Investments and Security Analysis: Land Rover PLC and Bond Valuation

Instructions:

The exam is comprised of two questions that will be equal weighted a written analysis (one page each question) will suffice for each question.  SEND TO ME VIA EMAIL

1. Is the Jaguar Land Rover bond case. There is a template spreadsheet posted on blackboard that will answer Q2 of the exam.
2. The Modern Manufacturing scenario is an asset allocation decision question. These questions will be answered in the same manner as the mid-term. Select your choice A, B, or C for to answer the question then provide a brief essay as to why you selected your choice, justify/provide rational for your selection.

Question 1:    Jaguar Land Rover PLC: Bond Valuation

Synopsis

Jaguar Land Rover, plc (JLR) announced two Senior Notes (bonds) issues in early 2015; the primary purpose of the bond issues was to replace their existing debt with new debt that was available at less than half the original rates of interest. Students will analyze whether this common financial management strategy adopted by many companies is indeed beneficial to the firm or its stakeholders, or both. Students are also challenged to determine the specific situations when this strategy can be justified.

This case is relatively short and designed to drive home the fundamental point that the value of an asset is the present value of its future cash flows at the prevailing market yield and that in efficient markets a firm does not stand to gain by shifting to cheaper debt. Most textbook examples and cases demonstrating the inverse relationship between yield and bond prices assume that a change in the market yield has led to change in the coupon rates for new issues. An interesting aspect of this case is that the substantial reduction in JLR’s credit worthiness, thereby employing a change in the company’s fundamental standing In such a scenario, does the firm benefit by replacing expensive debt with cheaper debt? The case is designed to evaluate bond valuation and reissuance.

There are 4 questions to address in this assignment you should complete this in one page plus the valuation (spreadsheet) analysis from Q2 below

1. What factors might have enabled JLR to raise new debt at less than half the coupon rate of interest in 2015, compared with the debt raise in 2011.

1. Compute the amount at which existing bondholders might be willing to surrender their holdings? [Attach the spreadsheet to the assignment or past the results here}.
2. Assuming JLR purchased all existing outstanding bonds at the price worked out in Q2; work out the incremental cash flows of this bond issue vis-à-vis the original issue. Does this financing strategy result in cost savings for JR? (This will also be calculated within the spreadsheet for question 2).

I have loaded a completed spreadsheet for these questions.

1. What other benefits, if any, might accrue to JLR because of this financing strategy? Does this strategy add value to the firm? What other benefits, if any, might accrue to JLR as a result of this financing strategy? Explain how this strategy adds value to the firm? To the existing bondholders? To JLR’s equity-holders?

Question 2

Modern Manufacturing Pension Plan Alternative Asset Allocation / Consideration

Keith North is Chair of the investment committee responsible for the governance of the Modern Manufacturing (MM) defined benefit pension plan. The fund is fully funded (no long term liabilities) and has followed a 60% public equities and 40% bonds since North has been chair. North meets with Desmond King, an actuarial and pension consultant, to discuss issues raised at the last committee meeting.

North notes that he investment committee would like to explore the benefits of adding alternative investments to the pension plan’s strategic asset allocation. North states:

Statement 1:

The committee would like to know which alternative asset would best mitigate the risks to the portfolio due to unexpected inflation and provide a relatively low correlation with public equities to provide diversification benefits.

The (MM) pension plan has been able to fund the annual pension payments without any corporate contributions for a number of years. The committee is interested in potential changes to the asset mix that could increase the probability of achieving the long term investment target return of 6%, while maintaining the pension funding status over long time horizon? Under this hypothetical scenario, the balance of the portfolio can be allocated to either bonds, hedge funds, or private equities.

King confirms with North that the committee has historically used traditional approach to define the opportunity set based on distinct macroeconomic regimes, and she proposed that a risk-based approach might be a better method. Although the traditional approach is relatively powerful for its ability to handle liquidity and manager selection issues compared to a risk-based approach, they both acknowledge that a number of limitations are associated with the existing approach.

King presets a report (Exhibit 1) that proposed a new strategic asset allocation for the pension plan. North states that one of the concerns that the investment committee will have regarding the new allocations is that the pension fund needs to be able to fund an upcoming early retirement incentive program (ERIP) that MM will be offering to its employees within the next two years. Employers who have reached the age of 55 and whose age added to the number of years of company service sum to 75 or more can retire 10 years early and receive the defined benefit pension normally payable at age 65.