Question

Use the following information about Surf Ltd.’s capital structure to answer the questions below;     

Surf’s capital structure is made up of;

	CAPITAL STRUCTURE
DEBT	Bonds
EQUITY	Preference Shares Ordinary Shares

• Surf Ltd. has 120,000 bonds outstanding with a face value of $100 each. These bonds have 5 years to maturity andpay an annual coupon of 7.5%. Surf’s statutory corporate tax rate is 30%.

• Moody’s Corporation is one of a big ratings agency which has given Surf 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%

• Surf Ltd. has issued 4 million preference shares, which pay an annual dividend per share of $0.375. They arecurrently trading at $3.75 each.  

• Surf 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.

NOTE: Round all dollar amounts to the nearest dollar and all percentages to two decimal places.

q1: What is Surf’s after‐tax cost of debt?

q2: What is the market value of Surf’s bonds?

q3: What is the market value of Surf’s preference shares?

q4: What is Surf’s cost of preference shares?  

q5: What is the market value of Surf’s ordinary shares?

q6:  What is Surf’s cost of ordinary shares?

q7: What is Surf’s WACC (Weighted Average Cost of Capital)?

q8: Assume the preference shares issued by Surf Ltd. are cumulative. Assume the company doesn’t pay any dividends this year on both Preference and Ordinary Shares. Nonetheless, next year, the company estimates that $3 million will be available to be paid out as dividends. Calculate the dividends per share the ordinary shareholders are expected to receive next year?

Answer 1

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