Question

Additional Information for All Question: Return on market is 10%, return on T-bills is 4%, and companies pay 40% corporate tax and 30% capital gains tax.

Greenleaf Inc. is a newly incorporated firm that requires $500 million in capital; and is raising capital through debt and equity only. The firm is comparing one of two options on capital raising.

Option A: The firm raises $200million through issuing bonds and $300 million through issuing 600,000 (0.6million) ordinary shares. Each bond offers a semi annual coupons of $26.0485, has a par value of $200, matures in 10 years, and offers a YTM of 10% to its investors. The firm is to offer an expected dividend of $0 at the end of the first year, and offers ordinary shareholders a return of 14.92% per year.

Option B: The firm raises a total of $500 million by issuing 1 million bonds and 500,000 (0.5million) ordinary shares. Each bond costs $250, offers semiannual coupons, has a par value of $200, matures in 10 years, and offer a YTM of 11% to its investors. Each ordinary share costs $500.

Q1. (a) Option A: Calculate the price of each bond and the number of bonds that need to be issued to raise $200 million.

     (b) Option B: Calculate the price of each share, and hence, the expected dividend $0 (correct to 4 decimal prices) at the end of the first year.

     (C) Option C: Calculate the coupon rate offered to bond Investors.

Answer 1

Q1. (a) Option A: Calculate the price of each bond and the number of bonds that need to be issued to raise $200 million.

Price = - PV (Rate, Period, PMT, FV) = - PV (10%/2, 2 x 10, 26.0485, 200) = $ 400

Number of bonds required = $ 200 mn / $ 400 = 0.5 mn = 500,000

     (b) Option B: Calculate the price of each share, and hence, the expected dividend $0 (correct to 4 decimal prices) at the end of the first year.

I think you have erroneously written Option B for this question. This should have been option A. Because price of the share is given in option B. I am assuming this question pertains to Option A.

The firm raises $300 million through issuing 600,000 (0.6million) ordinary shares. Hence, price per share = $ 300 mn / 0.6 mn = $ 500 per share

Price = 500 = D1 / Ke = D1 / 14.92%

Hence, D1 = 500 x 14.92% =  74.6000

     (C) Option C: Calculate the coupon rate offered to bond Investors.

There is no option C. I believe you intended to write Option B. I am assuming this question pertains to Option B.

Semi annual coupon = PMT (Rate, Period, PV, FV) = PMT (11%/2, 2 x 10, -250, 200) = $  15.18

Hence, coupon rate = 2 x 15.18 / 200 = 15.18%