Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

The following information is available for B&E Construction Ltd.s capital structure: Equity Financing: 65% by ordinary shares, of which the company management plans to pay

The following information is available for B&E Construction Ltd.s capital structure:

Equity Financing: 65% by ordinary shares, of which the company management plans to pay a $7.25 dividend per share in the next financial year. The firm is maintaining a 5.5 % annual growth rate in dividends, which is expected to continue indefinitely.

Debt Financing: 35% by corporate bonds that pay semi-annually 11.5% coupon rate with an annual before-tax yield to maturity of 10.25%. The bond issue has a face value of $1,000 and will mature in 35 years.

The net income of B&E Construction Ltd. in the current financial year is $1,540,760, and the company is considering investing in one of the two following projects to buy new machinery. Each option will last five years and have no salvage value at the end. The companys required rate of return for all investment projects is 9.5 %. The cash flows of the projects are provided below.

Option 1

Option 2

Cost

$482,000

$535,000

Future Cash Flows

Year 1

Year 2

Year 3

Year 4

Year 5

177 000

173 000

163 000

165 000

155 000

197 000

185 000

176 000

173 000

163 000

Required: Complete the following tasks:

  1. Calculate the current market value of the B&E Construction Ltd ordinary share if the average return of the shares in the same industry is 12.3%. (2 marks)
  2. Calculate the current price of the companys corporate bonds. (2 marks)
  3. Identify which option of machinery should the company accept based on the NPV method. (3 marks) (Note: Please round up the result of each calculation of PV to 2 decimal places only for simplification)
  4. Identify which option of machinery should the company accept based on Discounted Payback Period method if the company requires a payback of maximum of 3 years for all investment projects. (2 marks)
  5. Which investment criterion should the companys finance manager recommend for the capital budgeting decision making if the company management would like to know a break-even rate of return of those options? (1 mark)
  6. How much dividend B&E Construction Ltd. can pay its shareholders from the current year net profit given the chosen project you decided in question (c) and if the Residual Dividend Payout Policy applies? (1 mark)

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Money Talks Explaining How Money Really Works

Authors: Nina Bandelj ,Frederick F. Wherry ,Viviana A. Zelizer

1st Edition

0691202893, 978-0691202891

More Books

Students also viewed these Finance questions

Question

Distinguish between different kinds of bonds.

Answered: 1 week ago