Reference no: EM131902384

Your Group has been asked to consult with HMK Enterprises on how best to raise $10 million to finance new capital expenditures. The first option being considered is to issue five-year bonds with a face value of $1,000 and a coupon rate of 6.5% (annual payments). [A second option, issuing new common stock, will be considered in your Written Assignment for Week Three.]

I. To help the company decide on how best to proceed, your Group has derived the following table that summarizes the current financial market yield to maturity for five-year (annual payments) coupon corporate bonds of various ratings:

Rating                                        AAA         AA          A             BBB            BB

YTM                                           6.20%     6.30%    6.50%   6.90%        7.50%

a. if Standard & Poor’s or Moody’s puts a rating on the HMK bonds as AA, what will the price of the HMK bonds be when issued to investors?

b. to raise the $10M needed, how much total principal amount of these bonds must HMK issue to raise the money today, if the bonds are in fact rated AA? (assume that any fraction of a bond is rounded off to the nearest whole number)

c. what must the rating of the HMK bond be for them to sell at par?

d. suppose that when the bonds are issued, the price of each bond ends up at $959.54. Is this a discount bond or a premium bond? What do you think would be the likely rating of the bonds? Is it possible that your Group could advise management that this would basically be nothing more than the issuance of junk bonds by HMK? Would this be a good or bad thing to do, in your opinion, relative to the overall cost of capital to finance this investment? Why?

e. In discussing this with Mr. Moneypockets, the CFO, will you explain that the cost of the bonds to the corporation (assuming no financing costs that might be paid to an Investment Banker) could be greater or less than the coupon rate? In this case, based on your answer to part d., which would it be? What factors, such as riskiness of cash flows from the potential investment or the current debt load of HMK, might contribute to your explanation?

2) In helping to "rehearse" how best to approach the above questions, your Team decides first to try and solve this practical bond problem. (Show all calculations, of course, in your paper).

Exactly three years ago, your Team purchased a $1,000 face value bond for $1,211.16. The coupon rate was 6.5 percent with interest paid semiannually. Today, you sold that bond for $1,089.54. What was your rate of return for the 3-year period, or holding period yield, on this investment?