Cost of Capital

Original descriptive practice: 30 saved, 2 at 3 marks, 18 at 5 and 10 at 10. Debt and preference cash-flow costs, equity/growth/CAPM, retained earnings, WACC, target marginal costs and funding breakpoints. Original practice, not ICAI questions or official marking schemes. Native tables scroll on phones. Original preparation is not a live or complete official question bank.

Boundaries: Tax deductions and usable shields are case supplied. Approximate redeemable formulas differ from exact scheduled-flow IRRs. D0/D1, flotation, market/target weights and compounding periods are explicit. Market equity is not double-counted with retained reserves. Rates and future share values are conditional models, not live offers, legal permissions or guaranteed returns.

FM-C04-D001 · 5 marks

A company uses its historical average funding coupon to discount every new project. One proposal has markedly different business risk; equity investors require a return even though no cash dividend is planned this year. Required: Explain the relevant cost-of-capital concept and decision limits. (5 marks)

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Marks	Credit	Working / case application
1	Required return	Cost reflects appropriate provider expectations/opportunity cost, not only a past coupon or this year's payout.
1	Equity cost	No immediate dividend does not make investor capital economically free.
1	Relevant project	A materially different-risk project may require a risk-appropriate rate; historical company average is not automatically suitable.
1	Financing trade-off	Compare cost with financial risk/control and feasible terms, not lowest coupon alone.
1	Consistent appraisal	Use a rate matching cash-flow risk/tax/currency/timing convention; meeting a nominal accounting-return figure is not sufficient evidence of value.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 3

FM-C04-D002 · 5 marks

A hypothetical perpetuity debt unit has face Rs 100, annual coupon 12%, issue price Rs 95 and issue cost Rs 3 per unit. Coupon interest alone is fully deductible at the case tax rate 30%, with immediate usable tax shields. No other costs. Required: compute net proceeds, pre-tax and after-tax cost and explain coupon/cost distinction. No current legal issue permission is inferred. (5 marks)

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Marks	Credit	Working / case application
1	Coupon	12% x 100=Rs 12 yearly.
1	Net proceeds	95-3=Rs 92 per unit.
1	Pre-tax cost	12/92=13.0435%.
1	After-tax	12 x.70/92=9.1304%.
1	Distinction	Coupon uses face 100; financing cost uses actual net 92. Deductibility/tax timing are expressly supplied, not universal.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 7

FM-C04-D003 · 3 marks

Existing hypothetical perpetual debt pays Rs 10 annual coupon and trades at Rs 80. Historical issue proceeds were Rs 100; no new issue occurs. Use current market-price cost, tax 25% with full immediate coupon deduction. Required: calculate and explain the selected base. (3 marks)

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Marks	Credit	Working / case application
1	After-tax coupon	10 x.75=Rs 7.50.
1	Current cost	7.5/80=9.375%.
1	Base	Current market 80 is specified for existing capital; historic 100 would give a different measure. Do not subtract nonexistent new flotation costs.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 8

FM-C04-D004 · 5 marks

Two otherwise identical perpetuity debt offers pay Rs 8 annually for net proceeds Rs 100. Case A has usable full coupon deduction at 25%; case B has no tax deduction/shield on the supplied facts. Required: compare after-tax costs and explain why blindly multiplying every rate by 1-t is unsafe. (5 marks)

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Marks	Credit	Working / case application
1	A coupon net	8 x.75=Rs 6.
1	A cost	6/100=6%.
1	B cost	8/100=8% without a usable shield.
1	Difference	2 percentage points on these assumptions; no debt deduction is inferred for B.
1	Decision boundary	Real deductions/timing/tax capacity require facts; the exercise assumption is not current-law advice or proof debt always creates the maximum saving.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 9

FM-C04-D005 · 10 marks

A new bond unit yields net Rs 94 today, pays annual coupon Rs 10 at each year end for five years, and repays Rs 100 at the end of year 5 in addition to the final coupon. Only coupon is deductible at 30%; shields are immediate; redemption difference has no tax deduction. Required: construct issuer after-tax payment stream, calculate textbook approximate Kd, calculate exact cash-flow IRR using numerical solving, and explain differences/base errors. Round costs to two decimals. (10 marks)

Case-supplied amounts/terms; units stated in the question.

