Question
The following information of Fortune Co. is given: Assets $m Current assets 10 Fixed assets 90...
The following information of Fortune Co. is given:
Assets $m Current assets 10 Fixed assets 90
Total assets 100
Balance Sheets:
Liabilities and Equity $m Current liabilities 20 Non-current
liabilities 30 Equity 50 Total equity and liabilities 100
The net income of this financial year is $4 million. The
dividends of Fortune Co. are $2 million in total. The current stock
price is $6.5 per share and 30 million shares are
outstanding.
Now, the board directors of Fortune Co. are looking to an
investment proposal. To start up the project, new facilities are
required. The predicted cost of initial fund is $5 million. After
invested the new project, the net income can raise to $6.6 million
in next year and the new ROE can maintain forever. Since the
project is attractive, the board directors are willing to raise
fund from the market. According to the current economic
environment, Fortune Co. can issue new bonds or new stocks to
fulfill the initial investment.
Fortune Co. can issue two different types of bonds
(i) Bond A: Par value is $1,000, maturity is 4 years, coupon
rate is 8%
(ii) Bond B: Par value is $1,000, maturity is 6 years, coupon
rate is 4%
Both bonds paid the coupon annually. The required market
return of the new bonds is 6%.
Alternatively, Fortune Co. can issue new stocks at a discount
price $6 per share. The board directors want to maintain the
dividend payout ratio.
Required:
(a). Calculate the market price of Bond A and Bond B.
(b). Calculate the number of new bonds should be issued for
each of the bond.
(c). In the future, if the interest rate is expected to drop,
which one has greater price risk? Does it affects the cost of debt
of Fortune Co.? Please explain. (5marks)
(d). Calculate the new dividend growth rate. Since the
dividend growth is constant after the new investment, based on DGM,
please evaluate the cost of equity if Fortune Co. determined to use
new share to fulfill the initial fund need.
(e). If you are the CEO, will you issue new shares to fulfill
the fund need? Please briefly explain your reasons.
12
BBAZ16
Homework Answers
Answer #1
(a) Given,
BOND A
Par Value ( FV ) = $ 1000
Maturity ( N ) = 4 Years
Coupon Rate ( PMT ) = 8 % of 1000
= $ 80
Yield ( I/Y ) = 6 %
Therefore, Market Price Of the Bond ( PV ) = $ 1069.3021
BOND B
Par Value ( FV ) = $ 1000
Maturity ( N ) = 6 Years
Coupon Rate ( PMT ) = 4 % of 1000
= $ 40
Yield ( I/Y ) = 6 %
Therefore, Market Price Of the Bond ( PV ) = $ 901.6535
(b) No. of Bonds to be issued is depends on the Amount of Fund to be raised and also the Face Value of the Bond
= 5000
No. of Bonds to be issued of each type = 5000/2
= 2500 each
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