BBS stores

[herocomesalong]

Good day tutor,

I am at this question on BBS stores (06/09) and I dont understand how a reduction in credit spread can lead to an increase in the company’s earnings.

The question says “The reduction in the film gearing would improve the firm’s credit rating and reduce its current credit spread by 30 basis points”. BBS currently has a $770m loan, and so they added $1.5m (0.3%*770m*[1-35%]) to the earnings post.

Doesn’t a reduction in credit spread affect only the yield and hence market value?

[John Moffat]

If it were fixed interest borrowing then you would be correct.

However, because it has been swapped for floating interest borrowing, then it depends on whether they have the ability to vary the interest rate for changes in the credit rating. The answer has assumed that it will be varied (see the note below the last bit of workings for part (a) in the answer), but it is an assumption and so you would still get the marks if you assumed that it would not change (and the 1.5M was not therefore there).

[herocomesalong]

Wow this is one crazy hard question – makes the recent questions seem way too easy. Thanks again for the help 🙂

[John Moffat]

You are very welcome 🙂

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