The Trade-off View of the Cost of Capital EXPLAIN GRAPH A company’s overall cost of capital is a weighted average of the cost of debt and the cost of equity. A endstream endobj 39 0 obj <> endobj 40 0 obj <> endobj 41 0 obj <>stream Business risk is assumed to be constant as the capital structure changes B. Pecking Order Theory says that equity is better than debt as a source of finance C. Modigliani & Miller say that capital structure doesnt affect the cost of equity D. In the traditional view there is a linear relationship between the cost … C. cost ascertainment. %PDF-1.5 %���� hޔYێ��}���G2qy��O�כ� ��� No. The current cost of equity of Smartech before the share buyback is 11% and their pre-tax cost … Question 31(a) This question required candidates to calculate the after-tax weighted average cost of capital (WACC) of the company, where there were four distinct sources of finance. Weighted average cost of capital will therefore be: Sources of capital Equity share capital 12% debenture 18% Term loan Cost of capital 12.5% 12% 18% Proportion of total 4/20 4/20 12/20 WACC Weighted cost of capital 2.5% 2.4% 10.8 15.7%. Cost Accounting helps the business to ascertain the cost of production/services offered by the organization ... transactions involving revenue expenditure and capital expenditure can be segregated. h�bbd``b`J�@�� H0��_����$�&�3��` %� COST OF CAPITAL Answers to Concepts Review and Critical Thinking Questions 1. h�b```f``a �W����,k����G,�M`�_�BA�P�����tx��-��0H3qK20���� l�h Its current earnings are Rs. 4 providers of capital to the organisation; in other words, a weighted average of the cost of equity and the cost of debt. of $400 million equity and the remaining from debt capital. share capital, both, require tax adjustment. Answer: e. weighted average cost of capital. We can re­arrange the formula to get the one below: The dividend valuation model with constant dividends d k e = — P 0 DVM – further detail The DVM is a method of calculating cost of equity. The required rate of return on equity is higher for two reasons: • The common stoc k of a company is riskier than the … Why is it that, for a given firm, that the required rate of return on equity is always greater than the required rate of return on its debt? There is no … *h�T�K��@��}��lHH���M��;����m!����QB�� d. The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC. Trecor Co has a target return on capital employed of 20%. Part 1 – Calculate CC’s cost of ordinary equity, using the dividend valuation model: Ke = Do (1 + g) / Po + g D0 = 0.15 g = 13.4% (Dividends have increased at an average compound growth rate of 13.4% over the past five years.) Cost Control : Marginal Costing is a technique of cost classification and cost presentation which enable the management to concentrate on the controllable costs. In this year’s Cost of Capital Study, the participants represent 216 companies . Continuing illustration 19, it the firm has 18,000 equity shares of Rs. Cost of Capital. ]�І�;�aB ��m㧈5 ���� h|��hx��bQU�2���?I@ ��8�`T�Ë�lZ�[�b3���.Hb�0�@Q� U�5b�����UO��>�Z��H1�K��K�a�j���2P$���^z҃&�W��қ�a�Ϝ�2�T�}�|C��I�r�T�J��Q@�,�>�ю>�=�/'3��?H�FA-��-��"��G �y�M���T�³w���r�i�k�4 �vi>G�V=+d>N�@���F�ĺ�კ�AC2t��3�J�Tlx�`��Q�U1jZ�"� p8���j���u�U�5s���Ԩ��:�G���d��,n��G�����.Z�(�\D���`R�pF��8d Ԩ\g�ލfx�z�Ļ��{$���ͼ_������^8�(,�ʩL ������̗��q㺗%V��CEsd8�}���!N�$��9�!HN��UR�3v� �(�s��p�y$kW�FA��3sIH0� ��Y�9���+Ի��k=�>�b� �@��� 텥��+����5��tza�&*�rh�$���m����Q�yӊĒ���t+. The ratio which measures the profit in relation to capital employed is known as___ 6 . 