Issuing Debt and Bond Valuation
What avenues are available for for-profit and not-for-profit health care providers to increase their equity position?
What are the advantages and disadvantages to a taxpaying entity in issuing debt as opposed to equity?
Explain the difference between subordinate debentures and debentures.
Why would an investment banker syndicate a bond issue with other investment bankers?
If a $1,000 zero coupon bond with a 20-year maturity has a market price of $311.80, what is its rate of return?
A tax-exempt bond was recently issued at an annual 8 percent coupon rate and matures 20 years from today. The par value of the bond is $1,000.
If a required market rates are 8 percent, what is the market price of the bond?
If required market rates fall to 5 percent, what is the market price of the bond?
Charles City Hospital plans on issuing a tax-exempt bond at the bond is $1,000.
If required market rates are 6 percent, what is the value of the bond?
If required market rates fall to 12 percent what is the value of the bond?
At what required market rate (3,6, or 12 percent) does the above bond sell at a discount? At a premium?
Mercy Medical Mega Center , a taxpaying entity, has made the decision to purchase a new laser surgical device. The device costs $400,000 and will be depreciated on straight-line basis over five years to a zero salvage value. Mercy Medical could borrow the full amount at a 15 percent rate for five years. The after-tax cost of debt equals 9 percent. Alternatively, it could lease the device for five years. The before-tax lease payments per year would be $80,000. The tax rate for this MegaCenter is 40 percent. From a financial perspective, should Mercy lease the surgical device or borrow the money to purchase it and why?
Issuing Debt and Bond Valuation
1. What avenues are available for for-profit and not-for-profit health care providers to increase their equity position?
The avenues available for profit health care providers in order to increase their equity position include: Philanthropy, government grants sale of real estate. For non-profit health care providers, they include: Internal funds and stock issuances. (Cornett, M. M., Adair, T. A., & Nofsinger J. 2016).
2. What are the advantages and disadvantages to a taxpaying entity in issuing debt as opposed to equity?
Advantages of issuing debt (relative to equity): using debt provides a tax shield and is cheaper to a certain risk level. It is also better for shirt term financing. Issuing debts is an indication of company’s strength. This is because managers are confident that the company will not go into bankruptcy and they will not existing shares. Issuing debt also can signal company commitment to increase the total output to rival firms.
Disadvantages of using debt (relative to equity): issuing debt increases company’s risk level. Company is very sensitive to interest variability, economic downturns and more sensitive to changes in market conditions. If the company fails to pay, its assets can be taken as collateral. When a company take on more debts, it increase agency cost between equity holders and debt holders. (Cornett, M. M., Adair, T. A., & Nofsinger J. 2016).
3. Explain the difference between subordinate debentures and debentures.
A debenture is a sort of bond that does not use collateral. It's generally perceived as any unsecured long term obligation. Since the bonds are unsecured, it's basic for the issue to be beneficial for the company. As a result of its absence of security this makes the bond more risky. This risk means the security ought to pay a higher loan cost with a specific end goal to make up for the danger. The more noteworthy the danger the more noteworthy the financing cost ought to be on account of the issue does not have guaranteed to pay on the off chance that the organization is not gainful.
A subordinated debenture is comparative in character however for this situation they are payed as a subordinate issue. This leaves the subordinate debenture going about as a lesser obligation to the more senior debenture if there should arise an occurrence of bankruptcy. As you may envision these issues, albeit connected to the debentures, pay a higher loan cost
4. Why would an investment banker syndicate a bond issue with other investment bankers?
Investment banks usually a key role in issuance of local government securities, state and new corporate. Investment banks also face some risks in doing so. Investment banks provide one or more of the following services: purchasing some or all the securities from the issuer, reselling securities to the public and advising on the pricing issues, timing, volume of securities offered and other terms relating to securities.
5. If a $1,000 zero coupon bond with a 20-year maturity has a market price of $311.80, what is its rate of return? (Cornett, M. M., Adair, T. A., & Nofsinger J. 2016).
Zero coupon bond value = F / (1 + r)t
F = market price=$311.80 r = rate or yield =? t = time to maturity= 20years
1000= 311.80/ (1+r) 20
1000 (1+r) 20 =311.80
(1+r) 20= 0.3118
(1+r)=11.17
R=10.17%
6. A tax-exempt bond was recently issued at an annual 8 percent coupon rate and matures 20 years from today. The par value of the bond is $1,000
7. If a required market rates are 8 percent, what is the market price of the bond?
Zero coupon bond value = F / (1 + r)t
F = market price=?? r = rate or yield =8% t = time to maturity= 20years
1000= F/ (1+0.08) 20
1000=F/4.661
F (market price of the bond) = $214.55
8. If required market rates fall to 5 percent, what is the market price of the bond?
1000= F/ (1+0.05) 20
1000=F/2.653
F (market price of the bond) = $376.89
9. Charles City Hospital plans on issuing a tax-exempt bond at the bond is $1,000.
10. If required market rates are 6 percent, what is the value of the bond?
Zero coupon bond value = F / (1 + r) t
1000= F/ (1+0.06) 20
1000=F/3.207
F (value of the bond) = $311.8
11. If required market rates fall to 12 percent what is the value of the bond?
Zero coupon bond value = F / (1 + r) t
1000= F/ (1+0.12) 20
1000= F/ 9.65
F=$103.67
12. At what required market rate (5, 6, or 12 percent) does the above bond sell at a discount? At a premium?
A discount bond is simply a bond that is selling below its par value. It would be quoted at a price that is less than 100 percent of par, like 99.05. A premium bond is a bond selling above its par value. Its price will be quoted as over 100 percent of par value, like 101.15. A bond becomes a discount bond when market interest rates rise above the bond’s coupon rate. A bond becomes a premium bond when market interest rates fall below the bond’s coupon rate. The above market rate (5, 6, or 12 percent) is sold as discount bond. (Cornett, M. M., Adair, T. A., & Nofsinger J. 2016).
13. Mercy Medical Mega Center , a taxpaying entity, has made the decision to purchase a new laser surgical device. The device costs $400,000 and will be depreciated on straight-line basis over five years to a zero salvage value. Mercy Medical could borrow the full amount at a 15 percent rate for five years. The after-tax cost of debt equals 9 percent. Alternatively, it could lease the device for five years. The before-tax lease payments per year would be $80,000. The tax rate for this Mega Center is 40 percent. From a financial perspective, should Mercy lease the surgical device or borrow the money to purchase it and why?
Borrowing the money (loan) to buy the machine
$400,000 at a 15% per five years interest
0.15*400000=60,000
Total amount to be refunded =460,000
After tax debt = 0.09 *400,000= 36,000
Total cost= 460,000+36,000
= 496,000
Leasing
80,000*5= 400,000
Tax = 0.40*80,000*5= 160,000
Total cost= 560,000
Mercy should borrow the money and purchase l a new laser surgical device. This is because the total cost will be lower than that of leasing the surgical device by $ 64,000. Purchasing surgical device will help to minimize the total cost.
Reference
(Cornett, M. M., Adair, T. A., & Nofsinger J. 2016). M: Finance (3rd ed.). New York, NY: McGraw-Hill.
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