Professional Documents
Culture Documents
Excel Solutions To Cases
Excel Solutions To Cases
Case Solutions
Case #
1
2
3
4
5
6
7
8
9
10
ions
List of Mini-Cases
Chapter
Sunset Boards
S&S Air
S&S's Bond
8
11
14
17
18
21
Tax rate
Dividend percentage
2007
84,310
12,165
23,800
5,180
16,580
21,500
105,000
165,390
8,620
9,800
53,000
18,140
20%
30%
Output area:
165,390
84,310
16,580
23,800
40,700
5,180
35,520
7,104
28,416
8,525
19,891
201,600
106,450
21,640
26,900
46,610
5,930
40,680
8,136
32,544
9,763
22,781
2008
106,450
18,380
26,900
5,930
21,640
24,350
134,000
201,600
11,182
10,700
61,000
24,894
10,000
Owners equity
Long-term debt
Accounts payable
Short-term debt
Current liabilities
Total equity and liabilities
Accounts payable
Short-term debt
Current liabilities
Total equity and liabilities
Owners equity
Long-term debt
Capital Spending
Ending net non-current assets
- Beginning net non-current assets
+ Depreciation
Net capital spending
R
R
R
R
R
R
2007
57,396
134,000
105,000
26,900
55,900
19,406
7,625
11,781
65,374
55,900
11,781
(2,307)
5,930
8,000
(2,070)
9,763
10,000
(237)
1
The firm had positive earnings in an accounting
sense (NPAT > 0) and had positive cash flow from
operations. The firm invested R11 781 in new net
working capital and R55 900 in new net non-current
assets. The firm had to raise R2 307 from its
stakeholders to support this new investment. It
accomplished this by raising R10 000 in the form of
new equity and R8 000 in new long-term debt. After
paying out R9 763 in dividends to shareholders and
R5 930 in interest to lenders, R2 307 was left to
meet the firm's cash flow needs for investment.
2008
65,374
R 105,000
18,140
8,620
R 12,165
R 38,925
R 143,925
R 134,000
24,894
11,182
R 18,380
R 54,456
R 188,456
2
The expansion plans may be a little risky. The
company does have a positive cash flow, but a
large portion of the operating cash flow is already
going to capital spending. The company has had to
raise capital from lenders and shareholders for its
current operations. So, the expansion plans may
be too aggressive at this time. On the other hand,
companies do need capital to grow. Before
investing or loaning the company money, you would
want to know where the current capital spending is
going, and why the company is spending so much
in this area already.
Sales
COGS
Other expenses
Depreciation
PBIT
Interest
PBT
Taxes (40%)
NPAT
R
R
R
R
R
R
R
R
R
128,700,000
90,700,000
15,380,000
4,200,000
18,420,000
2,315,000
16,105,000
6,442,000
9,663,000
Dividends
Add to RP
R
R
2,898,900
6,764,100
Assets
Non-current assets R
1,000,000
41,570,000
42,570,000
Long-term debt
25,950,000
Current Liabilities
Accounts Payable
Short-term debt
Total CL
Total L&E
R
R
R
R
4,970,000
10,060,000
15,030,000
83,550,000
Growth rate
Minimum NCA purchase
20%
30,000,000
Output area:
Current ratio
Quick ratio
Cash ratio
Total asset turnover
Inventory days
Receivables days
Total debt ratio
Debt-equity ratio
Equity multiplier
Times interest earned
Cash coverage ratio
Profit margin
Return on assets
Return on equity
0.75
0.44
0.16
1.54
19.0
11.9
0.49
0.85
1.96
7.96
9.77
7.51%
11.57%
22.70%
Retention ratio
Internal growth rate
Sustainable growth rate
0.70
8.81%
18.89%
72,280,000
Current Assets
Inventory
Accounts rec.
