Chat with AIExam 19: Business Borrowing: Corporate Bonds, Asset-Backed Securities, Bank Loans, and Other Forms of Business Debt
Stock retirements due to a merger, acquisitions and buybacks exceeded 130 billion in 2001 and for the 12 month period ending June 2006 it exceeded $400 billion.
(90) 
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Silsbee Corporation, bearing a BB rating, is considering the public sale of $72 million in new corporate notes bearing 7-year maturities at an expected gross yield of 8.95 percent later this month. The company needs about $260 million in total but is hoping to raise the difference in its total financial need and the note offering by drawing upon other sources of funds. However, it does have an alternative offer of a private note sale to a small consortium of insurance companies at an expected gross yield of 9.04 percent. Silsbee's financial manager is trying to assess the potential advantages and disadvantages of each of these two approaches to raising medium-term capital funds.
(80) VerifiedUsing the information presented in this chapter please develop a list of possible benefits and costs of a public sale versus a private sale to help Silsbee's manager weigh the two options available to the company and reach a decision.
PUBLIC ISSUE:
Benefits = lower interest costs, establish the company's "name"
in the marketplace, less restrictive covenants.
Costs = public registration and periodic reporting, possible detrimental "signal", underwriting/distribution
fees, not as flexible.
PRIVATE ISSUE:
Benefits = more flexibility, more custom design possibilities, lower reporting costs, lower fees. Costs = more restrictive covenants, higher interest cost, no establishment of company "name"
in marketplace.
Contail-Guidar Corporation is in need of a 10-year loan for the upgrading of its production processing equipment in the amount of $18 million. The company has been offered a term loan from its principal bank at LIBOR plus two percentage points (where the London Eurocurrency rate now stands at 5.75 percent) with the stipulation that the firm maintain 15 percent of the loan in an interest-bearing deposit at the bank, earning the prevailing LIBOR rate on this deposit balance. In contrast, Contail's investment banker has suggested as an alternative that a public bond offering be made at an estimated open-market interest rate of 7.35 percent (given Contail's relatively high credit rating) with the $1,000-par value 10-year bonds sold at a net price (after commissions and discounts) of $950 per bond. Which approach would provide the best financing alternative for this company? Please explain your answer, developing a comprehensive list of the advantages and disadvantages of each financing alternative.
(83) VerifiedBANK OPTION:
Advantages = more flexibility, more custom design possibilities, lower reporting costs, lower fees. Disadvantages = floating rate of interest (present all in cost = 8.10%)*, more restrictive covenants, no establishment of company "name"
in marketplace, tying up too much cash with compensating balance account.
MARKET OPTION:
Advantages = fixed rate of interest (all in cost = 8.10%)**, establish the company's "name"
in the marketplace, less restrictive covenants.
Disadvantages = public registration and periodic reporting costs, possible detrimental "signal", underwriting/distribution fees, not as flexible.
* All-in cost equals Net Interest charges/Net Loan amount. Facts:
LIBOR + 2% currently = 7.75%. Gross Loan = 18,000,000,
Net Loan (Gross Loan less 15% compensating balance requirement) = 15,300,000. Gross Interest charge = 18,000,000 x 7.75% = 1,395,000.
Interest Earnings on 15% balance requirement (18,000,000 x 15% = 2,700,000) = 2,700,000 x 5.75% (LIBOR) = 155,250.
Net Interest charges = 1,395,000 - 155,250 = 1,239,750. So All-in cost = 1,239,750/15,300,000 = 8.102%.
** All-in bond cost using financial calculator = N (# of years), PV (Present value/price), PMT (Payment amount-assumed annual), FV (Future value/maturity value), solve for I (Interest/Yield).
So, N =10, PV = 950, PMT = 73.50 (7.35% x 1000 par value), FV = 1000. Solving for I = 8.098%
BEST SOLUTION FOR COMPANY:
Unless the current interest rate forecast shows a decline in medium-term rates, the fixed-rate market option seems best, particularly since the company will have the use of the entire $18 million, without the compensating balance requirement.
In February 2007 t he average maturity of commercial and industrial loans, weighted by loan amount, was
(70) Please explain what is meant by a private placement. Who purchases privately placed corporate bonds and why?
(74) What are the principal advantages to a business borrower from offering debt in the private placement market? Can you see any disadvantages?
(72) A corporation sells $5,000 par value bonds at par in the open market, bearing an 8 percent coupon rate. Costs of marketing the issue, including dealer's commission, amounted to $200 per bond. If the bonds are due to mature in 15 years, what is their before-tax cost to the corporation? If the issuing company is in the 35 percent tax bracket, what is the bond's after-tax cost to the firm?
(80) A bank quotes one of its corporate customers a loan at prime plus 4 percentage points when prime is 12 percent. Another bank, posting the same prime rate, quotes this same customer a loan at 1 1/4 times prime. Which loan would you recommend the corporation to take?
(79) Between 1995 in 2006, the stock of bonds outstanding issued by US financial and then financial companies more than tripled from $2.5 trillion to nearly $8.2 trillion.
(95) Please explain what is meant by the statement: "the financial markets are a supplemental funds source for business."
What factors appear to affect the volume of business fund-raising from the money and capital markets?
(79) For what purposes are commercial mortgages issued? What changes have occurred recently in the terms attached to these mortgage instruments?
(62) Please explain how the true cost of a corporate bond may be determined.
(76) The largest investor group in corporate and foreign bonds is foreign investors with investments in 2006 totaling over $2.7 trillion.
(83) What advantages does the issuance of debt have over other sources of funds that a business firm might pursue? How about disadvantages?
(82) A corporation borrows $5 million from a bank at a 12 percent prime rate. If the bank requires the company to hold 15 percent of the amount of the loan on deposit as a compensating balance, what is the effective interest rate on the loan?
(75) From 2000 and March 2007, the yield spread between Aaa corporate bonds and the 10 year U.S. Treasury note decreased from 159 basis points to 35 basis points.
(85) What is a leveraged buyout? A junk bond? What are the principal dangers associated with these financial devices and instruments?
(81) What is an equity kicker? What are its principal advantages over a straight commercial mortgage loan?
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