Time	Issuer cash movement, Rs
0	Receipt 94
1-4	Payment 7 each
5	Payment 107

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Marks	Credit	Working / case application
1	Net receipt	Year 0 receipt Rs 94.
1	Annual coupon net	10 x.7=Rs 7 each year.
1	Final cash	Year 5 Rs 107, not 100 alone or 107 plus another coupon.
1	Approx numerator	7+(100-94)/5=Rs 8.2.
1	Approx denominator	(100+94)/2=Rs 97.
1	Approx cost	8.2/97=8.453608%, 8.45%.
1	IRR equation	94=sum(7/(1+k)^j, j 1..5)+100/(1+k)^5.
1	Exact IRR	About 8.52% from the supplied annual cash flows; numerical residual must be checked.
1	Why differs	Approximation uses averaged capital and straight-line redemption difference; it is not an exact discounting identity.
1	Boundaries	Do not apply tax 30% to nondeductible redemption difference, use face 100 as proceeds, or report an approximation as exact IRR. No legal issue availability inferred.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 11

FM-C04-D006 · 5 marks

Net proceeds Rs 90, redemption Rs 100 after five years, annual coupon Rs 10, tax 30%. For this exercise's approximation, Scenario C permits deduction only of coupon; Scenario D permits a usable deduction of both coupon and the straight-line redemption difference. Use average capital(RV+NP)/2. Required: compute both approximations and separate assumptions. (5 marks)

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Marks	Credit	Working / case application
1	Common capital	(100+90)/2=Rs 95; difference/n=Rs 2.
1	C numerator	10 x.7+2=Rs 9.
1	C cost	9/95=9.4737%.
1	D cost	(10+2)x.7/95=8.8421%.
1	Scope	These are different explicit tax assumptions and approximate methods, not interchangeable current-law rules or exact IRRs.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 9

FM-C04-D007 · 10 marks

A case-supplied zero-coupon instrument receives Rs 70 today and pays Rs 100 exactly three years later; no other flows or tax shield. Required: calculate exact annual cost, textbook averaged-capital approximation and nominal rupee difference; demonstrate present-value verification and explain why dividing a total percentage by years is not exact. (10 marks)

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Marks	Credit	Working / case application
1	Cash dates	Receipt 70 now, only payment 100 at year 3.
1	Nominal difference	Rs 30 total rupee difference, not annual coupon.
1	Equation	70=100/(1+k)^3.
1	Exact rate	k=(100/70)^(1/3)-1=about 12.6248%, 12.62%.
1	PV verification	100/(1.12624788)^3 is about 70; solver/rounding tolerance applies.
1	Approx numerator	(100-70)/3=Rs 10.
1	Approx denominator	(100+70)/2=Rs 85.
1	Approx rate	10/85=11.7647%, 11.76%, not exact.
1	Invalid linear shortcut	(30/70)/3=14.2857% is not exact compound annual return.
1	Interpretation	No periodic coupon does not make finance free; larger proceeds/redemption difference weakens textbook approximation. Tax/legal/accounting not inferred.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 9

FM-C04-D008 · 10 marks

A valid three-year loan receives Rs 90 now. Principal repaid is Rs 30 at each year end. Coupon interest 10% of opening principal is paid with each instalment; fully deductible at 25% with immediate shields. No fees/tax on principal. Required: construct opening principal, interest, net interest, total cash payments each year and solve exact after-tax cost. Explain why a bullet-redemption averaged formula is unsuitable. (10 marks)

Case-supplied amounts/terms; units stated in the question.

