- The capital structure of Triumph Ltd. for the year ended 31st December 2020 is given below:
Rs.
| Equity share capital (Rs. 10 each) | 3,00,000 |
| Reserve & Surplus | 1,50,000 |
| Preference share capital (Rs. 100 each) | 2,40,000 |
| Debentures (Rs. 100 each) | 1,00,000 |
All these securities are traded in the capital markets. Recent prices are: debentures @ Rs. 100, Preference shares @ 125 and Equity shares @ Rs. 20 each.
You are required to calculate the overall cost of capital using market value as weight after taking into consideration the following further information:
- Rs. 100 per debenture redeemable at par : 10 year maturity, 12% coupon rate, 5% floatation costs, sale price Rs. 100.
- Rs. 100 Preference share redeemable at par : 8 years maturity, 10% Dividend rate , 4% floatation costs, sale price Rs. 100.
- Applicable tax rate : 50%
- The company’s EBIT for the year ended 31st December, 2020 are Rs. 2,40,000.
Growth rate in earnings : 5% p.a.
SOLUTION:
To calculate the overall cost of capital using market value as weights, we need to calculate the cost of each component of the capital structure and then determine the weighted average cost of capital (WACC).
Let’s calculate the cost of each component:
- Cost of Equity: Cost of Equity = Dividend / Market Price Dividend = Dividend Rate * Par Value = 10% * Rs. 100 = Rs. 10 Market Price = Rs. 20 Cost of Equity = Rs. 10 / Rs. 20 = 0.5 or 50%
- Cost of Preference Shares: Cost of Preference Shares = Dividend / Market Price Dividend = Dividend Rate * Par Value = 10% * Rs. 100 = Rs. 10 Market Price = Rs. 125 Cost of Preference Shares = Rs. 10 / Rs. 125 = 0.08 or 8%
- Cost of Debentures: Coupon Payment = Coupon Rate * Par Value = 12% * Rs. 100 = Rs. 12 Floatation Costs = 5% of Par Value = 5% * Rs. 100 = Rs. 5 Sale Price = Rs. 100 Net Proceeds = Sale Price – Floatation Costs = Rs. 100 – Rs. 5 = Rs. 95 Cost of Debentures = Coupon Payment / Net Proceeds = Rs. 12 / Rs. 95 ≈ 0.1263 or 12.63%
Now, let’s calculate the weights for each component:
Equity Share Capital = Rs. 3,00,000 Reserve & Surplus = Rs. 1,50,000 Preference Share Capital = Rs. 2,40,000 Debentures = Rs. 1,00,000
Total Market Value = Equity Share Capital + Reserve & Surplus + Preference Share Capital + Debentures = Rs. 3,00,000 + Rs. 1,50,000 + Rs. 2,40,000 + Rs. 1,00,000 = Rs. 8,90,000
Weight of Equity = (Equity Share Capital + Reserve & Surplus) / Total Market Value = (Rs. 3,00,000 + Rs. 1,50,000) / Rs. 8,90,000 = Rs. 4,50,000 / Rs. 8,90,000 ≈ 0.5056 or 50.56%
Weight of Preference Shares = Preference Share Capital / Total Market Value = Rs. 2,40,000 / Rs. 8,90,000 ≈ 0.2697 or 26.97%
Weight of Debentures = Debentures / Total Market Value = Rs. 1,00,000 / Rs. 8,90,000 ≈ 0.1124 or 11.24%
Now, we can calculate the WACC:
WACC = (Weight of Equity * Cost of Equity) + (Weight of Preference Shares * Cost of Preference Shares) + (Weight of Debentures * Cost of Debentures) = (0.5056 * 50%) + (0.2697 * 8%) + (0.1124 * 12.63%) ≈ 0.2528 + 0.0216 + 0.0142 ≈ 0.2886 or 28.86%
Therefore, the overall cost of capital (WACC) for Triumph Ltd. is approximately 28.86%.
Note: The growth rate in earnings provided in the information is not used in the calculation of the cost of capital.
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