Cash
Total CA
R
R
R
R
4,720,000
4,210,000
2,340,000
11,270,000
Total Assets
83,550,000
Tax rate
40%
Sales
COGS
Other expenses
Depreciation
PBIT
Interest
PBT
Taxes (40%)
NPAT
R
R
R
R
R
R
R
R
R
154,440,000
108,840,000
18,456,000
5,040,000
22,104,000
2,315,000
19,789,000
7,915,600
11,873,400
Dividends
Add to RP
R
R
3,562,020
8,311,380
Assets
Shareholder Equity
Ordinary shares
Retained profits
Total Equity
R
R
R
1,000,000
49,881,380
50,881,380
Long-term debt
25,950,000
Current Liabilities
Accounts Payable
Short-term debt
Total CL
R
R
R
5,964,000
10,060,000
16,024,000
Total L&E
92,855,380
EFN
7,404,620
30,000,000
New depreciation
Reduction in NPAT
Reduction in RP
R
R
R
5,943,221
541,932
379,353
Non-current assets
86,736,000
Current Assets
Inventory
Accounts rec.
Cash
Total CA
R
R
R
R
5,664,000
5,052,000
2,808,000
13,524,000
Total Assets
100,260,000
Assets
Shareholder Equity
Ordinary shares
Retained profits
Total Equity
R
R
R
1,000,000
49,502,027
50,502,027
Long-term debt
25,950,000
Current Liabilities
Accounts Payable
Short-term debt
Total CL
Total L&E
R
R
R
R
5,964,000
10,060,000
16,024,000
92,476,027
EFN
23,327,973
Non-current assets
102,280,000
Current Assets
Inventory
Accounts rec.
Cash
Total CA
R
R
R
R
5,664,000
5,052,000
2,808,000
13,524,000
Total Assets
115,804,000
2 Boeing is probably not a good aspirant company. Even though both companies manufacture airplanes, S&S Air manufactures small
airplanes, while Boeing manufactures large, commercial aircraft. These are two different markets. Additionally, Boeing is heavily
involved in the defense industry, as well as Boeing Capital, which finances airplanes.
S&S is below the median industry ratios for the current and cash ratios. This implies the company has less liquidity than the industry in
general. However, both ratios are above the lower quartile, so there are companies in the industry with lower liquidity ratios than S&S
Air. The company may have more predictable cash flows, or more access to short-term borrowing. If you created an Inventory to
Current liabilities ratio, S&S Air would have a ratio that is lower than the industry median. The current ratio is below the industry
median, while the quick ratio is above the industry median. This implies that S&S Air has less inventory to current liabilities than the
industry median. S&S Air has less inventory than the industry median, but more accounts receivable than the industry since the cash
ratio is lower than the industry median.
The total asset turnover ratio and the inventory and receivables days are all better than the industry median; in fact, all three ratios are
above the upper quartile. This may mean that S&S Air is more efficient than the industry.
The financial leverage ratios are all below the industry median, but above the lower quartile. S&S Air generally has less debt than
comparable companies, but still within the normal range.
The profit margin for the company is about the same as the industry median, the ROA is slightly higher than the industry median, and
the ROE is well above the industry median. S&S Air seems to be performing well in the profitability area.
Overall, S&S Airs performance seems good, although the liquidity ratios indicate that a closer look may be needed in this area.
Cost of bike
Balloon payment
Best offer after 4 years
Lease period
Interest rate
164,103
97,000
45,000
4
24%
Output area:
Present value
Interest rate per month
Number of lease payments
Future value
Monthly payment
R (164,103.00)
