Case Study: Corporate bonds

timer Asked: Jun 29th, 2018
account_balance_wallet $25

Question description

Part 1: Case Background

Five years ago, Shaffer’s Recliners issued $10,000,000 of corporate bonds with a 30-year maturity. The bonds have a coupon rate of 10.125%, pay interest semiannually, and have a par value of $1,000 per bond. The bonds are currently trading at a price of $879.625 per bond. A 25-year Treasury bond with a 6.825% coupon rate (paid semiannually) and $1,000 par is currently selling for $975.42.

Part 2: Case Analysis

1) Determine the yield spread between the corporate bond and the Treasury bond. If you are considering the investment in Shaffer’s bonds (that will be held to maturity) and require an 11% rate of return, would you purchase the bonds? Give reasons for your answer.

2) Alternatively, you could consider purchasing Shaffer’s preferred stock. Assume that the preferred stock has a current market price of $42, a par value of $50, and a dividend amounting to 10% of par. Would you be willing to buy the firm’s preferred stock? Why or why not? Your required rate of return for investments of this type is 12.5%.

3) Now assume that Shaffer’s Recliners has earnings per share (EPS) of $1.89, has 750,000 common shares outstanding, and has recently paid a dividend of $0.65 per share. Additionally, the firm has generated a net income of $1,417,500 and has common shareholders’ equity of $6,000,000 (book value). You believe the firm is in a constant state of growth, and your required rate of return for investments of this risk level is 18%. The firm’s common stock is currently trading for $45 per share. Based upon this information, would you be willing to purchase shares of common stock in the firm? Why or why not? Use both the present value of cash flows model and the free cash flow (FCF) approach to determine your answer. The firm’s current FCF is $109,237. Use the firm’s weight average cost of capital, which is currently at 15.83%, as the appropriate discount rate.

4) Would your decision to purchase shares of Shaffer’s common stock change if—rather than expecting the firm to experience a constant rate of growth—you expect the following variable growth pattern?

a. Fast growth of 25% for years 1 through 6
b. Moderate growth of 20% for years 7 through 10
c. Stable growth of 15% for years 11 and beyond

Part 3: Case Paper

Submit a written report that that responds to questions 1–4 (include all calculations as attachments or exhibits). The report should be is 1–2 pages in length, well written with introductory and concluding paragraphs, formatted as follows: double-spaced, one-inch margins, using a 12-point Times New Roman font. References must be appropriately cited as per the APA (6th Edition) citation guidelines.

Tutor Answer

School: Cornell University


flag Report DMCA

Thanks, good work

Similar Questions
Hot Questions
Related Tags

Brown University

1271 Tutors

California Institute of Technology

2131 Tutors

Carnegie Mellon University

982 Tutors

Columbia University

1256 Tutors

Dartmouth University

2113 Tutors

Emory University

2279 Tutors

Harvard University

599 Tutors

Massachusetts Institute of Technology

2319 Tutors

New York University

1645 Tutors

Notre Dam University

1911 Tutors

Oklahoma University

2122 Tutors

Pennsylvania State University

932 Tutors

Princeton University

1211 Tutors

Stanford University

983 Tutors

University of California

1282 Tutors

Oxford University

123 Tutors

Yale University

2325 Tutors