Dr. R.A.N.M ARTS AND SCIENCE COLLEGE�Affiliated to Bharathiar University , �Accredited with “ B+” NAAC�
Mrs. A. Raameswari M.Com(CA)., Assistant Professor,� Department of Commerce (CA)
Course Name : Financial Management
�Welcome You All
Financial Management
COST OF CAPITAL :
An investor provides long-term funds (i.e., Equity shares, Preference
Shares, Retained earnings, Debentures etc.) to a company and quite naturally he
expects a good return on his investment. In order to satisfy the investor’s
expectations the company should be able to earn enough revenue.
IMPORTANCE OF COST OF CAPITAL
1.Maximisation of the Value of the Firm.
2.Capital Budgeting Decisions
3.Decisions Regarding Leasing
4.Management of Working Capital
5.Dividend Decisions
6.Determination of Capital Structure
7.Evaluation of Financial Performance
Kd = I (1 - T) I = Annual Interest NP T = Tax Rate NP = Net Proceeds. |
CALCULATION OF COST OF IRREDEMABLE DEBT :
X ltd issue ₹ 50000 8% debentures at par, at premium 10%, at a discount
10%. The tax rate is 50%. Compute the cost of debt capital.
SOLUTION:
At par :
Kd = I (1 - T) I = ₹4000
NP T = 0.5
NP = 50000
= 4000 (1- 0.5)
50000
= 4%
At Premium :
Kd = I (1 - T) I = ₹4000
NP T = 0.5
NP = 50000 x 10% = 5000 + 50000=55,000
= 4000 (1-0.5)
55000
= 3.6%
At Discount :
Kd = I (1 - T) I = ₹4000
NP T = 0.5
NP = 50000 x 10% = 5000 - 50000=45,000
= 4000 (1-0.5)
45000
=4.4%
IRREDEEMABLE PREFERENCE CAPITAL : Kp =Dp Dp = preference dividend Np Np = net proceeds Kp = cost of preference capital |
COST OF PREFERENCE
An amount paid by company as dividend to preference shareholder is
known as Cost of Preference Share Capital. Preference share is a small unit of acompany's capital which bears fixed rate of dividend and holder of it gets dividendwhen company earn profit.
A company raised preference share capital of ₹ 1,00,000 by issue at preference
share of ₹ 10 each. Calculate cost of preference capital when they are i) at 10%
premium ii) 10% discount.
SOLUTION :
At 10% premium
Kp = Dp = 10,000 x 100
Np 1,10,000
Kp = 9.09%
At 10% discount
Kp = Dp = 10,000 x 100
Np 90,000
Kp = 11.11%
CAPITAL BUDGETING
Capital budgeting is the process of making investment decisions in long term assets. It is the process of deciding whether or not to invest in a particular project as all the investment possibilities may not be rewarding.
Process of Capital Budgeting
The most important step of the capital budgeting process is generating good investment ideas. These investment ideas can come from a number of sources like the senior management, any department or functional area, employees, or sources outside the company.
An entity must give priority to profitable projects as per the timing of the project’s cash flows, available company resources, and a company’s overall strategies. The projects that look promising individually may be undesirable strategically. Thus, prioritizing and scheduling projects is important because of the financial and other resource issues.
It is important for a manager to follow up or track all the capital budgeting decisions. He should compare actual with projected results and give reasons as to why projections did not match with actual performance. Therefore, a systematic post-audit is essential in order.
TECHNIQUES OF CAPITAL BUDGETING
Capital budgeting techniques are the methods to evaluate an investment proposal in order to help the company decide upon the desirability of such a proposal. These techniques are categorized into two heads : traditional methods and discounted cash flow methods.
Traditional methods determine the desirability of an investment project based on its useful life and expected returns. Furthermore, these methods do not take into account the concept of time value of money.
Payback period refers to the number of years it takes to recover the initial cost of an investment. Therefore, it is a measure of liquidity for a firm. Thus, if an entity has liquidity issues, in such a case, shorter a project’s payback period, better it is for the firm.
Under ARR method, the profitability of an investment proposal can be determined by dividing average income after taxes by average investment, which is average book value after depreciation