Reference no: EM133629931

Question

You have just graduated from university and are considering starting a new line clothing. To start the new line of clothing you require a capital outlay of $25,000 and net working capital of $1,000. The new line will sell for $18.99 per unit. Sales in year 1 are estimated to be 500 units. You have determined that sales will rise by 20% annually after year 1. Direct materials costs are estimated to be 20% of annual sales and direct labour costs 10% of annual sales. Fixed costs for the new business will be $2,000 annually. Your old product line will more than likely experience a drop in sales by $500 annually over the first four years of operating the new product line. You started the business a few years ago, after taking an awesome finance course in university. At that time your company issued 35,000 common shares which currently trade at $1.50 per share on the web site InvestO'Rama.com. They have a beta 1.50. Pundits are estimating that the InvestO'Rama.com market will rise by 22% over the next year and that riskless investments will earn an average 10.0%. Your company recently issued 250 coupon bonds at a price of 120. The bond's pay a 15% coupon, and have a term to maturity of 3 years The company's tax rate is 20% and its depreciation rate is 10%. You also note, the new product line is expected to grow at an annual pace of 4% after year 5.

Management is worried that interest rates might begin to fall. What bond-risk management strategy could be used to hedge against a drop in interest rates?