FIN 6501 Take Home Quiz Fall 2017 For questions 9 through 13, use the Starbucks
ID: 2790556 • Letter: F
Question
FIN 6501 Take Home Quiz
Fall 2017
For questions 9 through 13, use the Starbucks and Panera Bread spreadsheets that are saved in Canvas under ‘Files’.
Type up your answers in a separate document, and follow the length guidelines for each question. Hand in or email me your completed quiz by the end of class on Monday, November 27th. You can email me if you have questions.
(15 points) A CFO is proposing that her company goes to the debt market to issue a new bond, because current interest rates are low. The US government has kept benchmark rates at very low levels, and this has reduced the cost of borrowing for the company. Is the CFO right? Discuss. (2 paragraphs maximum)
(10 points) Explain whether the following statement is true or false: A company whose profits (EBIT) is lower than current interest payments is essentially bankrupt and should file for chapter 11 as soon as possible. (1 paragraph maximum)
(15 points) Suppose that the new US government reduces corporate taxes from 35% to 15% and also cuts the maximum marginal tax on personal income from 39.6% to 33%. Other taxes remain unchanged. Discuss how this change may affect the company’s capital structure and payout policies. (2 paragraphs maximum)
(5 points) Explain why corporate CFOs should target credit ratings and not only a specific leverage ratio. (1 paragraph maximum)
(10 points) Explain why bank debt can be more expensive than bonds for companies, even if the interest rate and fees charged by the bank are lower than what the company would pay in the bond market. (1 paragraph maximum)
(10 points) A corporation is considering whether to borrow money from a bank or in the bond market. The bank offered an interest rate of 5% to the firm. The bank debt will be collateralized and subject to covenants, and thus, the bank expects a recovery rate of 80% on the debt if the company defaults. The bank demands an expected return of 4.25% on bank debt. If the company issues bonds, the recovery rate on bonds upon default is expected to be 40%. The probability of default is the same for both bank and bond debt. Using these data, estimate the interest rate that the company will pay on its bonds. Assume that bondholders demand the same expected return as the bank.
7.(5 points) Explain why the following statement is wrong. (1 paragraph maximum)
“Stock repurchases reduce the number of shares outstanding and therefore increase stock prices, since the stock price is equity value divided by the number of shares outstanding.”
(5 points) Explain why some academics consider it a “puzzle” that companies pay a significant fraction of their income as dividends. (1 paragraph maximum)
The following questions will ask you to compare and analyze the debt structure for Starbucks and Panera Bread. The data that you need are available at Coursera’s website.
Starbucks is roaster, marketer, and retailer of specialty coffee worldwide. It has a market capitalization of 83B dollars. Panera Bread Company owns, operates, and franchises retail bakery-cafes. It has a market capitalization of 5B dollars.
9.(5 points) Examine the debt structure of Starbucks. Does Starbucks borrow from banks or from the bond market?
(5 points) What is the magnitude of the undrawn credit line that Starbucks has? What is the likely role of this credit line?
(5 points) Now check the data on bonds outstanding by Starbucks. What are the yields-to-maturity on Starbucks’ bonds?
(5 points) What is the main difference in the debt structure of Panera when compared to Starbucks?
(5 points) What would be your guess for the interest rate that Panera is paying on its bank loans? Explain your guess.
S&P; Capital IQ Panera Bread Copany (NasdaqGS:PNRA)> Financials> Capital Structure Sunmary Debt Sumarys Total Comnercial Paper Total Revolwing Credit Total Tern Loan Total Senior Bonds and Not Total Capital Leaze Total Principal D Total Adjuctments Total Debt Outstanding Undrawn Revoling Credit Total Undramn Credit 920% 38. 20% 1.70% 0% 99. 10% 0.50% 40 355 7.6 432.6 436.6 210 210 Total Secured Debt Total Ungecured Debt 425 97.3% 7.6 1.7% *Oct-02-2016, in USDExplanation / Answer
1. Yes the CFO is right, borrowing from bond market is less expensive specially for those companies having high credit ratings.
Therefore borrowing from the bond market us less expensive than borrowing from banks.
2. True a company whose EBIT is low than interest expenses is bankrupt as they are not having enough liquidity or profitability to pay off their interest expenses.
3. As the government has reduced corporate taxes by 20%, making it unfavourable for the companies to issue debentures as the interest tax sheild is reduced which will result in the overall reduction if net income available for shareholders.
So the company will more equity for expansions.
And dividends payment will also increase due to reduction in personal taxes rates which makes it favourable for investors to receive cash dividends.
4. Corporate CFO should target credit ratings and not just specific ratios, as improving credit ratings would make available cheaper debt.
5. Bank debt would be more expensive as compared to bond market for high credit rating companies. As bank will always charge its nominal interest rates which are higher than the lowest benchmark yield.
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