On August 1, 1998, Georgina Comer, CFO of Globalcom Inc. was meeting with the te

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On August 1, 1998, Georgina Comer, CFO of Globalcom Inc. was meeting with the team of investment bankers who were helping Globalcom issue bonds worth $ 6 Billion. The company planned to issue $2 Billion in medium term bonds that will mature in 5 Years and $4 billion in long-term bonds with a maturity of 30 years. Since Globalcom was issuing US dollar denominated bonds, these bonds were expected to make semi-annual coupon payments. The bankers had put together a report on current market trends and the exhibits below provide some of the information that was included in the report that Georgina received. At the time all of Globalcom’s bonds were rated A+ by S&P, but after the issue, it was widely expected that all of Globalcom’s bonds’ ratings would go down to BBB+.

Exhibit 7 –Interest rate on US Government Bonds

Month

Ending

Week Ending

June

July

Yields to Maturity in % per annum

1998

3-month

5.12

5.08

5.15

5.08

5.07

6-month

5.32

5.23

5.25

5.21

1-year

5.41

5.34

5.36

5.37

2-year

5.52

5.43

5.46

5.47

5.48

3-year

5.52

5.44

5.48

5.47

5.48

5-year

5.56

5.41

5.47

5.51

7-year

5.56

5.47

5.54

5.52

5.56

10-year

5.50

5.41

5.49

5.46

5.50

20-year

5.80

5.71

5.82

5.79

5.83

30-year

5.70

5.61

5.71

5.68

5.73

Exhibit 8 – Spreads (in Basis Points) of Industrial Corporate Bonds over comparable Maturity US treasury Bonds

Exhibit 9: The Value line Forecast of future dividends for Globalcom.

Valueline estimated that the cost of equity for Globalcom was 12% and it estimated that the firm will continue to grow its dividends at a rate of 5% per year forever beyond 2003.

Year

Dividend Per Share ($)

1999

$ 1.38

2000

$ 1.52

2001

$ 1.66

2002

$ 1.78

2003

$ 1.80

a. Estimate the yield to maturity (YTM) that Globalcom would have had to offer to investors for the 5 year bonds if they were to be issued today?

b. To the nearest cent, what price per $100 of face value would Georgina have gotten for her 30 year bonds if she decides to set the coupon rate at 6% for these bonds?

c. To the nearest cent, what would be your estimate of intrinsic value of Globalcom equity share ?

Month

Ending

Week Ending

June

July

Yields to Maturity in % per annum

1998

3-month

5.12

5.08

5.15

5.08

5.07

6-month

5.32

5.23

5.25

5.21

1-year

5.41

5.34

5.36

5.37

2-year

5.52

5.43

5.46

5.47

5.48

3-year

5.52

5.44

5.48

5.47

5.48

5-year

5.56

5.41

5.47

5.51

7-year

5.56

5.47

5.54

5.52

5.56

10-year

5.50

5.41

5.49

5.46

5.50

20-year

5.80

5.71

5.82

5.79

5.83

30-year

5.70

5.61

5.71

5.68

5.73

ndusthiall Issues 31-Jl98 13 31 13 84. 100 1OT 120 12B 149 51 75 85 65 71 81 110 100 114 1GA 64 76 127 142 Compied fom aerages of bonds rated by Standard& Poor's. Fno data is gven, it implies Standard & Poor's rates no bonds in that categry Abasis pont is 0.01% or 0-0001-One hunded basis ports (bps) equal 1.0%

Explanation / Answer

The answer to the following questions:

a.Since GlobalCom is estimate the YTM for a 5 Year bond we will take the 5 Year rate from the table for the week ending 31st July as 5.51 %

So the formula for YTM is as follows

[ C +(F-P)/n]/(F+P)/2

where c=coupon rates

F= Face value of the bond

P=Price paid for the bond

N= Number of maturity for the period

C=5.1% *2 Billion*2

=$.102 billion

Face Value =since the US treasury bonds follow the spreads in the basis points from the table we find that value for 5 year for A+ bond =$ 42 billion

P =Price paid

=$2 Billion

N =Maturity period ie 5years *2 =10

YTM =[.102+(42-2)/10]/(42+2)/2

=.185 ie approx 18.6%

b.The case for 30 year bond is as follows:

The Coupon rate choosen from the table is 5.73% for 31st july for a 30 year period.

So the coupon rate =5.73%*$ 4 billion

=.2292 billion

c. The calculation for the multi-stage growth model involves adding the present value of dividends paid to the present value of the company’s terminal value.

Time Pe

Face Value =The A+ rating which is obtained from the spread basis table which is $84 Billion

Price paid =$4 Billion

N =Maturity period ie 30 years * 2 since it have the semi interest payable ie 30*2 =60

Therefore YTM =[C+(F-P)/n]/(F+P)/2

=.2292+(84-4)/60/(84+4)/2

=.035 ie approx nearest 4 cent price per $100 of face value.

c.The calculation for the multi-stage growth model involves adding the present value of dividends paid to the present value of the company’s terminal value.

Time Period Dividend/Share Present Value Factor Present Value

1 $1.38 .8928 $ 1.23

2 $1.52 .7971 $ 1.21

3 $1.66 .7116 $ 1.18

4 $1.78 .6353 $ 1.13

5 $1.80 .5672 $ 1.02

Terminal Value $ 27.00

(Intrinsic Value of share) $ 32.77

The total Present Value from Y1 to Y5 is $5.77 .

Using the required rate of return of 12% and expected growth rate of 5% terminal value at Y5 is calculated as below:

=D5 /(K-G)

=1.80*(1+.05)/(.12-.05)

= $ 27

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