Yankee, a US firm, needs to raise USD1 billion or equivalent to acquire Broncon,

Question

Yankee, a US firm, needs to raise USD1 billion or equivalent to acquire Broncon, an Australian firm. Therefore, Yankee firm is trying to decide between the following three types of bond issues.
Assuming all else is equal, which is the least expensive bond issue solely based on All-in cost for Yankee firm? Please show your full workings. [Hint: Compare the annualized yield to maturity (YTM) for each bond issue. Use the possible internal rate of return given above to speed up your calculation.]
Initial No of Fees Types of Coupon Bonds ge Rate (per USD) Hint] Possible Internal Rate of Return (IRR) ? Maturit Payment (at Debt Exchan t-0) na One- Year off U.S bond 10.85%- | 3 6% . 2. 3.1577%.| 4.158% Euro- Eurobon | 6.5% | 0.65%. 3. 1. 6.7465%-| 7.22 16% 0.9 Dim- Sum Bond Rmb 6.00 55% . 1. | 0.8090 JI 2. 5.9360%-| 6.9360%

Explanation / Answer

Calculating the annualized yield to maturity (YTM) for each bond issue:-

1) U.S Bond

Since, Bo = -Intial charges+Interest/(1+kd)1 + Interest/(1+kd)2+ .........+Interest/(1+kd)n+ Prinipal/(1+kd)n

Where, B0 is price at the begining & kd is the YTM

In the present case, B0 is 1000,000,000 & int. is paid semiannaually @6%p.a =1000,000,000*6%*.5=30,000,000,

1000,000,000 =-8,500,000+30,000,000*PVAF(kd%,3*2 terms)+ 1000,000,000*PVF(kd%,3*2th term)   

Using hit & Trail approach & cheching whether Net present value(NPV) =0

Let IIR be 3%, then NPV =85,00,000

Let IIR be 2%, then NPV = -47,514,308.906

Thus Kd=2% + (47,514,308.906/56014308.906)*1 =2.848% & for the full year it would be 5.696%

ii) For Euro bonds

SInce 1$=.9Euro,

Therefore 1 billion euro=900.000.000 Euro,

In the present case, B0 is 900,000,000 & int. is paid Annaually @6.5%p.a =900,000,000*6.5%=585,00,000, & Initial charges would be .65%*900,000,000 = 5850,000

900,000,000 = -5,850,000+58500,000*PVAF(kd%,3 terms)+ 900,000,000*PVF(kd%,3th term)

Using hit & Trail approach & cheching whether Net present value(NPV) =0

Let IIR be 6%, then NPV =61,78,554

Let IIR be 7%, then NPV = -17659422.199

Thus Kd=6% + (61,78,554/23837975.97)*1 =6.259% & for the full year it would be 12.518%

SInce 1$=6 Rmb,

Therefore 1 billion euro=6000.000.000 Rmb,

In the present case, B0 is 6000,000,000 & int. is paid Annaually @5.5%p.a =6000,000,000*5.5%=330,000,000, & Initial charges would be .80%*6000,000,000 = 48,000,000

6000,000,000 = -48,000,000+330,000,000*PVAF(kd%,3 terms)+ 6000,000,000*PVF(kd%,3th term)

Using hit & Trail approach & cheching whether Net present value(NPV) =0

Let IIR be 5%, then NPV =33697440.881

Let IIR be 6%, then NPV = -128190358.483

Thus Kd=5% + (33697440.881 / 161887799.365)*1 =5.208% & for the full year it would be 10.416%

Therefore based on YTM of all three options , least expensive issue would be 1st one i.e US Bond because return requirred by the investor is low as compared to euro & Dim Sum Bond bond

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