Cost of Capital

1. Problem:-
J K brought public offer & has the following capital structure
Qty Rate Rs
1) Equity 5, 00,000 shares 20 1,00,00,000
2) 8% Preference 3, 00,000 shares 10 30,00,000
3) 10% Debentures 4,00,000 deb 15 60,00,000
Loan of Rs 35 lacs with interest at 12 %p.a.
The dividend on equity will increase from Rs 5 to Rs 8/ share.
Solution :-
According to the books of Account
Source Amount Weight After Tax Weight Weighted Cost
Amount
(a) (b) (a*b)
Equity 1,00,00,000 0.52 0.25 0.13 24,70,000
Preference 30,00,000 0.16 0.08 0.01 1,90,000
Share
Debentures 60,00,000 0.32 0.10 0.032 6,08,000
1,90,00,000 32,68,000
Cost of Capital (Equity)
Dividend = Rs 5/ Share
Par Value = Rs 20/ Share
5/20 * 100 = 25%
Weighted cost of Capital
17.2% 32, 68,000/1, 90, 00,000 * 100 =
After taking Loan

2. Source Amount Weight After Tax Weight Weighted
Amount (b) Cost
(a) (a * b)
Equity 1,00,00,000 0.45 0.4 0.18 40,50,000
Preference 30,00,000 0.14 0.08 0.0112 2,52,000
Share
Debentures 60,00,000 0.27 0.10 0.027 6,07,500
Loan 35,00,000 0.14 0.12 0.0168 3,78,000
2,25,00,000 52,87,500
Cost of Capital (Equity)
Dividend = Rs 8/ Share
Par Value = Rs 20/ Share
8/20 * 100 = 40%
Weighted cost of Capital
52, 87,500 / 2, 25, 00,000 * 100 = 23.5%
Weighted average cost of capital after taking loan is more than that not having a loan
borrowed.