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Calculate the price of the bonds

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Reference no: EM132364545

Delta Partners is an investment firm specialising in corporate advice, particularly in regard to raising finance and company valuation. One of its clients, Pagoda Industries Ltd, has approached Delta Partners seeking advice and assistance.

Pagoda Industries Ltd is a large company listed on the Australian Stock Exchange. It is a diversified company with manufacturing and trading divisions operating in a number of industries. Pagoda has recently developed a new product which is the first of its kind and which is expected to make a significant contribution to the company's future earnings. Pagoda needs additional finance to bring the product to market. The company is seeking to raise $20 million in debt finance through a bond issue. Pagoda would like to issue bonds with a face value of $1000, a maturity of 20 years and an 8 per cent annual coupon rate. Interest would be paid semi-annually. Pagoda is considering offering an 8 per cent coupon because it is not sure what rating its bonds would receive. Delta Partners has advised that similar bonds with an AA rating currently have a yield to maturity of 7.5 per cent and similar bonds with an A rating have a yield to maturity of 8.5 per cent. Required:

(a) Calculate the price of the bonds, and the number of bonds Pagoda would need to issue, if the company was to receive an AA rating

(b) Calculate the price of the bonds, and the number of bonds Pagoda would need to issue, if the company was to receive an A rating

Pagoda Industries Ltd expects its new product will give it a significant first mover advantage in the market and that is expected to provide growth in earnings per share of 400% within the coming year, and 75% growth in each of the subsequent 3 years. After that time, it is expected competitors will have developed and brought to market similar products with the result that Pagoda would expect earnings growth to drop back to its normal level of 3% per year forever. Pagoda's cash dividend was 10 cents per share last year and is expected to remain at that amount for each of the next 5 years as the company builds it retained earnings to finance research and development. In the sixth year, it is expected shareholders will be rewarded with payout ratio will be 80% of the earnings per share, and the payout ratio is expected to remain at that level forever. The required rate of return on Pagoda's ordinary shares is 20% per year and the latest earnings per share was 25 cents.

Required:

(a) Calculate the price that Pagoda Industries Ltd ordinary shares should be selling for in the market, assuming Pagoda's growth projections are accurate.

(b) Delta Partners is concerned that Pagoda's earnings growth projections, as a result of the new product, might be too optimistic in the first four years. Delta Partners is in favour of a more conservative approach and recommends the growth rates should be half (ie reduced by 50%) of those projections before growth returns to its normal 3% level. Calculate the price that Pagoda Industries Ltd ordinary shares should be selling for in the market, using Delta Partners growth projections.

Reference no: EM132364545

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