Answer to Question #197495 in Finance for Kajal

Question #197495

Cummins India Ltd has the following capital structure, which it considers optimal:

Debt 25%

Preference Shares 10%

Equity shares 65%

Total 100%

Applicable tax rate for the company is 25%. Risk free rate of return is 6%, average equity

market investment has expected rate of return of 12%. The company’s beta is 1.10.

Following terms would apply to new securities being issued as follows:

1. New preference can be issued at a face value of Rs. 100 per share, dividend and cost of

issuance will be Rs. 10 per share and Rs. 2 per share respectively.

2. Debt will bear an interest rate of 9%.


a. component cost of debt, preference shares and equity shares assuming that the company

does not issue any additional equity shares.

b. WACC.

Expert's answer

a. Component cost of debt is:

or 7.5%.

Cost of preference shares is:

or 12%.

and cost of equity shares is:

or 11.25%.


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