Skip to content

CA Intermediate · Financial Management and Strategic Management · Cost of Capital

Arjun Industries has 2,00,000 equity shares with a market price of Rs 150 each, 10% preference capital with market value Rs 50,00,000 (cost 10%), and 10% debentures with market value Rs 1,50,00,000 (trading at par). Next year's dividend is expected at Rs 9 per share, growing at 5% perpetually. The tax rate is 25%. Book values are equity Rs 2,00,00,000, preference Rs 50,00,000 and debentures Rs 1,50,00,000. What is the WACC using market value weights?

The WACC is 9.85%. Equity cost is 9/150 plus 5%, which is 11%, and after-tax debt cost is 7.5%. Market value weights are 60% equity, 10% preference and 30% debt. Weighted costs of 6.6%, 1.0% and 2.25% add up to 9.85%.

  1. A6.85%
  2. B9.85%Correct
  3. C9.56%
  4. D10.60%

Explanation

Ke = 9/150 + 5% = 11%. Kd after tax = 10% x 0.75 = 7.5%. Market values: equity Rs 3 crore, preference Rs 0.5 crore, debt Rs 1.5 crore, total Rs 5 crore, giving weights 0.6, 0.1 and 0.3. WACC = 6.6 + 1.0 + 2.25 = 9.85%. Book-value weights give 9.56%, and using pre-tax debt cost gives 10.60%.

Did you get it right without looking?

One question tells you little. A timed set on Cost of Capital shows your real accuracy, how long you take and where you lose marks.

Practise Cost of CapitalFree diagnostic mock

More Cost of Capital questions