Case 72 Essay

5131 Words Feb 17th, 2013 21 Pages
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a. SDI currently has two bond issues outstanding. Bond A has a $1,000 par value and a coupon rate of 10 percent, paid semiannually. This bond was issued 10 years ago, it has 10 years remaining to maturity, and it has 2 years of call protection left, after which it can be called at 104 percent of par. This issue is actively traded and highly liquid, and its most recent closing price was $1,092. The second issue, Bond B, is thinly traded, so no valid market quotation is available. This bond had a 25-year maturity when it was issued 2 years ago, a $1,000 par value, 5 years of call protection remaining, a call price of $1,100 when it becomes callable, and a 6.9 percent coupon paid semiannually.
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One of Tony Biddle’s customers has been offered some of the B bonds at a price of $850 per bond. Since this bond is illiquid and not actively traded, the customer does not know if $850 is a fair price. It was agreed that you should determine, for each bond, a fair value and a fair rate of return, and then use your analysis to help explain bond valuation to SDI’s executives. You were also asked to demonstrate how changes in the rate of inflation and in the company’s risk would affect yields and prices of SDI’s debt, and how that would affect capital budgeting decisions. The most recent S&P Bond Guide indicates that long-term bonds with varying ratings have the following yields: AAA 6.6% AA 6.9 A 7.6 BBB 7.8 BB 8.8 B 11.1 The average bond rating for construction equipment firms is single A. SDI’s bonds were rated single A prior to 1994, but then financial problems led to three downgradings, to a current rating of BB. b. SDI has perpetual preferred stock which pays a dividend of $8.25, is traded actively, and last traded at a price of $97. Bob Wilkes, SDI’s Chief Financial Officer (CFO), wants to know what the return to investors is on the preferred, and how that return compares to the return on SDI’s bonds and common stock. Bob also notes that most of the preferred is owned by non-financial corporations, and he wants you to explain why this is so. It is agreed that in your

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