Mgm Harvard Business School Accounting Case

a. What is the CD’s value at maturity (future value) if it pays 10 percent annual interest?

The company’s leverage ratio is 28% - 72% of its assets are financed by common equity and the company was profitable in the last reporting period. The company should easily raise additional funds from creditors and a convertible debenture will be an appealing venture for creditors who would want to purchase stocks of the company in the future.

Therefore the annual interest rate is 8% and the effective annual rate compounded quarterly is 8.24%

OCC and OCP together invested $750,000 into Dogloo in the form of subordinated debenture with 13% interest rate, which guarantees them stable interest cash inflows each year (Exhibit 4). The two investors’ combined ownership interest will be 0.5% of the Dogloo’s equity value because the company’s equity valuation is $213 million, exceeding $80 million; this will be the cash inflow at exit for the investors. Through calculation, the required equity value at exit is $238 million if the investors have an estimated IRR of 25% (Exhibit 4).

- The Bet-r-Bilt Company has a 5-year bond outstanding with a 4.30 percent coupon. Interest payments are paid semi-annually. The face amount of the bond is $1,000. This bond is currently selling for 93 percent of its face value. What is the company's pre-tax cost of debt?

Convertible debt and debt with stock warrants differ in that: (1) if the market price of the stock increases sufficiently, the issuer can force conversion of convertible debt into common stock by calling the issue for redemption, but the issuer cannot force exercise of the warrants; (2) convertible debt may be essentially debt, whereas debt with stock warrants is debt with the additional right to acquire equity; and (3) the conversion option and the convertible debt are inseparable and, in the absence of separate transferability, do not have separate values established in the market; whereas debt with detachable stock warrants can be separated into debt and the right to purchase stock, each having separate values in the market.

After the calculations you end up coming out with a rate of 14.87%. The third and final part of question three asks what rate you will need if the interest is compounded semiannually. All you have to do is double the amount of terms and you will come out with a lower number of 7.177%. Since the interest is compounded semiannually that means that you will need to times that number by two and you come out with your final number of 14.35%.

o Cost of debt in this case is 12.5% though MCI can raise $ 100 million more with this option in comparison to option (a) above. Servicing this debt would be a significant drain on the cash flow. o Please see Exhibit 3. (c) $600 million Convertible offering @ 7.625% 20 year with conversion at 54 per share o Using this option MCI can raise $ 100 million more than option (b) at 4.88% lower rate of interest. It also gives MCI an option to convert it to equity once the stock price reaches 54 (it is currently 47). Based on previous convertible offerings (As per exhibit 6 of case, 1978, 1979, 1980, 1981 and 1982), MCI has been converting it to equity within 18 months because of its high growth. As higher growth is projected for the next few years (Exhibit 9 of case), MCI is expected to convert this $600 million offering to equity, thereby reducing its leverage. o This option allows to finance its current activities and match capital inflows with expected investment outlays in the near future. It also allows MCI the option to eliminate the cash flow drain from servicing the debt once the stock price increases. o As per Exhibit 3 attached here, this offering will provide capital to meet the external financing needs for 1983.

13. What is the formula for the Present Value (PV) for a finite stream of cash flows (1 per year) that lasts for 10 years?

At an interest rate of 15% per year (3.75% for three months, the amount to borrow equals

In 2006, Merrill Lynch became the lead book runner for a $5 billion convertible bond issue for MoGen, Inc. This was the single, largest convertible bond issuance in history and required a considerable amount of effort on the part of Merrill Lynch’s Equity Derivatives Group to convince MoGen’s management to choose Merrill Lynch over its competitors. The case is focused on Merrill Lynch’s choice of the conversion premium and coupon rate to propose to MoGen management. This pricing decision requires students understand the concept of valuing a convertible as the sum of a straight bond plus the conversion option. Valuing the conversion option as a call option requires the

The bond principal repayment will be $6.25 million annually. The cash dividends will be $7.5 million annually on additional stock.

The answers are both the same as the answers of question 2 (PV of the interest tax shield).

16. If the nominal interest rate on an account is 1% and the inflation rate is 2%, the real interest rate is:

If MCI wants to issue $500 million of 20-year subordinated debentures, we first calculate the interest payment, which is $62.5. The total interest payment would be $116.6 by adding up the previous net interest, so we can calculate the interest coverage ratio by dividing the operating income in 1983 by the total interest payment, which is 2.53. Then we look up the