Quize exercise for cost of capital free pdf download

A company can re-issue these shares at any price but the total amount received on these shares should not be less than the amount in arrears on these shares. Here, the total amount refers to the amount received from the original allottee and the second purchaser. In simple words, considering the above example, the company is reissuing shares at Rs.

Now, according to the rule, the company cannot offer a discount more than the forfeited amount on the share. The amount of discount must not exceed the amount credited to share forfeited amount, i. Thus, the maximum discount that can be given is Rs. The company must charge a minimum price of Rs. Get Started for Free Download App.

Thus, option 4 is the correct answer. Answer Detailed Solution Below Option 4 : Ratio of the company would increase Rate of return of the company would decrease. Tax-shield would not be available on new debts. Equity shareholders would demand higher return.

The implicit cost of increasing the proportion of debt of a company is equity shareholders would demand higher returns due to the following reasons: The return on equity given to the shareholders is the money given to the owners as a percentage of the money they have invested in the company.

In the long-run debt is cheaper than equity as debt gives tax benefits to the company. So when the company increases the proportion of debt, the higher returns are calculated by dividing the earnings of the company after deducting the taxes by the equity of the total number of shareholders in the company.

Equity shareholders will thereafter demand higher returns on their investment. Debt Financing Advantages and Disadvantages: Advantages Disadvantages Retain control over the business Qualification requirements like a good credit rating to receive money Various tax advantages Collateral risk of assets Easy to make plans for finance Hard to have the financial discipline to repay on time Download Solution PDF Share on Whatsapp.

Equity shares are not easily saleable. Equity shares do not provide the fixed dividend rate. Generally the face value of equity shares is less than the face value of debentures. Equity shares have high risk than debts. Cost of Equity share is usually more than cost of Debt because: The debt is secured against the securities and has a fixed return on interest resulting in less risk. In the cost of equity share capital, there is the uncertainty of dividend and repayment of capital.

Thus, equity shares are considered as of high risk than debts. Equity share capital Preference share capital Debentures Retained earnings. Implicit costs. The implicit cost of retained earnings is the return that could have been earned by the investors, had the profit been distributed to them. Except for the retained earning, all other sources of funds have explicit costs of capital. Net Income NI Theory : According to this approach, capital structure decision is relevant to the valuation of the firm in as much as a change in the pattern of capitalization brings about a corresponding change in the overall cost of capital and the total value of the firm.

The critical assumptions of this theory are: There are no corporate taxes. The debt content does not change the risk perception of the investors. The cost of debt is less than the cost of equity. The following are the strengths of the NI approach: it tries to explain the effects of borrowings on the overall cost of capital. It explains and emphasizes favorable financial leverage. They are mutually exclusive investments. The cost of capital that applies to both investments is 12 percent.

Annual net cash flows include depreciation expenses. The two alternatives are 1 a conveyor system with a high initial cost but low annual operating costs and 2 several forklift trucks, which cost less but have considerably higher operating costs.

The decision to construct the plant has already been made, and the choice here will have no effect on the overall revenues of the project.

What is the IRR of each alternative? What is the present value of costs of each alternative? Which method should be chosen? To calculate an IRR the cash flows must include the inflows returns to the project as well as the cost.

Required a. Should the short-run effects on EPS influence the choice between the two projects? The most cost-effective method of mining gold is sulfuric acid extraction, a process that results in environmental damage. For the purposes of this problem, assume that the cash inflows occur at the end of the year. Should this project be undertaken, ignoring environmental concerns?

How should environmental effects be considered when evaluating this, or any other, project? How might these effects change your decision in part b? Envronmrntal damage is an example of externality. The firm should deduct the cost of it from the expected cash flows to get a better estimates of marginal benefits and costs.

If environemental costs are large enough then it may lead the manager to quit the project in hand. Sharon must make a decision. A good one could help her career and move her up in management, but a bad one could hurt her prospects for promotion. Should Sharon accept the new lease? Hint: Be sure to use 1 percent per month. What new lease payment would make Sharon indifferent between the new and the old leases? Sharon is not sure of the 12 percent cost of capital—it could be higher or lower.

At what nominal cost of capital would Sharon be indifferent between the two leases? Hint: Calculate the differences between the two payment streams, and find the IRR of this difference stream. What is the regular payback period for each of the projects? What is the discounted payback period for each of the projects?

If the two projects are independent and the cost of capital is 10 percent, which project or projects should the firm undertake? If the two projects are mutually exclusive and the cost of capital is 5 percent, which project should the firm undertake? If the two projects are mutually exclusive and the cost of capital is 15 percent, which project should the firm undertake?

What is the crossover rate? Suppose the relevant discount rate is 12 percent a year. Compute the NPVs for each of the three projects. Compute the profitability indices for each of the three projects. Suppose these three projects are independent. Which projects should the treasurer accept based on the profitability index rule? Suppose these three projects are mutually exclusive. Which project should the treasurer accept based on the profitability index rule?

The projects are not divisible. Which projects should the treasurer accept? Suppose that common stocks with the same risk as this investment offer a 10 percent expected return. Would you construct the motel? Why or why not? Suppose E. United States government securities maturing in one year yield 7 percent.