Ad-Free CAclubindia and Daily Updates on your mobile. Subscribe Now!

Reg PE-II FM (Doubt)

Vishal (CA Student) (218 Points)

22 May 2009

Dear All,

I hav a doubt in PE-II Financial Management, Cost of capital and capital structure chapter.

This is May 2004 exam problem. I have attched the problem and solution for ur reference as an attachment. Pls view it and kindly tell me how they arrived at cost of Debentures (10%) and cost of Preference capital (11%). Is there any formula to solve it. All books contain the same solution only.

Looking for reply...

Reply
Follow
Share

3 Replies

koolleo87 (1268 Points)
Replied 22 May 2009

Lets start with debentures.

Since the debentures are being traded in the market at Rs 981.05, it means that the present value of all the cash flow to be received by the debenture holder is 981.05.

Now we have the present value = 981.05.

Also, the periods when we will receive the cash flow. ie - 95 at end of first year, 95 at end of second year and 1095 ( 1000 + 95 ) ( Principal + Interest ) at the end of 3rd year.....

So, now we have to find out the rate of interest that the market has discounted. or required by the market which is also the cost of capital for debentures.

So, take '' YTM '' as the Cost of capital... Put that in the formula and you are done.