KSLU Solved Question Papers
Financial Management
Previous Year Question Paper with Solution
B.B.A. LL.B. (Five Years) · Sem 4
2012 Dec (70 marks) Examination
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Mumbai
B.B.A. LL.B. (Five Years) Sem 4 Financial Management 2012 Dec (70 marks) Question Paper with Solutions
First published on munotes.in on 21 October 2026.
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The question paper reproduced here is the paper as set by Karnataka State Law University at the 2012 Dec (70 marks) examination.
Contents
The questions below are the paper as Karnataka State Law University set it at the 2012 Dec (70 marks) examination, in the order it was set.
MarksPage
MarksPage
The Paper as Set
The questions in this volume are the questions asked at the 2012 Dec (70 marks) examination, reproduced as Karnataka State Law University set them, in the order it set them. Long reading passages are shortened to their first and last lines and our summary; the original paper prints them in full. Only the answers are ours. See the original question paper.
Duration 2½ hours · Total marks 70 · 20 questions answered
Instructions printed on the paper
- N.B. (1) Answer all 5 questions. (2) One essay type and one short note question or problem from each Unit have to be attempted, which is referred to as Part (a) and Part (b) in all the Units. (3) Figures to the right indicate marks.
How to use this volume
Solve the paper first, under exam conditions and against the clock. Then read the answers here and mark your own. Reading a solution before attempting the question feels productive and teaches very little, because recognising an answer is not the same as being able to write one.
Q1
Unit I
(a)What is Cost of Capital ? Explain the following terms : 1) Cost of Equity Capital 2) Cost of Debenture Capital 3) Cost of Preference Capital 4) Cost of Retained Earnings[9]
Answer
For full marks, cover: what cost of capital is, specific and overall; then each term in turn with its meaning, formula and a small worked figure: (1) cost of equity capital, (2) cost of debenture capital, irredeemable and redeemable, before and after tax, (3) cost of preference capital, irredeemable and redeemable, (4) cost of retained earnings; a summary table; and a conclusion.
Cost of capital
The cost of capital is the minimum rate of return a company must earn on its investments. Below it, the market value of its shares falls. It is the price paid for the use of funds. The cost of one source alone is its specific cost. The weighted average of the specific costs of all sources is the overall cost of capital (WACC). The four specific costs are explained below.
1. Cost of equity capital (Ke)
The return equity shareholders expect from the company. No return is promised to them, so the cost is estimated.
- Dividend growth model: Ke = D1 / P0 + g. D1 is the next dividend, P0 the market price (or net proceeds for a new issue) and g the growth rate. If D1 = Rs 4, P0 = Rs 50 and g = 5 per cent, Ke = 4 / 50 + 0.05 = 0.13, or 13 per cent.
- CAPM: Ke = Rf + β (Rm - Rf). With Rf 6 per cent, Rm 13 per cent and β 1.2, Ke = 6 + 1.2 × 7 = 14.4 per cent.
- Other methods relate dividends or earnings to price (dividend yield, earnings yield).
Equity dividends are not tax-deductible, so no tax adjustment is made.
2. Cost of debenture capital (Kd)
The interest the company pays on debentures, related to what it actually receives, and reduced for tax because interest is a deductible expense.
- Irredeemable debentures: Kd = I (1 - t) / NP. Take a 12 per cent debenture of Rs 100 issued for a net Rs 95, with tax at 30 per cent. It costs 12 × 0.70 / 95, about 8.84 per cent after tax.
- Redeemable debentures: Kd = [I (1 - t) + (RV - NP) / n] / [(RV + NP) / 2]. If the same debenture is redeemable at par after 5 years, Kd = (8.4 + 5 / 5) / 97.5 = 9.4 / 97.5, about 9.64 per cent.
The tax saving makes debt the cheapest source of long-term funds.
3. Cost of preference capital (Kp)
The fixed dividend paid to preference shareholders, related to the net proceeds. It is paid from profit after tax, so there is no tax adjustment.
- Irredeemable preference shares: Kp = D / NP. An 11 per cent share of Rs 100 issued for a net Rs 98 costs 11 / 98, about 11.22 per cent.
- Redeemable preference shares: Kp = [D + (RV - NP) / n] / [(RV + NP) / 2]. If redeemable at par after 5 years, Kp = (11 + 2 / 5) / 99 = 11.4 / 99, about 11.52 per cent.
4. Cost of retained earnings (Kr)
Retained profits involve no payment, but they belong to the equity shareholders, who could have invested them elsewhere. Their cost is that opportunity cost.
- Usually Kr = Ke. With Ke at 13 per cent, Kr is 13 per cent.
- Allowing for shareholders' personal tax and brokerage on reinvesting a dividend: Kr = Ke × (1 - personal tax) × (1 - brokerage). With personal tax at 20 per cent and brokerage at 1 per cent, Kr = 13 × 0.80 × 0.99, about 10.30 per cent.
Retained earnings cost less than a new issue of equity because no issue expenses arise.
Summary
| Term | Formula (main form) | Example result |
|---|---|---|
| Cost of equity | D1 / P0 + g | 13.00% |
| Cost of debentures (after tax) | I (1 - t) / NP | 8.84% |
| Cost of preference capital | D / NP | 11.22% |
| Cost of retained earnings | Ke (or Ke adjusted for personal tax and brokerage) | 13.00% (10.30%) |
The usual order, from cheapest to dearest, is debt, preference capital, retained earnings and new equity. Debt is cheapest because lenders bear the least risk and interest saves tax.
Conclusion. Cost of capital is the minimum return a company must earn on its funds. The cost of equity is the shareholders' expected return, found by the dividend growth model or CAPM. The cost of debentures is the after-tax interest related to the net proceeds. The cost of preference capital is the fixed dividend related to the net proceeds; both are adjusted for redemption where relevant. The cost of retained earnings is the opportunity cost to shareholders, usually equal to the cost of equity.
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