Year	Opening principal	Principal payment
1	90	30
2	60	30
3	30	30

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Marks	Credit	Working / case application
1	Opening principals	Years 1/2/3: 90, 60, 30.
1	Gross coupons	9, 6, 3.
1	Net coupons	6.75, 4.5, 2.25.
1	Year 1 payment	30+6.75=36.75.
1	Year 2 payment	30+4.5=34.5.
1	Year 3 payment	30+2.25=32.25.
1	IRR equation	90=36.75/(1+k)+34.5/(1+k)^2+32.25/(1+k)^3.
1	Cost	k=7.5% under par, no-fee, immediate-shield declining balance assumptions; verify PV 90.
1	Incorrect bullet treatment	Principal declines yearly, so treating 90 as a year 3 bullet and fixed 9 coupon misstates flows.
1	Scope	A single averaged redemption-difference formula is not suitable for gradual repayments; exact scheduled cash/tax facts control.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 13

FM-C04-D009 · 5 marks

A hypothetical preference perpetuity has face Rs 100, annual dividend 9%, issue price Rs 96 and flotation cost Rs 2. Preference dividend gives no tax deduction under case assumptions; compare a 30% tax rate without applying it to dividend. Required: calculate cost and address the "debt-like fixed payout means tax shield" claim. (5 marks)

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Marks	Credit	Working / case application
1	Dividend	9% x 100=Rs 9.
1	Proceeds	96-2=Rs 94.
1	Preference cost	9/94=9.5745%.
1	No coupon shield	Do not multiply by.7: case dividend is not deductible; debt-like payment pattern does not establish deductibility.
1	Boundary	The theoretical perpetuity calculation is not current permission to issue irredeemable preference capital or legal dividend availability.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 17

FM-C04-D010 · 10 marks

A stated permissible preference issue yields Rs 95 per unit net, pays Rs 8 annual dividend at year ends 1-4, and redeems Rs 105 at year 4 in addition to final dividend. No tax deductions. Required: construct flows, compute approximate cost and exact IRR, compare with an incorrect 30% coupon shield calculation and state method/legal boundaries. (10 marks)

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Marks	Credit	Working / case application
1	Initial funds	Rs 95 net received.
1	Annual dividend	Rs 8 at year ends 1-4.
1	Final amount	Year 4 Rs 113=105+8.
1	Approx numerator	8+(105-95)/4=Rs 10.5.
1	Approx denominator	(105+95)/2=Rs 100.
1	Approx cost	10.5/100=10.5%.
1	IRR equation	95=sum(8/(1+k)^j, j 1..4)+105/(1+k)^4.
1	Exact cost	About 10.67% from numerical solving; check residual.
1	Wrong shield	Multiplying dividend by.7 would give(5.6+2.5)/100=8.1% approx, but case permits no deduction.
1	Limits	Preference cost and debt cost share flow methods but not automatic tax treatment; approximations are labelled and actual dividend/redemption rights are case supplied.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 18

FM-C04-D011 · 5 marks

Expected annual ordinary dividend is Rs 6 forever; current ex-dividend price Rs 50. New issue price also Rs 50, but flotation cost Rs 2 per share. Use supplied perpetual dividend-price approach, no growth. Required: existing/retained required return and new issue cost, why no current payout alone implies no zero cost. (5 marks)

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Marks	Credit	Working / case application
1	Existing model	6/50=12%.
1	Net new proceeds	50-2=Rs 48.
1	New issue cost	6/48=12.5%.
1	Difference	0.5 percentage point increase from flotation under model.
1	Assumptions	Constant expected perpetuity and ex-dividend base are case supplied; no shareholder return guarantee or zero cost from absent immediate declaration.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 20

FM-C04-D012 · 5 marks

Last dividend D0 is Rs 4, current ex-dividend price Rs 80, and constant future growth 5% is assumed. Required: next dividend, existing Ke and cost of new shares with Rs 4 flotation cost each, correcting use of D0 unchanged. (5 marks)

