Shareholder value and the cost of capital 1) AJI Limited current share price is

Question

Shareholder value and the cost of capital

1) AJI Limited current share price is $20 and it has just paid a $1 dividend. As AJI is a mature firm, this $1 dividend is expected to grow at a rate of 4% per year. What is an estimate of the return shareholders of AJI Ltd expected to earn? 4 marks

2) AJI also has preference shares outstanding that pays $2 per share fixed dividend. If this stock is currently priced at $24, what is the return that preference shareholders expect to earn? 4 marks

3) AJI has issued a 5 year bond with a coupon rate of 11% and par value of $1,000. The price received by AJI was $1,200. What is AJI’s pre-tax cost of debt? 4 marks

4) AJI has 5m ordinary shares outstanding and 1m preference shares outstanding. Its liabilities have a book value of $20m. If AJI’s ordinary and preference shares are priced as in parts a) and b), what is the market value of the AJI’s assets? 4 marks

5) AJI faces a 30% tax rate. Given the information in parts a) – d), and your answer to those problems, what is AJI’s WACC? 4 marks

Explanation / Answer

1) ROE=income/equity= dividend in year 1/(equity)

Dividend in year =1*(1+4%)=1.04

equity=20

x=1.04/20=5.2%

2)ddividend/current price

2/24=8.33%

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