May 2012 IAI

Q)...From the following capital structure determine the appropriate weighted
average cost of capital using the market value weights.
Equity shares 3800000
Preference shares 800000
Debentures 5000000
15% Bank Loan-Long term 1800000
14% Bank Loan-Short term 1400000
Trade creditors 600000

Additional information :
1. Equity shares include the existing 60000 shares having current market
value of Rs. 40 per share and the balance is net proceeds from the new issue
in the current year (issue price of the share, Rs 40, face value Rs. 10;
floatation cost per share Rs. 5) The projected EPS and DPS for the current
year are Rs. 8 and Rs. 5 respectively.
2. Dividend indicated on preference shares is 16%
3. Interest rate for debentures 15.5%
4. Corporate tax 35%
5. Dividend tax 10%
6. Market value of preference shares is 850000.

This seems like a tough one....
Please answer this.....
I also have 1 more doubt...
In some questions depriciation is not added in cost of good sold...
due to which the gross profit values that i obtain is differnt from solutions...
So that really should not be matter...right..???
untill our final answer is correct..!!!

thanks & regards

 

I have 1 more doubt....
Q14 (a). The MIT (educational institute) has residence strength of 786 students. In addition to other basic
amenities, MIT provides hot water during the 3 months in winter. It has two boilers which operate
alternatively in the morning and evening and uses Kerosene oil as fuel.
The operational duration of one boiler in the morning is 3 hours and 2 hours in the evening in November
and January. Due to the winter vacation in December operational duration of the boilers is 1.5 hours in the
morning and evening. Fuel consumption per hour is 10 liters @ Rs. 15 per liter.
One worker operates the boiler in mornings and evenings. The daily labour cost is Rs. 100. A
maintenance cost is Rs. 4000.
To promote green energy the MIT wishes to setup solar heaters instead of conventional heaters.
The operating parameters of the green proposal are estimated as:
1. Solar heaters required :10@ Rs. 15000 each
2. Per heater installation cost: Rs. 2000
3. Annual maintenance cost: Rs. 3000
4. Salvage costs of both existing boilers: Rs. 3000
5. Useful life 10 year with zero salvage value
MIT purchases the fuel on the first day of the season. The option is considered in November month.
(a) Evaluate the financial viability of green proposal @ 12% RDR. You should make appropriate and
rational assumptions if necessary. [16 marks]
(b) Explain the non-financial considerations involved in making the decision [4 marks]
Ans 14 (1).
Financial analysis related to replacement of existing boilers Marks
Incremental cash flows:
Cost of solar
heaters 150,000
installation cost 20,000
Less Salvage value of existing boilers 3,000
167,000 2
Incremental Cash flows and NPV
Saving in fuel 59,700
Saving in labour 9,200
Saving in maintenance cost
1,000
Total saving 69,900
10 year annuity factor 6.33
Total PV 442,345 1
Less cash out flows 167,000
NPV 275,345 2
Recommendation: Since NPV is positive the proposal is viable
Working note
Nov Dec Jan
Use of boiler per day
5
3
5
Fuel per hour
10
10
10
Days
30
31
31
Total fuel used 1,500
930 1,550
Cost of fuel
15
15
15
Total cost of fuel 22,500 13,950 23,250 5
Working note 2
Total No of days
30
31
31
Labour cost
100
100
100
Total saving 3,000 3,100 3,100
Note 3
As MIT is educational institute so there is no tax implication 2


In this answer How is value of 10 year annuity factor determined...???????

Regards

 

Hardik, For your 1st question I would like to tell you that for there you will just have to find out the cost for each source of finance except the short term finance because such finance is not included in the weighted average cost of capital.
Since you are given the EPS and DPS you can find out the % profits that are given to the shareholders after the payment of dividends.
Then you can find the cost of equity of existing capital only for dividends given to them i.e. (dividend per share/price of share)
and then similarly for new capital raised (whose price of share will be taken after deducting flotation cost).
Then Debentures and Bank Loan cost can be found and should be calculated net after taking taxation into consideration.
Similarly for preference share you can find out dividend and then the corresponding tax on it divided by market price of shares.
Finally we can total all the cost of debt and capital and then divide it by total capital to get the answer.


**Assuming you have the solution