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 fundinge) 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
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 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
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
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 fundinge) Compute the weighted average cost of capital (WACC) under the traditional tax system
for the firm, using dividend constant growth model for calculation the
equity
The price of the bond is the current value an investor is willing to pay for the bond.
The dividend growth model is the valuation model that calculates the fair value of the stock on the assumption that the dividend grows at a stable rate in perpetuity or at different rates during the period.
The formula for commodities:
Price of the bond:
Price of common stock:
Price of preference shares:
a) Computation of current price of the bond:
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