2%
48
R
97,000.00
R
4,127.68
Total payments
Capital repaid
Interest paid
R
R
R
198,128.69
67,103.00
131,025.69
14%
38%
2 The more senior the bond is, the lower the coupon rate.
ond Issue
Inventory
Accounts receivable
Cash
Current assets
Accounts payable
Provisions
Tax owing
Short-term borrowings
Current liabilities
Net current assets
Net assets
Income statements
Gross profit
Depreciation
Other expenses
Abnormal items
Profit before interest
Interest
Profit before tax
Tax
Net profit after tax
Income from associate
Dividends paid
Transfer to non-distributable reserve
Retained profit for the year
2007
111,427
4,232
38,574
154,233
2008
108,693
4,895
28,554
142,142
2009
110,697
5,268
14,226
130,191
2010
113,623
5,569
120,919
2,006
2,712
99,135
2,438
2,856
2,712
77,551
1,625
3,706
2,712
87,968
812
4,556
2,712
34,485
43,656
204
78,345
39,182
48,895
241
88,318
42,770
52,953
332
96,055
47,502
57,984
465
105,951
37,887
1,847
3,573
6,442
49,749
28,596
154,233
41,958
2,445
2,866
6,048
53,317
35,001
142,142
45,067
2,644
3,747
51,458
44,597
130,191
49,169
2,544
4,608
26,486
82,807
23,144
119,192
2007
76,151
-22,471
-28,675
6,116
31,121
-4,335
26,786
-7,234
19,552
787
-12,500
-787
7,052
2008
83,451
-24,784
-31,211
-2,644
24,812
-7,364
17,448
-7,032
10,416
850
-14,000
-850
-3,584
2009
89,018
-25,584
-33,699
2010
94,191
-34,584
-25,419
29,735
-4,883
24,852
-8,698
16,154
850
-15,000
-850
1,154
34,188
-4,071
30,117
-10,541
19,576
850
-17,500
-850
2,076
10%
35%
20.83%
4,335
119,192
Output area:
Gross profit
Other expenses
Abnormal items
Cash taxes
NOPAT
2008
-3,573
-7,032
663
2,866
-2577
-9,653
2009
-2,866
-8,698
373
3,747
-1709
-9,153
2010
-3,747
-10,541
301
4,608
-1425
-10,804
120,919
-24,784
-99,135
-3,000
99,135
-25,584
-77,551
-4,000
77,551
-34,584
-87,968
-45,001
2008
83,451
-31,211
-2,644
-9,653
39,943
2009
89,018
-33,699
0
-9,153
46,166
2010
94,191
-25,419
0
-10,804
57,968
-3,000
-4,697
-5,239
4,071
-2,438
598
-10,705
-4,000
-3,588
-4,058
3,109
813
199
-7,525
-45,001
-4,732
-5,031
4,102
813
-100
-49,949
29,238
38,641
8,019
2009
26,467
After 2010
-5,000
48,020
487,739
2010
2010
4,546
276,480
Capital expenditure
Inventory
Receivables
Payables
Capitalised expenses
Provisions
I
FCF = NOPAT - I
WACC
20.83%
2008
24,197
331,689
-45,016
204
2,006
4,335
293,218
Equipment
Salvage value
R&D
Marketing study
Sales(units)
Depreciation rate
Sales of old PCB
Lost sales
Price
VC
FC
Price of old PCB
Price reduction
of old PCB
VC of old PCB
Tax rate
NWC percentage
Required return
Sensivity analysis
New price
Quantity change
R20,000,000
R3,000,000
R750,000
R200,000
sunk cost
sunk cost
Year 1
70,000
50.00%
80,000
15,000
Year 2
80,000
30.00%
60,000
15,000
Year 3
100,000
20.00%
Year 4
85,000
Year 5
75,000
R250
R86
R3,000,000
R240
R20
R68
29%
20%
12%
R260
100 NOTE: Change in units per year
Output Area:
Sales
New
Lost sales
Lost rev.
