A B C D E F G H Build-a-Model 2 Chapter: 20 3 Problem: 9 1 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 Maggie's Magazines (MM) has straight nonconvertible bond that currently yield 9%. MM's stock sells for $22 per share, has an expected constant growth rate of 6%, and has a dividend yield of 4$. MM plans on issuing convertible bonds that will have a $1,000 par value, a coupon rate of 8%, a 20-year maturity, and a conversion ratio of 32 (i.e., each bond could be convertible into 32 shares of stock). Coupon payments will be made annually. The bonds will be noncallable for 5 years, after which they will be callable at a price of $1,90; this call price would decline by $6 per year in Year 6 and each year thereafter. For simplicity, assume that the bonds may be called or converted only at the end of a year, immediately after the coupon and dividend payments. Management will call the bonds when the bonds’ conversion value exceeds 25% of the bonds’ par value (not their call price). Inputs: Straight bond yield 9% Current stock price $22.00 Expected growth rate in stock price 6% Dividend yield 4% Par value (and issue price) of convertible bond $1,000.00 Coupon rate on convertible bond 8.00% Maturity of convertible bond (years) 20 Conversion ratio 32 Call protection period (years) 5 Call price when call protection ends $1,090.00 Call price decline per year after protection period $6.00 Policy for call: Call when conversion value exceeds 25% 28 this percent over bond's par value. 29 30 31 a. For each year, calculate: (1) the anticipated stock price; (2) the anticipated conversion value; (3) the anticipated 32 straight-bond price; and (4) the cash flow to the investor assuming conversion occurs. At what year do you expect the 33 bonds will be forced into conversion with a call? What is the bond’s value in conversion when it is converted at this 34 time? What is the cash flow to the bondholder when it is converted at this time (Hint: the cash flow includes the 35 conversion value and the coupon payment, because the conversion is immediately after the coupon is paid.) 36 37 Will call the issue in the first year that the conversion >250 38 39 Year 40 41 42 43 44 45 46 47 0 1 2 3 4 5 6 7 Anticipated stock price Conversion at year end Value (1) (2) 22.00 704.00 $23.32 746.24 24.72 791.01 26.20 838.48 27.77 888.78 29.44 942.11 31.21 998.64 33.08 1,058.56 Convert? (Yes, no, or already) No No No No No yes Straight debt Cash flow to value of bondholder convertible if converted (3) (4) -$1,000.00 $80.00 $80.00 $80.00 $80.00 $80.00 $1,078.64 A 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 8 9 10 11 12 13 14 15 16 17 18 19 20 B 35.06 37.17 39.40 41.76 44.27 46.92 49.74 52.72 55.89 59.24 62.80 66.56 70.56 C 1,122.07 1,189.39 1,260.76 1,336.40 1,416.59 1,501.58 1,591.68 1,687.18 1,788.41 1,895.71 2,009.45 2,130.02 2,257.82 Conversion year = Value in conversion = D E F G H 6 $ 998.64 b. What is the expected rate of return (i.e., before-tax component cost) on the proposed convertible issue? Using the RATE function: N= 6 PMT = $80.00 PV = -$1,000.00 FV = $ 998.64 Rate = 7.981% As a check, using the IRR function and the cash flows in column F: Expected return to bondholders c. Assume that the convertible bondholders require a 9% rate of return. If the coupon rate remains unchanged, then what conversion ratio will give a bond price of $1000? Expected return required by convertible bondholders = 9% Hint: Use Goal seek to set the difference between the convertible bondholders' current return and the target return to zero by changing the input cell for the conversion ratio. Current difference between bondholders' current expected return and target return (multiplied by 1000) = Conversion ratio (given original convertible coupon rate) that produces the required yield (Note: after using Goal Seek, cut and paste the conversion ratio into the yellow cell): 1 I 11/26/2018 2 3 4 5 6 per share, sells for $22 7 bonds ng convertible 8 o of 32 (i.e., each bond 9 nds will be noncallable 10 6 per year in Year 6 and 11 he end of a year, 12 e bonds’ conversion 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 (3) the anticipated 31 year do you 32 expect the t is converted 33 at this low includes 34 the upon is paid.) 35 36 37 38 39 40 41 42 43 44 45 46 47 Build-a-Model Chapter: 21 Problem: 10 Start with the partial model in the file Ch17 P12 Build a Model.xlsx on the textbook’s Web site. Kasperov Corporation has an unlevered cost of equity of 12% and is taxed at a 25% rate. The 4-year forecasts of free cash flow and interest expenses are shown in the following table; free cash flow and interest expenses are expected to grow at a 5% rate after Year 4. Using the compressed APV model, answer the following questions. INPUTS (In millions) Year Free cash flow Interest expense Projected 1 $200,0 $100,0 Long-term growth rate Tax rate Unlevered cost of equity 2 $280,0 $120,0 3 $320,0 $120,0 4 $340,0 $140,0 5% 25% 12,00% a. Calculate the estimated horizon value of unlevered operations at Year 4 (i.e., immediately after the Year-4 free cash flow). Current 1 Free cash flow Horizon unlevered value of operations $200,0 Projected 2 $280,0 3 $320,0 b. Calculate the current value of unlevered operations. Current value of unlevered operations a. Calculate the estimated horizon value of the tax shield at Year 4 (i.e., immediately after the Year-4 free Current Interest expense Tax savings Horizon unlevered value of operations d. Calculate the current value of the tax shield. Current value of unlevered operations d. Calculate the current total value. Unlevered value of operations 1 $100,0 $25,0 Projected 2 3 $120,0 $120,0 $30,0 $30,0 Value of tax shield Total value 11/26/2018 s Web site. Kasperov 4-year forecasts of free d interest expenses are er the following mediately after the Year-4 ected 4 $340,0 y after the Year-4 free ected 4 $140,0 $35,0
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