HI5002 Finance for Business Tutorial Solution
HI5002 Finance for Business Tutorial 2
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:
- Calculate the current price of the corporate bond? (4 marks)
- Calculate the current price of the ordinary share if the average return of the shares in the same industry is 9%? (3 marks)
- Calculate the current price of the preferred share if the average return of the shares in the same industry is 10% (3 marks)
Giant Machinery Ltd is considering to invest in one of the two following Projects to buy a new equipment. Each project will last 5 years and have no salvage value at the end. The company’s required rate of return for all investment projects is 9%. The cash flows of the projects are provided below.
|Project 1||Project 2|
|Future Cash Flows|
- Identify which project should the company accept based on NPV (4 marks) (Note: Please round up the result of each calculation of PV to 2 decimal places only for simplification)
- Identify which project should the company accept based on simple pay back method if the payback criteria is maximum 2 years. (4 marks)
- Which project Giant Machinery should choose if two methods are in conflict. (2 marks)
Bermuda Cruises issues only common stocks and coupon bonds. The firm has a debt-equity ratio of 0.45. The cost of equity is 17.6 percent.
What is the pre-tax cost of the company debt if weighted average costs of the company is 13.5% and the firm’s tax rate is 35 percent? (10 marks)
Western Electric has 35,000 ordinary shares outstanding at a price per share of $47 and a rate of return of 13.5%. The firm has 5,000 preference shares paying 7% dividend outstanding at a price of $58 a share. The preferred share has a par value of $100. The outstanding bond has a total face value of $450,000 and currently sells for 102% of face. The pre-tax yield-to-maturity on the bond is 8.49%.
- Calculate the total market value of the firm. (3 marks)
- Calculate the capital structure of the firm. (3 marks) (Please round up the result at 3 decimal places)
- Calculate the firm’s weighted average cost of capital if the tax rate is 30%, assuming a classical tax system. (4 marks)
The Giant Machinery has the current capital structure of 65% equity and 35% debt. Its net income in the current year is $250,000. The company is planning to launch a project that will requires an investment of $175,000 next year. Currently the share of Giant machinery is $25/share.
- How much dividend Giant Machinery can pay its shareholders this year and what is dividend payout ratio of the company? Assume the Residual Dividend Payout Policy applies. (4 marks)
- If the company is paying a dividend of $2.50/share and tomorrow the stock will go ex-dividend. Calculate the ex-dividend price tomorrow Assuming the tax on dividend is 15%. (2 marks)
- Little Equipment for Hire is a subsidiary in the Giant Machinery and currently under the liquidation plan due to the severe contraction of operation due to corona virus. The company plans to pay total dividend of $2.5 million now and $ 7.5 million one year from now as a liquidating dividend. The required rate of return for shareholders is 12%. Calculate the current value of the firm’s equity in total and per share if the firm has 1.5 million shares outstanding. (4 marks)