Ques 1.
i) What are the factors affecting the capital structure of the company?
ii) The company raised preference share capital of $ 100000 by the issue of 10% preference share of $ 10 each. The floatation cost is 1%. Find out the cost of preference share capital issued at i) 10% premium ii) 10% discount
Ques 2. A company has the following amount and specific costs of each type of capital:
|
Types of Capital
|
Book Value ( in $)
|
Market Value
|
Specific Costs
|
|
Preference
|
100000
|
110000
|
8%
|
|
Equity
|
600000
|
1200000
|
13%
|
|
Retained Earnings
|
200000
|
-
|
-
|
|
Debt
|
400000
|
380000
|
5%
|
|
Total
|
1300000
|
1690000
|
|
|
|
|
|
|
Determine the weighted average cost of capital using
a) Book value weights
b) Market value weights.
How are they different? Can you think of a situation where the WACC would be the same using either of the weights?
Ques 3 Calculate the degree of operating leverage (DOL), degree of financial leverage (DFL), degree of combined leverage (DCL), for the following firms:
|
|
Firm A
|
Firm B
|
Firm C
|
|
Output(units)
|
90000
|
35000
|
200000
|
|
Fixed Costs (USD)
|
10000
|
16000
|
2000
|
|
Variable cost per unit
|
0.2
|
1.5
|
0.02
|
|
Interest on borrowed funds
|
4000
|
8000
|
-
|
|
Selling price per unit
|
0.6
|
5
|
0.1
|
Case Study
Merck International is a pharmaceutical company. It is not currently selling its product in India. However it is proposing t establish a manufacturing facility in India in near future.
The Company to be set up in India is to be a wholly owned affiliate of Merck International which will provide all funds needed to build the manufacturing facility. Total initial investment is estimated at Rs.50,000,000. Working capital requirements estimated at Rs. 5,000,000, would be provided by the local financial institution at 8 percent per annum, repayable in five equal installments beginning on 31st December of the first year of operation. In the absence of this concessional facility, Merck would have financed these requirements by a loan from its bankers in United States at 15 percent per annum.
The cost of the entire manufacturing facility is to be depreciated over the five years period in straight line method basis. At the end of fifth year of its operation all remaining assets would be taken over by a public corporation to be designated by the government of India with no compensation.
Sales and selling price are presented in the table below:-
|
Year
|
Sales in Units
|
Unit Price(Rs)
|
|
1
|
2,00,000
|
1,000
|
|
2
|
2,25,000
|
1,500
|
|
3
|
2,50,000
|
1,800
|
|
4
|
2,75,000
|
2,000
|
|
5
|
3,00,000
|
2,200
|
Variable costs are Rs. 600 per unit in year 1 and are expected to rise by 15% each year.
Fixed Cost other than depreciation are Rs. 20 million in year 1 and is expected to rise by 10% per year.
Other Information:
All profit after tax realized by the affiliate are transferable to the parent company at the end of each year. Depreciation funds are to be blocked until the end of year 5. These funds may be invested in local money market instruments, fetching a tax-free return of 15%. When the operating assets are turned over a local corporation, the balance of these funds including interest may be repatriated.
The income tax rate in India is 48% but there are no with holding tax on transfer of dividends. Dividends received by Merck International in the United states would be subject to 50% tax.
Merck International uses a 20% weighted average cost of capital for evaluating domestic projects similar to the ones planned in India. For Foreign projects in developing countries a 6% political premium is added.
Calculate the NPV and IRR for the project from the standpoint of the parent company. What are your recommendations for the proposal?