East Coast Yacht’s Expansion Plans

Corporate Finance:

Chapter 5: Financing East Coast Yacht’s Expansion Plans with a Bond

1. If the company benefits from the provision of the bond, then the coupon rate will be higher. If the bondholder’s benefit, then the bond will have lower coupon rate.

a. Bond’s with collateral will have lower coupon rate as bondholders have claim on collateral no matter what. It provides an asset which lowers default risk. Downside to company is that this collateral cannot be sold as an asset and needs to maintain it.

b. The more senior the bond, the lower the coupon rate.

c. A sinking fund reduces coupon rate because it provides a kind of future guarantee to bondholders. The company must make payments into the sinking fund or default so it must have positive cash flows.

d. A call provision would cause an increase in coupon rate. It must be used in the company’s advantage and bondholder’s disadvantage. The company can refinance the bond if interest rates drop and thus gain an advantage.

e. A deferred call would reduce the coupon rate in comparison to the above case. The bond will still have a higher coupon rate, but it offers bondholders some kind of protection. Company cannot call the bond during the protection period

f. This would lower the whole coupon rate. Repays the bondholder full future cash flows, but rarely receive full market value.

g. A positive covenant would reduce coupon rate. It protects bondholders by forcing company’s to benefit bondholders.

h. A negative covenant would reduce coupon rate in turn.

i. A conversion feature would lower coupon rate. Bondholders would benefit if company goes public, but company would be selling equity at discounted price.

j. If interest rates rise, then company need to pay higher interest rate, if rates fall, then company benefits.

2. Coupon bonds to sell = $30,000,000 / $1,000 = 30,000

The price of the 20-year, zero coupon bond when it is issued will be:

Zero coupon price = $1,000 / 1.0820 = $214.55

So, the number of zero coupon bonds the company will need to sell is:

Zero coupon bonds to sell = $30,000,000 / $214.55 = 139,827

3. Coupon bond principal payment at maturity = 30,000($1,000) = $30,000,000

The principal payment for the zero coupon bonds at maturity will be:

Zero coupon bond payment at maturity = 139,827($1,000) = $139,827,000

4. Annual coupon bond payments = 30,000($1,000)(.08) = $2,400,000

Since the interest payments are tax deductible, the aftertax cash flow from the interest payments will be:

Aftertax coupon payments = $2,400,000(1 – .35) = $1,560,000

Even though interest payments are not actually made each year, the implied interest on the zero coupon bonds is tax deductible. The value of the zero coupon bonds next year will be:

Value of zero in one year = $1,000/1.0819 = $231.71

5. P = $40({1 – [1/(1 + .03)]26 } / .03) + $1,000[1 / (1 + .03)26]

P = $1,178.77

And, if the Treasury rate is 9.10 percent, the make