Financial Management: Calculation of Cost of Capital and Investment Opportunity Schedule

This project aims to understand various aspects of financial management including calculation of cost of capital, floatation cost, and investment opportunity schedule. It also discusses the impact of new share issue, new debt issue, and good and poor weather on EPS. The project includes tables and calculations for better understanding.

Running head: FINANCIAL MANAGEMENT
Financial Management
Name of the Student:
Name of the University:
Author’s Note:

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Executive Summary
The aim of the project is to understand about the various aspects of the financial management.
The project aims at various kinds of corporate finance factors that influences the cost of capital.
The project aims at calculation of different sources and way of calculating cost of capital. The
different equity financing and the treatment of floatation cost is shown in the assignment. The
project aims at also classifying expenses at the various categories.

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Table of Contents
Question 1........................................................................................................................................3
Question 2......................................................................................................................................10
Question 3......................................................................................................................................11
Reference.......................................................................................................................................13

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Question 1
1) The existing market value capital structure of the Highsky Company:
Capital Structure Of the Company
Particulars Amount
Debentures 1,500,000
Equity 2,800,000
Debt/Equity 0.536
Table 1: Capital Structure of the Company
2) The floatation cost is the cost spent by the company when the company offers shares or
securities in the market to the public. Floatation cost arises from services like the
underwriting expenses or fees, legality charges, and the registration fees incurred while
offering a security (Gupta, 2016). Floatation costs are generally not included in the
incorporation for determining the cost for capital. The company adjusts the floating costs
in the cash flows as the expenses incurred for raising the capital for the company. For
Example, A company, which wants to raise $ 5 million worth of capital it then has to
incur the around 1% of the total capital raised as floating charge. So the net amount
raised by the firm will be 99% of the $ 5 million worth of capital (Gupta, Prakash, &
Rangan, 2018).
3) The cost of Equity is calculated for Equity, Debentures and Ordinary Shares.
Calculation of Cost of Capital
Long Term Debt 500000
Before Tax Cost Of Capital 11.41%
Tax Rate 30%
After Tax Cost of debt
7.9891
%
Formula= 12.10*(1-Tax Rate)
Preference Share Capital 120000

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0
Re=(D1/Po)+g 9.823%
Cost of Capital including Floatation Cost
Re=(D1/Po-F)+g
10.044
%
Floatation Cost 0.25
Where Growth is equal to 4.38%
2017 1
2016 0.982
2015 0.921
2014 0.832
2013 0.825
Movement of dividend from 2013-2017
Where Do is Equal to 1
Where D1 is Equal to 1.04
Where Po is Equal to 19.16
Ordinary Shares
Re=(D1/Po-F)+g
11.374
%
Where Growth is equal to 4.38%
D1 1.04
Flotation Cost 0.5
Po 15.37
4) The various method for calculating cost of capital is the Capital Asset Pricing Model and
through Dividend Capitalization Method. The CAPM model is calculated by the formula:
Expected Return = {Risk Free Rate of Return (Rf) + (Return on Market-Risk Free Rate
of Return)*Beta (B)}
The following approach of calculating the cost of capital considers risk involved in the
market with respect to the risk free investment (Barberis et al. 2015).
Whereas the Dividend Capitalization Method was the other method that was selected for
calculating the cost of equity via the formula Re= {((Do+g)/Po) + Growth} (Hirtle et al.
2016).

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5) An alternative way of calculation of the growth factor that is to be used in the dividend
growth factor is by calculating the growth of dividends in the form of IRR method in the
excel sheet (Lugert, et al .2016). The growth can be calculated by the following method
under the divided growth model as:
Growth = {(Dividend at Initial Year/Price at the Initial Year)-Required Rate of Return}
6) And 7)
Calculation of Weighted Average Cost of Capital
Finance Amount Source Weights Cost Weight*Cost
0-500,000 Debt 33.94% 11.41% 3.873%
Preference Share 32.98% 10.04% 3.313%
Equity Share 33.08% 11.37% 3.763%
Weighted Average Cost of Capital 10.948%
500,000-1,000,000 Source Weights Cost Weight*Cost
Debt 33.94% 12.11% 4.110%
Preference Share 32.98% 10.04% 3.313%
Equity Share 33.08% 11.37% 3.761%
Weighted Average Cost of Capital 11.184%
1,000,000-1,500,000 Source Weights Cost Weight*Cost
Debt 33.94% 12.11% 4.110%
Preference Share 32.98% 10.04% 3.313%
Equity Share 33.08% 11.81% 3.906%
Weighted Average Cost of Capital 11.329%
Breaking Point Ordinary Share 36,38,569
Breaking Point Debt 14,73,188
Breaking Point Preference
Share No change
8) Calculation Of WACC
Range of Total New
Financing WACC
0-500,000 10.948%