Net sales
Year 1
R17,500,000
3,600,000
1,300,000
R12,600,000
Year 2
R20,000,000
3,600,000
900,000
R15,500,000
Year 3
R25,000,000
Year 4
R21,250,000
Year 5
R18,750,000
R25,000,000
R21,250,000
R18,750,000
R6,020,000
1,020,000
R5,000,000
R6,880,000
1,020,000
R5,860,000
R8,600,000
R7,310,000
R6,450,000
R8,600,000
R7,310,000
R6,450,000
Sales
VC
Fixed costs
Dep
PBT
Tax
NPAT
+Dep
OCF
R12,600,000
5,000,000
3,000,000
10,000,000
(R5,400,000)
(1,566,000)
(R3,834,000)
10,000,000
R6,166,000
R15,500,000
5,860,000
3,000,000
6,000,000
R640,000
185,600
R454,400
6,000,000
R6,454,400
R25,000,000
8,600,000
3,000,000
4,000,000
R9,400,000
2,726,000
R6,674,000
4,000,000
R10,674,000
R21,250,000
7,310,000
3,000,000
0
R10,940,000
3,172,600
R7,767,400
0
R7,767,400
R18,750,000
6,450,000
3,000,000
0
R9,300,000
2,697,000
R6,603,000
0
R6,603,000
NWC
Beg
End
NWC CF
R0
2,520,000
(R2,520,000)
R2,520,000
3,100,000
(R580,000)
R3,100,000
5,000,000
(R1,900,000)
R5,000,000
4,250,000
R750,000
R4,250,000
0
R4,250,000
Net CF
R3,646,000
R5,874,400
R8,774,000
R8,517,400
R10,853,000
Salvage
BV of equipment
Taxes
Salvage CF
R0
-870,000
R2,130,000
VC
New
Lost sales
Net CF
Payback period
PI
IRR
NPV
Time
0
1
2
3
4
5
(R20,000,000)
R3,646,000
R5,874,400
R8,774,000
R8,517,400
R12,983,000
3.200
1.348
22.80%
R6,963,417.30
Year 1
R18,200,000
3,600,000
1,300,000
R13,300,000
Year 2
R20,800,000
3,600,000
900,000
R16,300,000
Year 3
R26,000,000
Year 4
R22,100,000
Year 5
R19,500,000
R26,000,000
R22,100,000
R19,500,000
R6,020,000
1,020,000
R5,000,000
R6,880,000
1,020,000
R5,860,000
R8,600,000
R7,310,000
R6,450,000
R8,600,000
R7,310,000
R6,450,000
Sales
VC
Fixed costs
Dep
PBT
Tax
NPAT
+Dep
OCF
R13,300,000
5,000,000
3,000,000
10,000,000
(R4,700,000)
(1,363,000)
(R3,337,000)
10,000,000
R6,663,000
R16,300,000
5,860,000
3,000,000
6,000,000
R1,440,000
417,600
R1,022,400
6,000,000
R7,022,400
R26,000,000
8,600,000
3,000,000
4,000,000
R10,400,000
3,016,000
R7,384,000
4,000,000
R11,384,000
R22,100,000
7,310,000
3,000,000
0
R11,790,000
3,419,100
R8,370,900
0
R8,370,900
R19,500,000
6,450,000
3,000,000
0
R10,050,000
2,914,500
R7,135,500
0
R7,135,500
NWC
Beg
End
NWC CF
R0
2,660,000
(R2,660,000)
R2,660,000
3,260,000
(R600,000)
R3,260,000
5,200,000
(R1,940,000)
R5,200,000
4,420,000
R780,000
R4,420,000
0
R4,420,000
Net CF
R4,003,000
R6,422,400
R9,444,000
R9,150,900
R11,555,500
Salvage
BV of equipment
Taxes
Salvage CF
R0
-870,000
R2,130,000
VC
New
Lost sales
Net CF
Time
0
1
2
3
4
5
NPV
(R20,000,000)
R4,003,000
R6,422,400
R9,444,000
R9,150,900
R13,685,500
R8,997,140.38
NPV/P
R203,372.31
Year 1
R17,525,000
3,600,000
1,300,000
R12,625,000
Year 2
R20,025,000
3,600,000
900,000
R15,525,000
Year 3
R25,025,000
Year 4
R21,275,000
Year 5
R18,775,000
R25,025,000
R21,275,000
R18,775,000
R6,028,600
1,020,000
R5,008,600
R6,888,600
1,020,000
R5,868,600
R8,608,600
R7,318,600
R6,458,600
R8,608,600
R7,318,600
R6,458,600
Sales
VC
Fixed costs
Dep
PBT
Tax
NPAT
+Dep
OCF
R12,625,000
5,008,600
3,000,000
10,000,000
(R5,383,600)
(1,561,244)
(R3,822,356)
10,000,000
R6,177,644
R15,525,000
5,868,600
3,000,000
6,000,000
R656,400
190,356
R466,044
6,000,000
R6,466,044
R25,025,000
8,608,600
3,000,000
4,000,000
R9,416,400
2,730,756
R6,685,644
4,000,000
R10,685,644
R21,275,000
7,318,600
