posttax cost of debt ? Denotations: r – 10% Bv -100 Bo -112 N – 8 yrs Formula for finding Kd Current value of debenture = interest (PVIFA At 7% 112 = 10(PVIFA 7%, 8) + 100(PVIF = 10(5.971) + 100(0.582) =59.71+58.2 =117.91 At 8% 112 = 10(PVIFA 8%, 8) + 100(PVIF = 10(5.747) + 100(0.540) = 57.47 + 54.0 = 111.47
7%, 8
)
8%, 8
)
Kd, n
) +maturity value (PVIF
Kd, n
)
Interpolation: Actual 112
Difference 5.91
At 7%
117.91 6.44
At 8%
111.47
= 0.07 + (0.08-0.07)5.91/6.44 =7.92 % Post tax cost of debt = 7.92(1-0.30) = 5.54 %
Ques. What is Omega’s cost of preference? Denotations: r – 9% Bv -100 Bo -106 N – 5 yrs Formula for finding Kp Current value of share = interest (PVIFA +maturity value (PVIF Kp, n)
Kp, n
)
At 7% 106 = 9(PVIFA
) + 100(PVIF
7%, 5
7%, 5
)
8%, 5
)
= 9(4.100) + 100(0.713) =36.9 + 71.3 =108.2 At 8% 106 = 9(PVIFA
) + 100(PVIF
8%, 5
= 9(3.993) + 100(0.681) = 35.937 + 68.1 = 104.03
Interpolation: Actual
106
Difference 2.2
At 7%
108.2 4.17
At 8%
104.03
= 0.07 + (0.08-0.07)2.2/4.17 =7.53
Ques. What is Omega’s estimated cost of equity using dividend discount model?
Div0 = 2.80 P0
=80
G
=10%
Ke = Div1 / P0 + g =2.80(1.10)/80+ 0.10 = 0.385 + 0.1080= 0.1385 = 13.85%
Ques. What is Omega’s estimated cost of equity using the capital asset pricing model?
Denotations: Rm- 7 (Rm-Rf)-7 β- 1.1 Ke= Rf+ (Rm-RF) β = 7 + 1.1(7) = 14.70%
Ques. What is Omega’s WACC using CAPM for the cost of equity?
Sources of fund
Proportio n
Cost
WACC
Equity
0.5
14.7
7.35
Preference
0.1
7.53
0.753
Debentures 0.4
5.54
2.216 10.319
Ques. What would be your estimate cost of capital for the new business?
Sources of Fund
Proportio n
Cost
WACC
Equity
0.5
17.5
8.75
Debenture
0.5
7.7
3.85
12.6
Ke = Rf + (Rm-Rf) β = 7 + (7) 1.5 = 17.5%
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