Question 3 (11 marks)

The following information is available for Blue Ocean Group Ltd.:

Debt: Outstanding corporate bond that pays annually 10% coupon rate with an annual before-tax yield to maturity of 12%. The bond issue has face value of $1,000 and will mature in 20 years.

Ordinary shares: Outstanding ordinary shares which just paid a $8.50 dividend per share in the current financial year. The firm is maintaining 4% annual growth rate in dividends, which is expected to continue indefinitely.

Green Lagoon is the daughter company of the Blue Ocean Group and has the following capital structure:

• 50,000 ordinary shares outstanding at a market price of $36 a share. The shares have just paid a $5.84 annual dividend and have a dividend growth rate of 2.8%.
• 32,000 preference shares with a 8% fixed dividend, outstanding at a market price of $50 a share. The preference shares have a par value of $100.
• The outstanding bonds have a total face value of $4,500,000. The bonds have face value per bond of $1000 and market price of 98.5% of face. The bonds before tax YTM is 8%. The corporate marginal tax rate for the company is 30%.

Required: Complete the following tasks:

1. Calculate the current price of the corporate bond for the Blue Ocean Group? (2 marks)
2. Calculate the current market value of the ordinary share of the Blue Ocean Group if the average return of the shares in the same industry is 13%? (2 marks)
3. Calculate the current market value (rounded off to the nearest whole number) and capital structure of the Green Lagoon (rounded off to two decimal places), identify the total weight of equity funding (2 marks).
4. Calcualte the cost of each funding source or Green Lagoon in case the company would like to raise new funds, using dividend constant growth model for calculation the cost of ordinary equity. (2 marks)
5. Compute the weighted average cost of capital (WACC) under the classical tax system for the Greeen Lagoon. (3 marks)