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Leland Industries Case 24
Debt Financing
Purpose: The case gives the student a chance to understand the many factors influencing bonds. Initially
the student concentrates on the variables affecting a bond rating and actually makes a basic bond rating
decision. The relationship of bond ratings to yield to maturity also is stressed through various
computations. The case also covers such innovative debt products as floating rate and zero-coupon rate
bonds. Finally the use of hedging to cover interest rate exposure is explored.
Relation to Text: The case draws on material from Chapters 8, 10, 11 and primarily Chapter 16. It
integrates cost of capital, hedging and long-term issues. The case should follow Chapter 16.
Complexity: The case is moderately complex. It should require 1-1½ hours.
Solutions
1. A potential bond issue by Leland would definitely not qualify for the AA1 rating that International
Bakeries enjoys and would be well above the B3 rating of Savanah Products. The bond would
undoubtedly fall somewhere between AA3 and A2.
A comparative analysis with the three most similar firms is presented below.
Dyer
Pasteries
Gates
Bakeries
Nolan
Bread
Leland
Industries
Leland generally falls below Dyer Pasteries on all measures except fixed charge coverage, so it is
unlikely to qualify for an AA3 rating. The firm appears to fall between the A1 and A2 categories. Its
2. The approximate yield to maturity (Y’) formula is:
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
%39.9
060,1$
50.99$
060,1$
4$50.103$
400$660$
25
100$
50.103$
))000,1($4.)100,1($6.
25
100,1$000,1$
50103
payment) (Principal 0.4 bond) theof (Price 0.6
maturity toyears ofNumber
bond theof Pricepayment Principal
payment interest Annual
.$
BakeriesnalInternatio
%35.10
952$
50.98$
952$
4$50.94$
400$552$
20
80$
50.94$
)000,1($4.)920($6.
20
920000,1$
5094
.$
Bakeries Gates
$1,000 $1,150
$157.50 15
.6($1,150) .4($1,000)
$150
$157.50 15
$690 $400
$157.50 $10 $147.50 13.53%
$1,090 $1,090
Savanah Products
-
+
=+
-
æ ö
+
ç ÷
è ø
=+
-
= = =
3. Kd (cost of debt) = Y (Yield) (1 – T)
4. Debt Outstanding
Year 1 $20,000,000 X .95 = $19,000,000
Interest Payment on Debt
This repayment method reduces interest expense over the life of the bond.
5. Interest savings on $20 million debt outstanding
Size of issue.............................................................................. $20 million
Interest savings (1 1/4%)......................................................... x 1.25
Since the aftertax cost of hedging is $120,000, there is a net aftertax benefit of $42,500 per year
6. a) Present value of $1,000 zero-coupon rate bond.
PV = FV X PVIF (Appendix B)
b) The number of bonds to be issued is:
bonds 290,161
124$
000,000,20$
vs.
par 000,1$
000,000,20$
= 20,000 bonds
c) The danger is that the corporation is not paying any interest on an annual basis, and for this
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
