Factors determining cost of finance
1. Terms of reference – if short term, the cost is usually low and vice versa.
2. Economic conditions prevailing – If a company is operating under inflationary conditions, such a
company will pay high costs in so far as inflationary effect of finance will be passed onto the
company.
3. Risk exposed to venture – if a company is operating under high risk conditions, such a company will
pay high costs to induce lenders to avail finance to it because the element of risk will be added on the
cost of finance which may compound it.
4. Size of the business – A small company will find it difficult to raise finance and as such will pay
heavily in form of cost of finance to obtain debt from lenders.
5. Availability – Cost of finance (COF) prices will also be influenced by the forces of demand and
supply such that low demand and low supply will lead to high cost of finance.
6. Effects of taxation – Debt finance is cheaper by the amount equal to tax on interest and this means
that debt finance will entail a saving in cost of finance equivalent to tax on interest.
7. Nature of security – If security given depreciates fast, then this will compound implicit costs (costs of maintaining that security).
8. Company’s growth stage – Young companies usually pay less dividends in which case the cost of this
finance will be relatively cheaper at the earlier stages of the company’s development.
marto answered the question on February 12, 2019 at 08:00
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Date posted: February 12, 2019. Answers (1)
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maintained an annual dividend payment of Shs. 180,000 including for the...(Solved)
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maintained an annual dividend payment of Shs. 180,000 including for the year ended 31
March 2005.
On 3 April 2005, the management of the company identified an investment
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be 25% per annum on cost over the next four years ending 31 March 2009.
All earnings would continue to be paid out as dividends to shareholders. The cost of
capital is 20%.
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Date posted: February 12, 2019. Answers (1)
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alternative machine models, Alpha and Beta for possible purchase in order to
increase the company's...(Solved)
The management of Biashara Ltd. is in the process of evaluating two
alternative machine models, Alpha and Beta for possible purchase in order to
increase the company's production level.
The following additional information is available:
1. Alpha costs Shs. 3,800,000 and will have a useful life of four years.
2. Beta costs Shs. 8,000,000 and will have a useful life of six years.
3. Both machines have no salvage value after their useful lives.
4. An investment in working capital amounting to Shs. 825,000 will have to be made
at the beginning of the first year of the machine‟s life regardless of the
model purchased.
5. The estimated pre-tax cash inflows for each of the machines are shown below:
6. The cost of capital to the company is 12% and the corporation tax rate is 30%.
Required:
(i) Calculate the undiscounted pay back period for each machine model.
(ii) Calculate the net present value (NPV) for each machine model.
(iii) Using the net present values computed in
(ii) above, advise the management on
which model to purchase.
(iv) The management of the company has received an alternative offer to lease
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Date posted: February 12, 2019. Answers (1)
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Date posted: February 12, 2019. Answers (1)
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Date posted: February 12, 2019. Answers (1)
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(ii) Scrip dividends. (2 marks)
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(b) Zatex Ltd. had the...(Solved)
(a) Define the following finance terms:
(i) Term structure of interest rates.
(ii) Scrip dividends.
(iii) Share splits
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Shs.
Ordinary share capital (200,000 shares) 4,000,000
10% Preference share capital 1,000,000
14% Debenture capital 3,000,000
8,000,000
Additional information:
1. The market price of each ordinary share as at 31 March 2005 was Shs. 20.
2. The company paid a dividend of Shs. 2 for each ordinary share for the year
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4. The corporation tax rate is 30%.
Required:
(i) Compute the weighted average cost of capital of the company as at 31 March
2005.
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ending 31 March 2006. The existing debentures will not be affected by this
issue. The dividend per share for the year ending 31 March 2006 is expected to
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Date posted: February 12, 2019. Answers (1)
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Date posted: February 12, 2019. Answers (1)
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The policy of the company is to finance capital investments with a 50% debt. The
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purchase of the machine in part. The loan principal is to be paid in equal annual
installments of Shs. 1,125,000 payable at the year end. The company's
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Required:
(i) The net present value (NPV) of the machine if fully financed by equity to
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equity or loan.
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Date posted: February 12, 2019. Answers (1)
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The investment will involve an initial capital outlay of Shs. 1.4 million and the expected
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The equipment is to be depreciated on a straight line basis over the duration of the
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Date posted: February 12, 2019. Answers (1)
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Date posted: February 12, 2019. Answers (1)
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Date posted: February 12, 2019. Answers (1)
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Date posted: February 12, 2019. Answers (1)
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