Capital structure of T Limited as on 1st April, 2024 is as under: Particulars ₹ Equity Share Capital (10 per share) 50,00,000 10% Debentures (100…

CA Intermediate · Financial Management and Strategic Management · PYQS · September 2024
Capital structure of T Limited as on 1st April, 2024 is as under: Particulars ₹ Equity Share Capital (10 per share) 50,00,000 10% Debentures (100 per Debenture) 40,00,000 12% Preference Share Capital (10,000 shares of 100 each) 10,00,000 Additional Information: (1) The risk free rate of return is 10%. The Beta of T Ltd. is 1.75 and the return on market portfolio is 12%. The Equity shares have a current market price of 70 per share. (2) The debentures are trading at a market price of 80 per debenture. The Debentures are to be redeemed after 5 years at par. (3) Preference shares are redeemable after 5 years at a premium of 5%, presently selling at 104 per share. (4) The Company pays tax at a rate of 30%. (5) The Cost of Debentures are to be calculated on Yield to Maturity approach. (6) The present value factors at 10% and 14% are: Year 1 2 3 4 5 PVIF0.10,t 0.909 0.826 0.751 0.683 0.621 PVIF0.14,t 0.877 0.769 0.675 0.592 0.519 You are required to calculate Weighted Average Cost of Capital (after tax) of T Limited using Market value weights.

Suggested Answer and Working Notes:

Cost of Equity Share Capital using Capital Asset Pricing Model (CAPM) Approach K e = R f + β (R m - R f ) K e = 0.10 + 1.75 (0.12 – 0.10) = 0.10 + 1.75 (0.02) = 0.135 or 13.5% Cost of Redeemable Debentures using Yield to Maturity (YTM) Approach Step-1: Identification of relevant cash flows Year Cash flows 0 Current market price (P o ) = 80 1 to 5 Interest net of tax [I(1-t)] = 10% of 100 (1-0.30) = 7 5 Redemption value (RV) = Face value i.e.100 Step- 2: Calculation of NPVs at two discount rates Year Cash flows (₹) Discount factor @ 10% (L) Present Value (₹) Discount factor @ 14% (H) Present Value (₹) 0 80 1.000 (80.000) 1.000 (80.000) 1 to 5 7 3.790 26.530 3.432 24.024 5 100 0.621 62.100 0.519 51.900 NPV +8.630 -4.076 Step- 3: Calculation of Cost of Debentures (K d ) K d = L + [NPV L / (NPV L - NPV H )] * (H-L) = 10% + [8.630 / (8.630 - (-4.076))] * (14%-10%) = 12.72% Cost of Redeemable Preference Share Capital using approximation method K p = [PD + (RV-NP)/n] / [(RV+NP)/2] K p = [12 + (105-104)/5] / [(105+104)/2] = 11.67% Calculation of WACC using market value weights Source of Capital Market Value Weights (a) After tax cost of capital (b) WACC (K o ) (c) = (a) x (b) Equity Share Capital (70x 5,00,000 equity shares) 3,50,00,000 0.8919 0.1350 0.1204 10% Debentures (₹ 80 × 40,000) 32,00,000 0.0816 0.1272 0.0104 12% Preference Share Capital (₹ 104 × 10,000 shares) 10,40,000 0.0265 0.1167 0.0031 3,92,40,000 1.000 0.1339 WACC (K o ) = 0.1339 or 13.39%

Topics: Part-A: Financial Management

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