Assignment 2
Question 1
a) At time of issue, price of the convertible bond is:
Value of straight market rate bond:
The difference in price of the convertible bond and the straight bond is
b) The potential benefit for the company is:
Convertible option acts as sweetener to attract bond purchasers
For the debtholders are:
Offers appreciation potential of the issuing company’s stock value with minimum downside risk
Superior claim power than common stock holders in case of liquidation
c) PV of the bond at the current date:
Value of the bond at maturity 1 year from now:
Value of the bond if converted right now:
Based on the current market condition, the current bondholders should convert their bonds for the following reasons:
The value of the conversion at current date is greater than the PV of the bonds from maturity ($1,120-997=$123)
TM’s stock price on maturity date may trade higher than the current stock price, but that’s an uncertainty.
The proceeds from selling the converted shares can be reinvested in market rate straight bonds at 4.8%, which is higher than the convertible bonds’ 4.5%.
d)
After conversion
Question 2
a) Cost of unleveraged equity:
Value of unlevered equity:
Price per share of the company if it were unlevered:
b) Total value of the company:
Value of its levered equity:
Share price with the current leverage ratio:
c) Method 1: M&M assumptions:
Method 2: CAPM
d) Total value of equity that MOC should issue is X:
e) Price per share in inefficient market:
Number of shares can issue at $8:
New price per share after issue had occurred:
f) In a perfectly efficient market, the after-issue price from the new issue and debt retirement is $7.5698 per e); therefore, the number of new shares MOC can issue is:
Total number of shares will be outstanding = 3,000,000+495,390=3,495,390
Share price following the additional equity is:
g)
Firm value
Debt value
Equity value
Tax shield
Before repurchase
54,000,000
30,000,000
24,000,000
12,000,000
After purchase
42m+0.4(30m-3.75m)=52,500,000
30m-3.75m
=26,250,000
52.5m-26.25m
=26,250,000
26.25m*40%
=10,500,000
Change in value
-1,500,000
-3,750,000
+2,250,000
-1,500,000
The debt repurchase program has increased the equity value of the firm by 2.25millions while decreased the value of debt by 3.75millions and overall firm value by 1.5millions. The overall firm value is decreased because 1.5millions worth of tax shield is forgone from the debt retirement.
h) First advantage to the shareholders or the company is that right offering allows the current shareholders to maintain their proportionate stake in the company because they have the right to purchase the new-issue shares before they are available in the open market.
Second advantage is that the rights offering price is usually at discount to the current market price. Shareholders that do not want to exercise their right can sell their right on the open market.
New shares MOC have to issue:
Number of rights required to purchase each new share:
i) Theoretical value of a right:
Share price during the ex-rights period:
Value of the right during the ex-rights period:
Question 3
a)
Net floating cost = floating cost – cost tax shield:
Net additional overlap cost:
b)
PV of preferred share dividends:
PV of cost of debt interests:
Net PV of saving is:
c)
It is not worthwhile to refinance preferred shares with debt at this time. However, if the cumulative dividend arrears payment are not included in the refinancing. The NPV will be:
The refinancing will then be viable.
d)
EPS calculation
Current preferred shares financing
Replace PS with new debt
Replace PS with ordinary shares
Face value of debt
13,000,000
12,000,000+13,000,000
=25,000,000
13,000,000
Face value of preferred shares
800,000*15=
12,000,000
0
0
Face value of ordinary shares
2,000,000*20=
40,000,000
40,000,000
40,000,000+12,000,000
=52,000,000