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Marks	Credit	Working / case application
1	Next dividend	D1=4 x 1.05=Rs 4.20.
1	Existing equity	4.2/80+.05=10.25%.
1	New net funds	80-4=Rs 76.
1	New equity	4.2/76+.05=10.5263%.
1	Wrong D0	4/80+.05=10% ignores one growth period. State constant growth/model assumptions; not guaranteed future performance.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 21

FM-C04-D013 · 5 marks

Next expected dividend Rs 5, growth 4%, market/issue price Rs 100, new flotation 5% of issue price. Required: retained and new-equity costs, net proceeds and explain why 5% must not be added as annual percentage point cost. (5 marks)

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Marks	Credit	Working / case application
1	Flotation amount	5% x 100=Rs 5 once per share.
1	Net proceeds	Rs 95.
1	Retained cost	5/100+.04=9%.
1	New cost	5/95+.04=9.26316%.
1	Treatment	One-time flotation adjusts funds received in this method, not automatically 9%+5%=14% annual cost; avoid duplicate adjustment in project appraisal.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 21

FM-C04-D014 · 5 marks

Dividend rose from Rs 2 to Rs 2.662 over three years. Current price Rs 50. Assume observed compound growth is expected to continue, and D0=Rs 2.662. Required: infer g, next dividend, Ke and discuss forecasting assumption. (5 marks)

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Marks	Credit	Working / case application
1	Compound growth	g=(2.662/2)^(1/3)-1=10%.
1	Next dividend	2.662 x 1.10=Rs 2.9282.
1	Cost	2.9282/50+.10=15.8564%.
1	Not linear	Total 33.1% rise divided by 3 is not exact compound g.
1	Forecast limit	Historical growth does not guarantee future growth; use continues only because case assumes it. Review model sustainability and risk.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 23

FM-C04-D015 · 5 marks

Earnings retention b=40%, return on reinvested earnings r=15%, D0=Rs 3, current price Rs 60. Use stable g=b*r with constant forecast assumptions. Required: calculate g, D1, Ke and assess claim that retention is permanent free finance. (5 marks)

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Marks	Credit	Working / case application
1	Growth	g=.40 x.15=6%.
1	Next dividend	3 x 1.06=Rs 3.18.
1	Ke	3.18/60+.06=11.3%.
1	Opportunity cost	Retained earnings belong to shareholders and have forgone return/payout opportunity; not free.
1	Scope	g requires supplied stable return/retention assumptions; more retention alone does not guarantee higher value or indefinitely sustainable six percent growth.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 23

FM-C04-D016 · 5 marks

Risk free rate 6%, expected market return 12%, beta 1.25. A second report describes "market risk premium 6%". Required: compute Ke from both wordings and identify wrong subtraction/double counting. (5 marks)

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Marks	Credit	Working / case application
1	Market premium	12%-6%=6 percentage points.
1	Beta premium	1.25 x 6%=7.5%.
1	Cost	6%+7.5%=13.5%.
1	Explicit premium wording	If 6% is already premium, use 6+1.25 x 6, not 6+1.25 x(6-6).
1	Model limits	Beta reflects systematic risk under model; historic estimates and required returns are not guaranteed realised returns or current market data.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 27

FM-C04-D017 · 5 marks

Rf 5%, market risk premium 8%, beta 1.1 initially. A case estimates prospective beta 1.4 after a business-risk change, with Rf/premium unchanged. Required: compute both required returns and change, evaluate using historical company WACC unchanged for all projects. (5 marks)

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Marks	Credit	Working / case application
1	Initial equity	5+1.1 x 8=13.8%.
1	Revised equity	5+1.4 x 8=16.2%.
1	Change	2.4 percentage points.
1	Risk matching	Different prospective risk requires review of appropriate project rate, not automatic old company average.
1	Limits	These are case estimates, not live beta or certainty; project financing/cash conventions also need consistent treatment.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 27

