Cost of Capital - Lecture Notes

Introduction

• Presenter: Gaurav Kaur
• Medium: YouTube Live
• Importance: Understanding this chapter is essential for the foundation of many other chapters

Initial Remarks

• Audience: Priyanka, Nitesh, Gavin, etc.
• Importance: Cost of Capital is a very important chapter
• Basic Preparation: Notes are available in the description

Cost of Capital

Departmental Structure

• Equity
• Reserves and Surplus
• Preference Share Capital
• Debt

Cost of Each Component

• Equity: GE - 15%
• Preference Share: KP
• Debt: KD - the only explicit cost and tax-saving component

Weighted Average Cost of Capital

• Formula: WACC = Σ(Wi * Ki)
• How to Create:
  1. List all sources of funds
  2. Calculate the percentage (weight) of each
  3. Calculate and sum the proportion of different costs

Examples

• Equity Share Capital: ₹5 lakhs, 20%
• Debt: ₹2 lakhs, 10%
• Formula: KE = Σ(Wi * Ki)

Current Cost and Tax

• Current cost of debenture is calculated on a current price basis
• Interest and Tax:
  • Interest is done on exemplary face value
  • Net cost is calculated considering the tax rate

Formula for Current Cost

• KD = (Interest * (1-T)) / Current Price

Redeemable Debt and Example

• Formula:
  • KD = (Interest * (1-T) + (RV-IV)/N) / (RV + IV)/2
  • RV = Redemption Value
  • IV = Issue Proceeds
  • N = Years

Summary

• Each source of funds has a different cost
• Tax effect is only on debt, which reduces the cost of debt
• Weighted Average Cost of Capital is used by combining all costs

Homework

• Question 4: Formula-based and application-based questions
• Will be discussed in the next class

Class Ended

• Feedback – The class did not feel hurried at all; everything was understood well

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Feel free to comment and discuss in your next class!