Question 1

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:

  1. Calculate the current price of the corporate bond?
  2. Calculate the current price of the ordinary share if the average return of the shares in the same industry is 9%?
  3. Calculate the current price of the preferred share if the average return of the shares in the same industry is 10%

 

Question 2

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
Cost $175,000 $185,000
Future Cash Flows

Year 1

Year 2

Year 3

Year 4

Year 5

 

76,000

83,000

67,000

65,000

55,000

  

87,000

78,000

69,000

65,000

57,000

 

Required:

  1. Identify which project should the company accept based on NPV method. (Note: Please round up the result of each calculation of PV to 2 decimal places only for simplification)
  2. Identify which project should the company accept based on simple pay back method if the payback criteria is maximum 2 years.
  3. Which project Giant Machinery should choose if two methods are in conflict.

 

Question 3

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.

Required:

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?

 

Question 4

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%.

 

Required:

  1. Calculate the total market value of the firm.
  2. Calculate the capital structure of the firm. (Please round up the result at 3 decimal places)
  3. Calculate the firm’s weighted average cost of capital if the tax rate is 30%, assuming a classical tax system.

 

Question 5

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.

 

Required:

  1. 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.
  2. 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 morning. Assuming the tax on dividend is 15%.
  3. 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.
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