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## Cost of Capital ### Step 3: Calculate the Weighted Average Cost of Capital (Ko) * K = (KW) + (KW) ### Step 4: Ascertain the Lowest Ko ### Step 5: Ascertain the Debt-Equity Mix The Debt-Equity Mix which corresponds to the lowest Ko is considered to be the optimal one. ## Capital Structure...

## Cost of Capital ### Step 3: Calculate the Weighted Average Cost of Capital (Ko) * K = (KW) + (KW) ### Step 4: Ascertain the Lowest Ko ### Step 5: Ascertain the Debt-Equity Mix The Debt-Equity Mix which corresponds to the lowest Ko is considered to be the optimal one. ## Capital Structure - Concept and Planning A company wishes to determine the optimal capital structure from the following information. Determine the optimum capital structure from the viewpoint of minimizing the cost of capital. | Financing Plan | Debt amount (Rs) | Equity amount (Rs)| After tax cost of debt (%) | Cost of Equity (%) | |---|---|---|---|---| | A | 8,00,000 | 2,00,000 | 14 | 20 | | B | 6,00,000 | 4,00,000 | 13 | 18 | | C | 5,00,000 | 5,00,000 | 12 | 16 | | D | 2,00,000 | 8,00,000 | 11 | 18 | **(Ans.: Plan 'C')** ## For Varying Levels of Debt-Equity Mix The estimates of the cost of debt (after tax) and cost of equity capital are given below | Debt as % of total capital employed | Cost of debt (%) | Cost of Equity (%) | |---|---|---| | 0 | 7 | 15 | | 10 | 7 | 15 | | 20 | 7 | 16 | | 30 | 8 | 17 | | 40 | 9 | 18 | | 50 | 10 | 21 | | 60 | 11 | 24 | You are required to decide the optimum debt-equity mix for the company by calculating composite cost of capital **(Ans.: 10/90, K = 14.2%, 20/80 = 14.2%)** ## A company has a share capital of Rs. 10,00,000 The company has a share capital of Rs. 10,00,000 divided into equity shares of Rs. 10. It has the major expansion programme requiring an additional investment of Rs. 5,00,000. The financial manager is considering the following alternatives for raising this amount. * Issue of 50,000 equity shares at par * Issue of 50,000 12% preference shares of Rs. 10 each * Issue of 10% debentures of Rs. 5,00,000 The company's present earnings before interest and tax are Rs. 4,00,000 p.a. You are requested to calculate the effect of each of the above modes of financing on E.P.S. and suggest the best alternative if: * EBIT continues to the same even after expansion * EBIT increases by Rs. 1,00,000. Assume tax rate 50% **(Ans.: (i) EPS = 1.33, 1.40, 1.75, (ii) EPS = 1.67, 1.90, 2.25)** ## The Present Capitalisation of a Company | | Rs | |---|---| | 4,000 5% Debentures of Rs. 100 each | 4,00,000 | | 2,000 8% Redeemable Preference Shares of Rs. 100 each | 2,00,000 | | 40,000 Equity Shares of Rs. 10 each | 4,00,000 | | | 10,00,000 |