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# Memo: Pricing of Proposed Debt & Equity Issues (Math Problem Sample)

Instructions:

Can you please answer the last part in question 3. and please answer question 6 completely both are highlighted in yellow I have included the answers to the other questions as you may need the information to answer... Thank you appreciate your help!!

*What would be the benefit of issuing zeroes, and how would this benefit be modified by a sinking fund?*

*Ms.Raymar was wondering what the impact on the price of the new shares would be if Carem froze dividend payments at the 2014 level for the next five years before resuming their normal growth.** *

Content:

Memo

To:Ms. Michelle Raymer, VP of Finance From:Kavneet Baweja & Ross SchneidmanDate:November 25, 2015Re:Pricing of proposed debt & equity issues

Carem Industries Case Study

Fin203: Managerial Finance / Fall 2015

Professor Ronald Frank

Completed by Kaveneet Baweja & Ross Schneidman

1. What annual coupon rates would Carem have to pay in order to issue 10-year par value bonds and receive proceeds of $2 million?

Value of the bond = Present value of the annual coupon interest + Present value of the principal amount after 10 years

Value of the bond = PVAF r% 10 years (Interest) + PVIF r% Year 10 (Principal)

Using the YTM rate of 11% for 10 years

Value of the bond = PVAF 11% 10 years (Interest) + PVIF 11% Year 10 (2,000,000)

From the Annuity tables:

PVAF 11% 10 years = 5.8892

PVIF 11% Year 10 = 0.3522

Current value of the bond = 2,000,000

Current value of the bond = 5.8892 (Interest) + (0.3522 x 2,000,000)

2,000,000 = 5.8892 (Interest) + 704400

5.8892 (Interest) = 1295600

Annual Coupon Interest rate = 215998.13

Annual Coupon % rate = 215998.13/2000000 x 100 = 11%

Since bonds are to be issued at par value, hence coupon rate would be equal to yield to maturity

=11%

2. What would be the impact on Carem’s funding plans if it included a call feature in the bond, effective five years from date of issue. The call price would be 110% of par value. What would be the benefits of including the call feature?

Including a call feature:

The Yield to Maturity rate = 11% + 0.5% = 11.5% /2 =5.75% compounded semi annually

Coupon rate is 11/2 = 5.5% n = 20, $55 (110/2)

Par value, Future Value = $1,000

Solving for Present Value

$55 x (PV 5.75% 20 Periods) + $ 1000 x (PV 5.75% 20 periods)

Present Value = ($55 x11.70638) + ($1000 x 0.326883) = $970.734

Total Proceeds = 970.7340 x 2,000 (number of bonds) = 1,941,468

This is below the expected $2,000,000 proceeds. The Company has an option of either receiving the lesser proceeds of $1,941,468 or increasing its coupon rate to fetch $2,000,000

Discussion

The call feature also makes the bond issue attractive since bondholders will expect a quicker repayment. This may however bring a cash flow constraint in year 5 if the life of the project invest...

To:Ms. Michelle Raymer, VP of Finance From:Kavneet Baweja & Ross SchneidmanDate:November 25, 2015Re:Pricing of proposed debt & equity issues

Carem Industries Case Study

Fin203: Managerial Finance / Fall 2015

Professor Ronald Frank

Completed by Kaveneet Baweja & Ross Schneidman

1. What annual coupon rates would Carem have to pay in order to issue 10-year par value bonds and receive proceeds of $2 million?

Value of the bond = Present value of the annual coupon interest + Present value of the principal amount after 10 years

Value of the bond = PVAF r% 10 years (Interest) + PVIF r% Year 10 (Principal)

Using the YTM rate of 11% for 10 years

Value of the bond = PVAF 11% 10 years (Interest) + PVIF 11% Year 10 (2,000,000)

From the Annuity tables:

PVAF 11% 10 years = 5.8892

PVIF 11% Year 10 = 0.3522

Current value of the bond = 2,000,000

Current value of the bond = 5.8892 (Interest) + (0.3522 x 2,000,000)

2,000,000 = 5.8892 (Interest) + 704400

5.8892 (Interest) = 1295600

Annual Coupon Interest rate = 215998.13

Annual Coupon % rate = 215998.13/2000000 x 100 = 11%

Since bonds are to be issued at par value, hence coupon rate would be equal to yield to maturity

=11%

2. What would be the impact on Carem’s funding plans if it included a call feature in the bond, effective five years from date of issue. The call price would be 110% of par value. What would be the benefits of including the call feature?

Including a call feature:

The Yield to Maturity rate = 11% + 0.5% = 11.5% /2 =5.75% compounded semi annually

Coupon rate is 11/2 = 5.5% n = 20, $55 (110/2)

Par value, Future Value = $1,000

Solving for Present Value

$55 x (PV 5.75% 20 Periods) + $ 1000 x (PV 5.75% 20 periods)

Present Value = ($55 x11.70638) + ($1000 x 0.326883) = $970.734

Total Proceeds = 970.7340 x 2,000 (number of bonds) = 1,941,468

This is below the expected $2,000,000 proceeds. The Company has an option of either receiving the lesser proceeds of $1,941,468 or increasing its coupon rate to fetch $2,000,000

Discussion

The call feature also makes the bond issue attractive since bondholders will expect a quicker repayment. This may however bring a cash flow constraint in year 5 if the life of the project invest...

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