3,000,000
0
R10,956,400
3,177,356
R7,779,044
0
R7,779,044
R18,775,000
6,458,600
3,000,000
0
R9,316,400
2,701,756
R6,614,644
0
R6,614,644
NWC
Beg
End
NWC CF
R0
2,525,000
(R2,525,000)
R2,525,000
3,105,000
(R580,000)
R3,105,000
5,005,000
(R1,900,000)
R5,005,000
4,255,000
R750,000
R4,255,000
0
R4,255,000
Net CF
R3,652,644
R5,886,044
R8,785,644
R8,529,044
R10,869,644
Salvage
BV of equipment
Taxes
Salvage CF
R0
-870,000
R2,130,000
VC
New
Lost sales
Net CF
NPV
NPV/Q
Time
0
1
2
3
4
5
(R20,000,000)
R3,652,644
R5,886,044
R8,785,644
R8,529,044
R12,999,644
R7,003,764.16
R403.47
Risk-free rate
Market risk premium
Beta of SDC
Number of shares in issue
Share price
Book value of ordinary shareholders' interest
Book value of outside shareholders interest
Coupon rate on new debt
Coupon rate on existing debt
Tax rate
Book value of long-term debt
Life of existing long-term debt
10%
6%
1.5
24,000,000
R5
R 80,000,000
R 10,000,000
15%
12%
29%
R 60,000,000
10
Output Area:
Cost of equity
After-tax cost of debt
Market value of ordinary shareholders' equity
Book value of ordinary shareholders' equity
Market-to-boook value of ordinary shareholders' intere
Assuming same market-to-book value for outside
shareholders' interest:
Market value of outside shareholders interest
Market value of total shareholders interest
Market value of existing debt
Market value debt-capital ratio
Market value equity-capital ratio
WACC
19.00%
10.65%
R 120,000,000
R 80,000,000
1.5
R 15,000,000
R 135,000,000
R 50,966,216
27.4%
72.6%
16.71%
NOTES
a)
Deferred taxation
Deferred taxation has no cost, as it is an interest free loan from the
Receiver of Revenue. Although, as in the case with depreciation,
deferred taxation has an opportunity cost, it is treated like depreciation
and is not included in the calculation of the weighted average cost of
capital.
b) subsidiaries
Outside shareholders
interest
As the
are in similar lines
of business and have similar risk
and growth prospects, we assume that their cost is the same as
ordinary shares.
c)
Bank overdraft
Fixed rand amount. Sets a base level of dividends and this can't be easily cut. However does lead to good
information transfer to investors as prospects are usually good and sustainable when dividends are raised.
Scrip dividends. Saves cash but enables firm to transmit information on size of dividend to investors.
However subject to the same issues discussed with cash dividends in terms of any dividend cuts.
On balance it seems that it is probably one year too early to consider the dividend. They should await the
finalisation of the contract (in 8 months time). Then, if no international expansion appears, and the firm
settles into a more mature mode, a dividend could be considered, starting at a low level for safety sake.
On the other hand, if management is contemplating an ongoing high level of R&D, the time to tell
shareholders is now that the current no dividend policy will continue. It will be important however to ensure
that they are given sufficient information about future plans to enable them to assess the likelihood of
positive NPV projects in the years ahead. Otherwise the share price will suffer, making it difficult for the firm
to raise new equity capital in the future.