FM-C04-D018 · 3 marks

Expected earnings remain Rs 8 per share forever under supplied earnings-price approach, price Rs 64. Required: compute model cost and state why it is not a universal dividend cash yield. (3 marks)

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Marks	Credit	Working / case application
1	Model rate	8/64=12.5%.
1	Distinction	Earnings not necessarily distributed dividends; earnings yield does not prove investor cash receipt 12.5% each year.
1	Assumptions	Use constant earnings/model conditions supplied; dividend growth/risk/cash need assessments can produce different equity estimates.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 21

FM-C04-D019 · 10 marks

After-tax costs already supplied: debt 6%, preference 9%, ordinary equity 12%. Book values Rs lakh: debt 40, preference 10, equity 50(including reserves). Market values: debt 30, preference 10, equity 100(includes market value of retained earnings). No new issue or other source. Required: calculate both weight sets/contributions/WACCs, explain difference, retained earnings double counting and relevance. (10 marks)

Case-supplied amounts/terms; units stated in the question.

Source	Book value	Market value	Supplied after-tax cost
Debt	40	30	6%
Preference	10	10	9%
Equity	50	100	12%

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Marks	Credit	Working / case application
1	Book total	40+10+50=100.
1	Book weights	Debt 40%, preference 10%, equity 50%.
1	Book contributions	2.4%, .9%, 6%.
1	Book WACC	9.3%.
1	Market total	30+10+100=140.
1	Market weights	21.4286%, 7.14286%, 71.4286%.
1	Market contributions	1.285714%, .642857%, 8.571429%.
1	Market WACC	10.5%.
1	No duplicate reserves	Market equity 100 already reflects shareholders' total claim; do not add retained reserves again as new market capital.
1	Relevance	Market weights reflect supplied current valuations; book and target/marginal weights answer different questions. Use appropriate current cost/risk/cash definition, not lowest computed rate just to validate project.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 33

FM-C04-D020 · 10 marks

Target new financing is 40% debt/60% ordinary equity. Retained funds available Rs 18 lakh cost 12%; new external equity cost 14%; debt marginal after-tax cost 6% through all amounts considered. Cases below/above breakpoint use source costs applicable to each additional rupee, not retroactive repricing. Required: find retained breakpoint, compute MCC bands, allocate a Rs 40 lakh programme across sources and compute total programme weighted cost. No project opportunity schedule is given. (10 marks)

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Marks	Credit	Working / case application
1	Break point	18/.60=Rs 30 lakh total new funding.
1	Lower band	MCC=.4 x 6%+.6 x 12%=9.6%.
1	Upper band	MCC=.4 x 6%+.6 x 14%=10.8%.
1	Programme debt	40 x.4=Rs 16 lakh.
1	Programme equity	40 x.6=Rs 24 lakh.
1	Equity split	Retention 18, external 6.
1	Weighted costs	16 x 6%+18 x 12%+6 x 14%=.96+2.16+.84=Rs 3.96 lakh annualised cost proxy.
1	Programme average	3.96/40=9.9%, same as(30 x 9.6%+10 x 10.8%)/40.
1	Marginal versus average	Next-rupee 10.8% is not 9.9% programme average and not applied retroactively to all retention.
1	Decision limit	No optimal investment volume without project risk/cash/opportunities; retained cost not zero and source breakpoint must be divided by equity weight, not debt weight.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 38

FM-C04-D021 · 10 marks

New finance uses 50% equity and 50% debt. Retained earnings available Rs 20 lakh cost 12%; external equity costs 15%. Debt costs 6% after tax for the first Rs 15 lakh of debt raised; further debt costs 8%. Rates apply only to incremental tranches, not retroactively. Required: calculate both total-funding breakpoints, ordered MCC bands and the financing/cost of a Rs 50 lakh programme. (10 marks)

