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Smu Question Paper
Q1. The following data is available in respect of a company :
Equity Rs.10lakhs,cost of capital 18%
Debt Rs.5lakhs,cost of debt 13%
Calculate the weighted average cost of funds taking market values as weights assuming tax rate as 40%.
Answer: We Know that, WACC = We Ke + WpKp +Wr Kr + WdKd + WtKt WACC = 0.67*.18+0.33*13(1-.40) =0.146 or 14.6%

A calculation of a firm’s cost of capital in which each category of capital is proportionately weighted. All capital sources – common stock, preferred stock, bonds and any other long-term debt – are included in a WACC calculation. All else equal, the WACC of a firm increases as the beta and rate of return on equity increases, as an increase in WACC notes a decrease in valuation and a higher risk.

Q2. ABC Ltd. provides the information as shown in table 6.21 regarding the cost, sales, interests and selling prices. Calculate the DFL.

Answer:

Q3. Two companies are identical in all respects except in the debt equity profile. Company X has 14% debentures worth Rs. 25,00,000 whereas company Y does not have any debt. Both companies earn 20% before interest and taxes on their total assets of Rs. 50,00,000. Assuming a tax rate of 40%, and cost of equity capital to be 22%, find out the value of the companies X and Y using NOI approach?
Hint: use the formula K0 = [B/(B+S)]Kd + [S/(B+S)]Ke

Answer: S= 1000,000/.22 =4545454.5 B=25,00,000 =K0=[25,00,000/[2500000+4545454.5)].14+[4545454.5/2500000+4545454.5)].22 0.0496+.142 =.1915 or 19.15% V = 5000000/0.1915 = 26,109,660.57

* Critical assumption is ko remains constant. * An increase in cheaper debt funds is exactly offset by an increase in the required rate of return on equity. * As long as ki is constant, ke is a linear function of

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