All in all, the decision to commence paying a dividend is one that needs very careful consideration, since
once the firm steps down that road, reversal of the decision has serious consequences. Most important of all
is the need for management to be certain that they will be able to maintain a steady profit stream to support
the dividends
30%
60%
10%
2%
25%
35%
R 30,000
R 22,000
R 5,000
16%
R 300,000
6
R 15,000
30%
R 20,000
R 23,000
R 5,000
Oct
Sales
Nov
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
R 100,000 R 120,000 R 190,000 R 150,000 R 120,000 R 140,000 R 150,000 R 200,000 R 240,000 R 162,000 R 120,000
Output Area:
Seasonal production
Oct
Nov
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sales
R 100,000 R 120,000 R 190,000 R 150,000 R 120,000 R 140,000 R 150,000 R 200,000 R 240,000 R 162,000 R 120,000
Discounts: 2% of 30% of last month's
sales
R 1,140
R 900
R 720
R 840
R 900
R 1,200
R 1,440
R 972
Net cash received after discount
R 55,860
R 44,100
R 35,280
R 41,160
R 44,100
R 58,800
R 70,560
R 47,628
On time net payers
R 72,000 R 114,000
R 90,000
R 72,000
R 84,000
R 90,000 R 120,000 R 144,000
Late payers
R 12,000
R 19,000
R 15,000
R 12,000
R 14,000
R 15,000
R 20,000
R 24,000
Cash from receivables
R 139,860 R 177,100 R 140,280 R 125,160 R 142,100 R 163,800 R 210,560 R 215,628
Labour
Materials
Expenses
Office salaries
Cash out
Net operating cash flow
Tax due
Computer
Loan repayment
Net cash flow for the month
Opening cash balance
Available cash
Level production
Expected sales for next 8 months
Average expected monthly sales
R 37,500
R 42,000
R 22,000
R 30,000
R 131,500
R 50,000
R 49,000
R 22,000
R 30,000
R 151,000
R 60,000
R 52,500
R 22,000
R 30,000
R 164,500
R 40,500
R 70,000
R 22,000
R 30,000
R 162,500
R 30,000
R 84,000
R 22,000
R 30,000
R 166,000
R 8,360
R 28,600
R 780
-R 6,340
-R 8,900
-R 700
R 48,060
R 49,628
R 8,360
R 5,000
R 13,360
R 23,000
R 8,600
R 13,360
R 21,960
R 19,676
-R 18,896
R 21,960
R 3,064
-R 6,340
R 3,064
-R 3,276
-R 23,900
-R 3,276
-R 27,176
R 19,676
-R 20,376
-R 27,176
-R 47,552
R 48,060
-R 47,552
R 508
R 26,628
R 508
R 27,136
R 1,282,000
R 160,250
Nov
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
R 100,000 R 120,000 R 190,000 R 150,000 R 120,000 R 140,000 R 150,000 R 200,000 R 240,000 R 162,000 R 120,000
R 1,140
R 55,860
R 72,000
R 12,000
R 139,860
R 900
R 44,100
R 114,000
R 19,000
R 177,100
R 720
R 35,280
R 90,000
R 15,000
R 140,280
R 840
R 41,160
R 72,000
R 12,000
R 125,160
R 900
R 44,100
R 84,000
R 14,000
R 142,100
R 1,200
R 58,800
R 90,000
R 15,000
R 163,800
R 1,440
R 70,560
R 120,000
R 20,000
R 210,560
R 972
R 47,628
R 144,000
R 24,000
R 215,628
R 40,063
R 42,000
R 22,000
R 30,000
R 134,063
R 40,063
R 66,500
R 22,000
R 30,000
R 158,563
R 40,063
R 52,500
R 22,000
R 30,000
R 144,563
R 40,063
R 56,088
R 22,000
R 30,000
R 148,150
R 40,063
R 56,088
R 22,000
R 30,000
R 148,150
R 40,063
R 56,088
R 22,000
R 30,000
R 148,150
R 40,063
R 56,088
R 22,000
R 30,000
R 148,150
R 40,063
R 56,088
R 22,000
R 30,000
R 148,150
R 5,798
R 18,538
-R 4,283
-R 22,990
-R 6,050
R 15,650
R 62,410
R 67,478
R 20,000
R 23,000
R 15,000
R 5,798
R 5,000
R 10,798
-R 1,463
R 10,798
R 9,335
R 19,676
-R 23,959
R 9,335
-R 14,624
-R 22,990
-R 14,624
-R 37,614
-R 21,050
-R 37,614
-R 58,664
R 19,676
-R 4,026
-R 58,664
-R 62,690
R 62,410
-R 62,690
-R 280
R 44,478
-R 280
R 44,198
Thhe costs of labour change with immediate effect in January where labour costs rise from R37 500 to R40 063. Later in the year level production labour costs drop below those of
seasonal production. The model assumes level production in line with average expected sales
Cash outflows for materials will only change in March under level production, since payment terms for purchases are 60 days.