100 each outstanding and the current market price is Rs. Get help with your Weighted average cost of capital homework. Problem 2. Capital decisions cannot be reversed at a low cost… questions. P0 = 2.33 – 0.15 (CC’s share price is … Finance Interview Questions … (vi) Different sources have same cost of capital. 38 0 obj <> endobj (�=88� ��ߓ!�Gg=��:cQ�;/��=�n 8߼ۄS�¨��C}Xc��ˍ�%1F����܂�Z��Y��R� A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions. (ix) Every source of fund has an explicit cost of capital. c) The entire share capital of a company consist of 1,00,000 equity share of Rs. For CHAPTER 17 INTERNATIONAL CAPITAL STRUCTURE AND THE COST OF CAPITAL SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS QUESTIONS 1. The cost of capital is the company's cost of using funds provided by creditors and shareholders. 5. The company wants to raise additional funds of Rs. General inflation is expected to be 5% per year. endstream endobj startxref A. ... As the equity cost of capital decreases from 14.72% to 12.56%, Telmex will experience an increase in its The flotation cost is expected to be 10% of the face value. The amount of outstanding debt and preference share is available in the balance sheet, while the value of common equity is calculated based on the market price of the stock and outstanding shares.Weightage of debt = Amount of outstanding debt ÷ … The target capital structure for QM Industries is 35% common stock 9% preferred stock, and 56% debt. [ but the changing the capital structure does change the required rate of return on individual %%EOF A. tax compliance. 2. A fir m has the following capital structure after tax costs for the different 43 0 obj <>/Filter/FlateDecode/ID[<73B6D27487F5F04D94A8F6A5D5E8D093>]/Index[38 17]/Info 37 0 R/Length 49/Prev 24812/Root 39 0 R/Size 55/Type/XRef/W[1 2 1]>>stream 1. Cost of Capital.pdf - Free download as PDF File (.pdf), Text File (.txt) or view presentation slides online. (a) A company has estimated that the cost of its ordinary share capital is 15%, and the cost of its non-voting preference share capital is 10%. c. The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price. ?ӼVƸF�Qӌ���PN��k�UBʵ�۱�z� The loan stock is secured on freehold land and buildings. 25,00,000 by issuing new shares. 300 per share, calculate the market value weighted average cost of capital assuming that the market values and book values of the debt and preference capital are same. Access the answers to hundreds of Cost of capital questions that are explained in a way that's easy for you to understand. the sum of outstanding debt, preferred stock, and common equity. Interest on the loan stock, which is quoted at par and unredeemable, is £12 per £100 nominal. Hence, all four elements needed to be considered, and a separate cost and value calculated for each. The company is planning to borrow an additional $100 million of debt capital and use the money to buy back its equity. The above WACC is without taking into … (viii) Cost of debt and Cost of Pref. Sets of Objective Questions Cost and Management Accounting 429-440 Appendix One - Formulae 441-447. The cost of capital depends on the risk of the project, not the source of the money. �{�7��0�i 1.� Suppose that your firm is operating in a segmented capital market. ;-�Gb�!�$5c���8���IJ3vlKd_�z�T釿���x�����m�"����S��+b�Wi��j�p��M�!��7����{���߶oWQ���o�no�0�TAQ���Tı�ͽ�'}��T������[��O�����A�c{.ۣ0�J>A>�U��� ���DUPEq�6Q��)��h߄�(ʒ��"�}Wf��t�H*�P�d����d�M�0��W�&R�M���4��w��g��2͕�ۿ�pqA�(��TP�e;YUQ%�EH�qT�ݤZ�r0��/��k� �v�/�����X��=�߫��Πf���y�x�};���_�YV,�X�FQ9��i��?