Land’o’Toys is a profitable, medium-sized, retail company. Several years ago, it
ID: 2730075 • Letter: L
Question
Land’o’Toys is a profitable, medium-sized, retail company. Several years ago, it issued a 6.5 percent coupon bond, which pays interest semiannually. The bond will mature in 10 years and is currently priced in the market as $1,037.19. The average yields to maturity for 10-year corporate bonds are reported in the following table by bond rating.
Bond Rating
Yield (%)
Bond Rating
Yield (%)
AAA
5.4
BB
7.3
AA
5.7
B
8.2
A
6.0
CCC
9.2
BBB
6.5
CC
10.5
C
12.0
D
14.5
Periodically, one company will purchase another by buying all of the target firm’s stock. The bonds of the target firm continue to exist. The debt obligation is assumed by the new firm. The credit risk of the bonds often changes because of this type of an event.
Suppose that the firm Treasure Toys makes an announcement that they are purchasing Land’o’Toys. Due to Treasure Toy’s projected financial structure after the purchase, Standard & Poor’s states that the bond rating for Land’o’Toys bonds will change to BB.
A. How do the bond investors feel about the announcement?
B. Explain the positives and negatives of purchasing a company.
Bond Rating
Yield (%)
Bond Rating
Yield (%)
AAA
5.4
BB
7.3
AA
5.7
B
8.2
A
6.0
CCC
9.2
BBB
6.5
CC
10.5
C
12.0
D
14.5
Explanation / Answer
Lndó Toy's YTM before the buyout
B. Some of the positives of purchasing a company are ;
1. There may be synergy of operations and financial structure that may lead to increased sales, net earnings due to leverage of common production and logistic facilties and removal of duplicacies.
2. The share price and market valuation of the company after purchase may increase if there is a positive perception about the purchase in the market.
3. There will be advantages of access to technology and R&D facility of the acquirer company and gain from exchange of information after purchase of one company by another.
Some of the disadvantages of purchase may be ;
1. When the synergy of purchase fails due to lack of matching of work culture and bad technological and commercial compatibility, the operating and financial aspects fail. The expected sales growth and financial margin cannot be achieved.
2. In case of bad purchases , the share price and market valuation goes down if the market perception of the purchase is not good.
3. The purchase process will cause some dissatifaction among some of the stakeholders of the acquired company like debtors , stock holders and employees if the purchase conditions are not favorable for them.
Lndó Toy's YTM before the buyout
YTM Formula= [Annual Interest+(Par Value-Market Value)/Years to Maturity]/(Par value+Market Price*2)/3 Given : Bond Par Value assumed as 1,000 Market Price 1,037.19 Years to Maturity 10 Annual Interest @6.5%= 65 YTM =[65+(1000-1037.19)/10]/(1000+2*1037.19)/3 YTM =5.99 % Approx So the rating of Bond prior to purchase is A After Treasure Toy's buyout , the Bond rating is downgraded to BB with YTM of 7.3% Semi annual YTM =3.65% Semi annual coupon =32.5 Revised Price of Bond after buyout: Semi Annual period Interest +Maturity Cash flow PV factor @3.65% PV of cash flows Period 1 32.50 0.965 31.36 Period 2 32.50 0.931 30.25 Period 3 32.50 0.898 29.19 Period 4 32.50 0.866 28.16 Period 5 32.50 0.836 27.17 Period 6 32.50 0.806 26.21 Period 7 32.50 0.778 25.29 Period 8 32.50 0.751 24.40 Period 9 32.50 0.724 23.54 Period 10 32.50 0.699 22.71 Period 11 32.50 0.674 21.91 Period 12 32.50 0.650 21.14 Period 13 32.50 0.627 20.39 Period 14 32.50 0.605 19.67 Period 15 32.50 0.584 18.98 Period 16 32.50 0.563 18.31 Period 17 32.50 0.544 17.67 Period 18 32.50 0.525 17.05 Period 19 32.50 0.506 16.45 Period 20 1,032.50 0.488 504.09 943.91 So Bond Price after buyout = $943.91 Bond Price before buyout =$1037.19 Bond Price change after buyout =-93.28= -8.99% So Bond holders will be unhappy about the purchase out by Treasure Toy's as the Bond Price will be reduced by-8.99%Related Questions
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