Leland Industries
Case 24
Debt Financing
Purpose: The case gives the student a chance to understand the many factors influencing bonds. Initially
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
Rating
AA3
A1
A2
?
Debt to Total Assets
35%
42%
47%
44%
Times interest earned
6.0X
5.5X
4.9X
5.7X
Fixed charge coverage
3.6X
4.2X
3.8X
3.7X
Current ratio
2.8X
2.3X
2.1X
2.0X
Return on equity
19%
17.1%
15%
16.8%
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
debt ratio, times earned and return on equity ratios indicate it falls closer to the A1 category than the
A2. However, its fixed charge coverage and current ratio are more in line with an A2 rating. On
balance, A1 is probably the most appropriate answer.
2. The approximate yield to maturity (Y’) formula is:
060,1$
060,1$
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
)000,1($4.)920($6. 20
920000,1$
5094
+
−
+
=.$
Bakeries Gates
5. Interest savings on $20 million debt outstanding
Size of issue …………………………………………………………………
$20 million
Interest savings (1 1/4%) ……………………………………………….
x 1.25
Interest savings ($)………………………………………………………..
$250,000
Taxes (.35) …………………………………………………………………..
–87,500
Aftertax benefit …………………………………………………………….
$162,500
Since the aftertax cost of hedging is $120,000, there is a net aftertax benefit of $42,500 per year
Aftertax interest savings ………………………………………………..
$162,500
Aftertax cost of hedging ………………………………………………..
–120,000
Net aftertax benefit ……………………………………………………….
$ 42,500
6. a) Present value of $1,000 zero-coupon rate bond.
PV = FV X PVIF (Appendix B)
FV = $1,000, n = 20, i = 11%
PV = $1,000 x .124 = $124