Question

Tiger Enterprises has, for several years, enjoyed relatively easy access to the bond markets. Their President/CEO is wondering whether they may have taken too much advantage of their access and borrowed more than they should have.

Tiger's debt ratio is currently 68%. If it reaches 70%, holders of certain bonds will be able to force a conversion of their bonds to common stock. This will significantly dilute the ownership of several major investors. Their long-term debt is currently structured as follows:

$5,000,000 of 4.2%, 20-year bonds due in 2035, book value is $4,800,000

$8,000,000 of 4%, 20-year bonds due in 2036, book value is $7,510,000

$20,000,000 of 5%, 20-year convertible bonds due in 2037, book value is $17,800,000

$10,000,000 of 4.8%, 30-year bonds due in 2048, book value is $8,100,000

Tiger has a current cash balance of approximately $10,000,000, which is $6,000,000 more than they consider to be the minimum cash balance that allows them to carry on operations smoothly. There are no short-term investments. Their major lines of business all generate positive operating cash flows and are expected to continue to do so.

Required: In preparation for next week’s board meeting, the CEO has asked you to draft a plan to bring the debt ratio down below 50% in the next two years. Identify at least one approach that will reduce the debt ratio in two years. If there is additional information, you need to formalize your plan, indicate what information you need. Consider how the Balance Sheet will look at the level of Assets = Liabilities+Equity. Use rough amount estimates if needed and work the debt ratio down from there. What changes would be required for this and how will the company implement those changes?

Answer 1

Solution:
Current Debt Equity Ratio	68%
Current Debts (Assuming there is no other debts)
	Due	Value
$5,000,000 of 4.2%, 20-year bonds due in 2035, book value is $4,800,000	2035	$48,00,000.00
$8,000,000 of 4%, 20-year bonds due in 2036, book value is $7,510,000	2036	$75,10,000.00
$20,000,000 of 5%, 20-year convertible bonds due in 2037, book value is $17,800,000		$1,78,00,000.00
$10,000,000 of 4.8%, 30-year bonds due in 2048, book value is $8,100,000		$81,00,000.00
Total Debts		$3,82,10,000.00	(Assuming this is 68% of total funds)
Total Funds Sources		$5,61,91,176.47	(38210000/ 68%)
Equity		$1,79,81,176.47	(Total Funds less Debts)
Spare cash available		$60,00,000.00
We can move with below approach for next 2 years
		Debt	Equity	Total	Debts Ratio
Current situation		$3,82,10,000.00	$1,79,81,176.47	$5,61,91,176.47	68%
Conversion of bonds in 2037 at book value		-$1,78,00,000.00	$1,78,00,000.00	$0.00
Redemption of bonds in 2035 at book value		-$48,00,000.00	0	-$48,00,000.00
Net debts/equity		$1,56,10,000.00	$3,57,81,176.47	$5,13,91,176.47	30%
Assuming conversion and redemption happens at book value for the sake of calculation
Assuming surplus cash of $ 60,00,000 can be used freely for redemption
There can be alternate approach also like issuing fresh equity so that debts portion get reduced but we haven't considered this as the entity is already having enough cash