Corporate Finance April 2026

Description

Corporate Finance

Apr 2026 Examination

 

 

Q1. SolarWave Appliances, a consumer durables manufacturer, plans a INR 1,000 million plant expansion. The CFO proposes a financing mix using market-value weights: 60% new equity at INR 150 per share, with an expected dividend per share this year of INR 9 and a long-run growth rate of 6%; 25% perpetual debentures at a 9% coupon issued at par; and 15% cumulative preference shares at INR 100 with a 10% dividend. The corporate tax rate is 30%, and flotation costs are negligible. The project’s base- case IRR is 11.5%. The board seeks a defensible hurdle rate and rationale for the capital mix aligned to wealth maximization. Apply the WACC framework using after-tax cost of debt, the Gordon growth model for cost of equity, and market-value weights to compute the firm’s hurdle rate. Based on your WACC and the stated IRR, recommend whether to proceed and explain one financing mix adjustment that could further lower WACC without materially increasing financial risk. What should the CFO do? (10 Marks)

Ans 1.

Introduction

Capital investment decisions are among the most critical responsibilities of financial management because they determine the long-term growth and value creation of a firm. When a company like SolarWave Appliances plans a large plant expansion, the financing structure and the required return on investment become central considerations. The cost of capital represents the minimum return that investors expect for providing funds to the business, and it serves as a benchmark for evaluating project feasibility. By aligning financing decisions with shareholder wealth maximization, management ensures that only value-creating projects are undertaken. In this context, determining

 

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Q2. A company faces two-year capital rationing and five independent investment opportunities (A–E). The cost of capital is 12%. Year 0 and Year 1 nominal capex budgets are limited to Rs.300 lakh and Rs.180 lakh, respectively. Projects A–D are indivisible (0 or 1), while E is scalable with a continuous scale factor s  [0, 2]. If both B and D are undertaken, a synergy adds Rs.15 lakh to PV of inflows. Precedence and exclusivity constraints: C can be selected only if A is selected; at most one of A or D can be selected. The PV of inflows shown is at 12% for the base scale (s=1). For E, if undertaken at scale s, its PV of inflows becomes Base_PV × sqrt(s), and its Year 0 and Year 1 capex both scale linearly with s. Choose the set of projects (including the optimal s for E) that maximizes total NPV subject to both-year budget constraints and logical constraints, and report the selected set (including s*) and the resulting maximum total NPV (Rs. lakh).

Project	Year 0 Capex (Rs. lakh)	Year 1 Capex (Rs. lakh)	PV of Inflows at 12% (Rs. lakh)
A	120	40	190
B	80	60	170
C	140	20	210
D	160	30	220
E (scalable)	70	30	120

 

Ans 2.

Introduction

Capital rationing occurs when a firm faces limits on available investment funds and must choose among competing projects to maximize value. In such situations, financial managers cannot simply accept all positive-return investments; instead, they must allocate resources carefully across time periods and projects. When multiple investment opportunities exist with interdependencies, logical

 

 

 

Q3(A). A firm plans to finance a Rs.1,000 crore perpetual project at a target D/V of 40%. The project’s steady-state EBIT is Rs.160 crore. Corporate tax rate is 25%. The risk-free rate is 6% and the market risk premium is 5%. The firm’s unlevered beta is 0.90. The pre-tax cost of debt is conditional on interest coverage (EBIT/Interest): if coverage

4.0× then kd = 8% p.a., otherwise kd = 10% p.a. Assuming the debt raised for this project equals 40% of the financing and remains perpetual, determine the WACC applicable to this project (use Hamada’s relation L = U[1 + (1  T)(D/E)] and market- value weights). (5 Marks)

Ans 3a.

Introduction

Determining the appropriate cost of capital is essential when a firm evaluates a long-term investment financed through both debt and equity. The weighted cost of capital reflects the overall return required by investors after considering financial risk and taxation. When leverage changes, the risk borne by equity holders also changes, which affects the required return on equity. Using market-value weights and risk-adjusted equity estimation helps ensure that the investment decision remains

 

Q3(B). Compute the firm’s WACC (percent, to two decimals) using market-value weights and recognizing a cap on the tax deductibility of interest, given the 30% corporate tax rate. All securities are perpetual. Use the data table below; assume debt trades at par so its pre-tax cost equals the coupon rate, and only the first Rs.60 crore of annual interest is tax-deductible (any excess interest gets no tax shield). For equity, use the Gordon growth model with the given D1, P0 and g to estimate k_e.

Source	Market value (Rs. crore)	Parameters
Debt	900	Coupon 9% p.a.; perpetual; only first Rs.60 crore of annual interest is tax-deductible
Preference	200	Dividend rate 12% p.a.; perpetual
Equity	1,400	D1 = Rs.8 per share; P0 = Rs.160 per share; g = 5% p.a. in perpetuity

 

(5 Marks)

Ans 3b.

Introduction

The weighted cost of capital reflects the overall return required by providers of debt, preference, and equity financing. In practical situations, tax regulations may limit the deductibility of interest expenses, reducing the effective tax advantage of borrowing. When evaluating financing costs using market-value weights, such regulatory constraints must be incorporated to obtain a realistic estimate of the firm’s cost of