Weighted average cost of capital

After calculating the cost of each component of capital, average cost of capital is general
calculated on the basis of weighted average method. Weights are given in proportion to each
source of funds in capital structure, then weighted average cost of capital is calculated. This
average cost of capital provides us a measure of the minimum rate of return which the proposed
investment must earn to become acceptable. The weighted average cost of capital occupies an
important place in finance. In financial decision making the after tax cost of capital is more
relevant.
The WACC can certainly be computed on after tax basis. In its calculation, each source of capital
funds gets the weight age according to its contribution in the total capital. In practice, different
sources of funds are used in different proportions.
The computation of the WACC involves the following steps:
1. Calculate the cost of each specific sources of funds on after tax basis include cost of debt.
2. Assign weights to all specific costs either in the form of ratios or proportions etc.
3. Weights may be either book value or market value weights.
The use of market value weights for calculating WACC is more appealing on account of
following reasons:
1. The market value of the securities is closely approximately to the actual amount to be
received from the sale of such securities.
2. The cost of each specific source of finance which constitutes the capital structure is
calculated according to the prevailing market price.
However, the use of market value as weights is subject to the following practical difficulties
- It may fluctuate considerably
- It is not readily available when compared to book value.
-

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 1

 1. From the following capital structure of a company, calculate the overall cost of capital,
using
a. Book value weights
b. Market value weights
Sources Book value Market
Value
Equity share capital (Rs. 10 per share) 45,000 90,000
Retained earnings 15,000 -
Preference share capital 10,000 10,000
Debentures 30,000 30,000
earnings- 13%; Preference share capital 10% and debentures 5%.

2. From the following capital structure of a company, calculate the overall cost of capital,
using

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 2

 a. Book value weights
b. Market value weights
Sources Book value Market
Value
Equity share capital (Rs. 10 per share) 45,000 90,000
Retained earnings 15,000 -
Preference share capital 10,000 10,000
Debentures 30,000 30,000
The after tax cost of different sources of finance is as follows: equity share capital:12%;
Retained earnings- 10%; Preference share capital 9% and debentures 6%.

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 3

 3. A company has on its books, the following amounts and specific costs of each type of
capital:
Sources Book values Market values Specific cost
Debt 400,000 380,000 5
Preference 100,000 110,000 8
Equity share capital 600,000 12,00,000 15
Retained earnings 200,000 - 13
13,00,000 16,90,000
Determine WACC using a book value weights and market value weights.

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 4

 4. ABC ltd provides following information:
Sources Book values Market values After tax cost
Debt 10,00,000 15,00,000 12%
Preference 8,00,000 7,50,000 7%
Equity share capital 2,00,000 2,00,000 14%
Calculate WACC using book value weights and market value weights.

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 5

 5. A company has on its books, the following amounts and specific costs of each type of
capital:
Sources Book values Market values Specific cost
Equity share capital 600,000 12,00,000 15%
Retained earnings 200,000 13%
Preference 400,000 380,000 5%
debt 100,000 110,000 8%
Determine WACC using a book value weights and market value weights.

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 6

 6. The following is the capital structure of the Bajaj automobiles ltd. together with the after
tax- cost of capital.
Sources Amount Proportion% Specific cost%
Equity share capital 6,00,000 60% 4
Preference 1,00,000 30% 9
debt 3,00,000 10% 12
The Bajaj automobiles plan to raise 400,000 additional capitals during the current year
to finance its investment projects. Assume that existing capital structure of the company is the
optimum capital structure and it rise roughly in proportional manner. Calculate the average cost
of capital and marginal cost of capital.

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 7

 7. Following is the capital structure of a company:
Sources Amount
Equity share capital 4,00,000
10% PS capital 2,00,000
Retained earnings 1,00,000
5% debt 3,00,000
10,00,000
Cost of equity capital %; Retained earnings 8%. Calculate WACC.

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 8

 8. Excel industries ltd has assets of Rs. 1,60,000 which have been financed with Rs. 52,000
of debt and Rs. 90,000 of equity and general reserve of Rs. 18,000. The firms total profits
after interest and taxed for the year ended 31/12/2020, were Rs. 13,500. It pays 8% interest
on borrowed funds and is in the 50% tax bracket. It has 900 equity shares of Rs, 100 each
selling at a market price of Rs. 120 per share. What is the WACC?

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 9

 9. ABC ltd has the following capital structure
4,000equity shares of 100 each Rs.4,00,000
10% /preference shares Rs. 100,000
11% debentures Rs. 5,00,000
The current market price of the share is Rs. 102. The company is expected to declare a
dividend of Rs.10 at the end of the current year, with an expected growth rate of 10% tax
rate is 50%.
Find out the cost of equity capital and WACC.
Assuming that the company can raise 3,00,000, 12% debentures find out the new WACC
if i. dividend rate is increased from 10 to 12%. Ii. Growth rate is reduced to 8%. iii. Market
price is Rs. 98.

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 10

 10. XYZ ltd has the following book value capital structure.
Particulars Amount Rs.
Equity capital 15
(shares of Rs. 10
each)
12% PSC of Rs 100 1
each
Retained earnings 20
11.5% debentures 10
(Rs. 100 each)
11% term loans 12.5

The next expected dividend on equity shares is Rs.3.6 per share; the dividend per share is
expected to grow at the rate of 7%. The market price per share is Rs. 10 Preference shares
redeemable after 10 years is currently selling at Rs. 75 per share. Debentures redeemable
after 6 years are selling at Rs.80 per debentures. The income tax of the company is 40%.
Calculate WACC book value weights.

