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 i f the average return of the shares in the same industry is 10%.

Answer 1

a) Calculate the current price of the corporate bond?

each corporate bond = $850.41, total debt = $850.41 x 3,500 = $2,976,435

b) Calculate the current price of the ordinary share if the average return of the shares in the same industry is 9%?

$176.80

c) Calculate the current price of the preferred share if the average return of the shares in the same industry is 10%.

$120

Step-by-step explanation:

issued $3,500,000, 10% coupon rate, 20 years to maturity, annual coupon per bond $100, YTM 12%

current bond price = PV of face value + PV of annuity

PV of face value = $1,000 / (1 + 12%)²⁰ = $103.67

PV of annuity using factor = $100 x 7.4694 (12%, 20 year annuity) = $746.94

current bond price = $103.47 + $746.94 = $850.41

current stock price = ($8.50 + 4%) / (9% - 4%) = $8.84 / 5% = $176.80

price of preferred stock = preferred dividend / market rate = $12 / 0.1 = $120