Treasure Island Ltd. currently has the following capital structure: Debt: $3,500,000 par value of outstanding non-callable bond that pays annually 10% coupon rate with an annual before-tax yield to maturity of 8.5%. The bond issue has face value of $1,000/bond and will mature in 20 years. Ordinary shares: 70,000 outstanding ordinary shares. The firm plans to pay a $4.50 dividend per share in the next financial year. The firm is maintaining 5% annual growth rate in dividend, which is expected to continue indefinitely. Preferred shares: 45 000 outstanding preferred shares with face value of $100, paying fixed dividend rate of 13%. Company tax rate is 30%. Required: Complete the following tasks: A) 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. B) Compute the weighted average cost of capital (WACC) under the traditional tax system for the firm.
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.
Question 5/2
Treasure Island Ltd. currently has the following capital structure:
Debt: $3,500,000 par value of outstanding non-callable bond that pays annually 10% coupon rate with an annual before-tax yield to maturity of 8.5%. The bond issue has face
Ordinary shares: 70,000 outstanding ordinary shares. The firm plans to pay a $4.50 dividend per share in the next financial year. The firm is maintaining 5% annual growth rate in dividend, which is expected to continue indefinitely.
Company tax rate is 30%.
Required: Complete the following tasks:
A) 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.
B) Compute the weighted average cost of capital (WACC) under the traditional tax system for the firm.
Step by step
Solved in 2 steps with 2 images
