Lavanya Limited wishes to raise additional finance of 20 lakhs for meeting its investment plans. It has - 4,20,000 in the form of retained earnings…

(a) Pattern for raising the additional finance: Equity 70% of 20,00,000 = 14,00,000 Debt 30% of 20,00,000 = 6,00,000 The capital structure after raising additional finance: (₹) Shareholders' funds Equity Capital (₹ 14,00,000 - 4,20,000) 9,80,000 Retained earnings 4,20,000 Debt (Interest at 8% p.a.) 3,60,000 (Interest at 12% p.a.) (₹ 6,00,000 - 3,60,000) 2,40,000 Total Funds 20,00,000 (b) Determination of post-tax average cost of additional debt: K d = I (1-t) Where, I = Interest Rate t = Corporate tax-rate On 3,60,000 = 8% (1 – 0.3) = 5.6% or 0.056 On 2,40,000 = 12% (1 – 0.3) = 8.4% or 0.084 Average Cost of Debt = [(₹ 3,60,000 × 0.056) + (₹ 2,40,000 × 0.084)] /6,00,000 × 100 = 6.72% (c) Determination of cost of retained earnings and cost of equity by applying Dividend growth model: K e or K r = (D 1 /P o ) + g = [D o (1+g)/P o ] + g Where, D o = Dividend paid = 40% of EPS = 40% × ₹ 5 = 2 g = Growth rate = Retained Earnings x Rate of Return = 0.6 x 0.10 = 0.06 or 6% P o = Current market price per share = 53 K e or K r = [2(1+0.06)/53] + 0.06 = (2.12/53) + 0.06 = 0.04 + 0.06 = 0.10 or 10% (d) Computation of overall weighted average after tax cost of additional finance: Particulars Amount (₹) Weights Cost of funds Weighted Cost (%) Equity (including retained earnings) 14,00,000 0.70 10% 7 Debt 6,00,000 0.30 6.72% 2.016 WACC 20,00,000 9.016