Mini-Case Analysis # 2 Financing Tuxedo Air’s Expansion Plans with a Bond Issue. BUSI 2093 Introduction to Managerial Finance February 17, 2019 Audrey Lowrie Vanessa David
Mini Case Background Mark Taylor and Jack Rodwell, the owners of Tuxedo Air, have decided to expand their operations. They instructed their newly hired financial analyst, Ed Cowan, to enlist an underwriter to help sell $35 million in new 10-year bonds to finance construction (Ross, et al., 2016). Chris has entered discussions with Suzanne Lenglen, an underwriter from the firm of Raines and Warren, about which bond features Tuxedo Air should consider and what coupon rate the issue will likely have (Ross, et al., 2016).
Defining the Problem Although Ed is aware of the bond features, he is uncertain about the costs and benefits of some features, so he isn't sure how each feature would affect the coupon rate of the bond issue (Ross, et al., 2016). As Suzanne’s assistant, a memo was prepared for Ed describing the effect of each of the following bond features on the coupon rate of the bond. As well as any advantages or disadvantages of each feature that is discussed below. Evaluation of the Problem The Security of the Bond Collateral backed bonds tend to have a lower coupon rate as compared to a bond with no collateral, as the collateral serves as a guarantee that in case the bond issuer fails to repay the debt, the collateral can be taken over and liquidated to recover the due amount. Collateral acts as a guarantee for the bond holders. Therefore, if the bond has a collateral or a security, then it will lead to an increase in the coupon rate of the bond The Seniority of the Bond Seniority of the bond is indirectly proportional to coupon rate. A firm can have several bonds at different seniority levels. However, the seniority level determines the rights of the bond holders; in case of default by the issuer. A bond that is senior as compared to other bonds would have first right to the liquidation proceeds, in case the issuer defaults. This means that they are more secured as compared to lower seniority bond holders and hence have a lower coupon rate. Therefore, Senior bonds have a lower coupon rate because they have less “default risk".
The Presence of a Sinking Fund A bond sinking fund is a restricted asset of a corporation that was required to set aside money for redeeming or buying back some of its bonds payable. The bond sinking fund begins when the corporation deposits money with an independent trustee. The trustee then invests the money for the balance in the sinking fund to increase. The balance in the sinking fund will also grow from additional required deposits made by the corporation. The bond sinking fund decreases when the trustee purchases or redeems the corporation's bonds. Sinking funds are seen to be less risky as compared to bonds with no sinking fund and hence have lower coupon rates. Therefore, A sinking fund will reduce the coupon rate because it is a partial guarantee to the bondholders. The
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