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Marks	Credit	Working / case application
1	Debt breakpoint	15/.50 = Rs 30 lakh total funds.
1	Retention breakpoint	20/.50 = Rs 40 lakh total funds.
1	First band	Through Rs 30 lakh: .5 x 6% + .5 x 12% = 9%.
1	Second band	Above 30 through 40: .5 x 8% + .5 x 12% = 10%.
1	Third band	Above 40: .5 x 8% + .5 x 15% = 11.5%.
1	Debt allocation	Total debt 25: first 15 at 6%, remaining 10 at 8%.
1	Equity allocation	Total equity 25: retained 20 at 12%, external 5 at 15%.
1	Cost sum	15 x.06 + 10 x.08 + 20 x.12 + 5 x.15 = Rs 4.85 lakh annualised proxy.
1	Programme average	4.85/50 = 9.7%; also (30 x 9% + 10 x 10% + 10 x 11.5%)/50.
1	Interpretation	Next rupee is 11.5%, not programme average 9.7%; source limits must be converted using their own target weights.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 38

FM-C04-D022 · 10 marks

A new Rs 100 lakh financing programme targets debt 40%, preference 10% and new equity 50%. Net debt proceeds Rs 95 per face-100 perpetual unit, annual coupon Rs 10, immediately usable coupon deduction at 30%. Preference dividend Rs 9 forever for net proceeds Rs 90, with no deduction. Equity D0 Rs 4, stable growth 5%, issue price Rs 80, flotation Rs 4 per share. Weights are based on net funds raised and the hypothetical perpetual terms are supplied. Required: calculate each cost, contribution and marginal WACC, and explain relevant assumptions. (10 marks)

Case-supplied amounts/terms; units stated in the question.

Source	Target net funds, Rs lakh	Cost terms
Debt	40	Coupon 10, net 95, coupon tax 30%
Preference	10	Dividend 9, net 90, no shield
New equity	50	D0=4, g 5%, issue 80, flotation 4

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Marks	Credit	Working / case application
1	Debt cost	10 x.7/95 = 7.368421%.
1	Preference cost	9/90 = 10% without a tax shield.
1	Next equity dividend	D1 = 4 x 1.05 = Rs 4.20.
1	New equity proceeds	80-4 = Rs 76.
1	Equity cost	4.2/76+.05 = 10.526316%.
1	Debt contribution	40% x 7.368421% = 2.947368%.
1	Preference contribution	10% x 10% = 1%.
1	Equity contribution	50% x 10.526316% = 5.263158%.
1	MCC	2.947368+1+5.263158 = 9.210526%, about 9.21%.
1	Limits	Net-funding target weights and model/tax terms are explicit. Do not substitute coupons, D0 or face-value weights; no current legal perpetuity issuance or project-risk verdict inferred.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 31

FM-C04-D023 · 10 marks

A bond receives Rs 95 now, pays Rs 8 gross coupon annually for three years, and at year 3 the holder may choose cash redemption Rs 100 or two ordinary shares. Coupon alone has an immediate usable 25% tax shield. Scenario A forecasts a share price Rs 60 at conversion; B forecasts Rs 45. Under the supplied valuation convention use the greater of redemption and forecast conversion value as terminal funding cost, plus the final net coupon. Required: construct both streams, solve both IRRs and explain forecast and cash/non-cash limits. (10 marks)

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Marks	Credit	Working / case application
1	Coupon net	8 x.75 = Rs 6 per year.
1	A conversion value	2 x 60 = Rs 120, greater than cash 100.
1	A final value	Year 3 total cost-value 126, years 1/2 cost 6.
1	A equation	95=6/(1+k)+6/(1+k)^2+126/(1+k)^3.
1	A IRR	About 13.97%, subject to numerical residual verification.
1	B terminal value	2 x 45=90; supplied option favours cash 100.
1	B stream	6, 6, 106; solve PV against 95.
1	B IRR	About 7.94%, subject to numerical residual verification.
1	Forecast uncertainty	Future share price/conversion choice is not guaranteed; sensitivity follows explicit forecast scenarios.
1	Economic versus cash	A uses non-cash share value as model funding cost, not a guaranteed Rs 120 cash repayment; actual terms/rights and dilution must be checked. No tax relief on conversion/redemption assumed.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 15

