Question

ABC capital structure is made up of; CAPITAL STRUCTURE DEBT • Bonds EQUITY • Preference Shares • Ordinary Shares • ABC Ltd. has 120,000 bonds outstanding with a face value of $100 each. These bonds have 5 years to maturity and pay an annual coupon of 7.5%. ABC’s statutory corporate tax rate is 30%. • Moody’s Corporation is one of a big ratings agency which has given ABC Ltd. a debt rating of AAA. The following table shows the current yields available in the market based on debt ratings. • The risk-free rate offered by the government on bonds is 1.7%. Debt rating Risk premium AAA 5.8% AA 6.5% BBB 7.2% BB 7.5% • ABC Ltd. has issued 4 million preference shares, which pay an annual dividend per share of $0.375. They are currently trading at $3.75 each. • ABC Ltd. has issued 8 million ordinary shares, which are currently trading at $5 each. Shareholders are to receive a dividend of $0.70 per share in the current year, and this dividend is estimated to grow at a constant rate of 2.5%in perpetuity.

What is the market value of ABC’s bonds? (show all the workings clearly)

Answer 1

Calculation of Price of Bond

Using BAII Calculator (Set C/Y=P/Y=1)

Years to Mature N =5

PMT = -7.5 (7.5% *100)

I/Y = 5.8

FV =-100

CPT -------> PV = 107.20

This PV can also be computed using excel as shown below

Once we get PV of bond as 107.20 we can calculate the market value of bond.

Thus market value of bonds = 107.2 * 120000 (bonds outstanding)

Thus , Markret value of bonds = 12864000