Question 5 (11 marks)

Treasure Island Ltd. currently has the following capital structure:

Debt: $3,500,000 par value of outstanding non-callable bond that pays annually 10% coupon rate with an annual before-tax yield to maturity of 8.5%. The bond issue has face value of $1,000/bond and will mature in 20 years.

Ordinary shares: 70,000 outstanding ordinary shares. The firm plans to pay a $4.50 dividend per share in the next financial year. The firm is maintaining 5% annual growth rate in dividend, which is expected to continue indefinitely.

Preferred shares: 45 000 outstanding preferred shares with face value of $100, paying fixed dividend rate of 13%.

Company tax rate is 30%.

Required: Complete the following tasks:

1. Calculate the current price of the corporate bond? (3 marks)
2. Calculate the current price of the ordinary share if the average return of the shares in the same industry is 11%? (2 marks)
3. Calculate the current value of the preferred share if the average return of the shares in the same industry is 10.5% (2 marks)
4. Calculate the current market value (rounded off to the nearest whole number) and capital structure of the firm (rounded off to two decimal places). Identify the total weights of equity funding (2 marks)

e. Compute the weighted average cost of capital (WACC) under the traditional tax system for the firm (2 marks)