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According to the scenario
(i) Proposal 1: Either buy back equity shares at their current share price, which would be cancelled after they have been repurchased; or
1) Question : what will be canncelled after the shares have been repurchased? I am not clear about that sentence.
According to the model asnwer (A)
The predatory acquisition of one company by another could be undertaken for a number of reasons. One possible reason may be to gain access to cash resources, where a company which needs cash resources may want to take over another company which has significant cash resources or cash generative capability. Another reason may be to increase the debt capacity of the acquirer by using the assets of the target company. Where the relative level of debt finance is increased in the capital structure of a company through a financial reconstruction, like in the case of Conejo Co, these reasons for acquiring a company may be diminished. This is because the increased levels of debt would probably be secured against the assets of the company and therefore the acquirer cannot use them to raise additional debt finance, and cash resources would be needed to fund the higher interest payments.
2) Question : the higher interest payments? why are they saying that? (cash resources would be needed to fund the higher interest payments)
According to the model answer (B)
Conejo Co may also feel that this is the right time to raise debt finance as interest rates are lower and therefore it does not have to offer large coupons, compared to previous years.
3) Question : how could we know interest rates are lower or higher?
The substantial increase in gearing, especially with respect to proposal 1 (Appendix 3), may worry some stakeholders because of the extra financial risk. However, based on market values, the level of gearing may not appear so high.
4) Question : Based on market value of what?? I can not understand that part.
The BoD should also be aware of, and take account of, the fact that going to the capital markets to raise finance will require Conejo Co to disclose information, which may be considered strategically important and could impact negatively on areas where Conejo Co has a competitive advantage.
5) Question: Can you please elaborate the above part? I cannot understand the logic( Disclosing info >> which is strategically important >> negative impact regarding competitive advantage??)
The current and new debt holders may be concerned that Conejo Co is not tempted to take unnecessary risks with the additional investment finance, but sensible use of restrictive covenants and the requirement to make extra disclosures to the markets when raising the debt finance should help mitigate these concerns.
6) Question : why are debt holders worried about that Conejo does not take unnecessary risks? what is the sensible use of restrictive covenants? The requirement to make extra disclosures to the markets when raising the debt finance should help mitigate these concerns.This sentence sounds good but is nonsense to me.
Thank you very much for your fantastic lecture and efforts and sorry about the long questions.
Plus
According to the conclusion answer part.
However, Conejo Co needs to be mindful of how it intends to repay the capital amount in five years’ time, the information it will disclose to the capital markets and the impact of any negative restrictive covenants.
Question ) what is the meaning of negative restrictive covenants?
is it more unfavour restrictive covenants?
1. The shares will be cancelled. The company buys them and then cancels them.
2. If there is more debt, then there will be more interest payable (and the coupon rate on the existing debt will be higher as per stated in the question).
3. The coupon rate on the existing debt is 5.2%. The govt bond yield curves rates (together with the yield spreads) are lower than 5.3%.
4. The market values of the debt and the equity (which is a more meaningful way of measuring gearing that using the market values).
5. If they are raising more money from investors then investors will want to know what the money is for. They might not want competitors to know that they are considering investing in new business ventures.
6. Debt lenders do not want the company to take unnecessary risks because then there is a risk that they might not be able to pay the interest on the debt (or in an extreme might collapse and not be able to repay the debt). The more it is disclosed and made clear to investors then the less worried the investors might be. Also restrictive covenants makes it more certain that investors will get their money back if things do go wrong (for example, include a covenant requiring immediate repayment of the debt if things drop below a certain level).
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