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Answer 4a:

Concepts of Cost of Capital:

a) All source of finance have its own cost. Out of long source finance, equity mode of sourcing is costlier than debt financing because of expectation of shareholders.

b) RISK VS. COST: Equity mode of finance will have low risk but costlier as against debt funds which will have high risk but relatively cheaper & have tax advantage thus reducing the net cost of debt.

Organizations have to effectively trade off between risk, cost & control.

c) Optimum Capital Structure: When the firm / organization has a combination of debt and equity, such that the wealth of the firm is maximum. At this point, cost of capital is minimum & market price of a share is maximum.

Procedure of calculating Weighted Average Cost of Capital (WACC):

It is computed by reference to proportion of each component of capital (book value or market value as

specified) as weights.

WACC = Sum [proportion of each component of capital (weights) * individual cost of capital]

Note: Tax rates needs to be adjusted in respect of debt funds.

|Computation of Weighted Average Cost of Capital (WACC): |

| | | | | |

|Nature of Capital |Value |Weights (basis of book |Cost of capital |Weights * Cost of |

| | |values | |Capital |

| | |O/S.) | | |

|Equity Capital |4,000,000 |33% |16.15 |5.38 |

| | |...