Question

Larissa Warren, the owner of East Coast Yachts, the main competitor to Deck Out My Yacht, has decided to expand her operations. She asked her newly hired financial analyst, Dan Ervin, to enlist an underwriter to help sell $40 million in new 25-year bonds to finance new construction. Dan has entered into discussions with Wilson Molina, an underwriter from the firm of Molina, Molina, & Rodriguez, about which bond features East Coast Yachts should consider and also what coupon rate the issue will likely have. Although Dan is aware of bond features, he is uncertain of the costs and benefits of some features, so he is not sure how each feature would affect the coupon rate of the bond issue. Dan is also considering whether to issue coupon-bearing bonds or zero-coupon bonds. The YTM on either bond issue will be 7 percent. The coupon bond will have a 6 percent coupon rate and is paid semiannually. The company’s tax rate is 38 percent.

1) How many of the semiannual coupon bonds must East Coast Yachts issue to raise the $40 million? How many of the zeros must it issue?

2). In 25 years, what will be the principal repayment due if East Coast Yachts issues the coupon bonds? What if it issues the zeros?

3) Suppose East Coast Yachts issues the coupon bonds with a Canada plus call provision. The call rate is the T-bill rate plus 0.45 percent. If East Coast calls the bonds in 9 years when the T-bill rate is 5.2 percent, what is the call price of the bond? What if the rate is 7.7 percent?