Question

Cotton On Ltd. currently has the following capital structure:

Debt: $3,500,000 par value of outstanding bond that pays annually 10% coupon rate with an annual before-tax yield to maturity of 12%. The bond issue has face value of $1,000 and will mature in 20 years.

Ordinary shares: $5,500,000 book value of outstanding ordinary shares. Nominal value of each share is $100. The firm plan just paid a $8.50 dividend per share. The firm is maintaining 4% annual growth rate in dividends, which is expected to continue indefinitely.

Preferred shares: 45,000 outstanding preferred shares with face value of $100, paying fixed dividend rate of 12%.

The firm's marginal tax rate is 30%.

Required:

a) Calculate the current price of the corporate bond?

b) Calculate the current price of the ordinary share if the average return of the shares in the same

industry is 9%?

c) Calculate the current price of the preferred share if the average return of the shares in the same

industry is 10%

I need this question answer please..

Answer 1

The current price of the corporate bond = $850.61

Note:

1. Current price of the bond equals the present value of all coupon payments and present value of the face value that will be paid on maturity.

2. Present value, as above, can be found both by usin TVM (time value of money) equations and also using the excel function =PV. Have given answer under both methods for reference.

Current Price of the Ordinary Share = $176.80

Note:

1. Current price of ordinary share can be found using Dividend Growth Model using the below formula:

Price per share = Dividend next year / (required return - growth rate)

Current Price of the Preferred Share = $120

Note:

1. Current price of preferred stock = Dividend payable / required rate of return