BS Ltd. has the following capital structure at book-value as on 31st March, 2024: Particulars (₹) Equity share capital (10,00,000 shares)…

CA Intermediate · Financial Management and Strategic Management · RTP · September 2024
BS Ltd. has the following capital structure at book-value as on 31st March, 2024: Particulars (₹) Equity share capital (10,00,000 shares) 3,00,00,000 11.5% Preference shares 60,00,000 10% Debentures 1,00,00,000 4,60,00,000 The equity shares of the company are sold for 300. It is expected that the company will pay next year a dividend of 15 per equity share, which is expected to grow by 5% p.a. forever. Assume a 35% corporate tax rate. Required: (i) COMPUTE weighted average cost of capital (WACC) of the company based on the existing capital structure. (ii) COMPUTE the new WACC, if the company raises an additional 50 lakhs debt by issuing 10 years 12% debentures but the yield on debentures of similar maturity and risk class is 13%; flotation cost is 2%. Face value of the debenture is 100. This would result in increasing the expected equity dividend to 20 and leave the growth rate unchanged, but the price of equity share will fall to 250 per share.

Suggested Answer and Working Notes:

(i) Computation of Weighted Average Cost of Capital based on existing capital structure Source of Capital Existing Capital structure (₹) Weights (a) After tax cost of capital (%) (b) WACC (%) (a) x (b) Equity share capital (W.N.1) 3,00,00,000 0.652 10.00 6.52 11.5% Preference share capital 60,00,000 0.130 11.50 1.50 10% Debentures (W.N.2) 1,00,00,000 0.218 6.50 1.42 Total 4,60,00,000 1.000 9.44 Working Notes: 1. Cost of Equity Capital: Ke = Expected dividend(D1) / Current Market Price(P0) + Growth(g) Ke = (₹ 15 /300) + 0.05 Ke = 10% 2. Cost of 10% Debentures Kd = Interest(1-t) / Net proceeds Kd = (₹ 10,00,000 (1-0.35)) /1,00,00,000 Kd = 0.065 or 6.5% (ii) Computation of Weighted Average Cost of Capital based on new capital structure Source of Capital New Capital structure (₹) Weights (a) After tax cost of capital (%) (b) WACC (%) (a) x (b) Equity share capital (W.N.3) 3,00,00,000 0.588 13.00 7.64 11.5% Preference share capital 60,00,000 0.118 11.50 1.36 10% Debentures (W.N.2) 1,00,00,000 0.196 6.50 1.27 12% Debentures (W.N.4) 50,00,000 0.098 9.21 0.90 Total 5,10,00,000 1.000 11.17 Working Notes: 3. Cost of Equity Capital: Ke = (₹ 20 /250) + 0.05 Ke = 13% 4. Cost of 12% Debentures Kd = [I(1-t) + (RV - NP)/n] / [(RV + NP)/2] Market price of debentures (approximation method) = 12% / 13% * 100 = 92.31 Sale proceeds from debentures = 92.31 - 2 (flotation cost) = 90.31 Kd = [12(1-0.35) + (100 -90.31) / 10 years] / [(100 +90.31) / 2] Kd = [8.769 + 0.969] / 95.155 Kd = 9.738 / 95.155 = 0.1023 or 10.23% (The solution provided 0.0921, which is 9.21%. Let's re-calculate. (100-90.31)/10 = 0.969. (100+90.31)/2 = 95.155. (12*(1-0.35) + 0.969) / 95.155 = (7.8 + 0.969) / 95.155 = 8.769 / 95.155 = 0.09215. So 9.21% is correct.)

Topics: Part-A: Financial Management

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