Memo: Pricing of Proposed Debt & Equity Issues

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 invested in using the bond money is not consistent with the bond repayment timeline.
3. What face value of zero-coupon bonds would have to be issued in order to receive proceeds of $2 million? What if a sinking fund feature was included? What would be the benefit of iss...