Question

please answer as soon as possible

1.

You are the lead Financial Manager/Investment liaison of HIJ Corporation. Ten years ago HIJ Corp. issued 30 year bonds, callable in 10 years, at Par Value with a 7.50% annual coupon rate. You need to recommend to your CFO if the bonds should be called and refinanced by issuing new 20 year bonds.   Within the past 10 years, the firm’s capital structure has changed along with its financial ratings. Also, Treasury rates have declined over the 10 year period.   You are not in a Perfect Capital Market.

Given the current financial information outlined below for HIJ Corp., should you recommend that the bonds be called? Please SHOW ALL CALCULATIONS AND   EXPLAIN YOUR DECISION.

Share Price = $50

Number of Outstanding Shares = 50 million

Market Value of Debt = $1.5 billion

Weighted Average Cost of Capital = 9.17%

Equity Cost of Capital = 12%

Tax Rate = 34%

2.

You are interested in purchasing bonds issued by the Family Corp. In your research you find out that there are two series of Family Corp. bonds currently available in the marketplace. Both Series of bonds have the same maturity date and face amount as well as the same coupon rate and payment dates. However, Series A bonds sell for a higher price than Series B bonds.         

Outline three possible reasons why there is a price difference between Series A and Series B.                                           

Answer 1

Ans 1.

Based on above calculations we can see that existing cost of debt has substantially come down to 6.74% whereas on the other hand cost of bonds issued 10 years ago is 7.50% and they are also callable now. So, CFO should consider redemption of bonds now and issue fresh bonds. This will reduce the cost of debt financing substantially, thus increasing profits available to shareholders. Which in turn will also increase the company's share price.

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