In October 2013, Shweta Gujral, newly promoted a senior assistant to the Financial Controller of Locomotive Public Limited, undertook the task of assessing six upcoming investment projects for the following year. Her task was to analyse these projects and present her findings to the Board of Directors at its upcoming annual meeting in 10 days. The proposed new project required an investment of Rs. 4.8 crore. Founded in 1985 by Late Shri A. V. Sinha, Locomotive Public Ltd. gained recognition as a leading producer of high-quality graphite, with a significant portion of its sales going to Japan. The rapid economic expansion of Japan in the 1990s led to a booming demand for graphite, and sales experienced rapid growth. Expanding its operations to include lithium mining, electric vehicle production, and all phases of energy production, Locomotive Public Ltd. achieved sales of Rs. 28 crores by 2013, with a record net profit after taxes of Rs. 134 lakhs. In the early 2000s, as Locomotive Public Ltd. expanded its product line, it formalized its capital budgeting procedure. Initially, capital investments were chosen based on average return on investment calculations submitted by individual departments. In 2006, this approach was replaced by one using present value as the decision-making criterion, incorporating cash flows, and adjusting for the time value of money. The cost of capital, set at 12 percent, was determined by taking a weighted average of the costs incurred in raising funds over the previous 10 years. Shweta's original assignment was to update this rate over the most recent 10-year period and determine the net present value of proposed investment opportunities using the newly calculated figure. However, she objected, arguing that changing interest rates and stock prices rendered this calculation of little present value. Shweta proposed using the current cost of raising funds, weighted by their percentage mark-up of the capital structure. The Financial Controller embraced this proposal, and Shweta was tasked with recalculating Locomotive Public Ltd.'s cost of capital, providing a written report for the Board of Directors to explain and justify this calculation. To determine the weighted average cost of capital, Shweta examined the costs associated with each funding source, focusing on the firm's intention to maintain its current financial structure, as indicated in Exhibit 1 through conversations with the Financial Controller and other members of the Board of Directors. Exhibit 1: Locomotive Public Ltd. Balance sheet for year ending March 31, 2013. Assets Cash Accounts receivables Inventories Total current Assets Net fixed Assets Goodwill Total Assets Amount 180,00,000 6,20,00,000 2,40,00,000 10,40,00,000 38,60,00,000 140,00,000 50,40,00,000 Liabilities Accounts Payable Short term debt Accrued taxes Total current liabilities Long term debt Preference shares Retained earnings Equity shares Total liabilities and equity shareholder's fund Amount 17,00,000 2,00,000 23,00,000 2,40,00,000 14,40,00,000 9,60,00,000 2,00,00,000 2200,00,000 50,40,00,000 She also ascertained that the robust growth patterns displayed by Locomotive Public Ltd. over the past decade were anticipated to persist indefinitely due to the diminishing supply of US and Japanese domestic oil and the escalating importance of alternative energy resources. In her further investigations, Shweta discovered that Locomotive Public Ltd. could issue additional equity shares, each with a par value of Rs. 25 and currently trading at Rs. 45 in the market. The expected dividend for the next period would be Rs. 4.4 per share, with an anticipated growth rate of 8 percent per year for the foreseeable future. The flotation cost was projected to average Rs. 2 per share. Another option was the issuance of preference shares at 11 percent with a 10-year maturity, facilitated by an investment banker, each with a par value of Rs. 100 and redeemable at par. This issuance would involve a flotation cost of 5 percent. Lastly, Shweta discovered that Locomotive Public Ltd. could secure an additional Rs. 40 lakhs through a 7-year loan from Punjab National Bank at 12 percent. Any amount raised beyond Rs. 40 lakhs would incur a cost of 14 percent. Short-term debt had historically been utilized by Locomotive Public Ltd. for meeting working capital requirements, and as the company expanded, it was expected to maintain its proportion in the capital structure to support capital expansion. Additionally, Rs. 120 lakhs could be raised through a 10-year bond issue with an 11 percent coupon at face value. If the need for more funds arose through long-term debt, an additional Rs. 60 lakh could be garnered through the issuance of 10-year bonds at face value, with the coupon rate increased to 12 percent. Any further funds raised through long-term debt would have a 10-year maturity with a 14 percent coupon yield. The expected flotation cost for the bond issue was 5 percent, and the issue price was Rs. 100, to be redeemed at par. In the past, Locomotive Public Ltd. had calculated a weighted average of these funding sources to determine its cost of capital. However, in discussions with the current Financial Controller, it was noted that while this served as an appropriate calculation for external funds, it did not account for the cost of internally generated funds. The Financial Controller concurred that there should be some cost associated with retained earnings but was uncertain about the specific cost. Locomotive Public Ltd. is subject to a corporate tax rate of 40 percent. Given these facts, Shweta would likely submit a comprehensive report to the Board of Directors of Locomotive Public Ltd., outlining the various funding options, their associated costs, and proposing a recalibrated cost of capital that incorporates both external and internal sources of funds, considering the corporate tax rate. The report would aim to provide the Board with a well-informed basis for decision-making regarding the most suitable financing strategy for the company's expansion and investment projects.