FM-C04-D024 · 5 marks

Net bond proceeds Rs 94; after-tax payment Rs 7 at each year end 1-5 plus principal Rs 100 at year 5. Discounting gives PV Rs 96.01 at 8% and Rs 92.22 at 9% (rounded). Required: estimate cost by interpolation, state signs and compare with exact solving. (5 marks)

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Marks	Credit	Working / case application
1	NPVsigns	At 8%: +2.01; at 9%: -1.78, so root lies between.
1	Interpolation fraction	2.01/(2.01+1.78) = .53034 of the one-percentage-point interval.
1	Estimate	8%+.53034% x 1 = about 8.53%.
1	Exact comparison	Exact scheduled-flow root about 8.52353%; rounded PVs and nonlinear discounting explain small difference.
1	Method boundary	Interpolation is an estimate, not an exact IRR; do not reverse signs or interpolate using coupon 10 instead of net 7.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 12

FM-C04-D025 · 5 marks

A face-100 bond raises Rs 100 net and pays 10% annual coupon in equal half-yearly instalments, redeeming at par after two years. Coupon deductible at 30% with immediate half-yearly shields; no other flows. Required: construct period payments, identify half-yearly after-tax IRR and compute nominal and effective annual costs. (5 marks)

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Marks	Credit	Working / case application
1	Half-year coupon	Gross 5; net 5 x.7=Rs 3.50 each half-year.
1	Stream	Receive 100; pay 3.5 at periods 1-3 and 103.5 at period 4.
1	Periodic IRR	3.5% per half-year at par.
1	Annual measures	Nominal 2 x 3.5%=7%; effective (1.035)^2-1=7.1225%.
1	Consistency	Do not call 7% effective or use an annual 5-coupon with two-year terminal date; appraisal periods and rate compounding must match.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 13

FM-C04-D026 · 5 marks

Book paid-up ordinary capital is Rs 30 lakh and retained earnings Rs 20 lakh. Total market equity is Rs 100 lakh. For this exercise only, follow the module convention allocating that market equity between the two in their book-value ratio; ordinary component cost 14%, retained cost 12%. Debt market value Rs 50 lakh costs 6% after tax. Required: allocate equity once, calculate WACC and prevent double counting. (5 marks)

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Marks	Credit	Working / case application
1	Allocation ratio	30: 20 = 60: 40.
1	Allocated equity	Paid-up 60, retained 40; sum 100, not 100+20.
1	Total funding	100+50=Rs 150 lakh.
1	WACC	(60 x.14+40 x.12+50 x.06)/150 = 16.2/150 = 10.8%.
1	Convention scope	This requested pedagogical allocation has no separate traded retained security; do not add reserves again. An all-equity single-cost market calculation is a different expressly defined treatment.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 33

FM-C04-D027 · 5 marks

Price Rs 100, next dividend Rs 4, constant growth 6%, constant-earnings proxy EPS Rs 10. CAPM inputs Rf 5%, market return 11%, beta 1.2. Required: calculate three estimates and explain why choosing the lowest automatically is weak. (5 marks)

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Marks	Credit	Working / case application
1	Dividend growth	4/100+.06 = 10%.
1	Earnings price	10/100 = 10% under its constant-earnings model.
1	CAPM	5+1.2 x(11-5) = 12.2%.
1	Different premises	Payout/growth/perpetuity assumptions differ from systematic-risk compensation; equal first two numbers do not prove equivalent economic models.
1	Selection	Use relevant evidence and fit; do not choose 10% merely to pass a project or treat any forecast as guaranteed realised yield.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 28

