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Sir, I am unable to correctly understand & calculate the following question in the past question called Bar Co (December 2011) requirement (b)
The requirement (b) is asking:
Calculate and discuss whether using the cash raised by the rights issue to buy back bonds is likely to be financially acceptable to the shareholders of Bar CoI am not sure how should I calculate whether it is financially acceptable for Bar Co that they can raise enough cash by the rights issue to buy back bonds. Could you plz explain this!
As I explain at the very start of my course of free lectures, the objective of the financial manager is to increase the wealth of the shareholders (which is measured by the market value of their shares).
So given that the question is asking whether or not using the money raised to redeem the bonds is financially acceptable, you need to calculate whether or not the new MV of the shares will be higher or lower than the TERP. I assume that you have watched my free lectures and are therefore happy that the theoretical new MV after a rights issue means that the shareholders end up making no gain and no loss. However, as again I explain in my lectures, the actual MV will depend on what the company does with the money raised.
In this question, they are using the money to redeem bonds, and on the information given in the question (the PE ratio) it would result in the new MV of the shares being less than the TERP and this would mean that it would not be financially acceptable to shareholders for the company to use the money to redeem the bonds. (Although, as the examiner states in his answer, it depends on whether in fact the PE ratio will stay constant which is why the question specifically asks you to comment on this.)
Sir, I am sorry but I couldn’t understand why the bond is calculated on nominal value in the examiner’s answer like this: Nominal value of bonds redeemed = 90m x (100/112·50) = $80 million
I know that company here is trying to raise enough cash like $90m to buy back the bond where bondholders have agreed that they will allow Bar Co to buy back the bonds at market value.
I have quite understood the calculation of EPS & PE calculation as you’ve mentioned in your last response BUT before EPS I have not understood any calculation & the reason behind doing those calculations like redeeming the bond & it is saving interest cost by that or EPS will be affected by the redemption of the bonds etc!
Please tell me what does mean by redemption of bond? And if we redeem bond then how does it save us any interest cost?
Could u plz explain me the calculation before EPS? Thank u
Redemption or redeeming the bonds is the same as buying back the bonds and cancelling them (i.e. repaying the holder of the bonds).
If the bonds are redeemed/repaid then from then on there is no interest payable because they have been cancelled.They are paying $112.50 for each bond. Therefore if they are paying a total of $90M they will be redeeming $90M/$112.50 bonds. Given that each bond has a nominal value of $100, it means they are repaying bonds with a total nominal value of 90M/112.50 x $100.
We need this, because the coupon rate of 8% is always on the nominal value and so this determines the interest that will be saved.The fact that there will be less interest payable means that the earnings available for shareholders will be higher (bearing in mind that the calculation that tax is calculated on the profits after charging interest).
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