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500,000-1,000,000 11.184%
1,000,000-1,500,000 11.329%
9) The Investment opportunity Schedule is given:
A B C D E F G
$0
$100,000
$200,000
$300,000
$400,000
$500,000
$600,000
$700,000
$800,000
$900,000
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
Investment Oppurtunity Schedule
Project Cost Estimated Annual Cash Inflows
Estimated Life (in years) Internal Rate of Return
10) The project that would be suitable for Investment in the project is the Project B, Project
D and Project F is the ideal investment selected.
Project Project Estimate
d Estimated Internal
Identificatio
n Cost Annual Life Rate
Cash
Inflows (in years) of
Return
A $4,00,000 $82,650 6 6.51%
B $2,00,000 $52,840 5 10.06%
0-500,000 500,000-1,000,000 1,000,000-1,500,000
10.700%
10.800%
10.900%
11.000%
11.100%
11.200%
11.300%
11.400%
WACC

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C $8,00,000 $1,63,40
0 7 9.83%
D $5,00,000 $1,15,24
0 6 10.13%
E $3,00,000 $61,600 7 9.99%
F $5,00,000 $1,58,12
0 4 10.12%
G $5,00,000 $1,31,27
0 5 9.81%
11) The projects should be selected on the basis of the funds that the company has which is
around 1.2million dollars, the project, which gives the highest IRR should be selected. So
the project that should be selected are Project B, Project D and Project F given the fact
that the fund of total 1.2 million dollar is utilized and the company is able to maximize
the return from the given set of possible investment projects (Bora, 2015).
12) If the capital structure changes then the cost of capital would rise for the firm making
borrowing cost more costly for the company. The calculations for the same is as follows
by taking the target structure mentioned:
Calculation of Cost of Capital Weights Cost Of Debt
Long Term Debt 1500000 60.00%
Before Tax Cost Of Capital 11.41% 6.848%
Tax Rate 30%
After Tax Cost of debt 7.9891%
Formula= 12.10*(1-Tax Rate)
Preference Share Capital 1200000 20.00%
Re=(D1/Po)+g 9.823% 1.965%
Cost of Capital including Floatation Cost
Re=(D1/Po-F)+g 10.044%
Floatation Cost 0.25
Where Growth is equal to 4.38%
2017 1
2016 0.982
2015 0.921
2014 0.832

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2013 0.825
Movement of dividend from 2013-2017
Where Do is Equal to 1
Where D1 is Equal to 1.04
Where Po is Equal to 19.16
Ordinary Shares 1000000 20.00%
Re=(D1/Po-F)+g 11.374% 2.275%
Where Growth is equal to 4.38%
D1 1.04
Flotation Cost 0.5
Po 15.37
Total Capital 3700000 100.00% 11.09%
13) The previous capital structure is better than the new one as the cost of capital for the firm
has significantly risen for the company. The comparison between the two is as follows:
Source of Finance
Existing
Rate
New
Rate
Long Term Debt 4.63% 6.85%
Preference Share
Capital 3.19% 1.97%
Ordinary Shares 3.07% 2.28%
Total 10.89% 11.09%
Long Term Debt Preference
Share Capital Ordinary Shares
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
Existing Rate
Long Term
Debt Preference
Share Capital Ordinary
Shares
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00%
New Rate

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Question 2
a) The impact on the Earning Per Share will be as follows via new share issue:
b) The
impact
on
Earning
Per
Share
will be
as
follows
via new debt issue:
Impact on EPS via New Debenture Issue
Particulars Old New
Current EBIT
3,50,00
0
4,50,00
0
Less Interest 16000 66000
Profit Before Tax
3,34,00
0
3,84,00
0
Tax @30%
1,00,20
0
1,15,20
0
Profit After Tax
2,33,80
0
2,68,80
0
Less: Payment to Preference Share
1,50,00
0
1,50,00
0
Profit Available to Ordinary Share Holders 83,800
1,18,80
0
Earning Per Share To Ordinary Share 0.3352 0.4752
Impact on EPS via New Share Issue
Particulars Old New
Current EBIT 3,50,000 4,50,000
Less Interest 16000 16000
Profit Before Tax 3,34,000 4,34,000
Tax @30% 1,00,200 1,30,200
Profit After Tax 2,33,800 3,03,800
Less: Payment to Preference Share 1,50,000 1,50,000
Profit Available to Ordinary Share Holders 83,800 1,53,800
Earnings Per Share To Ordinary Share Holder 0.3352 0.6152
Calculation of Interest
Book Value 2,00,000
Interest Rate 8%
Interest Amount 16000

