Question

Part- 1

Gertrude's Great Gloves issue bonds with a face value of $10,000, paying interest at j₂ = 12.75%, redeemable in exactly 13 years. An investor purchases the bond for $9,096.05. Calculate the cost of debt (j₂) for Gertrude's Great Gloves. You may give your answer as a percentage per annum to the nearest percent or use linear interpolation or a financial calculator to give a more accurate result.

Cost of debt = % pa

Part- 2

Hudaverdi Ltd pay current dividends of $1.64 per share with these dividends expected to grow at a rate of 2.9% per year in perpetuity. Hudaverdi Ltd shares are currently trading at $12.97 per share. What is the cost of equity finance for Hudaverdi Ltd? Give your answer as a percentage per annum to 1 decimal place.

Cost of equity = % pa

Answer 1

Part - 1

Information provided:

Face value= future value= $10,000

Current price= present value= $9,096.05

Time= 13 years

Coupon rate= 12.75%

Coupon payment= 0.1275*$10,000= $1,275

The cost of debt is calculated by computing the yield to maturity.

The yield to maturity is calculated by entering the below in a financial calculator:

FV= 10,000

PV= -9,096.05

N= 13

PMT= 1,275

Press the CPT key and I/Y to compute the yield to maturity.

The value obtained is 14.3201.

Therefore, the yield to maturity is 14.32%.

Part - 2

The cost of equity is calculated using the dividend discount model. It is calculated using the below formula:

Ke=D1/Po+g

Where:

D1= Next year’s dividend

Po=Current stock price

g=Firm’s growth rate

Ke= Cost of equity

Ke= $1.64*(1 + 0.029)/ $12.97 + 0.029

= $1.6876/ $12.97 + 0.029

= 0.1301 + 0.029

= 0.1591*100

= 15.91%.