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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: a) Calculate the current price of the corporate bond? (4 marks) b) Calculate the current price of the ordinary share if the average return of the shares in the same industry is 9%? (3 marks) c) Calculate the current price of the preferred share if the average return of the shares in the same industry is 10% (3 marks)

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Answer:

a) Calculate the current price of the corporate bond? (4 marks)

  • $818,18

b) Calculate the current price of the ordinary share if the average return of the shares in the same industry is 9%? (3 marks)

  • $176.80

c) Calculate the current price of the preferred share if the average return of the shares in the same industry is 10% (3 marks)

  • $120

Step-by-step explanation:

total debt = $3,500,000 par value 10$ coupon with a YTM of 12%

YTM = [coupon + (F - P)/n] / [(F + P)/2]

0.12 = [100 + (1,000 - P)/20] / [(1,000 + P)/2]

0.12(500 + 0.5P) = 100 + 50 - 0.05P

60 + 0.06P = 150 - 0.05P

0.11P = 90

P = 90/0.11 = $818.18

total debt = $818.18 x 3,500

stock price:

Div₀ = $8.50

Div₁ = $8.50 x 104% = $8.84

g = 4%

rrr = 9%

using the perpetuity growth model:

stock price = $8.84 / (9% - 4%) = $8.84 / 5% = $176.80

preferred stock:

Div = $12

rrr = 10%

using the perpetuity formula:

preferred stock = $12 / 10% = $120

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