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Holder
Calculation of Interest Old New
Book Value
2,00,00
0
5,00,00
0
Interest Rate 8% 10%
Interest Amount 16000 50000

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The impact on EPS via the Good and Poor Weather is given below:
Impact on EPS via New Share Issue
Particulars
Good
Weather
Poor
Weather
Current EBIT 6,00,000 3,20,000
Less Interest 16,000 16,000
Profit Before Tax 5,84,000 3,04,000
Tax @30% 1,75,200 91,200
Profit After Tax 4,08,800 2,12,800
Less: Payment to Preference Share 1,50,000 1,50,000
Profit Available to Ordinary Share Holders 2,58,800 62,800
Earning Per Share To Ordinary Share Holder 1.0352 0.2512
Impact on EPS via New Debenture Issue
Particulars
Good
Weather
Poor
Weather
Current EBIT 6,00,000 3,20,000
Less Interest 16,000 66000
Profit Before Tax 5,84,000 2,54,000
Tax @30% 1,75,200 76,200
Profit After Tax 4,08,800 1,77,800
Less: Payment to Preference Share 1,50,000 1,50,000
Profit Available to Ordinary Share Holders 2,58,800 27,800
Earnings Per Share To Ordinary Share
Holder 1.0352 0.1112
The indifference point between the two will be under the good weather case scenario where the
Earnings Per share of the company would not deviate much.
Question 3
Part A
Olivia in her twenties is a feminist activist who is taking part in the social issues as she is quite
young and the probability that she is a bank clerk is very less, it must be the case that Olivia is

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active in taking part in the social activities. The age and the concern of Olivia regarding the
social issues suggest that she is a feminist activist.
Part B
There has been a long run of reds in the roulette table and the probability for the same can be
quantified as the best bet can be made with a house edge, which carries the worst amount of
odds. The bet can be made as black/red or by the probability of odd/even and low/high option.
The low option will be the range that is (1-18) and high would be (19-36). The probability for
choosing the red would be the best option depending on the number of occurrence it has given.
The best option would be to go for the red color (Zhou & Xu, 2018).
Part D
The occupation of Ben could be that of an engineer as the age of Ben is between 32 years old and
lawyers who practice law or are well successful is of a age rage greater than the age range
specified. The points mentioned such as highly motivated and liked by others and on the ability
of the company gives a slight identification that Ben might belong to the Engineers profession
and background.

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Reference
Barberis, N., Greenwood, R., Jin, L., & Shleifer, A. (2015). X-CAPM: An extrapolative capital
asset pricing model. Journal of financial economics, 115(1), 1-24.
Bora, B. (2015). Comparison between net present value and internal rate of return. International
Journal of Research in Finance and Marketing, 5(12), 61-71.
Gupta, M. C. (2016). An Integrated Model for the Cost-Minimizing Funding of Corporate
Activities over Time. Review of Economics & Finance, 6, 1-18.
Gupta, M., Prakash, P., & Rangan, N. K. (2018). Cross‐Country Variability in Cost of Raising
Equity: Evidence from Seasoned Equity Offerings. International Review of Finance.
Hirtle, B., Kovner, A., Vickery, J., & Bhanot, M. (2016). Assessing financial stability: the capital
and loss assessment under stress scenarios (CLASS) model. Journal of Banking &
Finance, 69, S35-S55.
Lugert, V., Thaller, G., Tetens, J., Schulz, C., & Krieter, J. (2016). A review on fish growth
calculation: multiple functions in fish production and their specific application. Reviews in
Aquaculture, 8(1), 30-42.
Zhou, W., & Xu, Z. (2018). Probability calculation and element optimization of probabilistic
hesitant fuzzy preference relations based on expected consistency. IEEE Transactions on
Fuzzy Systems, 26(3), 1367-1378.

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