The capital structure of Shine Ltd. as on 31.03.2024 is as under: Particulars Amount (₹) Equity share capital off 10 each 45,00,000 15% Preference…

CA Intermediate · Financial Management and Strategic Management · PYQS · May 2024
The capital structure of Shine Ltd. as on 31.03.2024 is as under: Particulars Amount (₹) Equity share capital off 10 each 45,00,000 15% Preference share capital of 100 each 36,00,000 Retained earnings 32,00,000 13% Convertible Debenture off 100 each 67,00,000 11% Term Loan 20,00,000 Total 2,00,00,000 Additional information: (A) Company issued 13% Convertible Debentures of 100 each on 01.04.2023 with a maturity period of 6 years. At maturity, the debenture holders will have an option to convert the debentures into equity shares of the company in the ratio of 1 : 4 (4 shares for each debenture). The market price of the equity share is 25 each as on 31.03.2024 and the growth rate of the share is 6% per annum. (B) Preference stock, redeemable after eight years, is currently selling at 150 per share. (C) The prevailing default-risk free interest rate on 10-year GOI treasury bonds is 6%. The average market risk premium is 8% and the Beta (β) of the company is 1.54. Corporate tax rate is 25% and rate of personal income tax is 20%. You are required to calculate the cost of: (i) Equity Share Capital (ii) Preference Share Capital (iii) Convertible Debenture (iv) Retained Earnings (v) Term Loan

Suggested Answer and Working Notes:

(i) Cost of Equity Share capital As per CAPM Model K e = R f + β (R m - R f ) R f = 6% β = 1.54 R m -R f = 8% K e = 6% + 1.54(8%) K e = 18.32% (ii) Cost of Preference Share capital n = 8 Net Proceeds (NP) = 150 Redemption Value (RV) = 100 Preference Dividend (PD) = 15 K p = PD + (RV-NP) n (RV+NP) 2 K p = 15 + (100-150) 8 (100+150) 2 K p = 7% Alternatively, if we take NP as 100 and RV as 100, then solution can be done in the following way: Cost of Preference Share capital n = 8 Net Proceeds (NP) = 100 Redemption Value (RV) = 150 Preference Dividend (PD) = 15 K p = PD + (RV-NP) n (RV+NP) 2 K p = 15 + 150-100 8 150+100 2 K p = 17% (iii) Cost of convertible debenture Cash Redemption Value (RV) = 100 Share Redemption Value (RV): Value of share after 5 years = 25 x (1.06) 5 = 33.46 Share Redemption Value (RV) = 33.46 X 4 = 133.82 Therefore, investor will choose share redemption. Redemption Value (RV) = 133.82 Net Proceeds (NP) = 100 n = 5 Interest (i) = 13 Tax (t) = 25% K d = I(1-t) + (RV-NP) n (RV+NP) 2 K d = 13(1-0.25) + (133.82-100) 5 (133.82+100) 2 K d = 14.13% (iv) Cost of Retained Earnings K r = K e (1-t p ) = 18.32 % x (1-0.20) = 14.66% We can also take cost of equity as cost of retained earnings, Accordingly, K r = K e = 18.32% (v) Cost of Term Loan = 11% x (1-0.25) = 8.25%

Topics: Part-A: Financial Management

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