Question

The following information of Fortune Co. is given: Balance Sheets: Assets $m $m 10 20 Current assets Fixed assets 90 Liabilities and Equity Current liabilities Non-current liabilities Equity Total equity and liabilities 30 50 Total assets 100 100 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.

Answer 1

first 4 questions have been solved

	Bond A	Bond B
Rate of coupon on bond	8%	4%
Par value	1000	1000
Market rate of return	6%	6%
Market value	1333	667
Initial fund requirement	5000000	5000000
No. of bonds required to be issued	3750	7500
In future if the interest rate is expected to be dropped, then bonds with longer maturity will have greater price risk. i.e. Bond B
The company is committed to pay the coupon rate on the par value. Hence, it will not affect its cost of debt.
Initial fund requirement	5000000
Issue price of equity	6
No. of equity shares to be issued	833333.33
	Current	Revised
Earnings	4000000	6600000
Value of equity	195000000	200000000
ROE	2.05	3.30
Dividend [50% of earnings]	2000000	3300000
Cost of equity	1.025641	1.65