Question

ABC Ltd. issued $3,000,000 bond that has 15% coupon rate paid semi-annually. The bond has a face value of $1000 and will mature 12 years from now. The company has just paid a divided of $6.50 per share on its 50,000 ordinary shares. The company forecasted to maintain a growth rate of 5% in dividends in future. The company has 20,000 preference shares with $100 face value which has a market price of $120 per share. Requirements: 1. What is the value of the bond if required rate of return is 12%? 2. What is the price of the company's ordinary shares if required rate of return is 18%? 3. What is the dividend rate of the company's preference share if rate of return is 14%? 4. What is the market value of the firm? 5. Calculate the capital structure of the company by identifying weight of the financing and equity? 6. Compute the weighted average cost of capital (WACC) under the traditional tax system. Tax rate is 30% and use Dividend Growth model (DGM)

Answer 1

1]

Value of bond is calculated using PV function in Excel :

rate = 12%/2 (converting required annual return into semiannual return)

nper = 12 * 2 (total number of semiannual coupon payments = years to maturity * 2 = 12 * 2)

pmt = 1000 * 15% / 2 (semiannual coupon payment = face value * coupon rate / 2)

fv = 1000 (face value of bond receivable on maturity)

PV is calculated to be $1,188.26

2]

Price of share = next year dividend / (required return - growth rate)

next year dividend = current dividend * (1 + growth rate) = $6.50 * (1 + 5%) = $6.825

Price of share = $6.825 / (18% - 5%) = $52.50

3]

rate of return = preference dividend / price of preference share

14% = preference dividend / $120

preference dividend = $120 * 14% = $16.80

dividend rate = preference dividend / face value = $16.80 / $100 = 16.80%

4]

market value of firm = ordinary shares outstanding * price per share

market value of firm = 50,000 * $52.50 = $2,625,000