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 shareis $100. The firm plan just paid a $8.50 dividend per share. The firm is maintaining 4% annual growthrate in dividends, which is expected to continue indefinitely.Preferred shares: 45,000 outstanding preferred shares with face value of $100, paying fixed dividendrate 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 sameindustry is 9%? c) Calculate the current price of the preferred share if the average return of the shares in the sameindustry is 10%
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.
Cotton On Ltd. currently has the following capital structure:
Debt: $3,500,000 par
Ordinary shares: $5,500,000 book value of outstanding ordinary shares. Nominal value of each shareis $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 dividendrate 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
industry is 10%
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