Question

4)Please answer with workings.. Tqvm

Question 4 Wetherby Co is a listed company with 10 million $1 shares in issue. The shares are currently trading at $1.69. Historic dividend growth has been 4% per year, and this is expected to continue in the future. The most recent dividend was 18.45 cents per share. The company is also financed by two different types of bonds, with details as follows: • 50,000 (x $100) Redeemable bonds, with a market value of $105. The coupon rate is 6% and redemption is in 5 years at the par value of $100 50,000 x $100) Convertible bonds, with a market value of $90. The coupon rate is 5% and the bond holder can choose to convert each $100 nominal value bond into 80 shares in 3 years' time, or to redeem the bond at its par value. The company's tax rate is 25%. Required: (a) What is the cost of debt associated with the redeemable bonds? (10 marks) (b) What is the value of the conversion option of the convertible bonds? State any assumptions (4 marks) (c) What is the company's cost of equity? (3 marks) (d) The after tax cost of the convertible bonds has been calculated as 22.5%. Using this, and your answers in (a) and (c) above, calculate the company's weighted average cost of capital. (4 marks) le) Briefly explain the two conditions that would be necessary for the company to use its existing company weighted average cost of capital (WACC) as a discount rate for a new project appraisal? (4 marks) (Total 25 marks)

Answer 1

1. PV = 105, (Current Market Price of the Bond), FV = 100, PMT = 6, n= 5, Calculate i,

i = 4.63%,

Manual calculation is as follows:

100 = 6/(1+i) + 6 /(1+i)^2+ 6 /(1+i)^3+ 6 /(1+i)^4+ 106 /(1+i)^5

2. Cost of equity can be calculated using dividend discount model:

Po = D1/(r-g)

1.69 = 0.1845 * 1.04 / (r - 0.04)

r = 15.35%