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%

Answer 1

Part A:

Price of Bond = PV of CFs from it.

Period	Cash Flow	[email protected]	PV of Cash Flow
1	$                  100.00	0.8929	$                              89.29
2	$                  100.00	0.7972	$                              79.72
3	$                  100.00	0.7118	$                              71.18
4	$                  100.00	0.6355	$                              63.55
5	$                  100.00	0.5674	$                              56.74
6	$                  100.00	0.5066	$                              50.66
7	$                  100.00	0.4523	$                              45.23
8	$                  100.00	0.4039	$                              40.39
9	$                  100.00	0.3606	$                              36.06
10	$                  100.00	0.3220	$                              32.20
11	$                  100.00	0.2875	$                              28.75
12	$                  100.00	0.2567	$                              25.67
13	$                  100.00	0.2292	$                              22.92
14	$                  100.00	0.2046	$                              20.46
15	$                  100.00	0.1827	$                              18.27
16	$                  100.00	0.1631	$                              16.31
17	$                  100.00	0.1456	$                              14.56
18	$                  100.00	0.1300	$                              13.00
19	$                  100.00	0.1161	$                              11.61
20	$                  100.00	0.1037	$                              10.37
20	$              1,000.00	0.1037	$                            103.67
Bond Price	$                            850.61

Part B:

P0 = D0(1+g) / [ Ke - g ]

D0 = Just paid Div

g = Growth Rate

Ke = Required Ret

P0 = Price Today

P0 = D0(1+g) / [ Ke - g ]

= $ 8.50 ( 1 + 0.04 ) / [ 9% - 4% ]

= $ 8.50 * 1.04 / 5%

= $ 8.84 / 5%

= $ 176.8

Part C:

P0 = Pref Div / Required Ret

= $ 12 / 10%

= $ 120