# Avon Products Inc Essay

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Purpose of Exchange Offer:
The exchange offer represented a plan to gradually decrease the total dividend payout from Avon. With PERCS in place, only up to 18 million PERCS holders would continue to receive a dividend of \$2 per year. The remaining common shareholders would receive dividends of not more than \$1.50 a share per year unless the PERCS were redeemed. Hence, Avon would be able to decrease its dividend payout per common shareholder by at least 50 cents a share for the next 3 years.

Motivation of PERCS:
Using PERCS allows Avon to offer a choice of investments to its potential investors and shareholders. PERCS would appeal to investors who want an equity that pays a high and steady stream of dividend but with a limited upside
The payoff of PERCS is as follows:
• A quarterly dividend of 50 cents for 3 years.
• At maturity, it pays no more than \$31.50 in Avon common stock.

Hence, the fair value of PERCS is a sum of the following:
• Present value of all the quarterly dividend of 50 cents for 3 years.
• For the expiration value of \$31.50 or less for PERCS, we replicate by shorting a put option with a strike price of \$31.50 and time to maturity of 3 years and going long on a certain amount of zero coupon bond with similar maturity that pays \$31.50 on maturity.

Therefore, the fair price of PERCS is PV(all quarterly dividends) + PV(\$31.5) Put Option(X=31.5, T=3). Performing this calculation, we obtain a fair price of \$24.674 for PERCS. (See appendix for calculation)

4. Recommendation
We recommend that Avon PERCS be priced at a fair value of \$24.674.

Risk free rate 8.20% Valuation of Dividends
Period 1 2 3 4 5 6 7 8 9 10 11 12
Dividend 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5
PV of Dividend 0.49 0.48 0.47 0.461 0.452 0.443 0.434 0.425 0.417 0.408 0.4 0.392
Total PV of Dividends 5.2715 Valuation of Put Option
X 31.5
T 3
Sigma 0.313
R 0.082
S 24.125
Put Option Value 5.465 Present value of \$31.5 discounted 3 years at 8.2% 24.867 Fair Value of