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Question 2 (a) Capital structure of T Limited as on 1st April,2024 is as under: ` Equity Share Capital (` 10 per share) 50,00,000 10% Debentures (` 100 per Debenture) 40,00,000 12% Preference Share Capital (10,000 shares of ` 100 each) 10,00,000 Additional Information: (1) The risk free rate of return is 10%. The Beta of T Ltd. is 1.75 and the return on market portfolio is 12%. The Equity shares have a current market price of ` 70 per share. (2) The debentures are trading at a market price of ` 80 per debenture. The Debentures are to be redeemed after 5 years at par. (3) Preference shares are redeemable after 5 years at a premium of 5%, presently selling at ` 104 per share. (4) The Company pays tax at a rate of 30%. (5) The Cost of Debentures are to be calculated on Yield to Maturity approach. FINANCIAL MANAGEMENT AND STRATEGIC MANAGEMENT (6) The present value factors at 10% and 14% are: Year 1 2 3 4 5 PVIF0.10,t 0.909 0.826 0.751 0.683 0.621 PVIF0.14,t 0.877 0.769 0.675 0.592 0.519 You are required to calculate Weighted Average Cost of Capital (after tax) of T Limited using Market value weights. (8 Marks) (b) Explain Angel Financing. (2 Marks)

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Detailed Solution & Explanation

**QUESTION 2(a): Weighted Average Cost of Capital (WACC) — T Limited**

**Capital Structure of T Limited (as on 1st April, 2024):**

| Source | Book Value (\\displaystyle \\` \) |
|---|---|
| Equity Share Capital (\\displaystyle \\` \10 per share) | 50,00,000 |
| 10% Debentures (\\displaystyle \\` \100 per debenture) | 40,00,000 |
| 12% Preference Share Capital (10,000 shares of \\displaystyle \\` \100) | 10,00,000 |

**Number of Equity Shares** = 50,00,000 \\displaystyle \\div\ 10 = 5,00,000 shares
**Number of Debentures** = 40,00,000 \\displaystyle \\div\ 100 = 40,000 debentures
**Number of Preference Shares** = 10,000 shares

---

**Step 1 — Cost of Equity (Ke) using CAPM:**

\K_e = R_f + \\beta (R_m - R_f) \
\Ke=10K_e = 10\\% + 1.75 \\times (12\\% - 10\\%) \
\Ke=10K_e = 10\\% + 1.75 \\times 2\\% = 10\\% + 3.5\\% = \\mathbf{13.5\\%} \

---

**Step 2 — Cost of Redeemable Debentures (Kd) using YTM / IRR Approach:**

*Relevant Cash Flows:*
- Year 0: Current Market Price (outflow) = \\displaystyle \\` \80 per debenture
- Years 1–5: Net interest after tax = 10% \\displaystyle \\times\ 100 \\displaystyle \\times\ (1 − 0.30) = \\displaystyle \\` \7 per year
- Year 5: Redemption at par = \\displaystyle \\` \100

*Sum of PV factors (annuity):*
- At 10%: 0.909 + 0.826 + 0.751 + 0.683 + 0.621 = 3.790
- At 14%: 0.877 + 0.769 + 0.675 + 0.592 + 0.519 = 3.432

*NPV at 10% (Lower rate L):*
\NPV_L = -80 + (7 \\times 3.790) + (100 \\times 0.621) \
\= -80 + 26.53 + 62.10 = +\\mathbf{8.63} \

*NPV at 14% (Higher rate H):*
\NPV_H = -80 + (7 \\times 3.432) + (100 \\times 0.519) \
\= -80 + 24.024 + 51.90 = -\\mathbf{4.076} \

*Interpolation (IRR):*
\K_d = L + \\frac{NPV_L}{NPV_L - NPV_H} \\times (H - L) \
\Kd=10K_d = 10\\% + \\frac{8.63}{8.63 - (-4.076)} \\times (14\\% - 10\\%) \
\Kd=10K_d = 10\\% + \\frac{8.63}{12.706} \\times 4\\% = 10\\% + 2.72\\% = \\mathbf{12.72\\%} \