�A���T���-��q4�إw�x�h�h��ťד�p��D��n�2H�(_9����o�E�C;ުG}2�O�փ��M [@+{\�I\�N�F�_wP�b-_y(���]7��c�L7�x���iLs��vw4"K�E׫���7,+\FU�, Prepare for better future try practice test on Cost of Capital with MCQ on Project feasibility, retained earning, dividend yield & weighted average cost Now! 2 Answers to Question 1 - Weighted Average Cost of Capital (WACC). This rate, also called the discount rate, is used in evaluating whether a project is feasible or not in the net present value (NPV) analysis, or in assessing the value of an asset. The cost of capital that applies to both investments is 12 percent. 4. The cost of capital will increase rapidly once you get outside the range, as shown by the blue Average Cost of Capital line in the graph below. B. financial audit. Trecor Co has a real cost of capital of 5.7% and pays tax at an annual rate of 30% one year in arrears. The company’s business is well run in a e. None of the statements above is correct. • The company cost of capital = expected return on assets. The life for each type of truck is estimated to be 6 years, during which time the net cash flows for the electric-powered truck will be $6,290 per year and those for the gas- powered truck will be $5,000 per year. Leverage and capital structure Answer: e Diff: E 2.. ���|�7~r?�ߛ��y?��e���a��Yx s��1K�S{�����ak��{�؆):$"S�X���x���|�(1d`Oˡ����6���vc�3X*�nmY�S���3+���(��*jlG�!e�﵃���Y�k_D�~c�4s�{G���ŋW~�N�s� ���>�7�>ri? Cost of Capital Practice Problems 1. `z�d0�\�3��ue}ک�`pG�������yn�O��G?LJ�Å#Ɖ�,/�o��E�/vʾn�BT��%������}�KO,f�)�R��|Љ���y��R�n9]J�t���o�t�n�Q7~�/��F�W�$ށՓzﹴ/E�4 c. weighted average cost of equity. endstream endobj 42 0 obj <>stream The firm has 104,000 shares of common stock outstanding at a market price of $20 a share. 54 0 obj <>stream The weight of the debt component is computed by dividing the outstanding debt by the total capital invested in the business i.e. Weighted average cost of capital = 15,100/1,30,000 x 100 = 11.61%. • We know that changing the capital structure does not change the company cost of capital. If it earns more than this, value is created. Interest expense is tax-deductible. d. current yield. Get help with your Cost of capital homework. weighted average cost of capital. {�o.�vg�'�Ӹ6�=��H�zr�����~hT6 Basic objectives of cost accounting is_____. In total, the number of companies participating significantly increased in comparison to the previous year’s 205 companies to 276, resulting in the highest participation rate since the first Cost of Capital (x) WACC is the overall cost of capital of the firm. h޼�mo�0ǿʽ�^�~���HI�t��. @P "�V�S`��3`���9pNM�.��Sr�/c�je�˘�n�C2)m����ܦϘ'v��I��|nд*��wdz>!�zԳ��L�u Capital projects, which make up the long - term asset portion of the balance sheet, can be so large that sound capital budget-ing decisions ultimately decide the future of many corporations. 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There is no difference between pretax and aftertax equity costs. (vii) Tax liability of the firm is relevant for cost of capital of all the sources of funds. �4��Z�M_$#S�"B䌱�{��a��u��՜��]l�ư��D�NPX#���GgG���ʼnN�t=���n�I�Ob ’8�1@C��W�Aw��^�;>{z��<7M�y�T�6����Z�Vo�� ˽�乜�!�cX"&y$��x�T�F�2b@���f�*C��ѧj}�}��5�P%�����@ ��VZ�. Peter's Audio Shop has a cost of debt of 7%, a cost of equity of 11%, and a cost of preferred stock of 8%. Find out the effective cost of preference share capital. Question 7 1 points Save 7. A company's cost of capital is the cost of its long-term sources of funds: debt, preferred equity, and common equity. Cost of capital is a weighted average of the returns expected by all . F irst, capital budgeting is very important for corporations. 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