Question

Hudaverdi Ltd pay current dividends of $0.61 per share with these dividends expected to grow at a rate of 2% per year in perpetuity. Hudaverdi Ltd shares are currently trading at $6.91 per share. What is the cost of equity finance for Hudaverdi Ltd? Give your answer as a percentage per annum to 1 decimal place.

Cost of equity =  % pa

Gertrude's Great Gloves issue bonds with a face value of $1,000, paying interest at j₂ = 6.75%, redeemable in exactly 13 years. An investor purchases the bond for $900.11. Calculate the cost of debt (j₂) for Gertrude's Great Gloves. You may give your answer as a percentage per annum to the nearest percent or use linear interpolation or a financial calculator to give a more accurate result.

Cost of debt =  % pa

Answer 1

1) Hudaverdi Ltd.

Given information,

Current Dividend = $0.61 per share

Growth rate = 2% per year in perpetuity

Current share price = $6.91 per share

There is a standard formula to calculate cost of equity. Cost of equity is a type of return or reward paid by company to it's investors for investment in the equity.

where,

D₁ indicates expected dividend which company is going to pay in future. Here we have given current dividend and growth rate by which company is going to pay it's dividend in future. Now we have to calculate expected dividend i.e. dividend to be paid in future.

Therefore, expected dividend (D₁) = Current dividend + (current dividend* rate of dividend)

= $0.61 + (0.61*2%)

= $0.61+$0.0122

Therefore, Expected dividend(D₁) = $0.6222

P₀ indicates value of stock i.e. price of share. We have given current price of share as $6.91 per share which is currently trading. Therefore, Price of share (P₀) = $6.91

g is growth rate which is also given as g = 2% We will take it as 0.02 for calculation purpose.

Therefore, Cost of equity indicated by K_e =

= [ 0.09+0.02]* 100

= 0.11*100

Therefore,   K_e = 11%

Therefore cost of equity is 11% p.a.

2) Gertrude's Great Gloves

Given information,

Issue price of bond = $1,000

Interest rate = 6.75%

Reedemable no of years = 13 years

Purchase of bond price to investors = $900.11

Now we have to calculate cost of debt as a percentage and we have formula for this. As bonds are redeemable, we have issue price given and purchase price to investors is regarded as redemption price of bond for company as company is giving to investors @ $900.11. Formula for calculating cost of redeemable bond is,

Cost of redeemable bond =

where,

I indicates interest value as calculated below as $67.5

RV is redemption value given as $900.11

NP is net price of bond. Here, Net price is as good as Issue price as we have not given any expenses to deduct it from issue price. Net price is calculated by Issue price minus any expenses related to bond. But we have not given any expenses related to bond so net price will be same as issue price as $1,000.

n indicates number of years.

Interest rate is given as 6.75% and interest is calculated on face value as $1,000.

Interest value = $1,000*6.75%

Interest value = $67.5

Therefore, Cost of bond =

=

=

= ( Plus and minus sign mixed becomes minus)

=

= 0.0630*100

Cost of bond = 6.30% p.a.