1. How many of the coupon bonds must East Coast Yachts issue to raise the $40 million? How many of the zeroes must it issue? 2. In 20 years, what will be the principal repayment due if East Coast Yachts issues the coupon bonds? What if it issues the zeroes? 3. What are the company’s considerations in issuing a coupon bond compared to a zero coupon bond?
Module 3: Mini Case: FINANCING EAST COAST YACHTS’S EXPANSION PLANS WITH A BOND ISSUE
After Dan’s EFN analysis for East Coast Yachts (see the Mini Case in Chapter 3), Larissa has decided to expand the company’s operations. She has asked Dan to enlist an underwriter to help sell $40 million in new 20-year bonds to finance new construction. Dan has entered into discussions with Kim McKenzie, an underwriter from the firm of Crowe & Mallard, about which bond features East Coast Yachts should consider and also what coupon rate the issue will likely have. Although Dan is aware of bond features, he is uncertain as to the costs and benefits of some of them, so he isn’t clear on how each feature would affect the coupon rate of the bond issue.
Dan is also considering whether to issue coupon bearing bonds or zero coupon bonds. The YTM on either bond issue will be 7.5 percent. The coupon bond would have a 7.5 percent coupon rate. The company’s tax rate is 35 percent.
1. How many of the coupon bonds must East Coast Yachts issue to raise the $40 million? How many of the zeroes must it issue?
2. In 20 years, what will be the principal repayment due if East Coast Yachts issues the coupon bonds? What if it issues the zeroes?
3. What are the company’s considerations in issuing a coupon bond compared to a zero coupon bond?
4. Suppose East Coast Yachts issues the coupon bonds with a make-whole call provision. The make-whole call rate is the Treasury rate plus .40 percent. If East Coast calls the bonds in 7 years when the Treasury rate is 5.6 percent, what is the call price of the bond? What if it is 9.1 percent?
5. Are investors really made whole with a make-whole call provision?
6. After considering all the relevant factors, would you recommend a zero coupon issue or a regular coupon issue? Why? Would you recommend an ordinary call feature or a make-whole call feature? Why?
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