R 40,000
R 20,000
Cash at month end
(2)
R 35,000
R 52,500
R 22,000
R 30,000
R 139,500
R 15,000
Labour (1)
Materials (2)
Expenses
Office salaries
Cash out
(1)
R 30,000
R 66,500
R 22,000
R 30,000
R 148,500
R 20,000
Oct
Sales
Discounts: 2% of 30% of last month's
sales
Net cash received after discount
On time net payers
Late payers
Cash from receivables
R 37,500
R 42,000
R 22,000
R 30,000
R 131,500
R0
-R 20,000
-R 40,000
-R 60,000
-R 80,000
Jan
Feb
Mar
Apr
Level
May
Seasonal
Jun
Jul
Aug
The net result, as we see from the graph, is that a higher overdraft level from March through July will be needed if the production process is changed from seasonal to level. What the firm needs to establish is whether
the increased financing costs (note that level production will result in a build up of inventories) can be offset by any savings in labour costs as a result of not having to hire and fire workers with the season. These
potential savings are not discussed in the case.
Industry PE
Company EPS
Conversion price (stock)
Maturity (years)
Convertible bond coupon
Conversion value of bond
Plain vanilla coupon
R
R
12.5
1.60
25.00
20
6%
800
10%
Output area:
1 Share price
R20.00
R656.82
Floor value
R800.00
Conversion ratio
Conversion premium
32.00
25.00%
Chris is suggesting a conversion price of R25 because it means the share price will have
increase before the bondholders can benefit from the conversion, in this case 25 per cent
though the company is not publicly traded, the conversion price is important. First, the com
go public in the future. The case does discuss whether the company has plans to go publi
so, how soon it might go public. If the company does go public, the bondholders will have
market for the shares if they convert. Second, even if the company does not go public, the
bondholders could potentially have an equity interest in the company. This equity interest
sold to the original owners, or someone else. The potential problem with private equity is t
market is not as liquid as the market for a public company. This illiquidity lowers the value
shares.
The floor value of the bond is R800. This means that if the company offered bonds with th
coupon rate and no conversion feature, they would be able to sell them for 656,82. Howev
the conversion feature the price will be R800. In essence, the company is receiving R143,
conversion feature.
Thandi's argument is wrong because it ignores the fact that if the company does well, bon
will be allowed to participate in the company's success. If the share price rises to R40, bon
are effectively allowed to purchase shares at the conversion price of R25
3
Mark's argument is incorrect because the company is issuing debt with a lower coupon
they would have been able to otherwise. If the company does poorly, it will receive the be
lower coupon rate
4 Reconciling the two arguments requires that we remember our central goal: to increase th
of the existing shareholders. Thus, with 20-20 hindsight, we see that issuing convertible b
turn out to be worse than issuing straight bonds and better than issuing common stock if t
company prospers. The reason is that the prosperity has to be shared with bondholders a
convert.
In contrast, if a company does poorly, issuing convertible bonds will turn out to be better th
straight bonds and worse than issuing ordinary shares. The reason is that the firm will hav
benefited from the lower coupon payments on the convertible bonds
Both of the arguments have a grain of truth; we just need to combine them. Ultimately, wh
is better for the company will only be known in the future and will depend on the performa
company. The table below illustrates this point.
Convertible bonds
issued instead of
straight bonds
If the comp
High share
conversion
Expensive f
bonds are co
dilutes exist
outcome).
5 The call provision allows the company to redeem the bonds at the company's discretion. I
company's shares appear to be poised to rise, the company can call the outstanding bond
be possible that the bondholders would benefit from converting the bonds at that point, bu
eliminate the potential future gains to the bondholders