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knowledge bank -basic learning Cost of Capital-1

Q1.What do you understand by Cost of Capital? What are its components?

Q2.How is Cost of Debt different from Cost of Equity in terms of Risk and Return? Will it be correct to say that debt is a cheaper instrument than equity in a Tax environment? In case yes, do you agree that companies should lever their capital structure with as much debt as possible?

Q3.Under what circumstances the weighted average cost of capital should be taken as the relevant discounting factor in Capital Budgeting?

Q4.The dividend discount model considers dividends to have a bearing on the market value of shares.However, empirically it has been noticed that many companies do not give dividends; however, their share prices continuously rise. Explain this apparently unusual phenomenon. Try to relate the concept to the ultimate objective of financial management i.e. wealth maximization.

Q5.In case a company goes into a phase of deep turmoil resulting into negligible profits and zero taxes, what would happen to the cost of debt funds for cost of capital purposes?

Q6.Do the funds provided by sources such as accounts payable and accruals have a cost of capital? Explain.

Q7.ABC Ltd currently pays dividend of Rs 2 per share, and this dividend is expected to grow at 15 % annual rate for three years, and then at 10 % rate for the next three years, after which it is expected to grow at a 5 % rate forever. What value would you place on this stock if the required rate of return was 18%?

Q8.ABC Ltd has 9 % non callable Rs 100 face value preference shares outstanding .On January 1 the market price per share is Rs 73. Dividends are paid annually on December 3 1.If you require a 12% annual return on this investment, what is this stocks intrinsic value to you on January 1?

Q9.Using the dividend valuation model, is it possible to have a situation where a company grows 30 percent per year forever. (Ignore inflation).

Q10.Why would growth rate in earnings and dividend of a company not likely to continue in the long future?

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