---

**Step 3 — Cost of Redeemable Preference Shares (Kp) using Approximation Method:**

- Preference Dividend (PD) = 12% \\displaystyle \\times\ \\displaystyle \\` \100 = \\displaystyle \\` \12 per share
- Redemption Value (RV) = \\displaystyle \\` \100 \\displaystyle \\times\ (1 + 5%) = \\displaystyle \\` \105 per share
- Net Proceeds / Current Market Price (NP) = \\displaystyle \\` \104 per share
- Tenure (n) = 5 years

\K_p = \\frac{PD + \\dfrac{RV - NP}{n}}{\\dfrac{RV + NP}{2}} \
\K_p = \\frac{12 + \\dfrac{105 - 104}{5}}{\\dfrac{105 + 104}{2}} = \\frac{12 + 0.20}{104.50} = \\frac{12.20}{104.50} = \\mathbf{11.67\\%} \

---

**Step 4 — Market Values of Each Source:**

| Source | Calculation | Market Value (\\displaystyle \\` \) |
|---|---|---|
| Equity Share Capital | 5,00,000 shares \\displaystyle \\times\ \\displaystyle \\` \70 | 3,50,00,000 |
| 10% Debentures | 40,000 debentures \\displaystyle \\times\ \\displaystyle \\` \80 | 32,00,000 |
| 12% Preference Shares | 10,000 shares \\displaystyle \\times\ \\displaystyle \\` \104 | 10,40,000 |
| **Total** | | **3,92,40,000** |

---

**Step 5 — WACC Calculation using Market Value Weights:**

| Source | Market Value (\\displaystyle \\` \) | Weight (w) | Cost (k) | \\displaystyle w \\times k\ |
|---|---|---|---|---|
| Equity | 3,50,00,000 | 0.8919 | 0.1350 | 0.12041 |
| 10% Debentures | 32,00,000 | 0.0816 | 0.1272 | 0.01038 |
| 12% Pref. Shares | 10,40,000 | 0.0265 | 0.1167 | 0.00309 |
| **Total** | **3,92,40,000** | **1.0000** | | **0.1339** |

\\\mathbf{WACC = 0.1339\ or\ 13.39\\%} \

---

**QUESTION 2(b): Angel Financing**

**Angel Financing** is a form of **equity financing** in which an individual (or a group of individuals) — known as an **Angel Investor** — provides capital to entrepreneurs, early-stage businesses, or start-ups in exchange for an **ownership stake (equity)** in the company.

**Key Features of Angel Financing:**
1. **Nature**: It is an equity-based investment, meaning the angel investor becomes a part-owner of the venture in return for capital provided.
2. **Stage of Investment**: Angels typically invest during the **early/seed stage** of a business — when traditional lenders (banks) and institutional investors (VCs) are reluctant to invest due to high risk.
3. **Form of Investment**: The investment may be a **one-time lump sum** or provided as **ongoing capital injections through a series of investments**, depending on the milestone achievements of the start-up.
4. **Return Expectation**: Angel investors seek a **higher rate of return** than what is typically offered by traditional investments (savings accounts, bonds, etc.), commensurate with the higher risk they take on.
5. **Beyond Capital**: Apart from money, angel investors often bring **mentorship, industry expertise, and networking contacts** to the start-up — adding strategic value beyond mere financial support.
6. **Informal Nature**: Unlike Venture Capital (VC), angel investing is generally more informal, with angels using their personal funds rather than institutional money.

**Example**: An experienced entrepreneur who has exited a successful business may invest \\displaystyle \\` \50 lakhs into a tech start-up in exchange for a 15% equity stake, and also guide the founding team with strategic advice — this is angel financing.

Key Concepts to Understand

Debentures

Long-term debt instruments issued by a company to the public for raising loan capital, carrying a fixed rate of interest (coupon rate) payable regardless of profit. Debenture holders are creditors, not owners, of the company.

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