Blooming Ltd. currently has the following capital structure: Debt: $2,500,000 par value of outstanding bond that pays annually 12% coupon rate with an annual before-tax yield to maturity of 10%. The bond issue has face value of $1,000 and will mature in 25 years. Ordinary shares: 65,000 outstanding ordinary shares. The firm plans to pay a $7.50 dividend per share in the next financial year. The firm is maintaining 3% annual growth rate in dividend, which is expected to continue indefinitely. Preferred shares: 40 000 outstanding preferred shares with face value of $100, paying fixed dividend rate of 14%. Company tax rate is 30%. Required: Complete the following tasks: 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 value of the preferred share if the average return of the shares in the same industry is 12% d) Calculate the current market value (rounded off to the nearest whole number) and capital structure of the firm (rounded off to two decimal places). Identify the total weights of equity funding e) Compute the weighted average cost of capital (WACC) under the traditional tax system for the firm, using dividend constant growth model for calculation the cost of ordinary equity. please solve d & e sub parts
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Blooming Ltd. currently has the following capital structure:
Debt: $2,500,000 par
Ordinary shares: 65,000 outstanding ordinary shares. The firm plans to pay a $7.50 dividend per share in the next financial year. The firm is maintaining 3% annual growth rate in dividend, which is expected to continue indefinitely.
Preferred shares: 40 000 outstanding preferred shares with face value of $100, paying fixed
Company tax rate is 30%.
Required: Complete the following tasks:
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 value of the
d) Calculate the current market value (rounded off to the nearest whole number) and capital structure of the firm (rounded off to two decimal places). Identify the total weights of equity funding
e) Compute the weighted average cost of capital (WACC) under the traditional tax system for the firm, using dividend constant growth model for calculation the
please solve d & e sub parts
Cost of capital is the minimum rate of return which the company wants to earn on it's investment by forming an adequate capital structure which consists of proportionate value of equity, debt and preferred stock to minimize the overall cost of capital which is also known as the Weighted average cost of capital (WACC) to increase the wealth of shareholders in order to satisfy the expectations to earn extensively on their investments.
Part d)
Calculation of current market value of the firm is shown as under:
|
Particulars |
Current market value(per share)(A) |
Total no. of outstanding stock (B) |
Total market value of firm (C=A*B) |
|
Equity |
$125 |
65,000 |
$8,125,000 |
|
Debt |
$854.77 |
2,500 |
$2,137,000 |
|
Preferred stock |
$81.67 |
40,000 |
$3,267,000 |
|
|
|
Total Capital structure |
$13,529,000 |
Total weights of equity funding on the basis of market value is,
Hence, the total market value of capital structure is $13,529,000 and weights of equity is 60% in the capital structure.
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