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CASE STUDY : 1
Reliance company has a $
1,000 face value convertible bond issue that is currently selling in the market
for $ 950. Each bond is exchangeable at any time for 25 shares of the company’s
stock. The convertible bond has a 7 percent coupon. Payable semi-annually.
Similar non-convertible bonds are priced to yield 10 percent.
The bond matures in 10
years stock in Reliance sells for $ 36 per share.
Q1) What are the conversion
ratio, conversion price, and conversion premium?
Q2) What is the straight
bond value?
Q3) What is the conversion
value?
Q4) What is the option
value of the bond?
CASE STUDY : 2
Suppose your company needs
$ 15 million to build a new assembly line. Your target debt equity ratio is 0.90.
The flotation cost for new equity is 8 percent, but the flotation cost for debt
is only 5%. Your boss has decided to fund the project by borrowing money
because the flotation costs are lower and the needed funds are relatively
small.
Q1) What do you think about
the rationale behind borrowing the entire amount?
Q2) What is your company’s
weighted average flotation cost, assuming all equity is raised externally?
Q3) What is the true cost
of building the new assembly line after taking flotation costs into account?
Q4) Does it matter in this
case that the entire amount is being raised from debt?
CASE STUDY : 3
ABC Co. & XYZ Co. are
identical firms in all respects except for their capital structure. ABC is all
equity financed with $ 800,000 in stock XYZ uses both stocks and perpetual
debt, its stock is worth $ 400,000 and the interest rate on its debt is 10 per
cent. Both firms expect EBIT to be $ 90000. Ignore taxes.
Q1) Rico owns $ 30,000
worth of XYZ’s stock. What rate of return is he expecting?
Q2) Show how Rico could
generate exactly the same cash flows and rate of return by investing in ABC and
using homemade leverage?
Q3) What is the cost of
equity for ABC? What is it for XYZ?
Q4) What is the WACC for
ABC? For XYZ? What principle have you illustrated?
CASE STUDY : 4
The Nike Company sells 3000
pairs of running shoes per month at a cash price of $88 per pair. The firm is considering
a new policy that involves 30 days credit and an increase in price to $ 90.72
per pair on credit sales. The cash price will remain at $ 88 and the new policy
is not expected to affect the quantity sold. The
discount period will be 20
days. The required return is 1 percent per month.
Q1) How would be the new
credit terms be quoted?
Q2) What investment is
receivables is required under the new policy?
Q3) Explain why the
variable cost of manufacturing the shoes is not relevant here?
Q4) If the default rate is anticipated
to be 10 per cent, should the switch be made? What is the break even credit
price
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