Corporate Finance
Case 1.
Your grandfather is retired and living on his Social Security benef its and the interest he gets from
savings. However, the interest income he receives has dwindl ed to only 2 percent a year on his
$200,000 in savings as inte rest rates in the economy have dropped. You have been thinking about
recommending that he purchase some corporate bonds with at least part of his savings as a way of
increasing his interest income.
Specifically, you have identified three corporate bond is sues for your grandfather to consider. The first
is an issue from the Young Corporation that pays annual interest based on a 7.8 percent coupon rate
and has 10 years before it matures. The second bond was issued by Thom as Resorts and it pays 7.5
percent annual interest and has 17 years until it matures. The final bond issue was sold by
Entertainment, Inc., pays an annual coupon interest payment based on a rate of 7.975 percent, and has
only 4 years until it matures. All three bond issues have a $1,000 par value. After looking at the bonds’
default risks and credit ratings, you have very different yields to maturity in mind for the three bond
issues, as noted below.
Before recommending any of these bond issues to your grandfather you perform a number of analyses.
Specifically, you want to address each of the following issues:
1. Estimate an appropriate market’s required yield to maturity for each of the bond issues using the
table of credit spreads reported in
http://bondsonline.com/Todays_Market/Corporate_Bond_Spreads.php.
Young Corp. Thomas Resorts, Inc Entertainment, Inc.
Coupon interest rates 7.8% 7.5% 7.975%
Years to maturity 10 17 4
Current market price $1,030 $973 $1,035
Par value $1,000 $1,000 $1,000
Bond rating AA B BBB
2. T he bond issues are currently selling for the following amounts:
Young Corp $1,030
Thomas Resorts $ 973
Entertainment, Inc. $1,035
What is the yield to maturity for each bond?
3. Given your estimate of the proper discount rate, what is your estimate of the value of each of the
bonds? In light of the prices recorded above, which issue do you think is most attractively priced?
4. How would the values of the bonds change if (i) the market’s required yield to maturity on a
comparable -risk bond increases 3 percentage points or (ii) decreases 3 percentage points? Which of
the bond issues is the most sensitive to changes in the rate of interest?
5. What are some of the things you can conclude from these computations?
6. Which one(s) of th e bonds (if any) would you recommend to your grandfather? Explain.
FIN325 / Corporate Finance, Assignment #2
Case 2.
You have finally saved $10,000 and are ready to make your first investment. You have the three
fo llowing alternatives for invest ing that money:
• Capital Cities ABC, Inc. bo nds with a par value of $1,000 and a coupon interest rate of 8.75 percent,
are selling for $1,314 and mature in 12 years.
• Southwest Bancorp preferred stock is paying a dividend of $2.50 and selling for $25.50.
• Emerson Electric common stock is selling for $36.75. The stock recently paid a $1.32 dividend and
the firm’s earnings per share has increased from $1.49 to $3.06 in the past five years. The firm expects
to grow at the same rate for the foreseeable future.
Your required rates of return for these investments are 6 percent for the bond, 7 percent for the
preferred stock, and 15 percent for the common stock. Using this in formation, an swer the following
questions.
a. Calculate the value of each investment based on your re quired rate of return.
b. Which investment would you select? Why?
c. Assume Emerson Electric’s managers expect an earnings downturn and a resulting decrease in
growth of 3 percent. How does this affect your answers to parts a and b?
d. W hat required rates of return would make you indifferent to all three options?
Case 3.
The Nealon Manufacturing Company is in the midst of negotiations to acquire a plant in Fargo, North
Dakota. The company CFO, James Nealon, is the son of the founder and CEO of the company and
heir -apparent to the CEO position, so he is very concerned about making such a large commitment of
money to the new plant. The cost of the pur chase is $40 million, which is roughly one -half the size of
the company today.
To begin his a nalysis, James has launched the firm’s first ever cost -of – capital estimation. The
company’s current balance sheet, restated to reflect market values, has been converted to percentages
as follows:
Nealon, Inc., Balance Sheet—2013
Type of Financing Percentage of Future Financing
Bonds (8%, $1,000 par, 30 – year maturity) 38%
Preferred stock (5,000 shares outstanding, $50 par, $1.50 dividend) 15%
Common stock 47%
Total 100%
The company paid dividends to its common stockholders of $2.50 per share last year, and the
projected rate of annual growth in dividends is 6 percent per year for the indefinite future. Nealon’s
common stock trades over the counter and has a current market price of $35 per share. In addition, the
firm’s bonds have an AA rating. Moreover, AA bonds are currently yield ing 7 percent. The preferred
stock has a current market price of $19 per share.
FIN325 / Corporate Finance, Assignment #2
a. If the firm is in a 34 percent tax bracket, what is the weighted average cost of capital (i.e., firm
WACC)?
b. In the analysis done so far we have not considered the ef fects of flotation costs. Assume now that
Nealon is raising a total of $40 million using the above financing mix. New debt financing will require
that the firm pay 50 basis points (i.e., o ne -half a percent) in issu e costs, the sale of preferred stock will
require the firm t o pay 200 basis points in flotation costs, and the common stock issue will require
flotation costs of 500 basis points.
i. What are the total flotation costs the fir m will incur to raise the needed $40 million?
ii. How should the flotation costs be incorporated into the analysis of the $40 million investment the
firm plans to make?
PLACE THIS ORDER OR A SIMILAR ORDER WITH US TODAY AND GET AN AMAZING DISCOUNT :