FM-C04-D028 · 5 marks

An analyst sets D1 Rs 5, ex-dividend price Rs 50 and perpetual g 12%. Another values equity using Ke 10%, g 12% in P=D1/(Ke-g). Required: derive cost under the first supplied price relation, identify the second model failure and state forecasting checks. (5 marks)

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Marks	Credit	Working / case application
1	Cost relation	Ke=5/50+.12=22%.
1	Spread	Ke-g=10 percentage points in the first relation.
1	Invalid valuation inputs	Second spread 10%-12%=-2%; negative computed price is not a valid economic constant-growth perpetuity valuation.
1	Convergence condition	Perpetual dividend model requires Ke>g and feasible constant growth; equality also invalidates finite positive valuation.
1	Forecast caution	Do not assume 12% forever from a short trend; review growth/payout and model scope. Derived 22% is conditional, not live investor evidence.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 21

FM-C04-D029 · 5 marks

Company WACC 10% uses after-tax debt and nominal domestic-currency cash flows. Project X has materially different business risk; its analyst uses pre-tax accounting profit as cash flow, a real growth forecast and company 10% without adjustments. Required: identify mismatches and what must be grounded before a pass/fail verdict. (5 marks)

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Marks	Credit	Working / case application
1	Risk mismatch	Review project-specific risk; company WACC not automatic for different-risk project.
1	Cash measure	Accounting profit is not project free cash flow; reconcile capital spending/working capital/non cash amounts.
1	Tax match	Match after-tax cash-flow and financing/discount conventions, not pre-tax profit with after-tax rate indiscriminately.
1	Inflation/currency	Nominal rate and real forecast must be made consistent in the same currency and period.
1	No premature verdict	Cost number alone does not prove accept/reject; obtain appropriate cash schedules/risk assumptions and appraisal measure before concluding.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 5

FM-C04-D030 · 10 marks

Orchid Ltd plans new financing at 30% debt, 10% preference and 60% equity. Debt costs 7% after tax for the first Rs 12 lakh debt then 9% for further debt. Preference costs 10% throughout. Retained earnings Rs 18 lakh cost 12%; external equity 14%. Rates apply incrementally, not retroactively. Required: calculate breakpoints and MCC bands; allocate Rs 50 lakh programme, calculate its average cost and next-rupee cost; explain why internal funds are not free or sufficient for a project verdict. (10 marks)

Case-supplied amounts/terms; units stated in the question.

Source	Target share	First tier / resource
Debt	30%	12 lakh debt at 7%, then 9%
Preference	10%	10% throughout
Equity	60%	18 lakh retained at 12%, then external 14%

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Marks	Credit	Working / case application
1	Retention breakpoint	18/.60=Rs 30 lakh total funding.
1	Debt breakpoint	12/.30=Rs 40 lakh total funding.
1	First band	Up to 30: .3 x 7+.1 x 10+.6 x 12=10.3%.
1	Second band	Above 30 through 40: .3 x 7+.1 x 10+.6 x 14=11.5%.
1	Third band	Above 40: .3 x 9+.1 x 10+.6 x 14=12.1%.
1	Sources	Debt 15(first 12 at 7%, next 3 at 9%), preference 5 at 10%, equity 30(retained 18 at 12%, external 12 at 14%).
1	Total cost proxy	12 x.07+3 x.09+5 x.10+18 x.12+12 x.14=Rs 5.45 lakh.
1	Programme average	5.45/50=10.9%, also(30 x 10.3%+10 x 11.5%+10 x 12.1%)/50.
1	Next rupee	12.1% under continuing target mix; do not confuse with 10.9% average or reprice lower tranches.
1	Limits	Retained funds have opportunity cost; matching risk/tax/cash/project opportunities still required. No spend/issue/project acceptance action authorised by these exercise assumptions.

Original case; indicative capped allocation, not an official scheme. Use the supplied timing/tax/model conventions; equivalent correct work credited without duplication.

Official concept source, PDF page 38