Corporate Finance ADM 3350 M & P (Winter 2015) Assignment 1 Due Date: February 23, 2015 Question 1 (5 Marks) Varta Inc. has just issued a dividend of $1.50 per share on its common stock. The company paid dividends of $1.10, $1.15, $1.25, and $1.37 per share in the last four years. The stock currently sells for $48. a. What is your best estimate of the company's cost of equity capital using the arithmetic average growth rate in dividends? b. What if you use the geometric average growth rate? Solution: (3 + 2 = 5 Marks)
Part a. Period 1 2 3 4 5 dividend 1.1 1.15 1.25 1.37 1.5 Average growth (Arithmetic) growth 0.045 0.087 0.096 0.095 Growth = (P2 - P1)/P1

0.081

RE = D1/P0 + g = (D0 (1 + g))/P0 + g RE = 11.46%

Part b. We can get the geometric growth using the following formula: FV = PV*(1 + g)^n FV = PV = n= g = (FV/PV)^(1/n) - 1 g= 8.06% 1.5 1.1 4

RE = D1/P0 + g = (D0 (1 + g))/P0 + g RE = 11.44%

Question 2 (10 Marks) MyGuelph Inc. has the following balance sheet figures: Book Value $1.0 million $1.0 million $1.5 million $0.5 million

Debt (D): 8% coupon rate, annual coupons 10 years to maturity Preferred shares (P): 10% dividend rate Common shares (C/S): 100,000 shares (originally issued at $15/share) Retained earnings (RE)

Assume the marginal tax rate is 40 percent. Par value of the bond is $1,000. The present market conditions are following: Debt: The present market rate on similar risk 10-year bonds is 6 percent. (Hint: cost of bond is 6 percent) Preferred Shares: Similar risk preferred shares are providing yields of 8 percent. Common equity: Common share price is currently $25. a. What are the market values of Debt, Preferred Equity, and Common Shares? b. Find the Market Value proportions of these components.

Solution: (Part a (3 + 2 + 2) + Part b (3) = 10 Marks)
Part a. Debt Value: Total book value = $1 million; Par value of each bond = $1,000 Therefore,