Question 32c
DD Co has a dividend payout ratio of 40% and has maintained this payout ratio for several years. The current dividend per share of the company is $0·50 per share and it expects that its next dividend per share, payable in one year’s time, will be $0·52 per share.
The capital structure of the company is as follows:
| $m | $m | |
|---|---|---|
| Equity | ||
| Ordinary shares (nominal value $1 per share) | 25 | |
| Reserves | 35 | |
| 60 | ||
| Debt | ||
| Bond A (nominal value $100) | 20 | |
| Bond B (nominal value $100) | 10 | |
| 30 | ||
90 |
Bond A will be redeemed at nominal in ten years’ time and pays annual interest of 9%. The cost of debt of this bond is 9·83% per year. The current ex interest market price of the bond is $95·08.
Bond B will be redeemed at nominal in four years’ time and pays annual interest of 8%. The cost of debt of this bond is 7·82% per year. The current ex interest market price of the bond is $102·01.
DD Co has a cost of equity of 12·4%. Ignore taxation.
Required:
(c) Explain why DD Co’s capital instruments have different levels of risk and return. (5 marks)