Ram Ltd evaluates all its capital projects using discounting rate of 16%. Its capital structure consists of equity share capital, retained earnings,…

Working Note: Let the rate of Interest on debenture be x Rate of Interest on loan = 1.4x k d on debentures = [Int(1-t) + (RV-NP)/n] / [(RV+NP)/2] k d = [100x(1-0.30) + (100-98)/4] / [(100+98)/2] k d = [70x + 0.5] / 99 k d on bank loan = 1.4 x (1 - 0.30) = 0.98x K e = EPS / (MPS/EPS * PE) = 1 / PE = 1/4 = 0.25 K e = 0.25 Computation of WACC Capital Amount Weights Cost Product Equity 20,00,000 0.2 0.25 0.05 Reserves 30,00,000 0.3 0.25 0.075 Debentures 30,00,000 0.3 (70x+0.5)/99 (21x+0.15)/99 Bank Loan 20,00,000 0.2 0.98x 0.196x 1,00,00,000 1 0.125 + 0.196x + (21x+0.15)/99 WACC = 16% 0.125 + 0.196x + (21x+0.15)/99 = 0.16 Multiply by 99: 12.375 + 19.404x + 21x + 0.15 = 0.16 * 99 12.525 + 40.404x = 15.84 40.404x = 15.84 - 12.525 40.404x = 3.315 x = 3.315 / 40.404 x = 0.082049 ≈ 8.20% (i) Rate of interest on debenture = x = 8.20% (ii) Rate of interest on Bank loan = 1.4x = (1.4)(8.20%) = 11.48%.