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 11

 11. ABC ltd has the following book value capital structure.
Particulars Amount Rs. In
million
Equity capital (10 100
million shares of Rs.
10 each)
11% PSC of 10
1,00,000 shares of
Rs 100 each
Retained earnings 120
13.5% 5,00,000 50
debentures (Rs. 100
each)
12% term loans 80
Total 360

The next expected dividend on equity shares is Rs.1.50 per share; the dividend per share is
expected to grow at the rate of 7%. The market price per share is Rs. 20 Preference shares
redeemable after 10 years is currently selling at Rs. 80 per share. Debentures redeemable
after 6 years are selling at Rs.80 per debentures. The income tax of the company is 50%.
Calculate WACC using book value weights.

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 12

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 13
 12. Amit equipment has a capital structure target of 60% equity, 15% of preference and 25%
of long term debt. Amit financial analysts have estimated the after tax cost of debt.
Preference cost and cost of equity to be 9%,15% and 18% respectively. What is the
WACC?
A firm after tax cost of capital of the specific sources is as follows:
Cost of debt- 8%; cost of equity 17%; cost of preference shares 14%. It has the following
capital structure:
Debt capital Rs. 3,00,000
Preference capital Rs. 2,00,000
Equity capital Rs. 5,00,000
Rs. 10,00,000
Firm wishes to raise Rs. 5,00,000 for expansion of its plan. It estimates Rs.1,00,000 retained
earnings and balance as: long term debt Rs. 300,000 and preference capital of Rs.
1,00,000.determine Marginal cost of capital and WACC existing situation.

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 14

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 15
 13. As a financial analyst of a large company; you are required to determine the WACC of the
company using book value and market value weights. The additional information is given
below:

Company’s present book value capital

structure is
Debentures Rs. 100 per debenture Rs.8,00,000
Preference shares Rs. 100 per share Rs. 2,00,000
Equity shares Rs. 10 per share Rs. 10,00,000
Total Rs. 20,00,000

All these securities are traded in capital market. Prices are: debenture Rs. 110 per
debenture; preference shares Rs. 120 per share; equity shares Rs. 22 per share.
Anticipated external financing opportunities are
Rs. 100 per debenture redeemable at par, 10 year maturity 11%, coupon rate 4% flotation
cost and sale price Rs.100
Rs. 100 preference share redeemable at par, 10 year maturity 12% dividend rate, 5%
flotation cost, sale price Rs. 100.
Equity shares, Rs 2 per share flotation costs, sale price= Rs 22
In addition the dividend expected on equity share at the end of the year is Rs. 2 per share;
the anticipated growth rate is 7% and the firm has a practice of paying all of its earnings in
the form of dividend. The corporate tax rate is 35%.

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 16

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 17
 14. Suma Corporation has the following book value of capital structure.
Securities Amount After tax cost
Equity capital (15,00,000 1,50,00,000
shares @Rs. 10 each)
10% preference shares 50,00,000 10%
Retained earnings 1,00,00,000
13% debentures 60,00,000 13%
Term loans 12% 70,00,000 12%
4,30,00,000
Expected dividend is Rs. 2 per share. Calculate WACC.

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 18

 15. Manu industries wishes to determine the WACC for evaluating the capital budgeting
projects. You have been supplied the following information:
Liabilities Amt Assets Amt
Equity share capital 10,00,000 Fixed assets 25,00,000
Preference share 450,000 Current assets 15,00,000
capital
Debentures 900,000
Retained earnings 450,000
Current liabilities 10,00,000
40,00,000 40,00,000
Anticipate external financing information:
20 years, 14% debentures of Rs. 2,500 face value, redeemable @ 5% premium sold at par,
2% flotation cost.
15% preference shares, sales price of Rs. 100 per share, 2% flotation cost.
Equity shares: sale price 115 per share, flotation cost Rs. 5 per share.
Corporate tax rate is 55% and the expected growth in equity dividend is 8% per year. The
expected dividend at the end of the current financial year is Rs.11 per share. Assume that company
is satisfied with its current capital structure and intends to maintain it.

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 19

 16. Sridhar company has the following financing mix.
Particulars Amt ( in lakhs)
Equity capital (10 lakh share @ par value) 100
12% PSC (10,000 share @ par value) 10
Retained earnings 120
14% non- convertible debentures(70,000 70
debentures @ par value
14% term loan 100
Total 400
The equity shares of the company are trading @ 25. The next expected dividend per share is Rs.
20 and the DPS is expected to grow at the rate of 8%. The preference shares are redeemable after
7 years at par and are currently quoted at Rs. 75 per share on the stock exchange. The debentures
are redeemable after 6 years at par and their current market price is Rs. 90 per share. The tax rate
applicable to the firm is 50%. What is the WACC of the company?

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 20

 17. M industries wishes to determine the WACC for evaluating the capital budgeting projects.
You have been supplied the following information:
Liabilities Amt Assets Amt
Equity share capital 2,00,000 Fixed assets 4,00,000
20,000 of 10 each
Reserve & Surplus 130,000 Current assets 2,00,000
8% Debentures 170,000 investment 50,000
Current liabilities 150,000
650,000 650,000
You are required to calculate WACC of the company using balance sheet valuation. The
following additional information is also available:
- 8% debentures were issued at par
- All interest payment is upto date and equity dividend is currently @ 12%
- Short term loan carries interest 18% pa
- The shares and debentures of the company are all quoted on stock exchange and current market price
are as follows:
- Equity shares @ Rs 14 each
- 8% debentures are Rs. 98 each
The rate of tax for the company may be taken at 50%.

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 21

Cambridge Institute of Technology, Department of MBA, Sanjana S pg. 22