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Could you please explain how the answers are arrived at for:
1. R plc has in issue $400,000 8% bonds, redeemable in 5 years time at a premium of 10%. Investors require a rate of return of 12% pa. The rate of corporation tax is 35%
What is the total market value of the debt in issue?
2. X plc has a dividend yield of 8% and dividend cover of 2.4. What is the P/E ratio?
Much appreciated!
1 The market value is the present value of the expected receipts discounted at the investors required rate of return.
The expected receipts are the interest of 8% a year (so 32,000 per year) for 5 years; and the repayment of 440,000 in 5 years time. The market value is the present value of these flows, discount at 12%. Tax is not relevant – it is only relevant for the company when calculating the cost of debt. It does not affect the investors and it is the investors who fix the market value.
(The free lecture on the valuation of securities will help you)
2. PE ratio = MV / EPS
Dividend yield = dividend / MV, so MV = dividend / Divi yield
Dividend cover = EPS / Dividend, so EPS = Dividend x Dividend cover
So PE ratio = (dividend / divi yield) / (dividend x dividend cover)
= 1 / (divi yield x divi cover) = 1 / (0.08 x 2.4) = 5.21
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Could you please explain how you worked out 1 and dividend = 0.08 ?
Thanks
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