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Homework answers / question archive / The following information is available for B&E Construction Ltd
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 company’s 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:
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)
Calculate the current price of the company’s corporate bonds. (2 marks)
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)
