Answer to Question #271688 in Financial Math for Wangari

Question

Company ABC limited capital structure as December 31st 2020 was as follows.

Amount

Ordinary share 80,000@sh 10 sh 800,000

12.5% preference shares@sh 15 sh 900,000

10% debentures @sh 100 sh 600,000

14% bank loan sh 500,000

Retained earnings sh 450,000

Additional information

The market value of the Equity is sh 15 and firm pays 10% dividend whereas the growth rate was 5% pa.

The market price of preference was sh 25 and the debenture market value was sh 90.

The equity flotation fee per share was sh 1 and corporation tax was 30%.

Required

Compute the cost of each source of fund

Answer 1

Cost of each source computation

a) Cost of Equity

Cost of Equity=(Dividends Per Share/ Current Market Price Per Share)+Growth Rate of Dividends

Ke= (D_O(1 + g)/MPS) + g

10(1+0.05)/15+0.05

10.5/15 + 0.05

=0.7+0.05

=0.75

0.75*100

=75%

b)Cost of preference shares

K_p = Dp/NP

Whereas;

K_p = Cost of Preference Share

D_p = Dividend on preference share

NP = Net proceeds from issue of preference share

Thus,

K_p=(12.5%*25)/25

=0.26

0.26*100

=26%

c)Cost of debentures.

Kd=Interest*(1 – tax rate)+(Par Value - Market Value)^1/n/0.5(Par Value + Market Value)

10*(1 - 30/100)+(100 - 90)^1/0.5(100 + 90)

(7 + 10)/95

17/95

=0.1790

=17.9%