Chapter 14 – Long-Term Financing Instruments
Chapter 14 takes a closer look at features of debt financing instruments, a topic begun in chapter 5. Read Finkler, chapter 14. Do Question for Review #5; the spreadsheet for Coffin Corporation Bonds provides an example of how to do this problem. This is the bond described on Chapter 14 of the text. It is a $100 million, 20-year, 10% bond paying interest semi-annually. By inserting different market rates, you can see how the issue price of the bond is influenced by market rates. If you input a market rate above 10% the bond price goes below $100 million; for a market rate below 10% the price goes above $100 million; and if the market rate equals the contractual rate of 10% the bond price will equal par / face value. The second tab illustrates calculation of the price for the Coffin Bond after it has been outstanding 10 years.
Prepare a similar spreadsheet for the bond in Question for Review #5, using the provided template Bonds Ch 14 Q5. The first tab shows calculation of bond price at issuance with the market rate set equal to the stated rate of 5%. The second tab shows the analysis after the bond has been outstanding 10 years, again with the market rate set equal to 5%. Input the market rate of 4.5% and verify the selling price of the bond after 10 years is as shown in Finkler’s solution.
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Chapter 14 – Stanley Works Assignment #1
After carefully reading the article, go to Table 2 on page 63 of the article which shows a 3×3 matrix, 3 levels of term to maturity (columns) and 3 levels of interest deferral provisions, (rows). Locate Stanley Works in the Table, noting that it is in category C, indicating that it has a hybrid instrument which qualifies for 50% equity treatment. This means that despite being classified as 100% debt on the balance sheet, the rating agencies will view the hybrid as 50% debt and 50% equity for calculating key financial ratios.
Go to the Stanley Works 10-K and locate the long-term debt total on the Dec. 30, 2006 balance sheet ($679.2 million). Footnote I breaks down the components of this total. There are 8 long-term debt instruments the company has issued. Read the footnote and the 8-k disclosure and identify which debt instrument is the one in question, i.e. the hybrid that qualifies for 50% equity credit. From the table in footnote I, give the description of the instrument, interest rate, and dollar amount of the obligation.
Chapter 14 – Stanley Works Assignment #2
Receiving 50% equity credit means the hybrid has sufficient characteristics of permanence, interest deferral, and subordination. In this exercise we are going to list the relevant characteristics from the disclosures in footnote I and the 8-k filing.
1. Permanence. What is the term to maturity of Stanley Works’ hybrid?
2. Interest Deferral. Quote wording from the 8-k that indicates Stanley Works has the right to suspend interest payments on the hybrid.
3. Subordination. From the text below the table in footnote I, quote the description of the hybrid instrument in the first sentence.
Chapter 14 – Stanley Works Assignment #3
In this exercise we are going to examine the impact of the equity credit given to Stanley Works’ hybrid on a key financial ratio, the debt-to-equity ratio.
1. Before Adjustment for Equity Credit. From the face of the balance sheet, take the figure we have already identified for long-term debt ($679.2) and divide it by the Total Shareowners’ Equity. Show the calculation and the result; carry to 4 decimal places.
2. After Adjustment for Equity Credit. Re-calculate the debt-to-equity ratio by adjusting the figures from #1: decrease the long-term debt by $225 and increase shareowners’ equity by $225. Show the calculation and result; carry to 4 decimal places.
3. Calculate the % drop in the ratio (carry to 3 decimal places):
[ ratio before adjustment – ratio after adjustment ] / ratio before adjustment
You should find the drop in the ratio to be 41.6%.
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