East Coast Yacht's Expansion Plans

944 Words May 24th, 2008 4 Pages
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
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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 whole call price in 7 years is:

P = $40({1 – [1/(1 + .0475)]26 } / .0475) + $1,000[1 / (1 + .0475)26] P = $889.35

So, the growth on the zero coupon bond was:

Zero coupon growth = $231.71 – 214.55 = $17.26

This increase in value is tax deductible, so it reduces taxes even though there is no cash flow for interest payments. So, there is a positive cash flow created next year in the amount of:

Zero cash flow = 139,827($17.26)(.35) = $839,989.70

This cash flow will increase each year since the value of the zero coupon bond will increase by a greater dollar amount each year.

6. The